3 Reasons Why the Natural Gas Industry Is Attractive
The decline in oil prices still dominates headlines, while natural gas continues to fly under the radar.
After nearly a decade of declining natural gas prices, most investors have thrown in the towel. Even many energy companies have divested natural gas assets and shifted to producing oil. Those that stuck with natural gas have been faced with skepticism that making a profit with gas prices at less than $3 appeared impossible. However, incredible reductions in drilling costs have made it possible for many natural gas wells to break even, or even be profitable at current levels.
To illustrate this fact, consider that it took 1,560 rigs to produce 2.9 trillion cubic feet of shale gas in 2008. Today, the industry has 189 rigs, yet production is nearly five times higher. Such efficiency gains have been compared with Moore’s law, which has fueled the semiconductor industry for decades. However, this accomplishment has resulted in a persistently oversupplied industry, which has contributed to an 80 percent price drop.
However, there are reasons to be optimistic about rising demand for natural gas, which is a reliable, cheap and abundant source of energy. In fact, estimates show that demand for natural gas is expected to grow at twice the annual rate of oil. While it’s certainly a contrarian call, here are three reasons why natural gas is a compelling investment opportunity.
Exports are expected to drive a 20 percent increase in demand for U.S. natural gas by 2020.About 75 percent of this is expected to be fueled by Europe and Asia. Today, Europe relies on imports for 70 percent of its gas demand, with much of Eastern Europe being supplied by Russia. Recent geopolitical tensions highlight the need for a more stable source. Asia imports 30 percent of its supply currently, and this is expected to double by 2040. In order to ship gas overseas, it must be liquefied, otherwise known as LNG. After factoring in these costs and shipping, estimates show that $60-plus oil is needed for exports to be economical. However, export terminals are still being constructed, as these are long-term projects. In short, the U.S. has a major cost advantage in natural gas and will play an increasingly important role in meeting future demand.
Gas will replace coal as the primary source of U.S. power generation. Low gas prices are accelerating the shift away from coal. In 2010, coal accounted for 44 percent of the fuel used by domestic power plants, but has since fallen to just 30 percent. Meanwhile, gas has risen from 22 percent to 31 percent. While coal’s legacy as the world’s leading source of power is not likely to end abruptly, the transition is happening more quickly than most anticipated. For now, coal provides a floor to gas prices. Once gas reaches parity with coal, utilities capable of switching will do so, thus boosting demand. We believe coal eventually may be completely phased out. Policy makers are taking a more aggressive stand against carbon emissions, and coal is the primary culprit. Renewable sources would be an ideal replacement, but the technology is not yet sufficient. Gas is the most likely candidate to fill the gap.
Increased investments in pipelines and infrastructure will remove a major bottleneck over the next few years. Safely handling the product is one of the most daunting challenges facing the industry. Because it is a gas, it must be handled differently than a solid or liquid, like coal and oil. Utility companies need storage tanks connected to pipelines rather than storing loads of coal in a warehouse. Legacy infrastructure is grossly inadequate to handle the current supply, which is creating regional gluts, particularly in the Northeast. In some instances, regional gas trades for less than $1. The abundance in one region is constrained by lack of pipeline capacity to transport it to other areas, greatly reducing its value. More than $20 billion is being invested to remedy this issue over the next three years. Removing this bottleneck will make U.S. gas readily available throughout the country and facilitate higher demand.
The precipitous decline in oil prices captured the attention of most investors, but out-of-favor natural gas continues to fly under the radar. We expect U.S. producers will remain competitively advantaged to other geographies and benefit the most from growing demand. Unlike oil, gas is not controlled by a cartel; it is purely driven by supply and demand. This causes more pronounced differentials between geographies. For example, Asian gas prices are more than double those of the U.S. Despite current challenges facing the industry, natural gas is likely to become the world’s primary source of electric power. Estimates vary widely, but the U.S. is sitting on enough gas to supply the world for at least a century. Hopefully renewable sources will power the world in 100 years but until then, natural gas is the cleanest, cheapest, and most abundant hydrocarbon available.
