Natural Gas Overproduction

On December 27, 2013, Matt Wald published a piece in the New York Times titled New Energy Struggles on Its Way to Markets that points to the predictable consequences of having too many energy options chasing too few customers.

When there is excess supply compared to demand, prices tend to fall rather dramatically. Falling prices result in some suppliers being forced to either stop selling or to sell their product for an amount that is less than production cost.

Eventually, markets balance out as weaker suppliers are driven out, reducing both production and production capacity. Lower prices lead to increased demand and shifts in market share to options that seem to meet customer needs at a lower cost. The oversupply situation disappears and price begin to climb back to a more profitable level.

The cycle may continue, but only after a profitable period when supply does not quite match demand and prices soar high enough to encourage new competitors with new financial backers. There is nothing magical or original about these statements; they are fundamental concepts taught in both Economics 101 and Business Mangement 101.

In the economics courses, students often learn about the ideas as uncontrollable trends predictable by statistical analysis of soulless markets. However, in the business management courses, students learn that they will be responsible for taking actions to do whatever they can to influence both supply and demand in order to best position their enterprise for success. They learn how to market products to push demand to higher levels and they learn techniques for predicting demand and managing production to prevent inventory overhang and price-damaging gluts.

They also learn that it is sometimes beneficial to their long term success to put their products “on sale” at prices that are temporarily unprofitable. By holding sales events with marked-down prices, they stimulate new demand, weaken their competitors, and capture market share. Repeated sales events can help to drive some under-capitalized competitors out of business; that means more market share and the opportunity to allow prices to rise a more profitable level for a while.

It is that context that I have suggested to colleagues and writers like Matt Wald that there is a distinct possibility that low natural gas prices are less accidental than they seem most observers. As Wald pointed out in the conclusion to his article:

It is not clear how this struggle will play out over the next few years. At the moment, according to Mr. Webber, natural gas is so cheap that it is stunting construction of even new plants that would burn natural gas.

The people who operate the large, multinational commodity enterprises that supply natural gas in the United States are run by people who did very well in their business courses — including “courses” taught in the school of hard knocks by surviving in the day-to-day market. Those business leaders have worked hard to learn how to use the law of supply and demand to the benefit of their enterprises.

By pursuing horizontal drilling and hydraulic fracturing technology as rapidly as possible, gas suppliers have successfully lowered the price at which they are selling their fuel to a level that is unprofitable for most of their less heavily capitalized competitors. Since most gas extractors also extract oil, they have been able to finance their unprofitable gas operations from the healthy profits obtained by selling liquid petroleum at prices that are five times as high today as they were a dozen years ago. Other gas extractors have financed overproduction by convincing others that their newly discovered resources are worth paying five to ten times as much for leases as before the boom.

The long-running natural gas sales event has been working in the same way that sales events normally work. More customers are being attracted by the seductive pricing. They are building infrastructure that will take advantage of current natural gas prices, but that infrastructure will lock-in continued purchase of their chosen fuel option. Natural gas competitors are being weakened by being forced to either stop selling or to sell their product at prices that provide little, no, or negative margin above cost.

Though it might seem to some observers that all energy competitors other than natural gas are being hurt — or targeted — by the gas oversupply situation, it is might be useful to note that many gas companies are heavy investors in wind, solar and biomass projects, that they politically support generous financial incentives for those power sources, that they often form political alliances with unreliable renewable energy suppliers, and that they realize that unpredictable power supplies from wind and solar lead to the need to provide “firming” using the most responsive option available — which, as they have repeatedly informed us all — is natural gas.

Coal is an obvious target because it already has a large market share and it has numerous drawbacks that are easy to attack. In fact it is so unpopular that natural gas advocates have declared a war on coal and have openly participated with financial support for efforts like the Sierra Club’s Beyond Coal campaign.

It might also help to use the magic of archival searches to recall the optimism about the nuclear renaissance as exemplified by another Matt Wald article from 2007 titled Energy Bill Aids Expansion of Atomic Power. Back before the “shale gale” and the long running economic recession with its anemic recovery, major publication were producing paragraphs like the following about the potential for nuclear energy growth in the United States.

But the provision has the potential to considerably expand the nuclear industry, which plans to build 28 new reactors at an estimated cost of about $4 billion to $5 billion apiece. And while the nuclear industry would be the biggest beneficiary, the provision could also set the stage for billions of dollars in loan guarantees for power plants that use “clean coal” technology and renewable fuels.

The nuclear industry is enjoying growing political support after decades of opposition from environmental groups and others concerned about the risks. An increasing number of lawmakers in both parties, worried about global warming and dependence on foreign oil, support some expansion of nuclear power.

Each large nuclear plant produces as much energy each day as 200 million cubic feet of natural gas burned in an efficient combined cycle gas turbine (CCGT) plant. When there was a prospect of 28 new plants — with many more to follow if those plants were successful — the natural gas industry was facing the prospect of permanently losing a lucrative market for their product. The initial loss upon completion of 28 new nuclear plants would be about 3 billion cubic feet per day, and that number had the potential for substantial growth.

Is it really surprising that there has been an almost non stop effort since 2007 to teach us all that natural gas is clean, cheap, and abundant and that climate change is not as worrisome as it seemed to be? Should it surprise anyone to learn that George Mitchell, sometimes called the father of fracking, endowed a foundation that provided hundreds of millions of dollars to support programs like natural gas sustainability marketing.

For some odd reason, when I point out that energy business leaders learn early in their training programs that the law of supply and demand is something they need to understand so that they can control its effects on their businesses, people often accuse me of being a conspiracy theorist. Why?

What is so strange about pointing out that most businessmen are in business to make as money as they can as fast as possible, even if it hurts others, damages the long term health of the atmosphere, reduces the oceans’ ability to produce food, and results in the ever increasing risk of major conflicts over control of natural resources.

PS – It is worth noting that Bloomberg commodity market reports indicate that the natural gas sales event may be coming to an end. The current price of natural gas for delivery in Feb 2014 is nearly $4.37 per MMBTU. That is a 76% price increase since February 2012.

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