Thursday, October 14, 2010

Update on Natural Gas Prices

New well completion techniques, in particular multistage fracturing, combined with the 2008 recession (plus Stelmach's old new royalty scheme) have created havoc in Alberta's natural gas industry. It also has given us an entirely new outlook on energy supply now that shale gas (and other tight gas reservoirs) have added decades of gas reserves to our dwindling energy supply.

We still don't understand the impact of all these new technlogies and plays.Neither don't we know whether a similar revolution would be in the cards for oil production - less likely. I for one think that T. Boones Pickens is right with the assumption that natural gas is the 'cleanest' source of realistic energy supply for some decades to come. My personal ultimate hope lies in the potential of geothermal energy as I think the capacity for solar and wind energy are not sufficient to make North America fossil fuel independant. And that is a goal at least 50 years away if not further out into the future.

So for now, the natural gas reserves of the world and North America are limitless - at least in the decade or two ahead. On the otherside of the equation we have consumption and one restrained is infrastructure. Electricity generation is still dominated by coal and to switch a significant proportion to natural gas will take many years. The use of natural gas for heating purposes is already extensive; while natural gas as an energy source for transportation requires a lot of work as well (hydrogen car and propane using cars).

We can assume, coming out of the recession, demand for gas will likely increase but at a modest pace only. So really, gas prices are then mostly based on production supply; winter temperatures and summer temperatures. The one easiest to predict is production supply. I took this chart from the The Oil Drum website.

The chart show Daily Marketed Gas Production in the US in BCF/D over time. Also plotted is the number of gas chasing drilling rigs (dashed line) over time. If tomorrow no new wells would be drilled, gas production would drop off from 63Bcf/d to less than 30 Bcf per day within 2 years (Cyan curve). Chesapeak Energy who constructed this graph also calculated how much production would be added for  various rig counts. If 750 rigs were drilling for gas each month then gas production would drop to 52Bcf/d. With 1100 rigs gas production would be stable, while drilling with 1500 rigs (as at the peak in 2008) would result in production increasing to 72Bcf/d.

What would determine how many wells are drilled with how many rigs? Right the gas price; or better the profitability of drilling for gas. That question is dealt with in the next graph, where gas prices and production costs per Mmbtu are plotted over time. When gas prices are higher than production costs then it is profitable for companies to drill. Since gas reserves are 'unlimited' for now, gas price and production costs are strictly a matter of supply and demand. Chesapaeak's calculation and a rig count currently around 760 predicts a production drop to 52Bcf/d and with gas prices far below production costs this may get even worse. Consequently, demand and supply may be in balance within 2 years. Factors that may accelerate this are a cold winter on the east side (highest population centres) of the continent or warm summers in states such as California. Pricing is likely to be somewhat higher than projected production costs, so in the range of $8 to $10 dollars per mcf (1cf = 1027BTU or 1Mcf = 1.027MMBTU=301Kwh). That is nearly double today's prices.

Investors in oil and gas stocks are advised to start buying into companies with a diversified oil and gas  portfolio; while real estate investors may look forward to reinvigorated markets in the prairies of NW Alberta and in NE B.C.

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