Natural Gas Prices - Is the wild ride over?

Stable natural gas prices in the $6/MMBTU range will support the shale gas industry in the lower 48 and also construction of the Alaska gas pipeline. The Dallas Morning News reports these comments of Atmos Energy's Chairman (retrieved from Downstream Today):

"We've got a 100-year supply of natural gas that we know of, and we've got stable prices," Best said Friday during a panel discussion at a North Dallas Chamber of Commerce gathering. "It's Economics 101. When you have a big supply, you have stable prices, and those prices are stable today."

Natural gas prices have been around $4 per thousand cubic feet for the past year, after rising three times as high a couple of years ago. Natural gas companies have been producing more of the heating and electricity fuel in the U.S. because of cheaper and more effective technology.

Atmos operates the regulated natural gas utility in North Texas and elsewhere. The company doesn't make money by selling natural gas, only from delivering the gas.

Best said the sweet spot for natural gas prices is between $5 and $7 per thousand cubic feet.

"At that level, the producers could drill and would have a fair return. The consumers would not feel that prices were too high," he said.

Long term prices in this "sweet spot" range should help build American energy independence including the Alaska Gas Pipeline.

Another LNG Myth Busted

Some argue that an LNG terminal at Valdez can not compete with tidewater LNG projects. The conventional wisdom holds that tidewater LNG projects don't have to bear the cost of a long pipeline to feed the LNG plant. Is it possible that the low hanging fruit of tidewater LNG sites have been exploited and that now it's time to move inland gas to the coast for liquefaction?

This week the Gladstone LNG project announced that they have sanctioned the $16Billion 7.8mtpa LNG project. The project includes a 420 km (260 mile) gas pipeline.

This scope compares very closely to a Valdez LNG project option. A Y-line originating in Delta Junction would run about 270 miles to Valdez. 7.8mtpa LNG requires about 1.0 BCFD of treated natural gas. The AGIA findings considered a 2.0 BCFD LNG plant (LINK).

A pipeline feeding a Valdez LNG terminal would conceivably include a lateral at Glennallen for instate gas customers.

Of course the two projects are not an exact apples-to-apples comparison. An Alaska LNG option would have to tack on transportation charges to move gas from the North Slope to Delta Junction, and the pipeline route is more challenging in Alaska (Isabel Pass 3420', Thompson Pass 2812', subsurface frost and the Denali Fault). These challenges would tack on cost to the $16Billion budget.

The Gladstone Project scope includes upstream development cost (drilling wells, small pipelines, gas treatment etc.). Most of the upstream Alaska gas development has already been accomplished and the treatment cost of Alaska gas would be rolled into the transportation cost. It's possible that the Gladstone upstream development cost would offset the cost of Alaska specific challenges making the comparison more valid.

Conclusions:

1) The Gladstone project bust the myth of tidewater only LNG plants.
2) If Gladstone can do it - so can Alaska.
3) A Y-line from Delta Junction to Valdez supports instate gas line options.

The Future Price of Natural Gas

A lot of Alaska Gas Pipeline speculation focuses on the current "low" spot price of natural gas. Obviously no one wants to spend billions building a pipeline to connect Alaska natural gas to the lower 48 if inexpensive gas is available near consumers. But does the current low spot price really reflect the actual prices paid during the first 20 years of gas line operations? Probably not. To illustrate this point look at the following two examples:

1) The graph below shows the prices for NYMEX natural gas futures from the present to December 2023. These are prices that consumers of natural gas are willing to buy options to buy gas in the future. For example if you use natural gas to make steam or power or operate a heat treating furnace you might decide to secure an option to buy gas months or years in advance. When the settlement date of the contract comes up as a buyer you may elect to exercise the option or buy gas on the spot market depending on the spot price and the price paid out for the option.

(Data)

Look at the futures spread to understand the direction gas prices are going. Generally the trend is up, not drastically up, but steadily up. This is probably a reflection of expectations of moderate inflation in the coming decade and the gradual shift from coal to natural gas.

Inflation in the energy sector tends to amplify - first the commodity price increases, then the cost of adding production increases as the cost of steel and labor goes up. The past teaches us that we seldom get the balance right. During times of low cost we don't invest in new production fast enough and in times of high prices we tend to over build and prices collapse. Along the way cold weather, hurricanes, accidents and disruptions contribute to randomize the settlement prices for gas. Therefore, future prices five, ten or twenty years out are only important to projects with long time lines. In the case of the Alaska Gas Pipeline the price trend is favorable.

2) What about shale gas? Last week shale gas champion Chesapeake released preliminary 2010 operating results. Those result include disclosure of their hedging positions, namely that 96% of 2011 gas production is hedged at $5.84/MMBTU and 17% of 2012 gas production is hedged at $6.19/MMBTU (Link to Chesapeake Operational Results). Previously Chesapeake has indicated a target gas price of $6.00/MMBTU, and in April 2009 Chesapeake deferred production of gas when the price was in the $4.00/MMBTU range. Updated Link: (Chesapeake presentations)

Conclusion - Expect near term (1-2 year) return to $6/MMBTU gas prices. Someone is already buying options to buy Chesapeake gas at this rate and the evidence points to this price range as the sweet spot that promotes new discovery of natural gas and further development of shale gas fields. Fortunately it's a price range that will support building the Alaska gas pipeline.

2011 Alaska Gas Line Forecast

The big story for 2011 will be the results of the 2010 open seasons. Each pipeline project (APP* and Denali) will complete and execute precedent agreements where shippers make long term commitments to ship gas. Prediction: With a little luck we’ll hear some positive news on these agreements before the Nenana ice goes out (late April-ish).

To date we know that TransCanada (APP) did not meet its target for binding agreements by the end of 2010 (Fairbanks News-Miner 07 Dec 10). Imagine the difficulty of signing a binding contract loaded with conditional statements about tax rates, project mergers, the price of steel and long-term gas supply agreements. The project cost is also at risk due to uncertainty of interest rates. One day the Federal Reserve might just run out of ink and stop printing free money. That will jolt the bottom line of the project, although a small interest rate jolt might push the project in the right direction and cause a sense of urgency.

Maybe the APP delay is not a bad signal. The TransCanada AGIA proposal included a very notional estimate of the LNG option. It might take longer to execute the agreements if a viable shipper seeks to ship gas on a Y-Line LNG plant option smaller than the options outlined in the TransCanada AGIA base cases. For all we know a viable shipper may have bid to take gas off at Glennallen for in-state use. Prediction: Expect a viable shipper for a 7 MMTPA Valdez LNG plant, that's roughly equal to 1 BCFD, or half the notional capacity described in the TransCanada AGIA proposal.

The next big milestone, not shown on any official schedule, is the merger of the projects. The producers (ExxonMobil, ConocoPhillips, and BP), TransCanada and some surprise as yet unnamed shippers all know that they must converge at some point. Prediction: Project merger announcement in late 2011.

Of course my glass is half full, maybe two out of three of these predictions will come true. Best wishes for a happy and prosperous 2011.

*Nomenclature Note: Henceforth I’ll use the name “APP” to describe the Alaska Pipeline Project instead of TransCanada-ExxonMobil+AGIA.