Gas-Topians May be in for a Shock

June 29, 2012

The irrational exuberance around natural gas has been a cause for unsupportable predictions of 100 year supplies and energy revolutions in the US and elsewhere. Some folks have been concerned that natural gas will crowd out renewables in the future.

More and more evidence suggests that these ideas are not panning out – sobering if this information is even half right. I ran this by a few pretty smart and well informed people, who tell me it’s for the most part realistic

Automatic Earth:

..North America is collectively dreaming with regard to unconventional natural gas. While gas is undeniably there, the Energy Returned On Energy Invested (EROEI) is dramatically lower than for conventional supplies. The critical nature of EROEI has been widely ignored, but will ultimately determine what is and is not an energy source, and shale gas is going to fail the test.

As we pointed out in Get Ready for the North American Gas Shock in July 2011, the natural gas situation is not what it seems at all:

The shale gas bubble is a perfect example of the irrationality of markets, the power of perverse short-term incentives, the driving force of momentum-chasing, the dominance of perception over reality in determining prices, and the determination for a herd to stampede over a cliff all at once.

The perception of a gas glut has driven prices so low that none of the participants are making money (at least not by producing gas) or creating value. We see a familiar story of excessive debt, and the hollowing out of productive companies dead set on pursuing a mirage.

Many industry insiders know perfectly well that the prospects for recovering substantial amounts of gas are poor, and that the industry is structured as a ponzi scheme. Still, there has been money to be made in the short term by flipping land leases and building infrastructure to handle gas.

The hype is so extreme that those who fall for it contemplate, in all seriousness, North America becoming a natural gas exporting powerhouse, and a threat to Australian LNG producers, or to Russia’s Gazprom.

This concept, constructed from a mixture of greed and desperation (at the lack of conventional gas prospects), is entirely divorced from reality. (See here for Dimitri Orlovs excellent piece on why Gazprom has nothing to worry about.)

Nevertheless, euphoric hype is extremely catching. Given that prices are driven by perception, not by reality, hype has the power to change the dynamics of an industry, exaggerating boom and bust cycles in practice. The hype has resulted in the perception of glut – that North America is drowning in natural gas. The inconvenient fact that this peception is completely wrong does not alter its power in relation to prices.

Natural gas companies gambling on shale gas have been facing prices so low – far below the cost of production – that all of them have been producing gas unprofitably. The financial risk has been increasing dramatically as the companies have been drowning in debt trying to ride out the rock bottom prices that have been the result of people believing the fantasy. Finally,casualties of the financial shenanigans involved are emerging. It is very likely that there will be many more, as companies that have tried to ride out the low prices go under.

Wolf Richter:

Natural Gas: Where Endless Money Went To Die

Alas, thanks to the Feds zero-interest-rate policy and the trillions it has handed over to its cronies since late 2008, the sweeps of creative destruction have broken down. Instead, boundless sums of money have been searching for a place to go, and they’re chasing yield when there is none, and so theyre taking risks, any kind of risks, in their vain battle to come out ahead.

The result is a stunning misallocation of capital to the tune of tens of billions of dollars to an economic activity drilling for dry natural gas that has been highly unprofitable for years. It’s where money has gone to die. What’s left is debt, and wells that will never produce enough to make their investors whole.

But the money has dried up. And drilling for natural gas is collapsing. Last week, there were only 562 rigs drilling for dry natural gas, the lowest number since September 1999…

…At $2.53 per million Btu at the Henry Hub, the price of natural gas is up 33% from the April low of $1.90 per million Btu, a number not seen in a decade.

.But even if it doubled, it would still be below the cost of production. And if it tripled, it might still be below the cost of production for most producers. That’s how mispriced the commodity has become.


More from Wolf Richter:Dirt Cheap Natural Gas Is Tearing Up The Very Industry That’s Producing ItThe economics of fracking are horrid. All wells have decline rates where production drops over time. But instead of decades for traditional wells, decline rates in horizontal fracking are measured in weeks and months: production falls off a cliff from day one and continues for a year or so until it levels out at about 10% of initial production. To be in the black over its life under these circumstances, a well in the Barnett Shale would have to sell its production for about $8 per million Btu, pricing models have shown.…Drilling is destroying capital at an astonishing rate, and drillers are left with a mountain of debt just when decline rates are starting to wreak their havoc. To keep the decline rates from mucking up income statements, companies had to drill more and more, with new wells making up for the declining production of old wells. Alas, the scheme hit a wall, namely reality……The natural gas business is brutal. The peak in drilling occurred in September 2008 with 1,606 rigs. Then the financial crisis threw it into a vertigo-inducing plunge. After last years mini-peak, the plunge continued…Production lags behind rig count, and while rig count for gas wells has been setting new decade lows, production has been rising month after month to new record highs. But lagging doesn’t mean decoupled. And someday…. Oops, it already happened. It has started. Production has turned the corner, and not just in one field, but across the US.


