Natural Gas Supply and Demand Balance

The following is a guest post by Jon Friese who has formatted, with comments, excerpts from an excellent recent report by energy research firm Johnson Rice and Co. The post highlights graphically the fact that our natural gas feast or famine due to marginal unit pricing and focus on short term earnings/reserves is currently in the 'feast' stage. When we re-enter NG famine cycle depends on industrial demand, LNG imports and the depth of the coming production decline. Right now, a great deal of our natural gas resource is uneconomic to drill. Thanks to Jon, and the research folks at Johnson Rice.

Shale directed drilling rig count
Source: Johnson Rice & Company
-Click to Enlarge

Johnson Rice & Company (JRCO) was kind enough to provide their analysis of the current natural gas price situation. They are predicting a possible rebound in prices in late 2009, depending on the multiple factors they lay out in their analysis. We look into the details below the fold.

Natural Gas Supply and Demand Balance

Falling Production, Falling Demand and LNG

The Johnson Rice & Company (JRCO) constructed a model of production and demand flows and looked at what it will take to balance these flows at higher prices. This is exactly the kind of information and insight we need to build an improved dynamic model. I read the analysis with great interest and rushed to write it up to hear the comments of the TOD contributors.

Here is the summary of factors:

Current Oversupply 4.0 Bcf/d
3 Month Rig Lagged Production Effect -3.6 Bcf/d
Avg. LNG Import Increase 0.5 Bcf/d
Avg. U.S. to Mexico Export Drop 0.5 Bcf/d
Remaining Industrial Demand Drop 1.0 Bcf/d
Canadian Import Drop -0.9 Bcf/d
GOM Production Return 0.9 Bcf/d
Steepened Decline Curve Effect -1.3 Bcf/d
Year End 2009 Balance 1.1 Bcf/d

Table 1: Factors in the supply and demand balance

Production Passed Demand in the First Quarter 2008

For context I have added a chart of natural gas prices and rig counts. It is apparent that some time in the first quarter of 2008 production exceeded demand and prices started to tumble. Production continued to climb leading to the current oversupply.

Figure 1: Natural Gas Prices at the well head
-Click to Enlarge

The JRCO analysis backs up the production to the first quarter and estimates that the level of over production is 4 Bcf/d (without considering LNG or a drop in demand). Figure 2 shows that production in Q1 08 was about 53 Bcf/d and Dec 08 production was about 57 Bcf/d.

Figure 2: US Onshore Gas Production
Source: Johnson Rice & Company
-Click to Enlarge

Production Reduced by Falling Rig Counts

Drilling rates have been falling very rapidly and rigs are down from a peak of near 1600 to just over 810. However JRCO points out that it was the shale gas wells that caused the overproduction and that the number of shale gas rigs has only just fallen to the Q1 2008 level. Baker Hughes does not break out the active rigs by target and so I found the following graph fascinating. Most of the pull back in shale drilling has been in Barnett. Haynesville has built rig count despite the fall in prices.

Figure 3: Falling shale directed rig counts
Source: Johnson Rice & Company
-Click to Enlarge

The JRCO analysis makes a point of saying that most of the total rig count reduction has been in non-shale gas. They estimate that a drop of 541 non-shale rigs would have same effect as a drop of 400 shale gas rigs, when adjusted for well performance. The shale rig count is only down 3 rigs over Q1 2008

JRCO provided the following Internal Rate of Return graph. It clearly shows how the tight gas sands in the Piceance Basin are not competitive against the shale plays, but it is less clear to me why the Barnett shale should be dropping rigs rapidly and not Woodford or Fayetteville.

(Chesapeake has made a clear distinction between the "shale haves" and the "shale have nots" in their March 2009 Investor Report that we will examine in another post.)

Figure 4: Comparison of IRR for several natural gas plays
Source: Johnson Rice & Company
-Click to Enlarge

The total reduction in rigs (as of March 20th when the report was published) is expected to low supply by 3.6 Bcf/d in late 2009. However there are many complicating factors, such as the declining economy and increasing LNG supply.

Further Drop Expected in Industrial Demand

One of the largest unknowns is the current state of the economy. Are we in for a rebound or further declines? The JRCO analysis predicts further declines by examining past recessions and how they impacted industrial utilization. As you can see in Figure 5 that if the current recession matches the severity of either the '73 or '80 recessions that we still have about a 4% decline in industrial utilization left to go.

Figure 5: Comparison of industrial utilization during past recessions
Source: Johnson Rice & Company
-Click to Enlarge

They predict that this further decline in industrial utilization will translate into a drop in natural gas demand of 1 Bcf/d.

(There are some very interesting relationships between natural gas usage, industrial utilization, and GDP noted in the analysis that I hope to explore later).

