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The New Gas Wisdom

Unconventional gas sources put a ceiling on future prices.

Fortnightly Magazine - December 2008

upward adjustments. As the unconventional market has begun to emerge from the development stage, a new conventional wisdom on natural gas and its role in the overall U.S. energy sector is being born and being heralded by a well funded advertising campaign that promises a gas ‘panacea’ (see Figure 5) .

Back Where We Started?

What will this new outlook on the U.S. natural gas resource base mean for the gas and power markets? To begin to address this, we offer a few hypotheses, more to stimulate thought than to offer definitive (and inevitably embarrassing) predictions. In doing so, we start with a pretty heroic assumption, namely that the most recent set of forecasts around unconventional natural gas reserves and costs are roughly correct. Given that, we see the future rolling out in three basic phases.

Phase 1: The Return of Autarky: In the near term, U.S. demand will be met with domestic (unconventional) supply, with little need for additional LNG imports, and thus lead to the de-linking of U.S. gas from global gas—or oil—prices.

The amount of unconventional natural gas in the lower 48 now deemed economically recoverable is impressive, both in its absolute size, but even more so from the fact that it somehow previously was overlooked by the sector’s experts. In any case, based on recent forecasts of the likely range of natural gas demand, we believe the latest forecast of U.S. natural gas supply looks adequate to meet domestic needs for at least the next few decades. As an illustration, the lack of LNG cargoes drawn to U.S. shores in the current price environment has led Cheniere Energy (a leading developer of merchant LNG re-gasification terminals) to seek out producers such as QatarGas and even sign marketing agreements with middle-market players such as JPMorgan to extend contracts that would fill some of the excess U.S. re-gasification capacity. But what about increased gas demand resulting from a lower price environment? We already have noted the potential for demand destruction in large segments of the U.S. gas market, so why can’t these price-sensitive segments (traditionally viewed as composing over 30 percent of the market) create demand under lower prices?

We don’t believe that near-term demand growth from lower prices will be enough to make a real dent, at least in the short run. First, much of the industrial demand destruction that occurred over the past several years of higher gas prices is irreversible. Indeed, many gas-intensive industries, such as building materials and petrochemicals, have relocated not just to access lower-cost gas supplies, but also to get closer to the much more rapidly growing markets for their products in the Middle East, Asia, and Latin America. Second, the trend of increased penetration of all electric residential services has more to do with the basic economics of home access in the faster-growing, lower-heating-demand regions, than with the relative gas commodity price. As a result, lower prices are unlikely to result in a significant medium-term increase in residential demand, consistent with the famously low demand elasticity seen in gas consumption in the