I just arrived in Texas yesterday for my latest round of oil meetings.
The crude market continues to absorb accelerations in investment despite of some lateral price movements. That will be an important topic of discussion.
But my interest has moved in another direction.
Natural gas futures closed on the NYMEX on Thursday $4.14 per 1,000 cubic feet (or million BTUs). We have not seen prices reach these levels in quite some time.
As crude oil prices exhibit resistance in the face of demand concerns (largely overblown, as I have noted here before), the gas levels are rising quicker than anticipated.
This has a direct bearing on an investor's approach to the energy sector.
What is not happening is any fundamental switch from oil to gas. Crude will be moving up. In fact, the latest analyst indicators point toward increasing prices even in the face of higher surpluses.
But as gas settles north of $4, the prospects for expanding one's investment portfolio continue to improve.
In fact, there are a number of ways to make money as prices continue to rise.
The Surplus is Gone
I am sticking to the forecast that I made about six months ago.
Back then, I suggested that the average futures contract price would come in at $4.36 or better by June of this year and about $4.65 by October. Some are now suggesting this level may be the new normal, while predominant opinion is looking for prices to rise for several years, at least on average.
There are a number of factors that still must play out before we can set an expected floor in the mid-$4 range. Memories of last year's dips below $3 are still too recent. But there have been some interesting developments, and they make it unlikely that we soon revisit those lows.
For one thing, the market continues to drain down what had been a significantly heavy overhang of surplus volume. A more seasonal winter weather pattern has helped the draw down.
The 2011-2012 heating season had hardly been a traditional one. Abnormally warm temperatures, especially in the normally heavy natural gas dependent Northeast, had swelled stockpiles and driven down prices.
Looking back, the losses at the wellhead during this period actually contributed to the rise this time around. The advent of vast new unconventional reserves coming from shale gas and coal-bed methane had thrust operating companies into a cut rate survival competition. Too much production hit a market that did not need it, with the resulting glut serving as a main cause of the pricing decline.
And in this respect, we have another example of what I have been terming the most important change in energy markets to emerge in years. It is now playing out significantly in natural gas and it is the latest example of a major development.
This is all about balance.
Natural Gas Companies Focus on Cost Structure
Unlike the situation in gas experienced in the recent past, this time companies have been reducing the opening of new (or expansion of well debit at existing) drilling pads. These resources can be brought on stream quickly, but the real problem building over the last two years had resulted from the number of additional wells itself.
Once a well is brought on line it is more cost efficient to allow the flow to continue, even if the resulting gas is coming up essentially at margin.
As much as 90% of costs at many pads are a result of expenses incurred before the flow commences. It is cheaper to allow the flow to continue - even as market prices are declining - since the longer the flow, the less cost per cubic foot of production.
Therefore, this primary contribution to depressed prices needs to be addressed at the source. That is, a greater restraint on new drilling actually serves to improve the overall market price of the production resulting.
That brings us back again once again to the standard of balance.
As I have mentioned before, our new market parameters are all about balance. The resulting supply/demand relationship is more sensitive to a series of tradeoffs taking place all along the entire upstream-midstream-downstream sequence.
Sometimes these balance requirements cross energy types (gas instead of coal, renewables serving as backup support for hydrocarbons, biofuels instead of fossil, and so on).
Yet at other times, the balancing is more traditional and occurs within a single energy. In this case, the move addresses basin, region, grade, composition, type, process, or sourcing.
With natural gas, this means addressing a few key factors, including:
- The point of origin (which basin, serving which gathering, processing, transport, and storage infrastructure);
- The degree of impurities;
- Whether the fuel is dry (essentially methane only) or wet (having value added streams);
- Whether the fuel is from a conventional or unconventional source;
- The technology required to draw fuel to the surface; and,
- Whether the gas is free standing, associated (along with what is primarily a crude oil reservoir), shale, tight, coal bed methane or (someday) hydrates.
This latter approach is now underway in the gas market and is the primary reason for the stabilization and improvement in price. Now this is looking even more promising as we survey the increases on the demand side rapidly approaching.
These have been the subject of several treatments in OEI and extend from replacement of coal in power production, through rising industrial usage, advancing as feeder stock for petrochemicals, massive liquefied natural gas (LNG) export markets emerging later next year, and even prospects for broader application as a vehicle fuel.
We are hardly out of the woods with volatility in natural gas, and the pricing trajectory is not going to be one moving straight up. But it does look like we are now on track for a gradual further improvement.
And with that, the number of opportunities will be improving as well.
Related Articles and News:
Five Reasons Why Natural Gas Prices Will Continue to Rise
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Why Bigger Isn't Always Better in the Oil Business