Why Isn't Natural Gas at $19.50 Per Mcf?
Posted on: Thursday, 3 July 2008, 03:00 CDT
By Strand, Rick
This article is a departure from the usual format, but I want to discuss the current price of natural gas and its sluggish behaviour against the booming oil price. Traditionally gas was evaluated at its energy content which, when compared to the energy content of a barrel of conventional oil, was about one-sixth. This traditional measurement was used for years as a tool for evaluating gas reserves in barrels of oil equivalent (BOE). Therefore, it was a tool for setting the value of reserves in a single format.
Over the last half dozen years this traditional measurement has lost its validity as the price of natural gas has failed to maintain its place in a rising oil price environment.
The reasons for this disconnect are manyfold:
OIL IS A WORLDWIDE COMMODITY, GAS IS NOT
Oil transportation and user infrastructure are fully developed so oil becomes a fungible, worldwide commodity. If a refinery in Texas doesn't need the oil then it can be rerouted to China or Japan or England or Spain or India or Sri Lanka . . . you get my drift.
Not all oil can go all places, but skipping the restriction on undesirable grades, it is easy to deliver to almost any market.
This is not true of gas - the infrastructure for transporting gas is less developed and has a higher starting hurdle. This is also true of the infrastructure for the end user, who has to be tied to the gas pipe.
You can't transport natural gas to your farm in rural Asia on a yak, but you can with oil. (How many barrels can a yak carry? Is there a market for larger two-barrel yaks? What kind of grass mileage do they get? Can I get one with a DVD for the kids? I need on with cup holders.)
The number of liquefaction plants (delivery to tankers) and gasification plants (removal from tankers) continues to grow. This growth is fast and furious as oil users, like China, look to replace oil importation (a shrinking supply commodity) with natural gas (a growing supply commodity).
China, for example, started importing LNG in 2006; England in 2005. Though the technology has been around for years (the first U.S. regasification plant started in 1971; in France in 1972), the growth and proposed growth is huge. Worldwide, there are already 26 liquefaction terminals and 60 regasification terminals, but there are 65 liquefaction and 181 regasification terminals either proposed or under construction.
This tells me that eventually there will be a worldwide infrastructure that will allow gas to be delivered to markets with the demand, which ideally should allow gas to be sold at its energy equivalent to oil.
WHAT DOES THAT MEAN FOR NORTH AMERICA?
There are no liquefaction plants in North America, only regasification plants. We can import but we can't export.
North American natural gas is trapped on this continent, so no matter what price natural gas is selling for in Asia or Europe, it is nearly irrelevant since we cannot deliver. More about why it is nearly irrelevant and not totally irrelevant later.
Think back to the '80s (yes, my children I remember that decade), Alberta natural gas was stuck here, and even though natural gas was $2.50 (U.S.) at Henry Hub, we could not get it to market down east because the gas delivery system did not exist. Our gas price was $1.50 (Cdn.).
Gas pipelines were built and Alberta gas became saleable as a competing commodity to Henry Hub gas. And prices equalized. Think of equalization as price at market less transportation cost, just like oil. This helps explain the difference in the chart at left, but a better comparison would be Edmonton Sweet Price to AECO because both compensate for transportation.
North America is now in a similar situation - the only demand that can be met with North American gas is North American demand. As we can import natural gas, our demand can be met with offcontinent supply. However, our temporary oversupply cannot be moved offshore.
MATURING NORTH AMERICAN DEMAND
For the last few decades, North America has increased the pace of the development of the natural gas delivery infrastructure - from the east coast of the United States to Vancouver Island has been integrated into the natural gas system. The gasification of utilities in North America has also increased demand. The big utilities used to be able to switch back and forth between oil and gas depending on relative energy cost, but over the last two decades, with both pressure from the Environmental Protection Agency in the U.S. and a growing energy price differential in favour of using natural gas, fewer utilities are being rebuilt or built to switch.
All this adds up to mature growth in North American demand; it will still grow, but it is tied more to the growth in population and economy than to developing new customers.
IMPORTS AT ANY PRICE
Here is the part where the price elsewhere in the world is nearly irrelevant, but not totally irrelevant. As long as the demand in the rest of the world allows the extra LNG floating around to be sold at a higher price than they can dump into North America, then it will as soon as there is LNG with no home, it comes to North America.
In other words, we become the cousin you take to the prom.
Because of the lag in the development of natural gas infrastructure, there exists the potential for times when LNG is looking for a home. Some gas fields feeding a liquefaction plant can be shut in when demand and price are low (Trinidad), but quite a bit of gas behind the liquefaction is associated gas, which is produced when producing oil (Saudi Arabia).
When the U.S. has lots of gas and the price falls, like last year, Trinidad shuts in. Saudi Arabia has a different dilemma - it either flares off the associated gas, mothballs the plant and the tankers, or it sells it into the largest developed infrastructure and market, North America.
The cost of transportation and compression is between $3 and $5, so getting $6 for gas seems a lot better than the expense of mothballing for a month or two.
Last spring, when England and Spain no longer required natural gas, North America absorbed it on top of an already stretched storage system. This further depressed the gas price, but it was still net positive for the sellers over mothballing and flaring.
THE CURE
The increase in infrastructure, including more gasification plants in high growth areas such as China, will eventually turn LNG into a worldwide commodity that will rival oil in price per energy unit. Once a more consistent year-round marketplace develops, the world will buy its gas at a level closer to price parity with crude oil.
For North America, the cure comes as collateral to the worldwide infrastructure, fewer imports and growing local demand will slowly allow natural gas to sell at its energy equivalency.
The North American marketplace already imports less LNG than it did in 2004 and 2005. The price has been better elsewhere, and when the offshore infrastructure is deep and broad enough, imports to North America will shrink some more, and our internal demand growth will drive our prices up.
THE TIMELINE
As I see it, it should take until about 2010 for the effects of the infrastructure building going on now to bring about a North American gas/oil parity price.
Richard G. Strand, CIM, FCS1, DMS, CH.P, is the President of HOME Investment Management Inc., a registered portfolio manager/ investment councelor in Alberta and Ontario, and Canadian Managed Futures Inc., a Portfolio Manager-Exchange Contracts, in Alberta, B.C. and Saskatchewan, and a commodity trading manager in Ontario. To learn more, check out these two websites: homeinvmgmt.ca and canadianmanagedfutures.com.
Copyright Northern Star Communications Ltd. May/Jun 2008
(c) 2008 Energy Processing Canada. Provided by ProQuest Information and Learning. All rights Reserved.
Source: Energy Processing Canada
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