The belief that America has a 100-year supply of natural gas has been repeated so frequently that it is often accepted as fact. Bill Powers, an energy expert and author of the recently published book, "Cold, Hungry and In the Dark: Exploding The Natural Gas Supply Myth," reveals the actual status of natural gas production in the United States. His prediction for rising natural gas prices, based on meticulous research of shale gas fields, have major implications for energy investors. As rising demand meets reduced supply, neither imports from Canada, LNG, or technology will significantly alleviate the situation. In explaining the lack of easy alternatives and blowing apart the myth of the shale gas miracle, Bill Powers challenges investors to plan for an American economy that will not be fueled by an endless supply of cheap energy. On July 3, the author shared his findings in this phone interview.
Denny Wright: Please discuss the myths of natural gas supply in the United States.
Bill Powers: It is very similar to the housing market and the market for credit default swaps in 2006. Those types of investments where they explode one day and people wonder why it happened but it was fairly obvious if you looked at what was going on. That's what I see happening with natural gas. In my book I blow apart several widely held myths about natural gas and how we are headed for much higher prices. Demand continues to grow but supply in the United States is rolling over. I see the fact that we are relying more and more on natural gas, even discussing exporting it as profoundly bad policies, which will lead into a 1970s-style natural gas crunch. But only worse.
Denny Wright: Around 2005 the common belief in America was that housing prices could never down. It sounds like you think there is a similar outlook on natural gas prices always remaining low.
Bill Powers: Correct, if you look at gas, we are at a 18-19 year low on rig count for gas directed drilling and looking at storage within the five year average, but what's most telling is the damage that's been done to the balance sheets of companies involved in shale gas drilling. I tweeted (billpowers1970) a few weeks ago that Chesapeake Energy (NYSE:CHK), the second largest producer of gas in the country and the largest producer of shale gas, is now expecting their gas production to go down 5% this year. This is very important because they have had huge problems and write-downs. Chesapeake took large write-downs to their Barnett and Haynesville fields last year of over 4tcf from those two fields. Their costs are higher than previously believed to produce the gas. Most shale gas players with very few exceptions, maybe Cabot (NYSE:COG) and Range (NYSE:RRC), are expecting very weak production and a lot of them are expecting production to go down. Exco (NYSE:XCO) and Ultra Petroleum (UPL) are going to see production go down. EOG (NYSE:EOG) will also have reduced production. BHP (NYSE:BHP) will likely see gas production fall this year because they are walking away from Haynesville after taking a huge write-down on the field last year. Encana (NYSE:ECA) is seeing production decline in the United States. These are all top 20 producers and whose production declines are not going to be offset by companies that are growing production in the Marcellus.
Denny Wright: Today, Chesapeake is selling over a billion dollars of assets to Exco. Meanwhile oil moves higher on news from Egypt but natural gas drops again today. Your thoughts?
Bill Powers: There was a white paper written by a research analyst at the Federal Reserve Bank of Dallas several years ago that discusses the connection between oil and gas prices. Historically, it's been a ten to one relationship, even though on an energy equivalent basis, it's six to one. What we see over the short term, like a lot of relationships it can trade anywhere and can be stretched to extremes. However, over time, what this paper said is exactly what's happening right now. Producers will drill oil projects and stop drilling gas wells. Eventually, gas will move back towards its 10 to 1 relationship, which puts the price at $10. Additionally, one of the things that never is talked about is that Canadian exports to the United States will fall dramatically in the next five years. Canada is at record demand because of increased demand for natural gas from fertilizer and oil sands companies. Production has fallen for over ten years and it shows no signs of stopping. Given Canada's current production trajectory and the fact that there is large export capacity in British Columbia, we are going to see a very large impact on prices. The commencement of Canadian exports will move North American prices to world levels over the next several years. World gas prices vary depending on the region of the world. At the low end, LNG is going for nine dollars in Europe and 15 dollars in Brazil, Argentina, and Chile. At the high end, LNG is being landed for 16-17 dollars in Japan. The price in the United States will probably fall somewhere on the lower half of that range but it will be substantially higher than it is today.
Denny Wright: If you were the CEO of a plastics or fertilizer business, where would you base your company?
Bill Powers: It depends on where you were selling your fertilizer. There is a very large Egyptian company along the Mississippi River in Iowa that actually owns IFC (Iowa Fertilizer Company) and, they have spent over a billion of dollars building the first world scale fertilizer plant in the United States in 25 years. Canada is also an attractive place given the amount of natural gas and the extensive pipeline system. In the United States one risk you would run as an industrial user are supply interruptions once natural gas prices really rise. In Canada, I think you are less likely to have that happen.
Denny Wright: In your book, you quote then Chesapeake CEO Aubry McClendon in 2008: "The surprise I have for people today is that the technological breakthrough that we have developed in finding gas from shale changes everything about what you think about natural gas scarcity in America." Could you please comment on the widespread belief that improvements in technology will continuously increase production.