Its still just a little notch in the curve. But its a sign that the collapse in rig count is translating into lower production numbers. And when the steep decline rates are beginning to overlap the drop in rig count, production will head south in a dizzying trajectory.
Money has been thrown at the industry, but the notion is dawning that the game is up and that returns will never materialize. The ponzi scheme has reached its natural limit, and investors are waking up to the realization that they have been chasing a fantasy.

Ironically, just as the washout begins, natural gas prices may have bottomed. Conventional natural gas in North America peaked in 2001. Coal bed methane and now shale gas have been revealed to be massively overblown as an energy source. Producers are reaping the consequences of malinvestment and will be going out of business. Demand has been building with the transition from coal to natural gas for power generation. This is an ideal set up for a supply collapse and subsequent price spike.

North America is poised for a huge natural gas shock. Far from being an exporter, North America is going to experience a natural gas supply crunch. Prices will be rising at the same time as peoples purchasing power falls precipitously, thanks to deflation. The structural dependency on natural gas that has been cemented in recent years is going to guarantee maximum pain as prices reconnect with reality.

41 Responses to “Gas-Topians May be in for a Shock”

  1. Martin Lack Says:

    EROEI is the key to defeating the lazyness and industrial inertia that is – apart from ongoing subsidies 12 times those given to renewables – driving all forms of unconventional hydrocarbon exploitation.

    I am currently in discussion with the Geological Society of London (GSL – of which I am a Fellow and a Chartered Geologist) regarding the laissez-faire aspects wihin both their position on exploitation of the Arctic and their position regarding Hydraulic Fracturing; both of which seem accept the continuance of business as usual. Unfortunately, turkeys don’t vote for Christmas, so the GSL is not going to demand that hydrocarbon exploration be made illegal (even if doing so would save the planet) but, even so, is there not room for a bit more moral courage…?

  2. rayduray Says:

    Hi Martin Lack,

    I’m wondering if you (or anyone) are familiar with and/or would care to comment on “Sustainable Energy — Without the Hot Air” by UK scientist David Mackay?

    http://www.withouthotair.com/Contents.html

    A friend recently read this and sang high praises. I’ve looked it over and felt it was a bit on the generalist side. I don’t object to the goal the author has set himself, which seems smart, i.e. informing the citizenry about our energy choices going forward. But I think the eventual answers are perhaps more nuanced than Mackay is willing to bog himself down in. The devil’s in the details, and all that.

    At any rate, it’s delightful that someone with your background is willing to join the fray here at Crock’s Corner. 🙂

    Cheers!

    • Martin Lack Says:

      Hello rayduray,

      Yes I am familiar with MacKay’s book (and particularly fond of page 6 in the introductory Motivations section). However, I have been criticised for citing it on this website, as Mackay has allegedly made some erroneous assumptions in order to arrive at his overall conclusion that 7 to 10 billion humans cannot survive on renewables alone. Personally, I am in favour of replacing fossil fuels with renewables and nuclear energy (but that is very much a minority view here and elsewhere).

      Notwithstanding all of that, I am pretty sure that it was MacKay’s work that led to the UK’s Dept for Energy and Climate Change (minimisation one presumes!) – DECC – producing their Pathways 2050 online toolkit, which is interesting to play with to see if you can solve the problem of how to power our future:
      http://www.decc.gov.uk/en/content/cms/tackling/2050/2050.aspx

      • rayduray Says:

        Martin,

        Re: “However, I have been criticised for citing it on this website, as Mackay has allegedly made some erroneous assumptions in order to arrive at his overall conclusion that 7 to 10 billion humans cannot survive on renewables alone. ”

        Yes, for one thing I’d think this massive human population will need the soon-to-be-absent protein from a collapsing resource like the oceans. http://www.livescience.com/4288-study-marine-species-collapse-2048.html

        [Aside: There’s a smart video here for those interested in further thoughts on the ocean as an exploitable resource:

        http://www.youtube.com/watch?v=myUoi_xWeiY&feature=plcp ]

        And they might need arable lands that probably won’t exist as sub-tropical deserts spread as they’ve shown indications of doing in the Mediterranean region and the Dustbowlification of the American Southwest. http://tinyurl.com/7xj7hqz

        Having plenty of renewable energy without affordable food? How is that going to work out do you suppose? 🙂

        ***
        Re: “Personally, I am in favour of replacing fossil fuels with renewables and nuclear energy (but that is very much a minority view here and elsewhere).”