LNG Imports Expected to Increase

One area that has been keenly discussed on TOD lately is how much new LNG will come on line this year and how much of that LNG will make it to the US.

The JRCO analysis offers several insights. First is Table 2 of major LNG projects coming on line 2009 (mostly late 2009) showing the expected supply and primary market (mostly long term contracts).

Yemen LNG 0.85 Bcf/d U.S. & Mexico on 20 year contracts
Tangguh Trains 1 & 2 1.0 Bcf/d Pacific Basin but some to Mexico
Qatargas-2 Train-1 1.0 Bcf/d Mostly Japan
Rasgas-2 1.0 Bcf/d Mostly Europe (South Hook)
Sakhalin-2 0.625 Bcf/d Pacific Basin

Table 2: New LNG Supplies, capacity and primary market

All told, about 5.1 Bcf/d is coming onto the market. (Just for context, U.S. gas demand is over 50 Bcf/d and the oversupply is 4 Bcf/d). However most of that natural gas is destined for other locations on long term contract. The LNG slated for Mexico will reduce U.S. exports and thus must be counted.

JRCO also provided this regression which I found very helpful. It looks at the price differential between the UK National Balancing Point price and NYMEX. The correlation is rough, but still useful. (It would be very helpful if someone explored other relationships and tried to identify the factors that explain the outliers).

Figure 6: LNG Imports seem to rise as NYMEX increase above UK NBP price
Source: Johnson Rice & Company
-Click to Enlarge

Trinidad supplies about 2 Bcf/d of natural gas to the Atlantic region. The cost to ship to Europe is about $0.25 per Mcf over the U.S. So when the NYMEX price is very close to the UK price, there is a good chance the cargos will be diverted to the U.S. JRCO use NYMEX and NBP futures to estimate when that might happen. It looks like there is possible window for Trinidad LNG to come to the US this summer.

Figure 7: Futures price window for Trinidad LNG to direct to U.S.
Source: Johnson Rice & Company
-Click to Enlarge

In total, they estimate that the U.S. will receive an increased 0.5 Bcf/d supply of LNG. They also estimate LNG arriving in Mexico will cause drop exports an additional 0.5 Bcf/d of supply.

Additional Reduction Needed

Table 1 summarized the expected supply and demand balance. The total oversupply is expected to shrink to 1.1 Bcf/d. A larger reduction in drilling rigs will be needed to balance the market and bring prices back up. JRCO estimates that it will take shutting down another 45 conventional rigs and 45 Rockies rigs to take 1.2 Bcf/d off the market by the end of 2009 (Figure 8).Since the report was published on March 20, Baker Hughes reports that the natural gas rig count has fallen another 88 rigs, which is nearly the number to reach balance.

Figure 8: Supply reductions from shutting down drilling rigs
Source: Johnson Rice & Company
-Click to Enlarge

Since prices are still low, it is probable that rig counts will continue to fall. This may well cause an overshoot condition and supply will fall below demand and cause a price spike. It will be interesting to watch if the drop in rig count begins to slow or just continues on down.

Watch List

Johnson Rice Company provides the following watch list of indicators that will be helpful for tracking what is happening with prices as the summer unfolds:

"What are we looking for to signal a turn around in Natural Gas pricing?:

1) Continued reduction in onshore gas rig count, and ultimately falling production
2) A rebound in industrial utilization, signaling a rebound in industrial natural gas demand
3) LNG imports to start dropping (end of Summer?), with the UK/NYMEX differential being the leading indicator"


Every Thursday: Natural Gas Injection Numbers
Every Friday: BHI & SMITH Rig Counts
Every Friday: Bloomberg LNG Tanker Destination Report"

Thanks Jon.

I wonder what happens to NG demand if there is chain reaction down auto-supply chain if GM etc. head towards bankruptcy.

i'm not seeing where this data is coming from.

re: figure 2 "onshore production"

"Figure 2 shows that production in Q1 08 was about 53 Bcf/d and Dec 08 production was about 57 Bcf/d."

according to the doe here:

dry ng production, total dry ng production, was about 55 bcfd in 1q08 and about 58 bcfd in dec'08. this is from a linear regression. total dry ng production was also 58 bcfd.

Yes, I felt the title might be mistaken as the hurricane clearly dropped production. (not that hurricanes don't have some impact on onshore production.)

i'm still not seeing where the onshore production data is coming from. federal gom alone marketed production amounted to 8 bcfd in 1q08 and 6 bcfd in december. subtracting the federal gom marketed production from total would put onshore production at 47 bcfd or less 1q08 and 52 bcfd or less in dec '08. how do we reconcile the jrco reported onshore production with the doe ?

marketed production exceeds dry gas production by about 3.5%.

