With domestic supplies of natural gas growing with exploration and production in shale gas fields in the US, new opportunities—and risks—are upon us, notes Peter Way of Block Traders' Oil & Gold Monitor.

In our last letter, we made a case for recognizing that the energy scene in the US had made a (largely unrecognized) highly significant change in the past couple of years.

Lately, not because of our note, more and more recognition of the change is coming to light. The increased exposure is largely due to the magnitude of its importance to this country’s future well-being.

Assertions of national energy independence possibilities have become part of the political, upcoming election scene. Discussions of CNG-fueled passenger car developments are starting to be observed.

ExxonMobil (XOM) has made further deals to ensure its major position in NatGas production, and has made public its plans to begin exporting US-sourced NatGas to markets abroad, where substantially higher market prices may be obtained.

Confirmation of the stream values and prospective extent of “wet gas” (accompanied by associated liquid petroleum forms, including crude) reserves are becoming more available. Less valuable “dry gas” activity is shrinking, with drill rigs formerly devoted to these fields being withdrawn to serve on the more remunerative fields under development. Additional rail transportation resources are being made available to move product from areas like North Dakota that formerly had no such need.

Further evaluations of shale fields continue to add substantially to recoverable reserves estimates. Utica joins the adjacent Marcellus (OH, PA, NY), as well as the Bakken (ND) and Eagle Ford (TX) fields as major developing areas. Expansion of highway fueling stations for CNG-fueled truck transportation is progressing, with financial support of major NatGas producers.

Is this all just another “gas bubble” that the energy industry has seen many times before? Will the present enthusiasm intensify a NatGas oversupply that has pushed prices down to the low of $2 a mcf from its multi-year average of $7, and keep market prices in the $3 to $5 range for the next few years until the quick, cheap resources are extracted and committed?

We believe that the answers are all contained in the question above, concealed by a presumption that the “excess supply” will be lacking new markets. That would remove the motivation for producers to look for more cheap resources and sustain the oversupply. It is a wrong presumption.

What has become evident is that advances in extraction technology—horizontal drilling and hydraulic fracturing (fracking)—have so altered the cost economics as to make geological formations that are known to be widespread in the US now not only viable “technically recoverable” resources, but highly profitable ones.

What has been discovered is that the volumes of available hydrocarbons are far more extensive than originally expected, and because along with the “dry gas,” there are large proportions of liquids (NGLs and Crude) that substantially up the pay content of the wells’ flowstreams. The strong motivation is there, both from the reserves abundance and the cost-payoff balance to pursue and intensify this kind of production.

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All energy sources and uses are integrated by a common denominator, the delivered cost of an employable BTU (British Thermal Unit—a measure of heat content). Many applications of BTUs can be engineered to use a variety of fuel sources (i.e. electrical utility generation), while some (aircraft propulsion) are far less likely. Fuel source substitution is the order of the day in the energy business, driven by the utilized cost of the delivered BTU.

The calculations can get pretty intricate where demand has predictable variations in a continuing need. Electric utilities, where circumstances permit, have used off-peak (fueled) generating capacity to pump water to reservoirs at elevation so that hydroelectric turbines in peak demand periods can provide needed capacity.

In other situations, off-peak (interruptible) power is sold at cheaper (but still profitable) prices to industrial heavy users of electrical energy as an alternative to their higher-cost alternatives.

An important part of that cost calculation in every case, is the delivery cost. Coal mined at lowest production costs, but far from its ultimate usage, finds rail transport to be the practical answer, but there must be a reduction in what price miners can get from Utilities at the generating station.

Crude pipelined to refiners has the same cost offset. Now, new production from the Bakken Shale fields in North Dakota—where there is no available pipeline capacity—is turning to rail tank cars to deliver liquids.

That may be a temporary situation. Pipeline economics are very advantageous, once the transport facility is in place. But the installation cost is enormous. That makes it essential that there be an assurance of continuing demand to keep the transportation unit operating at a high level of capacity, or the pipeline will never be built. That consideration has kept limited the construction of gas pipelines to electrical utilities, limited by supply assurances, rather than demand factors.

