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Did Exxon Misplay Its Bet on China?
07/30/2010 9:44 am EST
If new estimates are right, China won't import as much liquefied natural gas as once thought, leaving big energy companies—particularly Exxon Mobil—in the lurch.
You wouldn't think that any company, especially a company as savvy as Exxon Mobil (NYSE: XOM), could overlook China.
But that may be exactly what Exxon Mobil did in formulating its plan to pin the company's growth on natural gas—and in particular on liquefied natural gas, or LNG.
According to Wood Mackenzie, an oil and gas consulting company based in the United Kingdom, China looks like it will need only half as much additional liquefied natural gas in the decade beginning in 2020 than big energy companies—among them Royal Dutch Shell (NYSE: RDS.A), BP plc (NYSE: BP), Chevron (NYSE: CVX), and, yes, Exxon Mobil—had projected.
Projects such as Exxon Mobil's Qatargas Trains 4 and 5, RasGas, and Al Khaleej Gas in Qatar, the South Hook LNG terminal in Wales, and the Golden Pass LNG terminal in Texas, which made investment sense when it looked like China would import an additional 16 million tons of LNG annually in the coming decade, now face a scenario in which China would add only half as much to its annual imports.
That would hit all the international oil and gas companies hard, but it would hit Exxon Mobil especially strongly because the company has based its investing strategy on natural gas in general and liquefied natural gas in particular.
What's changed since, say, March, when Exxon Mobil announced it would increase capital spending 4% in 2010, to almost $28 billion, in a big bet on natural gas? And since its purchase of US natural gas producer XTO Energy for $28 billion?
Here's what: China is going to put new natural-gas-releasing technologies to work faster than previously thought.
Until very recently, oil and gas industry analysts were predicting that Europe would be the next region to put these technologies to work. The US gas shale boom began in the Barnett Shale formation of Texas and then spread east to Arkansas, Louisiana, and, most recently, to the Marcellus Shale formation that underlies most of the Appalachian region. Companies that developed fracturing and drilling technologies to release the gas during that boom had been looking to Europe as the next frontier. The past three to five years have seen an explosion of mapping and exploration from France eastward into Austria.
But while so much attention was focused on Europe, Chinese energy companies, led by PetroChina (NYSE: PTR), had started to map, explore, and tentatively develop natural gas fields in that country's own shale formations. From that early work, it now seems likely that China will produce 12 billion cubic feet of natural gas a day by 2030 from those shale formations and from continuing investment in coal gasification and coal-bed methane.That's equal to roughly a fifth of China's current production of natural gas—and more than enough to change the global economics of natural gas. (For context, US natural gas production will be about 60 billion cubic feet a day this year.)
NEXT: Six Ways China Is Changing the Game|pagebreak|
China Puts Gas Pedal to the Metal
How does rising production of unconventional gas in China change the game?
First, it turns the opportunity for an open-ended LNG boom into a window of opportunity. During the next two or three years, China will need to import LNG in the quantities that energy companies investing in natural gas have projected. But as China's own supplies of gas from unconventional sources gradually come online, a gap will open between what energy companies had projected China would need and what China actually imports.
Second, growing production from unconventional sources in China won't just damp imports of LNG; they'll radically reduce China's need to import conventional natural gas through pipelines from central Asia and Siberia. Recent years have seen a barrelful of deals between China and natural gas producers in Russia to build pipelines and secure supply. Those deals, like the investment in LNG, now come with a ceiling: By 2020, China still will import natural gas by pipeline, but it won't need any new pipeline capacity after that date, according to Wood Mackenzie.
Third, China now meets a relatively small percentage of its energy needs—about 4%—with natural gas. (Coal accounts for 68% of primary energy use, oil for 19%.) That will change as domestic supply grows and as China's government continues its policy of reducing carbon emissions by shifting to natural gas and alternative energy sources such as wind and solar. A likely winner from this shift is CNPC Hong Kong, a subsidiary of PetroChina that looks likely to be the parent company's vehicle for increasing natural gas distribution. Other names to check out include China Oil & Gas Group and China Resources Gas Group, as well as giant PetroChina.
Fourth, China's diminishing need for increased supplies of LNG changes the economics of the natural gas industry in Europe more than anywhere else. China looks to be emerging as the number two market for shale gas investment and technology deals—instead of Europe. (This depends, as always with China, on the kind of profits China will allow non-Chinese companies and investors.) China's shift to domestic unconventional sources of natural gas means that new LNG capacity coming online in, say, 2015 or so will keep prices for LNG low. Perhaps low enough to make importing LNG into Europe more attractive than exploring for and developing unconventional shale gas reserves in Europe itself.
Fifth, the growth of the LNG market pushed natural gas toward the status of a global commodity. That's now a fact of life, even if the oil and natural gas industry decides to cut back on investment in new LNG capacity. Because natural gas had been so hard to transport across ocean barriers—pipelines under anything but a short stretch of water are so expensive that they add too much to the price of natural gas—natural gas was sold in a series of continental or national markets with the price determined by supply and demand in that market. The growing global supply of LNG that can be shipped long distances has changed that.
Cheap LNG from Qatar competes with domestic natural gas to depress the price of natural gas at hubs in Louisiana. As the rate of increase in China's demand for additional LNG slows over the next decade, prices for LNG are likely to stay so low that only the lowest-cost producers (or the state-controlled producers who are willing to subsidize national companies) will find the business attractive. That's likely to lead to a reduction in new investment in LNG. But because these projects have such long lead times, LNG capacity that was planned based on China's projected need for 16 million tons of new LNG imports by 2020 will still come online during a good part of this decade. I think we can count on a long period of low prices for natural gas in the United States.
Sixth, all this makes the $4 billion in subsidies to encourage the use of natural gas as a fuel for trucks included in the stripped-down national energy bill proposed by Senate majority leader Harry Reid, D-Nev., a reasonable first step in a transition away from a crude-oil-based transportation system. Natural gas is likely to remain abundant and low-priced long enough for such a policy to produce results, and the market isn't likely to force prices so hard to the upside that a move toward natural gas will turn into an expensive dead end. (For more on why the proposed energy bill is as wimpy as it is, read this blog post on my Web site.)
All this is based on projections, not on actual natural gas production. And as any wildcatter will tell you, studies don't produce a calorie of energy—unless you burn them.
Right now there's a lot of debate about exactly how much natural gas these shale formations will ultimately produce. Recent projections that have just about doubled US natural gas reserves based on projected production from these shales, for example, are based on assumptions about the productive life of a natural gas well extrapolated from the life of conventional natural gas wells. There's enough data now so that skeptics have begun to argue that these projections are wildly wrong because wells tapping unconventional shale reservoirs of gas show much faster rates of decline than wells in conventional fields. If that's true, somewhere down the road, and sooner than we think, that abundant supply of natural gas is going to get much tighter.
At the time of publication, Jim Jubak did not own or control shares of any company mentioned in this column.
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.
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