Category Archives: shale oil and gas

shale oil and shale natural gas (iii): shale gas

January 31, 2014 By in Industry Analysis, Mining, shale oil and gas Tags: , , , , , , , Leave a comment

shale gas vs. shale oil

The impact of the development of shale oil deposits in the US is primarily macroeconomic and global.  The effects of shale natural gas, on the other hand, are very specific to the US.

Why?  …for natural gas, in almost all cases you need a pipeline to deliver it (the other (very expensive) option is cryogenics).

As I mentioned in my post two days ago, over the vast majority of my investing career an Mcf of natural gas (one thousand cubic feet, the basic unit) has sold at more or less the same price as oil, based on heating value.  Today an Mcf sells for only a fifth of that amount.

What happened?

The simple answer is “shale.”

Three factors, the first two of which natural gas and oil share in common:

1.  Most of the costs of finding oil and gas are up front–finding prospective acreage, buying mineral rights and then drilling a well. There’s also the cost of “dry holes,” meaning wells that come up empty.

In a successful well, outputs typically beings to flow to the surface without much assistance.  The out-of-pocket cost of delivering a unit of oil or gas, once the upfront money has been spent, is pretty low.  So prices can fall a lot before output is forced off the market by negative cash flow.

2.  It’s actually worse than that.  Petroleum engineers want to create a steady underground flow of output to a given well, to ensure that the most hydrocarbons will be drained before another well must be dug.  Stopping the flow creates the risk that output will start up later at way under the former rate–and that (expensive) extra wells have to be sunk to get at the oil or gas.

In the case of natural gas, sellers also typically have long-term contracts that require them to be able to deliver specified amounts. So they’re not free to turn off the taps, even if they wanted to.   Also, oil and gas sometimes both come out of the same well so the operator is stuck taking the latter to get at the former.  In this case, giving the gas away may be cheaper than reinjecting it into the ground–which is what most places require by law.

And, of course, the development company may need cash flow from its wells to pay salaries, service debt or fund capex.

3.  Unlike oil, natural gas can’t just be sold into a global commodity market, for use anywhere.  No pipeline network, no potential customers with gas furnaces and hookups to the local gas utility = cap the well.  The gas is worthless (this was the situation in the US right after WWII).

Today, the US is crisscrossed by huge networks of gas pipelines, so that’s not a problem.  But the customer base is relatively static in the short term (the pipeline thing).  In a situation where supply is expanding and demand is relatively inflexible, the only way for the market to clear is for prices to drop through the floor.    …which is what they’ve done.

It seems to me they’re going to stay there for a long while.

implications

Natural gas customers will continue to enjoy lower bills for heating and air conditioning.  For residential users, this means more money to spend on other stuff.  For industrial, it means higher profits.

Electric utilities are starting to substitute natural gas for coal in power generation.  Again, lower consumer and industrial prices.  European companies are already beginning to complain that their electricity costs are a competitive disadvantage.

The US petrochemicals industry is structured to use natural gas feedstocks;  Europe is based on oil.  …a huge advantage for US firms.

Foreign hydrocarbon-intensive industries are beginning to relocate plants to the US to benefit from low natural gas prices.  These are typically not labor-intensive operations.  So other than construction work, no employment bonanza.  But every little bit helps.

I think we’re still in the early innings of this story playing out.

investments?

I can think of three areas:

–strong consumer discretionary companies will probably enjoy a small, but continuing, tailwind

–shale oil and gas exploration/development companies.  I haven’t looked, but my instinct would be to zero in on small rather than large, and the lowest-cost operators.

–equipment suppliers (I own Chicago Bridge and Iron (CBI)), although these have had quite a run over the past six months.

 

shale oil and shale gas (ii): shale oil

January 30, 2014 By in shale oil and gas Tags: , , , , 2 Comments

conventional wisdom…

In recent years pre=shale oil),conventional wisdom about world oil supplies has been dominated by several ideas:

–that world oil production is at, or near a peak (Wikipedia has a good summary

–that steadily increasing demand will be generated by nations like China and India (when three billion Asians trade in bicycles for motorcycles, and then motorcycles for cars…), leading to sharp price increases

–the continuing pivotal role of OPEC–despite members’ competing national agendas–both in supplying oil to the rest of the world, and in asserting the rights of the oil-producing nations to be fully paid for selling their principal asset to the rest of the world

–the (oversimplified) asymmetry between major industrial oil consuming nations, which–ex the US–have little petroleum output of their own, and producing nations, with not much going for them economically other than oil

–the central role of the US, the largest and most profligate oil consumer in the world, in moving D-day for a supply crisis closer to the present.  Two powerful special interest groups, Big Oil and Big Autos, have forged a unique alliance to block the (demand-lowering, government spending-funding) taxation of oil and oil products that is the norm elsewhere.

Less talked about, but still important, is the activity of  hydrocarbon “national champions: in places like China and Japan.  These are firms, some publicly traded, whose main mission is to secure oil supplies for delivery to the home country in times of shortage.  To them, profits are a distant second to getting control of barrels.

Other forms of planning for the upcoming shortage have been high up on the political agendas of most countries (ex the US) for years.  The development of nuclear power generation is one prominent example.

…may be turned on its head,

in two ways:

1.  The situation of the US, as the glutton at the world energy table, is changing.  It’s not that we’re consuming less.  It’s that, thanks to shale oil, domestic oil production is beginning to increase.  Also, the extremely low relative price of domestic natural gas, thanks to shale gas (tomorrow’s topic) is prompting users who can do so to switch from oil to gas.  The shale revolution is also beginning to get foreign oil users to relocate plants to the US so they, too, can use cheap gas as a feedstock.

2.  The shale oil/gas business is so new that no one knows yet what deposits may lie within the borders of large European or Asian oil-consuming nations.  These may also be very large, although natural gas recovery faces the distribution infrastructure issues I outlined yesterday.

consequences

There are certainly geopolitical implications as/if the asymmetry between petroleum producers and petroleum users shifts.  If/as that happens, will the Middle East be as important in politics?  Probably not.

Commodities speculation based on the idea of ever-rising oil prices may abate.

Alternate energy, particularly forms requiring large government subsidies, may lose investment appeal.

The oil industry itself may shift further away from the idea of Indiana Jones-like exploration for mammoth new oilfields toward the profit calculations of pocket protector-equipped mining engineers assessing recovery prospects from well-mapped shale prospects.  This probably favors smaller companies over larger ones.

Energy exploration and development firms with marginal success rates, whose main appeal is therefore their leverage to rising energy prices, become (even) more speculative than before.