Solar and Wind Will Drive Natural Gas Up

The price of natural gas in the U.S. has about doubled in a bit less than a year despite the fact that U.S. production has actually increased by about 5%.  This is due in part to new horizontal drilling techniques being applied to recently developed vast “unconventional” gas fields in the U.S. and Canada. So it might seem like the price of gas has gotten ahead of fundamentals.  But there are good reasons to be bullish about gas prices longer term. 

Natural gas is inherently cheap on two scores.  One is that the BTU equivalency of gas to oil would price gas around $23 per Mcf, nearly double its current price.  Also, gas is the cleanest burning fossil fuel, so it should be advantaged if and when carbon taxes are passed to deal with climate change. 

Gas is a regional market and supplies in Europe and Japan are tighter than in the U.S. Thus prices are higher there, allowing them to outbid U.S. LNG terminals for imports, which has virtually eliminated LNG supply coming to North America.  Moreover, European and Asian gas supply prospects may be even tighter after 2009, as discussed here, which would continue to preclude LNG supplies from the U.S. market absent much higher prices. 

Meanwhile demand for North American natural gas is growing from a number of markets including fertilizer and Canadian oil sands production.  In the future natural gas demand for transportation and electricity production will grow.   A strong marketing effort to promote natural gas for buses, delivery trucks,  and other heavy urban vehicles like garbage trucks, is one source of future rising demand.  Reports are starting to surface of people converting cars from gasoline to natural gas, a common practice on other continents.  

A second important market likely to strengthen in near future years is electric power generation.  That market is turning strongly away from coal in the U.S. and Europe and toward alternatives like solar and wind which are non-base load sources, meaning they work during some days and some hours a lot better than others.  When they don’t work, the generating plants must have “peaking capacity” to bring them quickly up to nameplate capacity.  Natural gas is the way to obtain short term bursts of generating capacity.

An example of this was described in the Oil & Gas Journal (4/7/08) in an article about the enormous new additions to wind power being constructed in Texas and Oklahoma as follows (p.19):

“Between Amarillo and Midland, capacity factors can rise of fall by 60% within 12 hrs.  So by 2011, when Texas has about 10,000 Mw of installed wind capacity, power generation might rise or fall by 6,000 Mw in half a day, requiring the sudden start-up or short-down of 15 - 20 peaking plants [powered by natural gas] to balance the load. “

Are wind and solar key parts of America’s coming energy revolution?   If so, count on natural gas as well.  

In the same issue a piece titled “Climate Bill Seen Raising Gas Use” quantifies the growth of natural gas that will be required for new wind and solar capacity, saying, “The Climate Stewardship and Innovation Act sponsored by Sens. Lieberman and McCain would raise gas demand by an average 14%/year against reference-case levels during 2020 - 2030.”  That’s a little further out than investors need to concern themselves with.  But the substitution of wind and solar for coal is happening already, spurring more gas use.

One concern about natural gas investments is the important variability caused by weather conditions.  Hurricanes can destroy supplies temporarily; hot summers and cold winters add enormously to demand; and temperate weather can destroy gas demand as we have seen in recent years.  Therefore it is very hard to predict what the price of natural gas will be by October, say, at the end of the summer and the 2008 hurricane season.  But lately gas storage has been  running a few percent below the five year average, providing a slight bullish background to the market. 

In the longer term, weather conditions may be less of a factor.  The fundamental bullish long term trends discussed above, less likely to be influenced by weather conditions, make me want to participate in the natural gas market, both through stocks like XTO and many others and by owning calls on long-dated natural gas futures contracts. 

Comments

[aquaculture]

physorg.com/news114876...

[richjoy]

Thanks Jim for another fine article. I continue to like natural gas more than I like oil (though I invest in both).

