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May 20, 2015

Greetings:

The hydraulic fracturing boom has unlocked massive new supplies of natural gas, and in the process has driven gas prices to rock-bottom levels. But signs of building gas demand suggest that a long-term price recovery is in the works.

Since 2010, the benchmark price for natural gas futures contracts has mostly held below $5 per million British thermal units (MMBtu). Frequently, the price has dipped as low as $2 per MMBtu, as drillers from Pennsylvania to Texas have raised output from previously uneconomical gas deposits buried in shale and other hard-to-drill rock.

The flood of new supplies has been dramatic. U.S. gas production rose more than 32% from January 2010 to January 2015, vaulting the U.S. into the top spot among gas producers worldwide. That's good news for gas users, since more supply has helped push prices down, but bad news for gas producers, for the same reason. The number of rigs actively drilling for natural gas has plummeted, from more than 800 in January 2010 to a bit more than 200 today. And yet output continues to soar: The Department of Energy figures supply will rise a healthy 6% this year from 2014's already-high level.

It might be tempting to assume that gas prices will remain low for the foreseeable future. However, demand is also on the rise, and it figures to ramp up further in coming years as the U.S. burns more gas for everything from generating electricity to fueling trucks and ships.

Power Shift

Take power plants. In 2010, the share of electricity generated by burning natural gas was a modest 24%, versus nearly 45% for coal. But because of tougher environmental regulations that are forcing many coal plants to close, the DOE expects gas to generate 31% of the nation's power in 2015, versus 36% for coal. (The total amount of power generated this year will likely come in right around 2010's level because of stagnant growth in demand for electric power.)

With even more coal plants slated to be retired over the next few years, utilities will increasingly call on gas to help take up the slack. Renewables are still in their infancy, and new nuclear plants are proving extremely expensive to build, meaning that neither of those sources can easily replace the amount of coal-fired capacity being lost. The DOE estimates that the coal plants closing this year alone accounted for 1.6% of all power generated in the U.S. last year. That's a lot of megawatt-hours to replace.

Gassing Up

Demand for gas is also growing from a surprising source: Fleets of trucks switching from costly diesel fuel to cheaper compressed or liquefied natural gas to save on fuel costs. Though still a tiny slice of total demand, gas consumed by vehicles has risen more than 17% over the past five years. Much of that growth has come from an expanding fleet of gas-powered garbage trucks and other trucks that follow relatively short, predictable routes served by dedicated natural gas fueling stations.

The recent slide in diesel prices has made switching to new gas-powered trucks less compelling. Clean Energy Fuels, an installer of CNG and LNG fueling stations that has benefited from the recent gas-to-diesel shift, expects a bit of a slowdown in 2015, says spokesman Gary Foster. But the company continues to open new fueling stations and believes truck fleets will gravitate to gas in the long run.

Foster says that even with diesel prices down from last year, gas still costs less than the energy-equivalent amount of diesel. As oil prices rebound, that advantage should widen again. Plus, he says, builders of truck engines are starting to introduce more models that run on LNG, which should hasten adoption in a few years.

And note that even ship owners are starting to take a harder look at gas as an alternative to cheap but polluting bunker fuel. One company, TOTE, is commissioning the world's first oceangoing containerships powered by LNG, the first of which is scheduled to enter service late this year. TOTE CEO Anthony Chiarello says the firm is moving to clean-burning LNG to meet tightening rules on maritime emissions that govern ships traveling within 200 miles of the coast of the U.S. and other participating countries. At $350 million for two new LNG-powered vessels, it's an expensive solution, but Chiarello predicts that other shipping lines will follow suit in five to 10 years.

Exports Ramping Up

The U.S. has long been a net importer of natural gas. But that's about to change, once a handful of LNG export terminals begin liquefying some of America's newfound gas riches and loading it onto tanker ships bound for Europe and Asia. The first export terminal, Cheniere Energy's Sabine Pass facility in Louisiana, is slated to begin shipments as soon as the end of the year. Four more export terminals -- from Cheniere, Dominion, Freeport LNG and Sempra Energy -- are also in the works and scheduled to come on line by 2019.

Combined, those terminals will be able to export about 9 billion cubic feet of gas per day when they're fully operational. That represents a bit less than one-eighth of all the gas consumed in the U.S. in February (the latest month for which output data is available). Gas exports via pipeline to Mexico also figure to climb.

Price Outlook

So where do gas prices go from here? After briefly surpassing $6 per MMBtu during the "polar vortex" cold snaps of last year, gas has gradually trended down, to about $3 per MMBtu today. Amazingly, even the brutal cold that sent gas demand in the Northeast to all-time records this past winter couldn't nudge prices higher.

Predicting short-term gas price movements is notoriously difficult, says Stephen Schork, who covers energy markets as editor of the Schork Report. "Traders have had their faces ripped off" guessing wrong on which way the market will move next, he says. Anything from an unusually cool spring to a freak summer heat wave can roil prices.

But in the longer run, gas prices look poised to trend higher. Demand not only will keep rising, but the rise will accelerate as the U.S. simultaneously generates more power from gas and exports more to overseas markets. Prices will stay volatile, but we see them heading toward an average of closer to $4 per MMBtu than the $2-$3 level that has prevailed in recent years. Bouts of prolonged summer heat or winter cold could cause higher spikes.

Gas consumers should figure on their bills rising over the next couple of years and act accordingly. That might mean locking into a long-term supply contract if the price on offer seems right; investing in insulation to reduce winter heating needs; or replacing old, inefficient gas appliances.

Higher gas prices bode well for gas producers. The biggest suppliers, such as Chesapeake Energy, Anadarko, Devon Energy and Southwestern Energy, figure to reap the biggest profits when prices do turn higher.

Sincerely,

Jim Patterson
jpatterson@kiplinger.com

P.S. Never hesitate to write me directly with questions or comments about any of the topics we cover, or anything else energy related. You can find previous issues of Energy Alerts or Kiplinger's Tech Alerts here.