Robert Rapier: From Peak Oil to Peak Fracking?

It is hard to overstate the shift that has taken place in the energy markets since 2005. That was the year the late Matt Simmons published Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy and set off a fierce debate about whether Saudi Arabia — and the world as a whole — had reached a global peak in oil production. In fact, according to Google Trends, searches for the phrase “peak oil” peaked in 2005, but then spiked once more when oil prices rose sharply in 2008.

Yours truly was very much involved in that public debate. My position now is still very much consistent with my position then: A global peak and decline in oil production represents a very serious threat to our industrial civilization, and it is risky to be overly dependent upon depleting resources so concentrated in the less stable regions of the world. More importantly, though, the world doesn’t require oil production to peak in order to suffer certain expected consequences of peak oil — like much higher oil prices.

But my position was also that the world was not quite yet at peak oil, and that high prices would provide a great incentive to bring new production online. Those who loudly proclaimed in 2005 that peak oil had arrived lost credibility when global oil production did in fact advance.

Following the price spike in 2008, interest in peak oil plummeted. However, a new term cropped up in a growing number of Google searches; one very much related to the decline in peak oil interest. Searches for “hydraulic fracturing”, or simply “fracking” began to rise just as interest in peak oil waned.

Interest in peak oil waned in part because the recession quickly depressed prices, but also because advances in hydraulic fracturing (fracking) and horizontal drilling began to change the narrative and  the supply/demand balance. In the US, oil production that had been declining since 1970 suddenly reversed course and in 2009 began to increase at a rate unprecedented in our history — to the benefit of many of the companies we cover in The Energy Strategist.

The natural gas markets have also changed radically since 2005. Not to pick on Matt Simmons, but in 2003 he also predicted, with “certainty,”  that by 2005 the US would be embark on a long-term natural gas crisis for which the only solution was “to pray.” Simmons wasn’t the only one to think that a natural gas crisis was imminent. In fact, it was widely believed that this would be the case, and companies began to plan and build liquefied natural gas (LNG) import facilities to cope with the expected shortfall.

Natural gas prices began to spike ever higher during 2005, and the Henry Hub Gulf Coast Natural Gas Spot Price crossed $15 per million British thermal units (MMBtu) that December. That was also the month that my former employer ConocoPhillips (NYSE: COP) bought natural gas producer Burlington Resources for $35.6 billion. As a result of what would ultimately prove to be an ill-timed purchase, ConocoPhillips shares spent years underperforming those of competitors as natural gas production began to climb and depress prices.

Since the low point in 2005, natural gas production in the US has risen every year. In 2012, dry natural gas production was a full 33 percent higher than in 2005, with major implications for consumers and businesses alike.

Consumers benefit from lower heating and electricity bills, as many utilities have switched from coal to natural gas. In 2012 a paper from Yale estimated that in 2010 alone, when the spot price of natural gas averaged $4.37/MMBtu, lower natural gas prices were adding over $100 billion a year to the US economy. In 2012 the benefit was even greater as the average price slid all the way to $2.75/MMBtu.

As a result of the lower natural gas prices, manufacturers such as chemical companies began to invest in US projects again. The American Chemistry Council has identified $16 billion in potential chemical sector investors that it says would create 17,000 new jobs and provide $33 billion in new revenue.

One of the companies hardest hit by the new supplies of natural gas was Cheniere Energy (NYSE: LNG). Cheniere built a $2 billion LNG import facility just as LNG imports began to plummet. Its share price followed suit, falling from $40 in 2007 to $1.12 by late 2008.

But Cheniere proved resilient, and decided to convert its Sabine Pass facility on the Louisiana/Texas border into an LNG export base. It has received approval to do so from the Department of Energy, and given the current differential between US natural gas prices and LNG prices in other parts of the world, the terminal looks well-positioned to do brisk business. As a result, Cheniere’s share price has come back to the vicinity of $30.

The cost of moving LNG from the US into foreign markets has been estimated at $6/MMBtu, and in 2012 the differential between US natural gas and LNG in Japan was $14/MMBtu. The differential between the US and European markets was above $8/MMBtu. These differentials provide a compelling economic case for LNG exports.

This push to export LNG is pitting heavy natural gas consumers like Dow Chemical (NYSE: DOW) against natural gas producers like ExxonMobil. Like ConocoPhillips, ExxonMobil shares have underperformed in recent years because of the company’s ill-timed $41 billion buyout of natural gas producer XTO Energy in 2009 — when natural gas prices were around $6 per MMBtu. The acquisition of XTO made ExxonMobil the largest US natural gas producer, but in June 2012 then-CEO Rex Tillerson famously complained that “We are losing our shirts” on natural gas production because of low prices. LNG exports could change that equation.

They should result in higher domestic natural gas prices, hurting Dow and certain other heavy users of natural gas, alongside consumers. Regardless, expect more LNG licenses to be approved, and as long as natural gas production remains strong natural gas producers in the US should benefit.

So investors can expect higher natural gas prices, but not a return to the lofty levels of 2005. As higher demand boosts prices, some of the natural-gas production shut-in during the recent slump will be brought back online, bolstering supply and limiting the price increases.

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