It's going to be very telling as to how far the unconventional NG rig count will eventually drop. Many here already know that I consult for one of the biggest UNG players. In just two months, by early March, we cut our UNG rig count from 18 to 3. We did it very quickly and at a great financial penalty. I suspect we need to wait another few months before we can guess the bottom. Not all operators could ramp down as quickly as we have. The catch all phrase running through the oil patch right now is the "preservation of capital." Some good reasons for this new philosophy: though borrowing costs are down so is availability. During 4Q 08 a number of the big independents drew down their credit lines in excess of $1 billion each on the chance that those credit lines would be reduced with year-end revaluations. Given the significant reduction in cash flow due to the lower NG prices such actions guarantee a certain level of operations in the near term future. But there are other uses for that cash: acquisitions. Lots of talk on the street in Houston about who might buy who. Not only does a big cash reserve allow the strong to go after the weak, it also allows those companies badly injured by low revaluations to mount a defense. I suspect we won't see too many serious acquisition efforts for another few months. And then maybe not even then. The LNG import question seems to be the biggest unknown holding the more aggressive companies back. Acquisition economics are not as encumbered by short term low NG as are the UNG wells which demand adequate prices the first couple of years of production. Most major acquisitions are based on a 4 to 5 year payout. But the potential for LNG imports to suppress prices for a similar period might kill the typical acquisition frenzy normally seen in such down markets.

The other big source of US NG increased production rate was the Deep Water Gulf of Mexico. Fortunately we had the Independence Hub come on line just in time to help with the loss of production from hurricane damaged shelf fields. The time frame for DW development can’t be adjusted as quickly as the onshore plays. While GOM shallow water rig utilization dropped from 1/1/08 to 67% by 1/1/09, drillship utility held at 100% and semisubmersibles at 96%. Day rates for semi’s run between $550,000 to $600,000 per day while drillship rates have actually increased from $525,000 to $650,000 per day in the last 12 months. While good news from a supply standpoint for the economy, it also represents a big negative for the UNG players and the acquisition minded. Though the DW fields take many years to come on line they do typically represent a huge amount volume hitting the market at once. As a result those operators will commonly be searching for markets a good 6 to 12 months before the field begins producing. Obviously such efforts only soften the NG market even further

But as I stated a few days ago elsewhere, I’m optimistic for the long term deliverability of NG to the US economy. While the UNG players have been shoved to the sidelines today, we’ve developed the technology to tap a huge resource base WHEN THE PRICE SUPPORTS RETURN. The amount of NG locked up in the gas shales truly is great. But how much gets developed will float with the price. At $3.50/mcf the reserve base is rather small. Run prices back to $9/mcf and we’ve added trillions of cf of NG assets. It is there. And those companies whose survive this down turn in the oil patch will throw themselves back into the plays when the economics return IMO. Though the combination of slow economic recovery and cheap LNG imports might delay the restart for many years these reserves won’t disappear. They’ll be our country’s nest egg which will hopefully help us mitigate the worst effects of PO when they arrive.

At $3.50/mcf the reserve base is rather small. Run prices back to $9/mcf and we’ve added trillions of cf of NG assets.

But where will the inflation adjusted aggregate social 'profit' come from to pay $9 per mcf? We need cheap resources (and/or less complexity and/or less population and/or less waste and/or less (perceived) inequality) in order to generate 'gain' for the whole system. Without cheap natural resources there is no profit - I don't see us ever being able to afford $9 per mcf for any period of time under the current system - the gas is there but we are unlikely to get it. Looking back from the future, 2008 will have been all time high US NG production, and # of natural gas companies in business...

Am I way off base in thinking this way???

Nate -- the short answer as to where the $9/mcf will come from is the same place it did last time. But I agree with your general tone as I read it: the population as it now numbers cannot sustain itself at a level of comfort it desires let alone the billions wishing to improve their lot. But with demand will come the price support and those reserves will be produced. How we take advantage of this to modify BAU is another matter. We might figure it out...we might not. But the technology to produce this asset has been developed. Until 4 or 5 years ago no one suspected these volumes could be produced at any price. It's society's job to find "the inflation adjusted aggregate social 'profit'". I'm just a geologist. My abilities are pretty much limited to finding the crap. It's up to mankind to figure out his path to the future or to it's end.

But Rockman this is the crux of the problem with EROEI obviously a large number of resources remain potentially profitable at some price point. Some like methane hydrates need technical development before this price point is discovered. But thats the intrinsic problem with just using price to determine resource viability. Its simply not sufficient. Aggregate increasing energy prices now are a net negative on the economy overall at some price point we will force a significant number of Americans to adopt a different lifestyle. It may not be direct and in fact most of its secondary i.e a factory becomes uncompetitive at a a certain NG price point can afford the capitol costs and shuts down.

Now demand for NG from this factory declines but far more important is that the shutting of the factory takes out a broad spectrum of demand for a wide range of products and of course causes a cascade of debt defaults.

