America’s Natural Gas Glut – Opportunities ahead?

18 Apr

Source: US EIA

You may not be aware already but in the United States, over the past three years a huge glut of natural gas has emerged. Improvements in ‘fracking’ technology have allowed companies to exploit shale gas fields which were previously considered uneconomical – since then natural gas production has boomed. Every producer was expecting to get rich but that has lead to the US overproducing natural gas, and prices are at a 13 year low.

As The Oil Drum points out

U.S. shale plays share many characteristics with the gold rushes of the nineteenth and early twentieth centuries. Both phenomena result from extreme promotion. Anyone can join. Every participant believes that they will get rich. Great amounts of capital are destroyed as entrants try to get a position. The bonanza is exhausted sooner than most expected (Andreoli, 2011) and few profit in the end except for the vendors that serve participants.

They conclude

The gold rush mentality taken by companies to enter shale plays has added expensive leases and new pipelines to those costs, further complicating shale gas economics.

Looking forward, however, natural gas prices are not going stay at these low levels..

US Active Rigs - Source: US EIA

On the supply-side, due to the aforementioned gold-rush mentality, many natural gas producers paid very highly for their land leases. At the current price of roughly $2 per million British Thermal Units, energy companies are making a loss on their gas projects. Basic economics dictate that loss-making businesses close down, and this is what we are seeing.  The number of active rigs in the US has fallen from roughly 1,000 in 2010, to approximately 600 today.

Equally on the demand-side of the equation, structural changes are taking place. For instance, many power plants are switching from coal to gas (due to the low price of gas, and environmental legislation discouraging coal). Several new cars are being fitted with engines which run on CNG (Compressed Natural Gas), and petrol stations are adding CNG to their pumps. For these two infrastructural changes to take place however, they will take time to implement and it is difficult to predict the long-term impact of these changes.

Source: Valero Corp conference March '12

What I have discussed so far however only covers the US domestic issues. If we were to take our scope further afield, we would see that elsewhere in the world there are natural gas shortages. In Europe, gas is trading at 4x the US price and in Asia, as much as 6x. So surely this is a enormous arbitrage opportunity, US prices should rise and prices outside the US should fall. So why is that not happening already?

As I found out, the US has a substantial LNG (Liquified Natural Gas) import capacity, but very limited export capacity. So regardless of that huge price differential, no one can take advantage of it. Naturally, companies have clocked onto this and have been pushing to create LNG export terminals. Cheniere Energy earlier this week were granted the rights to create one. Nevertheless, gas cannot be expected to leave the US from the terminal until late 2015. As for other terminal projects, the US government will not give the go-ahead until a study into the price impact on consumers from exporting gas, has been completed later this year. Even then, it will still be at two or three years before the projects start operating.

To summarise, US natural gas prices are expected to stay low for at least a couple of years, but perhaps rise somewhat in the medium term. Until more demand comes on tap through gas-powered cars, gas power stations and arbitrage with the world, demand will stay fairly constant and in the meantime, supply is tailing off because producers are making losses.

In terms of trading, I would buy natural gas futures because this current price cannot be sustained with producers losing money. But I do not want to be picking a bottom in the market yet, and also risk losing money through contango, not to mention that my broker has a 43 tick spread on Natural Gas as well. I think there must be good opportunities with energy-related equities and I plan to investigate in the coming weeks.

1 Comment

Posted by on April 18, 2012 in Trading Ideas


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