What's new in exploration

	Vol. 228 No. 6
ARTHUR BERMAN, CONTRIBUTING EDITOR, bermanae@gmail.com

The impending US gas supply crisis: Why prices will increase

Natural gas prices should be falling, but they are slowly rising. The winter of 2006–2007 was one of the mildest on record. At the end of the heating season, working gas in storage was 20% above the five-year average. Storage at the end of the heating seasons in both 2006 and 2007 were the highest for that time since 1991. Gas futures settlement prices and spot prices have been almost the same since January 2006. All of these factors usually mean that gas prices should fall, but at the beginning of May 2007, spot gas prices were at the upper end of their five-year average, near $8 per million BTUs and rising.

The explanation for these apparent contradictions is found in some disturbing trends in gas production and consumption, underlying the superficial appearance of abundance. Simply put, the US is at or very near the limit of its capacity to supply gas from North American exploration and production.

An analysis of North American gas production and the ratio of proved reserves to production (R/P) provide the following conclusions:

• Remaining years of gas supply in North America declined from 18.6 years in 1988 to less than 10 years in 1998.
• R/P has stayed flat since 1998, slightly less than 10 years, due to regular new reserve additions. US reserves grew from 162 Tcf in 1998 to 193 Tcf at year-end 2005. Most of this new gas is from unconventional sources, such as shale gas, tight gas and coalbed methane.
• Canadian gas reserves have declined from 99 Tcf in 1984 to 56 Tcf today. Some of Canada’s gas is sold in the US. Canada will probably curtail exports of gas in the future, preferring to use it to process oil sands.
• Mexican gas reserves have declined from 77 Tcf in 1985 to only 15 Tcf today. Mexico’s gas does not contribute to US supply.

This means that near-term future US gas supply depends on the capacity of domestic E&P companies to continue to find and rapidly exploit new unconventional gas sources. This is a perilous situation, because the most prolific of these resources, including the Barnett Shale, are already in relatively mature stages of development.

Operator costs have tripled since 2003, yet the number of active onshore rigs has doubled. Producers are struggling to keep pace with the demand for gas. They have not yet reached a critical threshold, because there have been no serious supply disruptions. What has occurred is a gradual but steady increase in gas commodity prices punctuated by periodic up/down spikes that are driven mostly by short-duration, weather-related events.

North American gas production peaked in 2001 at 27.4 Tcf/year and has declined 4% since then to 26.2 Tcf/year. The most recent peak in production (the true peak was in 1973) occurred in 2001 at 19.6 Tcf/year, and has declined 6% since then to 18.5 Tcf in 2006.

More distressing is the reversal of the decline in gas demand.* Peak winter demand for gas fell 0.3 Tcf/month between 2003 and 2006 but, in the past year, it has rebounded by 0.2 Tcf/month. Both residential and industrial power consumption increased more than 20% for the first quarter of 2007 compared to the same quarter in 2006 (EIA Natural Gas Weekly Update, May 3, 2007).

It is only a matter of time before the US experiences a significant gas supply crisis. We have had supply disruptions every 2–3 years mostly from weather-related problems that are beyond our control. Recent examples include: a 2001 cold winter and electric grid failure in California caused a 450% jump in national spot prices; a cold winter in 2003 resulted in a 250% spike in overall gas prices; in 2005, hurricanes Katrina and Rita disrupted platforms, pipelines and refineries to cause a 220% increase in gas prices nationwide for several months. Future supply crises will be worse because of declining reserves and production, and increased dependence on gas-generated electric power.

There are no solutions that are either probable or timely. It is too late to reconsider building new gas-generated power plants. It is unlikely that a new onshore gas play, either conventional or unconventional, will be discovered in the US or Canada that will provide significant new supplies. Mexico is closed to competitive E&P, and Pemex has a spotty record of making new oil or gas discoveries in the past 25 years. LNG is an obvious remedy to supply depletion, but infrastructure and transportation will take many years to develop, and LNG imports to the US have actually declined since 2004.

Arctic gas holds great promise for future North American gas supply, but development and pipeline construction put this resource fairly far in the future. The US Outer Continental Shelf (OCS) probably offers the best relatively short-term remedy for the impending gas supply crisis. Resource estimates for the GOM deep shelf are about 50 Tcf, and recent proposals for new OCS leasing by Interior Department could potentially open 45 Tcf to exploration.

LNG will be a good investment, but US companies have to find ways to compete for sales contracts with Europe and Asia, which are far ahead in their sense of urgency for a secure source of gas. Gas exploration and production should be very profitable for companies that are positioned to act, and have not been misled by short-term signals that gas prices may fall or stay relatively flat. 

*Last year, I wrote optimistically about US gas supply (Houston Geological Society Bulletin, 2006, V. 49, No. 3, pp. 25-40) based largely on demand decline. The reversal of this and other global trends is responsible for my shift in position on gas supply.

Correction: My sincere thanks to Nels Voldseth for pointing out some errors in the decline rates for the Barnett Shale in my March column. The correct average decline rates for vertical wells are 50%-30%-25%-20%; for horizontal wells, they are 90%-80%-60%-25%. The premise of the column still stands: most Barnett Shale wells will lose money. A more robust economic model than I presented at that time suggests that 23% of vertical wells and 10% of horizontal wells will pay out at current gas prices. If this month’s column is correct and gas prices go up a lot, there is still hope for the Barnett Shale! Thanks, Nels! By the way, to other readers that commented, hyperbolic decline curves are not necessarily the rule in unconventional reservoirs. AEB

Arthur Berman is a geological consultant specializing in petroleum geology, seismic interpretation and database design and management. He has over 20 years working for major oil companies and was editor of the Houston Geological Society Bulletin. He earned an MS in geology from the Colorado School of Mines.