The Wonderful Curse


Production constraints and demand pressures mean high gas prices are here to stay.

Production constraints and demand pressures mean high gas prices are here to stay.

Fortnightly Magazine - December 2007

Volatility in energy prices is both a scary and wonderful thing. It brings risks that must be managed under uncertain future conditions. It also brings opportunities to profit from price movement and competitive market advantages exploited through strategy, skill and luck. Just how good the outcome of such volatility can be depends on how well each market participant studies the fundamentals, manages uncertainty and remains flexible.

With natural-gas supply and demand nearly in balance, gas prices and volatility levels have remained tenaciously steep by most historical measures since early 2003. The horrific hurricane damage sustained in 2005 in the Gulf of Mexico added further stress to domestic natural-gas and oil supply infrastructure that is not quite yet back to normal. U.S. crude oil production in 2006 averaged about 5.1 million bbl/day, down slightly from 2005 levels as a result of the hurricanes. And offshore gas production averaged 7.8 Bcf/day in 2006, down nearly 20 percent from mid-2005 levels, although some is undoubtedly due to gas-deliverability depletion. Since that time, gas prices have retreated but still remain well above long-run supply cost.

Current high gas prices reflect several factors that have converged into the “perfect storm.”

First, the high cost of replacing natural-gas production across all basins has raised the price floor. The gradual reduction in supply from conventional gas basins and the steady increase from unconventional basins, coupled with increased imports of liquefied natural gas (LNG), has exacerbated the situation. Absent immediate alternative sources of supply, these price levels will persist for some time.

Second, persistently high crude prices (in part due to increased global turmoil) have strengthened the “crude sympathy” that exists between the two commodities. High oil prices “allow” gas prices to rise due to competitive fuel switching. Also, the petroleum supply industry tends to favor oil development over gas when prices rise, because oil development costs less and leads to production sooner than gas development does. And due to cold weather, a record amount of natural gas was withdrawn from storage in February, dropping inventories below the five-year maximum for the first time in more than a year.

Oil and gas price moderation likely will occur after several years, but the actual timing and extent are still subject to large amounts of uncertainty. In particular, price declines are not expected until significant new sources of supply materialize in North America.

For some time, Global Energy has considered the impending increase in LNG supply as one sign that moderation eventually would occur, and the recent startup of the Gulf Gateway Energy Bridge and Altamira projects bolstered this opinion. Additionally, significant new LNG-import capacity is now under construction (such as Canaport in New Brunswick), as is more drilling for “unconventional” gas. These projects are scheduled to enter service in time to moderate North American gas