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The New Gas Wisdom

Unconventional gas sources put a ceiling on future prices.

Fortnightly Magazine - December 2008

trends has immense consequences, not just for the gas industry, but for power generators and energy-intensive industrial sectors as well. The long period of abundant conventional natural gas production throughout the late 1980s and 1990s, combined with breakthroughs in gas-turbine efficiency and the prospect of comprehensive electricity liberalization, were key factors behind the boom in gas-fired generation construction in the later 1990s, as well as the messy aftermath that followed. The prospects for cheap gas led to an over-reliance on new gas capacity. Companies who bet on a sustained period of abundant and cheap domestic natural gas were sorely disappointed as gas-generation capacity factors sank—victims of overbuild and diminished relative economics. On the other hand, investors in domestic natural gas production, and the midstream assets required to get the new production to market have seen periods of impressive performance.

Convergence Consensus

Over the past five years or so, a new consensus has been emerging around the future direction of the U.S. gas market. Over this period, in part due to the demand growth from the gas-generation sector, the North American gas market tightened dramatically. This consumption growth was coupled with accelerating decline rates and diminishing yields of conventional natural gas production in the United States with little additional supply coming on-line despite historically high gas prices and extraordinary levels of exploration activity. Gas-price spiking became evident as supply/demand became imbalanced. The market began to anticipate long-term higher prices—and the embrace of the LNG solution tightened (see Figure 3) .

Given growing gas demand, especially from power, and the prospects of dwindling supply, gas imports increasing appeared inevitable. The obvious consequence would be the convergence of the world’s heretofore regional natural gas markets, and as a result, the convergence of gas and crude oil prices. In practical terms, this implied an era of historically high natural gas prices. The economic argument was straightforward. North America would be obliged to meet its growing needs for natural gas via increased LNG imports. Given the tightness of current LNG-liquefaction capacity and the massive and rapidly escalating capital expenditures needed to bring additional LNG trains on line, it seemed likely that suppliers would be able to impose the same contractual terms for LNG exports long established in the North Asian and European markets. Specifically, LNG cargoes would be secured under long-term contracts, explicitly linked to oil prices. And given most analysts’ view of the prospects for a new era of oil prices in the $60/barrel and above range, this implied a future with natural gas prices in the $8 to $12/MMBtu range through the next decade. The lack of new liquefaction capacity coming on line over the past few years has accentuated concerns about tightness of global LNG, a major concern for gas buyers (and owners of re-gasification capacity in lower-cost markets like the United States) around the world.

As noted, it took a while for many to accept the notion that U.S. natural gas prices could equilibrate at these historically high levels, rather than near earlier estimates of LNG imports’ long-run marginal cost of $4.50 or