Natural Gas Under Siege

By Paul Ziff, CEO, Ziff Energy Group, Calgary, Alberta | June 2012 Vol. 239 No. 6

The North American natural gas producing industry is “under siege.” The current price is far below the full cycle cost to replace gas that is produced and sold. The details of the predicament are described. With this article, I want to start with some of my solutions first.


Solutions

I envision various solutions to this dilemma, based on my four decades of gas consulting experience.

Unconventional Gas Demand
Unconventional gas demand allows producers to upgrade their gas price to an oil price equivalent:

1. Exporting gas as LNG to Asia can reduce the gas supply overhang, upgrading the overall gas price. Export capacity can be developed at existing LNG import facilities, such as Sabine Pass, Cheniere, and Lake Charles, LA, in the U.S., or at new “greenfield” projects such as the KM LNG project on the west coast of Canada that Apache is championing with top independents Encana and EOG;
2. Additional new announced greenfield LNG exporting projects by worldwide major Shell, with support from leading Asia firms, along with other potential LNG west coast export projects;
3. Leaders such as Talisman, which is joint venturing with Sasol regarding the development of new business strategy of synthetic crude oil to take low-cost natural gas and produce a premium-priced diesel fuel;
4. Implementing gas policies pertaining to gas for vehicles and trucks, especially commercial fleets in urban areas.

Other Demand Solutions
1. Preference for gas use in power generation, in recognition of the much lower level of emissions than coal;
2. Considering expanding the ethanol additive for vehicle fuel (natural gas is a key feedstock for making ethanol).

Potential Supply Solutions
1. Cost discipline by producers, not only to constrain current gas drilling until more of a supply/demand balance is achieved, rather to shut in gas production from gas fields that can be produced later. A minority of producers are doing this, however, to a very modest extent
2. Scheduling annual production maintenance during periods of low gas demand (and price).

Natural Gas Under Siege

As Figure 1 shows, U.S. natural gas prices at Henry Hub have descended to a low not observed since the 1990s when the industry was awash in natural gas due to the “Gas Bubble.” The picture is the same for Canadian gas prices.

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Figure 1: Henry Hub Gas Price (15 years).

Unfortunately, gas prices are so low that the cash costs for many wells (operating costs, royalties) exceed the gas price received, resulting in negative cash flow. On a “full cost” basis, all producers are losing a ton of money. What does full cost mean? Simply put, it is the price required to replace the gas produced. As Figure 2 illustrates, the full cost includes 1) Operating Costs; 2) Royalties payable to the owner; 3) the large capital cost to Find and Develop the reserve; 4) Cost of Capital, which includes interest on corporate debt, and profit on the Investment; 5) Corporate Income Taxes; and 6) Corporate Overhead (staff and offices).

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Figure 2: Sinking Gas Fortunes.