Sunday, February 17, 2013

Natural gas consumers just got a big subsidy from investors, but it can’t continue

It isn’t often that the world’s working stiffs get a chance to fleece rich investors. But that’s essentially what has happened as a result of the vast overinvestment in natural gas drilling in the United States. That overinvestment has led to a glut which last April pushed the price of U.S. natural gas down to $1.82 per thousand cubic feet (mcf), a level not seen since 2001.

Investors have essentially subsidized natural gas through huge loss-making investments, creating an oversupply that has sent prices significantly below the average cost of new production. That means consumers get cheap natural gas while investors kick themselves for not realizing that they were buying into a flawed concept—one that oil and gas consultant Art Berman has called “an improbable business model that has no barriers to entry except access to capital, that provides a source of cheap and abundant gas, and that somehow also allows for great profit.”

The conventional wisdom is that prices are likely to stabilize between $3 and $4 per mcf and stay there for the rest of the decade as the natural gas drilling juggernaut continues. There just one problem with this outlook. The juggernaut has most definitely NOT continued.

Since the last week of August 2008 when the count of active U.S. natural gas drilling rigs peaked at 1606, the number of active rigs has plunged to just 425 for the week ending February 8.

Investors who helped to fuel the boom included hedge funds, wealthy individuals and institutional investors, all of whom chipped in a lot of money to finance the drilling of individual wells for what turned out to be meager payouts. None are eager to get burned that badly again.

In addition, the share prices of publicly traded drillers such as Chesapeake Energy, Devon Energy, Encana, and Southwestern Energy—who put an extraordinarily large proportion of their efforts and funds into finding natural gas (as opposed to oil)—have plummeted. That decline has for now made raising new capital through stock issuance a relatively rare event.

Furthermore, many drillers—who borrowed heavily to help finance their drilling efforts—now find themselves deeply in debt, groaning under the weight of interest charges and loan repayments. But, they’ve been unable to do much except sell assets to counter the devastating effects that low natural gas prices continue to have on their balance sheets.

It’s hard to imagine the same investors and banks deciding that for the rest of the decade, they’ll keep repeating what they’ve just done.

As for the drillers, they have moved on. They have already repositioned their rigs for drilling oil which is currently fetching a splendidly profitable price near $100 a barrel, that is, near the historically high levels seen since 2008. It turns out that even the natural gas drillers don’t believe the natural gas story any more if we judge by their actions. Indeed, even the biggest booster of the cheap (but somehow profitable) natural gas forever narrative, Chesapeake Energy, has given up and turned its focus to oil.

So, where does that leave the working stiffs who heat their homes with natural gas, the utilities who burn it to make electricity, and the chemical manufacturers who use it as a feedstock for many chemicals including nitrogen fertilizer? They all face an uncertain future in which natural gas prices are likely to rise significantly, perhaps even returning to the double-digit nosebleed levels of 2008 before gun-shy investors and drillers will dare to take the necessary steps to bring on significant new supply.

Which begs the question: What if drillers and investors wait that long to move back into the natural gas fields in force?

Petroleum geologist Jeffrey Brown of Export Land Model fame offered a startling response in a conversation at a recent conference I attended. The production decline rates of the shale gas wells that are providing the bulk of new U.S. supplies are so high—60 percent in the first year and up to 85 percent by the end of the second year—that we may never be able to return to today’s production level.

That would certainly put a nail in the coffin of the natural gas abundance narrative.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he writes columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin, The Oil Drum,, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at


Anonymous said...

Hmm, yet DOE still says there's 800 trillion cubic feet of recoverable shale gas. While the decline rate might be high, it seems new wells can be drilled all over the place.

Kurt Cobb said...

Anonymous cites the DOE estimate, but we must keep in mind that even if it turns out to be a good one, it is the rate of drilling which will be a constraint. Replacing 85 percent of the production you've just drilled every two years AND trying to grow production at the same time will likely be impossible at some point since the number of rigs, the number of people and the number of support vehicles and supplies won't be sufficient to increase production.

We may see higher production rates at that point. But then production would cease to grow and probably begin to decline.

All this is premised on much higher prices. And, it may be premised on entirely new technologies that haven't been invented if the recent University of Texas study concerning the Barnett Shale is correct. In fact, if that study is correct, then the DOE estimate is vastly overinflated.

Keep in mind that the DOE estimate is really of "technically recoverable resources" and it says nothing about whether those resources will be "economically" recoverable. If they aren't profitable, they aren't coming out of the ground in any great quantity.

