The shale gas boom of the last years has led many to believe that America is on its way to energy independence. With several LNG export terminals under construction there seems to be a consensus that the US will become a major LNG exporter soon. In a recent interview with The Energy Report Bill Powers, author of “Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth“, offers a refreshing, contrarian perspective:
The facts are starting to show that declines for the older shale plays such as the Barnett, Haynesville, Fayetteville and Woodford are very serious. More important, once production growth from the Marcellus slows down, it will no longer be able to offset declining production from shale plays as well as conventional, offshore, CBM and tight sands production, which are all in terminal decline.
The low price of gas alone isn’t causing these write-downs. A lot of it has to do with the poor performance of these wells. There’s been a lot of evidence put forward by myself, Art Berman, who wrote the forward to my book, and David Hughes, that the shale industry has overbooked its reserves by approximately 100%. The write-downs of the last few years have largely proven this out. More importantly, if shale operators are writing down reserves at the rate we’ve seen, this also speaks volumes about the total recoverability of all shale gas in the United States.
The decline will become more evident once the aerial extent of the Marcellus fields becomes more clear. This is starting to happen in southwestern Pennsylvania, where Range Resources Corp. (RRC:NYSE), one of the most aggressive producers in the region, is now saying in its investor presentation that it and other operators have defined the outer limits of some fields. Once you run out of the high-quality, liquids-rich drilling locations in Washington County (southwestern PA), you will get a very large fall-off in productivity.
Many of the people promoting the 100-year myth were doing it for either financial or political reasons.
Unlike a lot of people who make statements about the amount of gas that’s out there and provide little or no empirical evidence to support their claims, I have almost 600 footnotes in my book that explain exactly where my estimates of future shale gas recoveries come from.
In addition, the Securities and Exchange Commission (SEC), after heavy lobbying, changed its rules in 2010 to allow for a significant increase in proven undeveloped reserves to be booked, so the SEC was also complicit in the perpetuation of the shale gas myth. Without this change in how shale gas reserves were booked in 2010, most shale operators would have been forced to take large write-downs rather than booking increases in reserves. I believe this rule change by the SEC grossly distorts the value of a company’s reserves since it allowed for a large increase in the booking of proven undeveloped reserves.
I think it will be similar to the housing crisis, where a handful of people saw it coming and profited from it. There was significant evidence that housing prices were unsustainable, but most people were surprised when the housing bubble popped. People from Alan Greenspan to Ben Bernanke and others had a lot of information about the economy and how unsustainable house prices were, but did not want to talk about it publicly. There’s a saying that “the impossible can become the inevitable in the blink of an eye.” I think this will happen with natural gas. For example, in the first week of December 2000, gas prices went from around $4/Mcf to over $10/Mcf in only a few trading sessions. This was due to falling production, lower storage levels and a cold spell that set in across much of the United States. This price spike was the first of numerous spikes during the last decade.
Few remember that U.S. gas production fell from 2002 to 2007.
Shale gas is a finite resource. When prices start to escalate, unfortunately, the situation will be even worse than the spikes we had in the early part of the 21st century, and even more so than the 1970s. From 2000–2010, we were able to increase our imports of LNG, and in the 1970s we built dozens of nuclear-fired power plants and hundreds of coal-fired power plants to reduce demand for natural gas. Now we are seeing the nuclear industry in decline, with five plants shutting down this year out of 104 plants, and many more closing in the next two to three years. Dozens of coal-fired power plants will be shutting down before mercury emissions laws take effect in 2015 and few new plants are likely to be built given the stringent emissions standards.
Even worse, for the first time in the industry’s history, world LNG trade shrank last year. We are seeing record-high global prices for LNG with no sign that this is going to slow down or reverse. When the U.S. is forced to go back out and try to secure cargos to import LNG, the prices we will be forced to pay are going to be much higher. The current price of LNG in Chile, Brazil and Argentina is $14–15 per million British thermal units ($14–15/MMBtu). In Japan and Korea it’s been over $16/MMBtu. Even Mexico is currently importing LNG at $16/MMBtu due to demand outstripping supply and lack of pipeline capacity to connect to U.S. markets. The U.S. is going to be forced to pay much higher prices when it will not be able to meet its own domestic needs, as shale gas rolls over and Canadian imports decline as the country begins exporting LNG to Asia via British Columbia.
Barring a major new shale gas discovery in the very near future, the future of U.S. LNG exports will have to do with how much domestic demand falls off. A lot of these terminals will probably get built only to lie dormant when the government declares force majeure and cancels overseas contracts. Politicians will look at their constituents and see all sorts of suffering, from higher electricity bills to higher food prices to higher home heating bills, and say they are going to pull the export licenses from all these LNG plants. As I say in my book, “Overseas customers do not vote.”
I think that energy equities will provide some of the best returns available anywhere over the next 10 years, similar to what we saw in the 1970s. Shortly after the U.S. eliminated convertibility of the U.S. dollar into gold in 1971, which I consider a default, we saw massive inflation. Oil and gas and precious metals and equities related to these two sectors were among the very few investments that paid off in that era. The returns in those investment classes were fantastic, whereas just about everything else, from government bonds to general equities to tech stocks, got destroyed. I think we’re heading toward a similar period. Even though natural gas has been one of the only commodities left behind by the flood of liquidity over the last five years, it is also one of the most volatile commodities. I am looking for a period of serious outperformance by natural gas over the next decade.
The U.S. is heading toward world gas prices. To recap, this means double-digit prices within the next three to five years for a number of reasons. First, in addition to lower U.S. production, our imports from Canada are going to be diverted toward Asia through LNG exports. Canadian production continues to fall, and 2013 will mark the 12th year since it peaked. Canada will be unable to export to both the U.S. and Asia due to lower production and record domestic consumption. Second, the U.S. is now far more reliant on natural gas to generate electricity than it was in the 1970s. The U.S. got out of that gas crisis by building nuclear and coal-fired power plants, not through increased gas production. Last, this time it’s going to be very difficult to destroy demand because we are starting to see manufacturing come back to the U.S. and coal and nuclear plants are closing.
Bill also shared some investment opportunties that you might find interesting. I recommend you read the full interview here.
Source: The Energy Report