Natural Gas[p]! A conversation with an Industry Insider

Real late posting but so worth it...

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As a natural resource planner for a county updating its General Plan, understanding resource use and depletion is important to understand when formulating a plan of action for the next quarter century. Getting the best information to present to the decision makers is tough when there is an overload of available information out there to draw upon. So a goal of mine has been to contact individuals in various positions that may have first hand information that may shed more light on the energy situation. Today was one of those days. I had an interesting discussion with a senior level executive of one of this country’s reputable energy firms. Both the executive and the firm will remain nameless for purposes of this posting. What follows is a general synopsis of key points of discussion on the subject of natural gas supply, depletion, pricing and trade.

On the overall North American Natural Gas situation:

When asked about the various natural gas supply and demand charts circulating out there from various sources (such as the EIA, Matthew Simmons, CERA, California Energy Commission, Sempra, and ASPO) that paint differing pictures of depletion in North America, the executive confirmed that the pessimistic projections of future gas supply were in fact the most probable to occur. In his professional opinion (which was backed by years of hands-on experience in the energy sector) the natural gas situation is on the verge of significant shortfalls. Depletion is taking an increasing toll on producers by forcing them to drill more frequently and in more challenging locations. New wells are producing less and depleting faster than ever before. Drilling activities are at all time highs with exploration firms unable to significantly increase capacity due to acute equipment and labor shortages. (This fact has been corroborated by various business journals observing the run-up in drilling rates charged to the various energy firms). Meanwhile depletion rates in mature regions are reaching distressing proportions. South Texas depletion rates have begun to reach levels of 14 to 15 percent. The overall Lower 48 depletion rate is now approaching 2 percent per year, which in itself is problematic as natural gas demand has been increasing by 2 percent per year.

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On the accuracy of the various projections:

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Our executive was very familiar with the Simmons assessment of the natural gas situation. His company’s own internal projections aligned closely with the pessimistic scenarios of natural gas supplies painted by Simmons and others. He was less than impressed with the commonly referred to assessment of future North American supplies depicted by the EIA however. That assessment—in his opinion—relied on ridiculously optimistic assumptions of future production that were unlikely to ever materialize. The agency’s perennially optimistic assessments largely originated out of political considerations. According to the executive, they used to make more pessimistic assumptions until Congress cut their funding in the mid 1990’s. Since then, the EIA has sung a more upbeat tune about energy reserves. This similar level of optimism permeates the USGS and influences some of the consultants (that accept federal funds) as well.

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On pricing of natural gas:

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Natural gas prices in North America now move more or less in tandem, regardless of the actual location on the continent, due to the interconnected nature of the transcontinental pipeline network. Any increase in supply in one area will affect prices everywhere else. Likewise, increased costs in one or more areas will raise overall prices. In recent years, there has been a tremendous amount of drilling for tight gas in the Rocky Mountain region, drilling that is relatively expensive when compared to conventional sources. Costs for tight gas and other similar sources tend run at $5-6 per MMBTU, significantly higher than the 1990’s averages. (This, when combined with increased demand and decreasing supply have introduced volatility into the gas futures market and lifted overall prices to unseen levels.) Over the longer term he believed natural gas could get significantly more expensive, due to both supply limitations and crude oil price increases. Under no scenario could he foresee prices ever falling below $4.50 per MMBTU.

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On LNG:

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According to this executive, LNG is North America’s last hope. Although not expressed in those words, per say, it appeared to him that perhaps it is our only hope. He is of the opinion that significant global supplies of natural gas will continue to exist for sometime to come, primarily in Russia, Qatar and Iran. Those sources ultimately will need to be accessed and developed. His enthusiasm for LNG was tempered however by realistic expectations. Globally, the demand for LNG has outstripped supply capabilities, resulting in capacity limitations at the point of liquification. This demand will only increase as North American needs increase in concert with those of Asia and Europe. As more liquification facilities are constructed, the next supply constraint appears to be the vessels themselves. A further chokepoint for this country exists with the regasification plants. Only four are operational, none on the West Coast. Over a dozen have been proposed for construction along the coast but as of this spring, only one, Sempra’s Energy Costa Azul plant has actually completed the permitting stage and is under construction, with a completion date of early 2008, according to their website. The remaining LNG facilities still face numerous obstacles ranging from governmental permitting to local opposition groups.