This is the problem with citing large estimates without any context. It's worth noting that dry natural gas production in the United States has been flat for more than a year showing that rate is the key number to watch.

There is enough gold dissolved in the world's oceans to make all those who are reading this comment billionaires. But it will never be economical to extract. Much of the presumed natural gas resource is likely to be in the same category. It's there, but it will be too costly to get out.

Unknown said...

I agree for the most part Kurt, but with any investment, there is some risk involved. The problem here is that there was too many producers and too much of the resource they produced. On top of that, there is no infrastructure to put all those resources to work efficiently. Bring the price back up around $6-$7 MMCF and the producers will again hit the gas fields hard and heavy to meet the demand, and will do so profitably unless they drive the price too low again.

Kurt Cobb said...

Joshua Beel is generally correct. At some price, drillers will come back to the natural gas fields. I'm not certain that $6 will be enough, especially since the all-in cost of many gas wells being drilled now is above $8 per mcf.

But, whatever the price, Beel points to a key problem. When the drillers do come back, they will likely overdrill again bringing on too much supply which will then tank the price.

This pattern is not unusual in resource exploitation. But in this case, it hardly forms the basis for consistent and rising supplies which the industry had promised and upon which their vision of a natural gas-based economy was premised.

Jake said...

I think it's awfully presumptuous that drillers will again overdrill should prices rise. Certainly this could be the case for independent producers/wildcat operators - but these are the guys that most likely lost, or have almost lost their shirt the first time around. It would be in the best interest of the big producers, such as those you have mentioned, to take a different approach than they did the first time around - especially considering what has happened. I personally doubt they are that dumb, but what do I know... Otherwise, I enjoyed your article. Thanks.

Kurt Cobb said...


The pattern of overdoing it on production is so firmly documented historically that it is almost certain that it will happen again.

BTW, it was the big, sophisticated producers such as Chesapeake and XTO who did the most to create the glut. Sophistication and size don't necessary lead to wisdom or restraint.

So, no, it won't surprise me if they make the same mistake all over again. The momentum that builds up at the top of a bull market carries far into the downswing as market participants continue to believe that the latest drop is only a pullback that will lead to even higher highs. They tend to believe that until the market is well and truly glutted at which time they finally realize their losses and move on.

On the other hand, if drillers do happen to show uncharacteristic restraint in the next upswing that means that natural gas supplies will remain limited thereby confirming my thesis that rate limitations will prevent widespread conversion to natural gas in the medium to long term.

Anonymous said...

Mr. Cobb, as always your work is insightful and timely, thank you.

The cummulative debt for major tight oil players must also be staggering. All funded by the same financial sources as the tight gas play. My economic projections (I am a oil producer myself) for tight oil resources that decline at the cummulative rate of 75% the first 3 years of production life suggest even the biggest of shale players have to continue to borrow enormous sums of CAPEX to stay on the drilling treadmill.

As sweet spots are drilled up and more marginal areas begin to get drilled, by those same companies, tight oil economics become even more marginal than they already are; rates of return on enormous investments and available net income to service debt all goes down, down, down. Ultimately the same fate awaits tight oil lenders and, unfortunately, share holder equity, as what occured in the Barnett shale, and the Fayetteville and Haynesville, likely the Marcellus, etc.

Will American tax payers eventually end up bailing out all these big unconventional tight oil and gas players?

I think perhaps, yes. Then perhaps at this late stage of maintaining our domestic oil and gas production base we are more "nationalized" than we realize.

Mike Shellman

Anonymous said...

The first poster responding - I don't know what qualifications DOE uses to come up with the 800 million tr. cu. ft. amount, nor am I qualified to critique it. However, the resource figure DOE uses is larger than the tech. rec. amount - you were talking about a glut but DOE also say U.S conventional nat. gas reserves will run low in as little as 10 years.. some others on the oil drum have commented that while drilling rig count has dropped, many wells are still waiting to be fracked..

Anonymous said...

Also, nat. gas drilling rigs were moved to drill for oil..

Kurt Cobb said...

With regard to technically recoverable resources for shale gas mentioned in the first comment, the latest DOE estimate has been revised drastically downward, primarily based on a new USGS assessment. The latest estimate is now 304 trillion cubic feet as of July 20, 2012. And, of course, this says nothing about whether such resources will ever be economically recoverable.

Anonymous said...

You're right - it is highly unlikely the UTRR is the actual RR.