Past occurrences of NatGas “bubbles” have emphasized in the thinking of using industries the irregularity of cheap prices and excess product availability. Now the energy industry confronts the virtual certainty that huge quantities of NatGas will be abundantly available at probable delivered costs (assuming available pipeline capacity) that alternative fuels (rail-delivered coal) may rarely be able to meet. Look for bond issues financing the new pipelines.

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A parallel to electric utility market expansion exists in the highway truck transportation market. The low-hanging fruit of local delivery-and-use operations like FedEx, UPS, and recently, the State of Virginia’s own government-transit needs, are already being met, or are in the process of being provided for.

But the longer-distance haulers need refueling capabilities. These are being developed initially by Clean Energy (CLNE), a Boone Pickens company, which is building a network of hundreds of coast-to-coast CNG refueling stations. Others apparently are following their lead, which will expand and hasten the truck hauler fuel-conversion actions.

In the private consumer transport opportunity area (not yet a market), there is already an in-stock CNG-fuel automobile, the Honda Civic CNG model being offered at roughly $27,000, with mpgs of 27 city, 38 highway, and none of the distance limitations of electric cars.

The present highlighted pitch is on emission absence, rather than fuel price economy. When this gets to be a significant market, the abilities of the existing gasoline service station network will undoubtedly become quickly expanded to vend CNG, at minimal installation costs relative to the potential demand and profits.

Given that conversion kits for conventional cars are readily available and in use in several foreign markets, as fueling economies become evident here, there will undoubtedly be tragedies from incompetent installations, followed by legislative fights over inhibiting regulations, ultimately followed by the growth of an industry populated by present installers of sound systems and other automotive embellishments. But there also is likely to be major auto-industry conversion to new-car CNG models.

How quickly that all happens depends a lot on how the energy industry is able to influence the marketplace for prices of the competing fuels. What? Say it isn’t so! For shame, in a “free-market” democracy, where the consumer is king? How could that happen?

Seems to me that in ages past, things just like that with the Standard Oil Trust, and others, have caused problems. Philosophically, the creator of comic strip character Pogo perhaps had the insightful notion, as he described a lesser annoyance: “Albert, you gotta expect ‘skeeters to skeeter; skeeterin’s their business.”

We’ll have to see how well those “noble” guardians of the public’s “well-being” from their enclave in the “beltway” will be able to provide any constructive refereeing in the matter. Please remember, they’re from you-know-where, and are “professionals here to help you.”

Right now, prices for crude at $90 a barrel are 22 to 25 times the $3.50-$4 price for NatGas. Some say coal can get competitive if NG goes much above $4. But Crude’s heat content in BTUs is only six times that of NG, while its price ratio is nearly four times that 6-to-1 relationship.

If coal holds NG to $4, and current retail gasoline prices are at $4 a gallon, perhaps CNG could be provided approaching as low as $1, certainly by no more than $2.

Reflecting on the simpler processing of CNG compared to crude’s cat-cracking required refineries, does gasoline at a competitive pump price of $2 suggest a crude price perhaps as low as $45 a barrel?

It all is going to take time and a lot of brutal negotiating before economic sense gets returned to the competitive scene. But it looks like new investments in purely-crude-based ventures may have a tough slog.

The broadening number of independent US hydrocarbon producers makes it much more difficult to keep prices from seeking rational relationships. That’s encouraging.

For now, we have a current fix on what the market pros at the block trade desks of the major market-making financial institutions think their big-fund clients are likely to do with the prices of many energy-industry firms between now and the presidential inauguration day early next year. We also know how well prior examples of those current forecasts have worked out in the past.

We tend to emphasize those issues where current investments seem to have much better than average odds of attractive payoff results. But we also report on the more lackluster potential candidates, to give some sense of what might be in store, for comparison purposes.

Everything stems from a common evaluation process of self-protective market hedging actions based on rational, forward-looking judgments, expressed by us in terms intended to make prospects as comparable and understandable as possible. But in as complex a game as this, with so many movable parts and players, don’t expect any guarantees.

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