July 2020

The Last Barrel

Natural gas: Commodity or by-product?
Craig Fleming / World Oil

In 1982, I was working for a small independent that operated several gas wells in eastern Oklahoma. The wells produced high-Btu wet gas, selling for around $0.25/ MMBtu, when the low-pressure gathering system would take production. In western/southeastern Oklahoma, home of the mighty Morrow and Spiro gas wells, producers where selling their product for around $2.25-$2.50/ MMBtu. But any sign of a warm winter would send HH benchmark prices crashing downward, along with the rig count.

It seemed to me that the U.S. had more natural gas than we could use or export at that time, so why were authorities still building coal-fired electric generation facilities? And with gas trading at approximately $1.60/MMBtu in June (or $0.60/ MMBtu in constant dollars after adjusting for 38 years of inflation) the fuel is clearly a bargain and meets the requirements for electrical power generation—i.e. cheap and plentiful.

Shale production and virus create new glut. Thanks to increased casinghead gas from U.S. shale fields, and reduced demand caused by Covid-19, the world is once again inundated with an ample supply of natural gas. In April 2019, oversupply in the Permian was so extreme that natural gas prices at the Waha hub reached a record low of minus $9.00/MMBtu. This combination of factors should cause gas output to decline 2.6% this year, with production of casinghead gas forecast to fall approximately 5.5%, compared to 2019 levels.

Before Covid-19, analysts predicted total global natural gas production would increase to 4.23 trillion cubic meters (Tcm) in 2020, from 4.07 Tcm last year. This estimate has been revised down to 3.96 Tcm for 2020, rising to 4.02 Tcm in 2021 and to 4.09 in 2022. Production from natural gas fields, which was initially expected to grow to 3.69 Tcm this year, from 3.52 Tcm in 2019, is now expected to reach just 3.45 Tcm instead, before recovering to 3.48 Tcm in 2021 and to 3.55 Tcm in 2022.

The biggest drop in casinghead production will occur in North America, which accounts for about 50% of the global output. From a level of 259 Bcm in 2019, associated gas output will fall to 246 Bcm in 2020 and remain flat in 2021. After that, analysts forecast outputs of 256 Bcm in 2022 and 269 Bcm in 2023. The Middle East appears more resilient, with output projected to drop from 95 Bcm in 2019 to 91 Bcm in 2020, quickly recovering to 94 Bcm in 2021 and 99 Bcm in 2022.

Demand and consumption forecast. The virus is also projected to contribute to a record drop in demand. Consumption should slump 4% this year, or twice the amount lost after the 2008 financial crisis, according to the IEA’s 2020 Gas Report. Global demand is expected to rise by just 1.5%, annually, to 2025, compared with a previous forecast of 1.8%.

“This year’s record decline represents a dramatic change of circumstances for an industry that had become accustomed to strong increases in demand,” said IEA Executive Director Fatih Birol. “The Covid-19 crisis will have a lasting impact on future market developments, dampening growth rates and increasing uncertainties.” The outlook marks a retreat in optimism from the IEA, which speculated in 2011 that gas was entering a “golden age” as a bridge fuel for swapping out carbon-heavy coal for renewables.

Annual gas consumption had already started to slow. In 2019 demand grew just 1.8% amid mild temperatures and slowing economic growth, particularly in China. That’s in line with the average growth rate over 2010–2017. European demand fell 7%, year-on-year, in the first five months of 2020, as coronavirus lockdowns curbed electricity consumption and industrial use of natural gas. Demand for natural gas in the power sector accounted for half of the decrease in worldwide consumption. Mature markets, such as Europe and North America, will recoup most of the losses next year, and lower gas prices will help demand recover in China and Asian emerging markets.

LNG outlook. China will become the largest LNG buyer in 2023, overtaking Japan, while India’s consumption will approach that of South Korea, now the third-biggest consumer. Slower growth in gas demand will mean liquefaction capacity additions will outpace LNG import growth through 2025, potentially reducing the prospects of a tighter market.

Global LNG trade will rise 21% by 2025 from 2019, reaching 585 Bcm. The U.S. should become the biggest seller of the fuel in 2025. “After a very strong wave of investments in new LNG projects, LNG consumption will be trailing behind capacity, which leaves the market with opened net selling positions, rising competition in the new markets in emerging regions,” says Jean-Baptiste Dubreuil, IEA natural gas analyst.

Buying the dip. Warren Buffett’s Berkshire conglomerate spent $4 billion to purchase natural gas transmission and storage assets from Dominion Energy, including a 25% interest in the Cove Point LNG facility. The deal greatly enhances Berkshire’s footprint in the natural gas business. After the purchase, Berkshire Hathaway Energy will carry 18% of all interstate natural gas transmission in the U.S., up from 8% currently.

Perfect opportunity. The green community has proposed a viable change model using natural gas to help transition to cleaner fuels. The plan is to generate more electricity with natural gas (vs coal), while updating battery technologies, then “encourage” consumers to buy electric cars. This model is being applied successfully in China to help reduce smog in its major cities. Now is the perfect time to ramp-up this transition to take advantage of a stagnant labor force, reduced construction costs and an ample supply of natural gas. But are there any companies, with sufficient capital, willing to step-up and take a leadership position? In any case, Mr. Buffet has answered the question about the future of natural gas in the U.S.

About the Authors
Craig Fleming
World Oil
Craig Fleming Craig.Fleming@WorldOil.com
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