Innovative drilling technology has opened up a treasure of natural gas reserves in our own backyard. But the United States is still adjusting to its newfound riches. Natural gas prices recently bounced off 10-year lows, and near-term prospects are only for a seasonal recovery until more power plants switch from coal to gas and unless an export market were to develop.
Rapidly rising shale gas production and dramatically lower demand due to unseasonably warm winter weather combined to push unit prices for natural gas below $2 in April, a particularly soft period of demand between the winter heating and summer cooling seasons. That was in stark contrast to the $13 unit price topped in 2008, when it was not uncommon to see shares of natural gas producers, such as EOG Resources (EOG), rise 40%-50% within a few months.
Those days may be long gone although, for now, the gas price tumble appears to be over. The Energy Department noted that gas usage for March rose 40% and coal consumption declined 20%, as lower-priced gas displaced relatively more expensive coal at utilities. Consumers are now beginning to fire up their air conditioners, too, boosting demand from gas-fired electric power plants. Moreover, a number of producers, including ConocoPhillips (COP), Encana (ECA), and Chesapeake Energy (CHK) have announced they are no longer going all out to pump gas.
But natural gas inventories remain bloated. At the end of May, inventories of natural gas in storage facilities were a whopping 35% above the year-earlier tally, according to the U.S. Energy Information Administration. That much surplus will take time to use up.
Over the very long term, there seems little doubt that natural gas demand will rise significantly, potentially replacing coal as the second most commonly used fuel after oil. That is as its abundance, price advantage, and relatively cleaner burning nature favor it for use in power generation and for heavy industry, such as in chemicals facilities. Overall, global gas demand could rise by 60% in the coming 25-30 years, according to Exxon Mobil (XOM - Free Exxon Stock Report). That is the energy giant’s rationale for investing heavily in natural gas reserves. A number of drilling companies have followed Exxon’s lead in building up their gas-production capabilities, too.
Above and beyond a steady rise in the uptake of gas by industry, the launch of an export market could help producers realize more for their natural gas. The trouble there is that the U.S. government is taking a go-slow approach towards exports. So far, only one company has received a license to export gas in liquefied form, known as LNG, even as a dozen or so more applications await a decision from the Department of Energy. The government wants to research the effect of gas exports on domestic prices before it approves substantial fuel shipments abroad. The goal is to preserve the benefit of low domestic prices. Then, assuming there are ample supplies left over, some gas exports may well be allowed.
Facilities designed to convert natural gas to liquids, such as diesel fuel, are another way the gas glut might be drawn down. Construction of those types of plants might be seen as an alternative to export facilities, since the diesel fuel manufactured could be sold within U.S. borders.
While these irons in the fire offer promise down the road, they don’t do much for producers stuck with low price realizations right now. Near-term natural gas prices will probably only enjoy further support if drillers maintain their production discipline and if the summer cooling season provides a helping hand. Another check on gas prices is the possibility that if they rise too much, power plants could switch back to coal. But barring uncooperative weather patterns, the worst news for gas prices appears to be past.
At the time of this article, the writer did not have positions in any of the companies mentioned.