        Sounds like something Jim Hansen might say. And I might concur. I’ve never been one to be too concerned about being in a well-informed minority, just as long as I can make a rational case for my argument. And clearly nuclear has a place in the future energy mix of our civilization in spite of the pesky waste disposal issue.

  3. rayduray Says:

    Here’s one of Martin and the other realists regarding nuclear power. This is a chart showing the relative safety of nuclear versus other energy sources. It’s quite a compelling story:

    http://transitionvoice.com/2011/03/nukes-are-scary-but-dont-forget-coal/

    In a nutshell: “For every person killed by nuclear power generation, 4,000 die due to coal, per unit of energy produced.”


  4. Rayduray – McKay is a shill for nukes pretending to be an unbiased source. I went into this in detail in response to Martin Lack. McKay can do math alright, but multiplying numbers correctly does not mean you have made correct or reasonable assumptions. For example, he assumes that cars used energy inefficiently in present form, and assumes that has to be replaced by the same amount of electrical energy. Wrong. Electric energy from solar and wind would obviously power electric vehicles which are at least four times more efficient. A series of such unrealistic, biased, assumptions adds up to very flawed, unscientific, non peer reviewed opinion piece, masquerading as unassailable truth. Whenever you assess such things, check to see if they are peer reviewed from a reputable scientific group. If not, see what references are given and if the references are same.

    • rayduray Says:

      Hi Christopher,

      Thanks for your thoughts. As I read the 10 page synopsis of Dr. Mackay’s “Sustainable Energy” book I had exactly the same objections that you did. Mackay’s work seemed to me to be a generalist’s gloss. That much we agree on.

      Is Mackay a shill for nuclear? Possibly. But on the other hand, we have no other power generation system that solves the GHG issue as well as providing reliable base load power as a proven and effective technology today. [The exception being regions blessed with hydroelectric capabilities, but which are fully built out in the developed world.]

      We Western middle class folks have it good. We have reliable 24/7 power whenever we want to flip on the computer, condition the air or heat the tea kettle, etc.. What wind and solar power simply have not solved is how to provide continuous power. That’s why I haven’t become enamored of the German mandate to eliminate nuclear power from the mix. What’s there alternative? Largely it is lignite. A terrible choice on the GHG front.

      One of the grand visions I have is of a re-engineered system with all renewables and sensible storage for the intermittency of wind and solar being take up with a massive fleet of smartly controlled batteries that power a transportation fleet. This is coming, but it seems to me a mature system of this sort is still decades away.


  5. Rayduray- no one knows exactly how all this will play out. One thing for sure, nuclear is unlikely to play a part in it for economic reasons alone. Too often, the arguments are that it’s nuclear or nothing. Or that alternatives just can’t do it. Or as you say, they can’t get here in time. Yet nuclear takes more than a decade to happen. Clearly, nuclear is not a viable short term solution. For the longer term, existing nuclear power plants are aging. Even if nuclear installation was expanded greatly, total capacity would barely budge. Painted from a real world assessment of these factors, nuclear seems less likely to play any significant role in GHG.
    The base load power issue is a technical one. The common misunderstanding is that base load power is reliable and other power isn’t. On a large scale, solar and wind are reliable and predictable. In fact, because of their distributed nature, they are less likely to be affected by disasters. All power plants require maintenance and down time. For wind and solar, less than 1% of capacity needs to be down for maintenance. For large centralized power, the whole unit goes down and must be replaced by other large capacity. Base load power has less ability to throttle. Nuclear is pretty much on or off. Base load power’s non throttle ability costs money. It means other generation has to stand ready for peaks not covered by base load power. In reality, for the near term, solar and wind seem less of a problem than feared. For one, wind has grown much faster than many anticipated and will continue to grow at a torrid pace. Solar is doing likewise and will surprise many. The real story is how truly amazing their growth and success is. I think there is sound evidence in Peter’s videos to be more optimistic. Germany and Japan are doing OK without nuclear. That lesson should not be lost on us.

