Sunday, February 27, 2011

When the believers stop believing: Chesapeake dumps shale gas assets

Only two years ago Chesapeake Energy Corp. president Aubrey McClendon was telling us about the limitless future of natural gas in North America. It was going to free us from foreign oil by allowing us to convert our vehicle fleet to run on domestically produced natural gas from vast shale deposits. Technology was now making these deposits accessible, and McClendon offered up "research" done by a nonprofit largely funded by his company that showed that these deposits could power America for another century.

It is a good thing that McClendon, who still runs Chesapeake, isn't taking his own advice these days. Back in mid-2008 when natural gas prices leapt above $13 per thousand cubic feet, the company was riding high as the darling of the shale gas drillers.

Since the crash in late 2008, natural gas prices have been mired in the $3 to $4 range, not high enough to justify the high costs associated with most shale gas drilling. And that means, of course, that natural gas drilling is taking place only in those spots which are deemed easy enough and cheap enough to exploit profitably at these prices. Gas drilling rig counts in North America slipped from more than 1,600 at the end of August 2008 down to fewer than 700 during the worst of the bust in mid-2009 and settled at 906 last week, according to Baker Hughes.

In testimony before the U.S. Congress in 2008 McClendon said to our elected representatives: "Many of you think of our industry as being part of the 'oil and gas industry' and therefore attached at the hip to the oil industry. However, nothing could be further from the truth." (PDF) He went on to say:
Imagine tomorrow if your hometown or national newspaper proclaimed that you had introduced a plan that would, in one stroke, cut gasoline's cost in half, reduce our oil imports, improve our air quality, enhance national security, strengthen the dollar, reduce greenhouse gas emissions and create tens of thousands of new jobs in the U.S. in the automotive, truck, steel, natural gas and related industries. The papers might say you just have changed the course of American history.

It was an inspiring vision even if delivered in a somewhat obsequious manner. With the high-minded help of America's domestic natural gas drillers, the country could free itself from the tyranny of oil, McClendon told the House Select Committee on Energy Independence and Global Warming.

Fast forward to today. So poor is the natural gas business now that McClendon has decided to sell off a good portion of Chesapeake's shale gas assets in order to concentrate on oil trapped in shale. Why? Because the price of oil is so much higher relative to natural gas, proving that price is the key driver in exploiting hard-to-get hydrocarbon resources. Since McClendon's 2008 testimony, the natural gas industry seems to have been rejoined at the hip to the oil industry (or perhaps it was never really separated). So much for cheap, abundant natural gas for the next century. So much for freeing ourselves from the tyranny of oil.

In truth, I don't blame McClendon for doing what he's doing. His job is to make money for his shareholders, and unlike many presidents of public traded companies, McClendon owned a huge stake in the company before a margin call nearly wiped him out. Since then he has bought back about 900,000 shares according to Chesapeake's latest proxy statement (PDF). Before the margin call he owned more than 33 million shares representing about 5 percent of the company, far more than most corporate chief executives.

But just because McClendon's interests are aligned with his shareholders doesn't mean they are aligned with the interests of the American public. And, the notion that a self-interested energy company executive can give solid advice to Congress about long-term policy is nonsense. Of course, policymakers need to collect information from the oil and gas industry in order to understand our current energy situation. But that is altogether different from expecting objective policy advice.

So, where does that leave us with respect to natural gas in the United States? We are not quite back to where we were before the shale gas boom. But domestic natural gas supplies aren't going to be as plentiful as previously believed. The shale gas boom that had seemed to raise U.S. domestic gas production by 11 percent turned out to be a mirage. The U.S. Energy Information Administration (EIA) announced in early 2010 that as a result of poor methodology, it had been overestimating U.S. domestic gas production by (surprise) about 10 to 12 percent, almost the same amount as the growth attributed to the shale gas boom.

And, the same agency--an agency known for its persistently optimistic energy supply forecasts--now shows domestic gas production stagnant through 2020 and barely meeting tepid growth in demand through 2035. (The EIA has been known in the past to simply match production to projected consumption and assume that supplies will somehow come from somewhere.) The stated reason for the less-than-buoyant projection is that growth in shale gas production is expected only barely to offset declines in production from other sources of natural gas.

Natural gas prices are low now because the U.S. economy remains in low gear. Should it accelerate to high gear, count on much higher natural gas prices as demand picks up. Then perhaps we'll have a shale gas boom again followed by a bust.

Both the murky projections of future natural gas supplies and the wildly cyclical nature of the industry make it a questionable platform for energy security. What America and the world needs now are new steady, dependable and climate-friendly sources of energy, sources as steady as the rays of the sun and as clean as the wind on plains.


Anonymous said...

Kurt, thanks for the good article. You are saying that gas prices are low because the US economy is not growing. Why does the NG industry continue to dump an oversupply of gas into the market? They should learn from OPEC and limit the supply artificially. That would be in the national interest as well as in the interest of the gas industry. Prices of gas should be a touch below oil prices to make sure that the reserves are not depleted too fast.

In addition to clean energy we need most of all a substantial amount of energy conservation. Europe consumes on average half the energy we consume without sacrificing life quality. But then again prices of energy are substantially higher in Europe than they are here in the US.

Kurt Cobb said...

To propose that the government or the industry limit the amount of natural gas produced in the country in order to stabilize the price and encourage conservation would be an unprecedented intrusion into the free market, right? Wrong! The Texas Railroad Commission which regulates the oil and gas industry in the state essentially used to fulfill the role Saudi Arabia does now, regulating production so as to act as the swing producer in the world to smooth out supplies.

I say "used to" because that was true in the days before the United States peaked in its oil production which was 1970. Before then the Railroad Commission "prorated" wells forcing oil companies to produce at only a set percentage of the well's potential rate, changing the rate in response to rising or fall prices to maintain steady oil supplies to the market.

This essentially kept prices up when they would have tanked, and kept them down when they would have skyrocketed.

Thus, wide price swings were avoided and this made planning and exploration in the industry much more predictable. It also meant the oil wasn't squandered in an orgy of overproduction and price cutting.

Henry Kissinger proposed in the 1970s a floor on oil prices in the United States to be implemented by a sliding import fee that changed with prices, but always maintained a minimum price that would encourage conservation and alternatives.

It also would have met with approval from the domestic oil and gas industry had it ever been implemented, successfully splitting domestic producers off from international producers politically.

But instead of adopting a rational, self-interested energy policy, we adopted no policy which meant one that was most amenable to foreign oil producers.

We are making the same mistake again by following a policy that squanders domestic natural gas. This country has a long history of manipulating energy prices and production for specific policy aims. When we decided to deregulate the industry completely what we got was what you would expect: high volatility and high uncertainty that has plagued the country for 40 years.

Naturally, what I'm talking about would mean higher prices. But it would also mean a better environment for developing alternatives to fossil fuels and it would encourage conservation.

In the current environment, such a policy would seem impossible. But things can change. Look at how much is suddenly changing around us in ways no one anticipated.

Mark Goldes said...


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