What’s new in exploration

	Vol. 229 No. 6
ARTHUR BERMAN, CONTRIBUTING EDITOR, bermanae@gmail.com

The limits of global gas supply

Natural gas prices in the US are more than $11/MMBtu (Henry Hub), an increase of more than 96% since September 2007. They haven’t been this high since the 2005 supply interruption after Hurricanes Katrina and Rita. As recently as mid-February 2008, Bloomberg predicted that gas prices would remain around $8/MMBtu for the rest of the year, and Raymond James forecast prices below $7. These predictions failed to recognize that we have reached the limits of global gas supply, at least for a while.

Natural gas prices reflect real supply and demand balance, as well as the perception of near-term changes in that balance. The key factors that suggest a gas supply limit include US production trends, growth in consumption, competition and delays in LNG supply, gas for ethanol production, and the linkage of gas and crude oil prices.

US gas production increased 4% in 2007, to 19.3 Tcf, mostly due to Barnett Shale additions of more than 1 Tcfg. But gas consumption outpaced production gains, increasing 6.2% in 2007, to 23 Tcf, and 11.3% for the winter heating season compared to a year ago. This was in large part due to electrical power generation, which has increased 35% (1.7 Tcf) over the last five years, and 10% (0.7 Tcf) over 2006-2007, to 6.9 Tcf. Consumption for electricity rose 20.7% during November 2007 through February 2008 from the same period the year before.

Natural gas has been the preferred fuel for most new electrical power generation plants built in the US since 2000, because of its greater efficiency and environmental acceptance compared with all other fuels. Despite coal’s abundance and low cost, it is unlikely that its use will increase. Environmental concerns have focused on CO2 and other contaminants produced by burning coal. More critically, low-sulfur coal reserves are simply not available beyond current supply for existing projects. Since 2000, year-end stocks of coal for power generation have averaged 12% of consumption. This is equivalent to ending the calendar year with 2.7 Tcf of working gas in storage, or about enough for six weeks of winter heating.

The winter of 2006-2007 in Europe was unusually mild, and large volumes of LNG were released to the spot market. Unprecedented amounts were imported to the US, resulting in record gas storage levels (3.5 Tcf by Nov. 15, 2007) at the start of the winter heating season. Imports of LNG from March to August 2007 approached 3 Bcf a day. By November 2007, LNG imports to the US had fallen to about half of the previous year’s imports, and through the 2007-2008 heating season, LNG has averaged 40% of ordinary import levels. Despite an anticipated surplus by 2008, LNG has so far failed to meet supply expectations. This is because of construction delays of several large liquefaction projects and cost inflation. The global credit crisis has further clouded the future of some new LNG projects.

Demand for LNG has reached record highs, and some markets in Asia are paying up to $20/MMBtu. The Chinese companies PetroChina and CNOOC announced a long-term LNG contract for $60 billion with Qatar for deliveries that were already contracted to European and North American buyers. Singapore has made a long-term LNG arrangement with BG because of “strategic security” concerns. Kuwait has concluded a large contract with Qatar this year, so it can meet its air-conditioning needs while preserving oil production for export.

Earthquake damage to a major nuclear power plant in Japan in July 2007 has increased demand for LNG in that country. LNG imports to the US are at their lowest level since 2003. Even with gas prices above $10, the US is unable to compete in the global LNG market, and the weak dollar will compound the problem. Recently completed regasification facilities have found little supply, and the likelihood for significant spot purchases in 2008 is low.

A new oil/gas price ratio seems to have formed over the past 10 months.

The US government’s enthusiasm for ethanol as an alternative to gasoline has created about 1.2 Bcf of gas demand per day to meet today’s 9 billion gallons of mandated ethanol production. Natural gas is required throughout the ethanol cycle to produce fertilizer, pesticides, steam and electricity. This will escalate to 2.1 Bcfd by 2012 and to 4.9 Bcfd by 2030 to meet requirements of 15 and 30 billion gallons per year, respectively.

In June of last year, I wrote in this column about an impending gas supply crisis. In August, I stated my belief that LNG would not greatly affect the global balance in the near term. At this writing, these concerns remain valid. While gas and crude oil prices have become largely disconnected over the past decade or so, since July 2007, these price trends again correlate strongly, albeit at a higher ratio (11-12 range, oil/gas), suggesting that market concerns exist about both gas and oil supplies, see figure.

While gas imports from Canada are currently high, the lack of gas drilling in 2007 will affect supply, and internal demand for tar sands processing could limit future supply for export to the US. For all of its abundance, coal does not offer an acceptable solution.

Price trends are cyclic, and high prices depress demand. Weather and storage patterns will cause prices to rise and fall, and prices should decrease during the summer and fall. There will be new supplies of gas as North American shale gas drilling increases and completion methods improve. Despite delays, LNG and Arctic gas projects offer hope for the future. Yet market fundamentals have changed, and gas is now a global commodity. We have approached the limits of global supply, at least for a while. 

Some data was provided by IHS. Its ongoing support is greatly appreciated.