  6. rayduray Says:

    Hi Christopher,

    TEPCO has just announced it is about to restart a nuclear power plant that was damaged in a 2007 earthquake. TEPCO has also made an arrangement with the Japanese government that basically transfers the Fukushima clean-up costs onto the taxpayer. This is a 10 year deal with private interests taking back the profit stream after the worst of Fukushima’s clean-up costs are borne by the taxpayer. It’s a hideous and shameful racket, but not at all unlike what we’d do here in U.S.

    Japan is also faced with very high imported fuel costs at present, having a negative impact on Japan’s balance of trade.

    ***
    Germany shut down about 40% of its nuclear power capacity in 2011. There’s still a significant amount of nuclear energy being produced in Germany:

    http://www.world-nuclear.org/info/inf43.html


  7. Rayduray- in 2005, while the US was under a pro fossil fuel administration highly antagonistic to alternative energy, few would have predicted such startling growth in wind energy in Iowa such that 20% of its electricity comes from wind. Likewise, few would have predicted Germany’s solar success. Far from it. And yet here we are. And you are telling me one nuclear plant in Japan may be put back online. Is there no more room for solar or wind in Japan? Hardly. One thing that has remained constant over the years is how much alternative energy has been ignored, dismissed, and overlooked and how much the arguments in favor of so called conventional power generation have been overplayed. I will make a prediction for you. All of the major sources of power will change in the next 10 years. They already have. In less than 30 years natural gas will diminish its role. Coal will continue to diminish its role. Nuclear will not be a major factor. The biggest surprise? Rooftop solar. It is growing and will grow much faster in the next 10 years. Global warming, exponential growth, and resource depletion are all part of an unsustainable world future. No technological fix can keep up with exponential growth. Food and water, the basic necessities, are being impacted in ways that affect growth. The big problem now is that the world is resorting to worse means of meeting demands for growth and consumption, like tar sands, deep water and arctic drilling, tracking and so on. Solutions that ignore the problem of exponential growth will have little long term effect. Otherwise, we are ignoring the 800 pound gorilla in the room. Those means that worsen our situation for short term, like tar sands, must be avoided, while we must seek a path to a balanced, sustainable, future.

    • rayduray Says:

      Christopher,

      You wrote: “Those means that worsen our situation for short term, like tar sands, must be avoided, while we must seek a path to a balanced, sustainable, future.”

      I’m going to play the realist here. Tar sands are profitable, and getting more so all the time. The tar sands play is not going to be stopped by sincere environmentalists finding this energy source to be odious. Far from it. The tar sands people will just buy as many legislators, presidents, and courts as needed to maintain their business model.

      As far as a balanced and sustainable future is concerned, I do not have that much faith in the human species to do anything except to race head-long and headstrong past obvious tipping points into a catastrophic future.

      Recall the cynicism of the monsters who created our financial crisis of 2008. In email exchanges traders would write to each other about the impending collapse that “IBG, YBG” meaning ‘I’ll be gone and you’ll be gone when the stuff hits the fan, so let’s just keep on scamming the system’. This is how the world is run today.

      And I’m just observing, Ray

      • Martin Lack Says:

        IBG/YBG – The phrase you are searching for is “intergenerational injustce”.

        I am not getting into debate about Nuclear (again), but am sure I would agree with you if you were to say “Tar Sands are only economic because of fossil fuel subsidies”…?

    • rayduray Says:

      Christopher,

      I like the direction you are heading in. But the point of my previous post about IBG/YBG is that much of the human species is reacting to the limits to growth, increasing climate weirding and our exponential race to hit the resource wall at suicidal speed with the cliched response, “Frankly, my dear, I don’t give a damn.”

      To paraphrase Margaret Mead, ‘Never doubt that a large group of thoughtless, selfish citizens can destroy the world. Indeed, it is the only thing that surely will.’

      For example, when you tell Americans in the Midwest that you want to raise their cost of gasoline by a dollar per gallon by shutting in the tar sands, you’ll be amazed at how many of them frankly don’t give a damn about climate change.


  8. Rayduray – I understand your weariness and wariness of the ” monsters who created our financial crisis”. You are getting to the root of the problem right there. You are right, there are financial pressures and those with greed and no morals will turn to IBG, YBG resulting in fracking and so on. I for one, will oppose them. I spent years pushing for the impossible dream of a better tomorrow. I am not about to give up now. Not while the revolution is just getting in gear and beginning its inevitable rise. Take heart. Times may be difficult, but unprecedented change for the better is on the horizon.

  9. mrsircharles Says:

    => Fracking Ireland – A Boom and Bust

    “In the US shale gas production costs a multiple of the current selling price.”


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