Bill Powers: One of the big myths that I try to dispel in the book is that advances in technology can be counted on to save the day. Multi-stage fracture simulations and long length horizontal wells were big advances in technology which opened up lots of new reserves in formations that were previously uneconomic. However, we will need accelerating advances in technology to offset the declines. Modern shale gas wells are very high decline wells and now the United States has a very high decline production base. Nearly 35% of United States gas production is from shale wells that historically decline in the first five years faster than most conventional wells. I think technology will certainly help, as will higher prices. However, there are limits to technology. For example, natural gas production in the Gulf of Mexico peaked in 1997 at 14bcf per day and now its under 4bcf per day. There have been huge advances in seismic technology and deep water drilling but it couldn't overcome the fact that the Gulf of Mexico is a very mature area. Most fields in America are very mature and we've been fortunate enough to delay price increases through the hydraulic fracturing of shale plays. Also, it's not just technology that has kept prices from rising, it has also been the incredible amount of foreign capital that has come into the United States. A lot of the wells that have been drilled in the last five years have been woefully uneconomic partly because of zero percent interest rates. I think cheap money is going away and technology is hard to predict and does not advance in a smooth upward curve.
Denny Wright: Last year, Exxon CEO Rex Tillerson said his company was "losing our shirts on natural gas." Do you think this will change as prices increase, or will production costs mitigate any pricing improvements?
Bill Powers: Exxon has been struggling to keep its overall production from going down in recent years. They have become increasingly reliant on natural gas in North America and Qatar to replace dwindling oil reserves. This is a company that is struggling to replace reserves and a lot of the places where they can go to find gas and oil are now off limits to them. I think Exxon (NYSE:XOM) will be increasingly profitable as gas prices rise, however when you look at the 40 billion dollars or so they paid for XTO Energy, I think that was a lot of money for assets that probably are not going to provide a great of a rate of return. But given that the company is blowing down its high quality oil asset base, it needs to replace its reserves. By buying XTO it was able to do so. The company will continue to buy back shares and pay dividends but will it ever have a return on its shale gas investments? Probably not given the low prices that we have seen over the last several years.
Denny Wright: In the beginning of your book, you explain that in the 1970s increasing natural gas demand and prices were alleviated by coal and nuclear energy. Today, are there similar scalable substitutes that can temper any possible natural gas price increases?
Bill Powers: I expect to see declining dependence on coal and nuclear for electricity generation. In fact, as gas prices rise and push up electricity prices, I see solar going to grid parity in many areas of the country. Right now, we are seeing coal and nuclear plants getting retired and, it will be difficult for natural gas and renewables to pick up the increased demand. I see a huge boom in solar and alternative energies, especially distributed power among the very important changes that I see coming. As always, the market will adjust, as prices go higher, demand will be destroyed. Because of the inelasticity of the natural gas demand curve, it's going to take very high prices to destroy some demand. As a country, we need to consider ways of consuming less electricity and natural gas and consider the approach of the Netherlands. How can we make use of our existing resources to make sure that all stakeholders receive maximum benefit? That may be setting production limits or other methods of extending the life of our existing reserves because I think higher prices are going to cause a lot of economic pain and take many people by surprise. As individuals, there are many things we can do. I spoke with a radio station in Connecticut last week, which mentioned that utilities in the state are pushing the agenda of converting homes from heating oil to natural gas. I think that may be trading one problem for another. While there is a large pipeline in Connecticut, depending on natural gas to heat homes will increase demand and expose homeowners to wild price swings. Given the huge advances in efficiency and the recent drop in costs, homeowners should also consider geothermal systems and solar.
Denny Wright: What is the best use of natural gas in America given a future of decreased production?
Bill Powers: Manufacturing is the best use for natural gas. I don't think using it for transportation or generating electricity should be the priority. There is much we can do to increase the efficiency of the existing electrical grid. We can increase the installed base of residential solar to reduce line loss and use oil and natural gas for manufacturing and hopefully, high value added manufacturing. For transportation I am a big believer that electric vehicles will be the way forward. I like the idea of owning an electric car and never going to the dealership or buying gas. There will be a lot more electric vehicles on the market and cheap recharging stations everywhere that will make the idea of putting in a $350,000 natural gas refueling station seem ridiculous.
Denny Wright: What type of reaction have you received since your book was published?
Bill Powers: It's only been out for a couple of weeks but the people who have read it have been positive. I did an interview with someone who didn't agree with my conclusion and I asked, "Where am I wrong?" He couldn't find anything factually wrong but simply did not like my conclusion but that's ok. I tried to share all I learned in the book. I also try to put into perspective how absurd some of the shale gas resource estimates are. For example, the biggest field in the Western Hemisphere by production history, not opinion, not potential resources, not future recovery potential, is the Hugoton field in Kansas. According to the Geological Survey of Kansas it has produced slightly more than 35tcf over 70 years. So when shale promoters come out and say the Marcellus may have produced 489tcf what they are saying is that it will produce 15 times as much as the Hugoton. That's a hard number to believe given that the Marcellus has only been in commercial production for a little more than 5 years. The biggest field in Europe is the Groningen field in the Netherlands, which is estimated at 39tcf. Only one field in the world, the Urengoy field in Western Siberia has produced over 150 tcf (the exact number is not known because lot a lot of it came out in the Soviet era). While there is no doubt that shale gas is an important energy resource, I try to make very clear in the book that its significance has been vastly overstated.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.