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The plants themselves are huge undertakings, capable of supplying one to two BCFs of gas per day. Each ship actually holds on average 3.3 BCFs of gas, though some hold as much as 4.5 BCF. This translates into a ship mooring on average, every three to four days. The unloading process takes approximately 12 or so hours (as does loading in fact), with an average voyage from the West Coast to Indonesia (the only country to have signed a formal contract with a US firm) taking around 20-24 days. Voyages to Sakhalin could probably be made in less than 20 days and those to Australia, probably longer than 25 days.

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For the next decade, the executive expects the LNG situation to remain very tight due to the capacity constraints described above, with significant price upside risks. Over the long haul, he expects LNG to become a dominating component of North American supply. By 2020 he believes that LNG will comprise one third of North American supply to potentially as high as one half of all supplies. This is much higher than the EIA estimate. LNG will have to grow if the US has any hope in meeting the expected demand. What is not clear is how all of this will be paid for. LNG infrastructure is a significant investment and a study conducted a few years back by Exxon indicated it takes an average of 4-6 billion dollars and many years of preparatory work to add one BCF of new gas capacity. In addition to the regasification plant siting difficulties, producing countries have been hesitant to allow liquification facilities to be situated or expand to meet the market forces due to either sheer greed (seeking the best possible terms) or nationalistic concerns. And as mentioned before, new tanker construction capacity will also serve to limit throughput in the system. Also not clear from this discussion is how many vessels will actually be required to serve the California market. If a one BCF LNG terminal requires one delivery every four days and each ship can make a round trip every 50 days, my calculations indicate that you would need about 12 ships to service that one facility. Obviously more new terminals would imply more ships and therein lies the problem. According to Sempra, their ships have been secured, however this remains to be seen for the rest of the domestic demand. The number of ships required by my own estimation to serve the anticipated 2020 demand would likely exceed the total number of ships in existence or contracted for at present.

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On Supply and Demand in general:

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He, like everyone else was surprised how dramatically the supply/demand balance for North American gas supplies shifted since 2000. No forecasts saw this happening and no economic model currently exists to predict the impacts of significantly high energy prices. Since the first price run-ups, a sizable amount of industrial gas demand has been destroyed (permanently) in North America (e.g. the fertilizer industry). Future supply problems will likely run into more painful periods of price adjustments as the “easy demand” has already been destroyed. The executive does not believe any true shortages (e.g. rationing) will ever occur in North America, unless one or more governments start setting prices. Either the price will ration off the remaining supply or government price controls will force the local utility to ration the physical supply. In either case, reading between the lines indicates what seems to be an underlying concern that serious natural gas supply imbalances are certain to occur over the next few years.

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On Peak Oil:

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On the subject of Peak Oil, our executive was not only fully aware, but was actively following recent developments. Though oil is not his area of expertise, he understood and accepted the theory of Peak Oil production and was monitoring recent developments with both Ghawar and Cantarell with understandable apprehension. Oil in general, is of particular a concern to him since natural gas prices have been tracking somewhat similar to that of oil, per BTU. He anticipates that if oil prices were to climb through the roof, gas prices will follow suit, throwing a monkey wrench of sorts into supply and demand projections. When asked about a near term peak of global oil supplies in the next year or two, he responded by saying he did not want to even think about the implications of that possibility. Apparently it had crossed his mind already.

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In Summary:

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This was a good conversation. He was very knowledgeable and very forthcoming with both facts and opinions. Since he was, I will respect his wish to remain anonymous on the subject matter, so I will not divulge his name or his employer. I guess when you badger as many energy firms as I have, you’ll find someone with something to say.