[DaveinHackensack]

Natural gas does still appear cheap, but when is the last time it has traded on a BTU-equivalent basis with WTI crude? According to a Rice University Study from November of 2007, ( www.rice.edu/energy/pu... ), the historic relationship between oil prices and natural gas prices has been about 7.5 to 1, i.e. a barrel of oil has tended to trade for the same price as 7.5 million BTUs (7.5 MMBtu) of natural gas (the energy content of a barrel of West Texas Intermediate crude oil is about 5.8 MMBtu).

In this space, I continue to hold a small Texas-based royalty trust, TIRTZ.OB.

[starkoski]

Jim I hammered you yesterday on the Nigeria oil article but I totally agree with you on this nat gas article. Good work and go have a beer.

[Alan von Altendorf]

The Rice study is a rearview mirror, looking at where we've been historically. The US has a natural gas surplus. About half of current Michigan production is being stored subsurface pending increased demand and lower taxes. Neither of those seem likely, do they?

[petersterling]

Great article on Gas. I love it partly because I own equity in a private company with its foot on two super-giant natural gas deposits, Blake Ridge, Sth Carolina and Bering Sea, Alaska. see; strategicnine.com

Yes the Dem's consumer-punishing, n carbocap and trade legislation will make gas the prefered power station fuel.

The switching of cars to compressed natural gas, (CNG) is so straightforward. In Australia 30 years ago, nearly every corner garage converted any car in a few hours for $500, by adding a gas tank into the trunk and running a line to the carburetor. The car still ran on gasoline as well. Today virtually every Aussie taxi uses CNG as its cheaper and cleaner too.

There needs to be a government backed plan to

A) install above-ground CNG refilling tanks at perhaps every 5th gasoline station.

B) Train installation garages like Smog check stations today, to retrofit cars for CNG.

C) Provide incentives (tax holidays, infrastructure loans etc.) to get large new gas resources, to the market more quickly.

There is no reason that 25% of the US fleet should not be running natural gas in 10 years time (needs around 5Tcf p.a. gas).

[keeter]

Great column.

gohaynesvilleshale.com

[gatormn]

He forgot to mention why the natural gas prices go up.
It is because the natural gas companies see a rise in oil prices so they just say why not$$$$ big $ in their pockets and then blame it on demand.
Here in Minnesota the cost inflates almost double every year why just because they can raise it.
They like to make money off the Minnesotains and other northern states.
So dont think it is about supply and demand because it has very little to do about that.

[David Lentz]

I second (third, fourth, whatever) the praise for a great column that throws light on a subject without a lot of illumination -- the downside of green energy.

It seems to me that there are alternatives to natural gas as a "filler" or backstop source of electricity, like overbuilding the wind/solar power generation facilities (perhaps using the excess energy to split water into hydrogen & oxygen, or storing the excess energy in any of several capital intensive methods). Geographical diversification of the green power facilities helps a lot as well, as it is pretty unlikely that the wind will stop blowing in TX, KA, NE, ND all at the same time -- that's just a way to implement an overbuilding strategy. But the one that seems most amenable to being "switched on" to fill in when green power fades is nuclear.

But for the next decade (at least), natural gas is likely to be the easiest and cheapest source of instant-on power.

[blink0404]

For me it looks like nat gas services are a better option than nat gas producers. NBR is performing extremely well, while DVN and RRC is falling a little bit.
Here's an article on coal, natural gas producers and natural gas services that readers might find informing if readers are interested in these sectors: www.greenfaucet.com/tr...

[MLB]

I understand the reasons behind the potential for natural gas prices increase but I fail to see how wind and solar would contribute to this factor based on your post here.

[User 224210]

Don't forget that the wind/gas synergistic relationship in Texas works both ways. Currently, Texas is about 50% dependent on natural gas for power generation and as wind power increases, it cuts into the demand for gas, since gas is more dispatchable. In other words, wind displaces gas, not coal. Wind is cutting into that 50%.... In other markets, where coal dominates, gas demand might increase to be dispatchable to meet the shortfall when the wind stops blowing.