The next case is the critical one and it works in had with the first case. Remaining industries of all types now face both rising energy costs and excess capacity. Rising energy costs impact short term cash flow and excess capacity does also as prices must be lowered. This means that these business and they are generic across the economic spectrum are going to try and borrow as much money as they can. Credit lines will be drawn down and suicide contracts signed in and effort to stay in business. Rising defaults will put pressure on real interest rates causing them to rise. So you see a major debt crunch coming as lenders that do lend at government rates are forced further into insolvency and those that attempt to lend at rates matching the default level simply cause even more strain on the capitol markets.

Finally the energy industry itself is operating in the exact same capitol markets and competing with its customers for capitol to fund expansion of energy project that may eventually cause energy prices to drop. In general one can expect the energy industries to hoard cash and slow expansion as they themselves face both rising costs for money and uncertain demand levels. Also of course this situation sparks a internal merger and acquisition flurry which overall impairs the ability of the industry to develop new resources leading to even higher prices and more demand for mergers. Overall I suspect far more capitol will flow into mergers than into expanding production. This merger activity further impairs the capitol markets and is not in this situation a good thing. And once the mania starts the tendency is for capitol to be sucked into the quick returns provided by mergers vs extensive investment in expansion.

Now on the customer side you have a similar situation starting to occur as more and more business get into deep financial trouble the solution will often be a merger or purchase of a defunct companies assets for pennies on the dollar. We will see merger mania spreading across a wide range of industries. Generally this results in downsizing the workforce after the merger driving the demand drop across the economy. In general these mergers actually increase the debt load making the new entities even less viable to rising energy costs leading to more borrowing and eventual default.

Thus in a declining EROEI our capitol markets act in reverse destroying the people trying to save themselves. The intrinsic problem is that no one can repay their debts. The concentration of capitol in the energy industry does nothing to help since the economic effects are broad and caused by the combination of rising energy prices and excess capacity.
The energy industry can produce all the expensive resources it wishes but this does nothing but increase the excess capacity problem and erode the balance sheets of its own customers.
If this sounds like a vampire then your on the right track.

And of course underlying all of this will be the fact that debt can be offered to infinity at some price the continued injection of debt at ever higher costs is the real problem.

This is how I think the real underlying fact that EROEI is no longer sufficient to sustain our current economic system plays out. The coupling is through rising energy costs, debt and ever increasing overcapacity despite company failures. No one is a winner in this game and I'd argue the accumulation of capitol in the energy sector is just a small part of the overall amount of money moving. The debt taken on to offset capitol accumulation in the energy industry is far larger than the amount of money flowing into the energy industry. In fact most of the money going into the higher prices is going into production costs by definition. Its literally being burned up.

Although Japan is not the world and a global energy decline provides no outlet its instructive to look at Japan in this context since they import all of their energy. They where unable to escape persistent deflation despite a range of financial tricks for decades.
The only reason Japan has survived until now is via exports. Well the entire world can run a export economy so its not a viable solution further borrowing does no good and in fact it acts to hasten the decline rate.

In closing I think you will find given the above that we will experience ever increasing energy prices in the long term from now on out. As the cash flows into the energy industry I contend that mergers will take the lion share of the money and that the amount devoted to expansion will remain insufficient to offset the increasing costs. The energy industry will in effect fiddle while Rome fails to burn :)

And last but not least underlying all of this is the fact that our economy is really a group of ponzi schemes once real growth stops a facade of growth via merging of ponzi schemes to create new pyramids that can go slightly higher before they themselves collapse will serve to hide our real situation. The biggest ponzi schemes will of course be bailed out at taxpayer expense further delaying the day of reckoning for a bit longer but its all a facade there is nothing real under the covers. No one is making any real long term gains not even the energy industry.

And last but not least this does not mean that capitol and assets won't accumulate and concentrate I've argued that the other big winner will be our banking system which will cease fractional reserve lending and lend money on assets that sell after getting them for nothing via a big laundering scam with the US government. Indeed one can expect wealth to become heavily concentrated and its not clear that the energy industry itself will be able to resist taking on extreme leverage to fund mergers eventually resulting in more and more assets taken over by banks. As energy will probably be one of the key components of an asset backed currency I expect as what I've outlined plays out that eventually the energy industry itself will be forced into bankruptcy and bank take over.

The fact that the energy industries customers cannot intrinsically afford their products seems to indicate that at some point financial leverage will grow to the point that the banking industry can take over. Under the covers they do this by lending to both parties and simply waiting for defaults at some point once enough debt has been injected even the energy industry will falter.

And last but not least the banking industry simply does not care since once its seized enough assets it can simply issue a new asset backed currency with limited or no fractional reserve lending and viola they survive and in fact given they would then seriously withdraw credit at that point they massively increase their asset base as credit is exponentially harder to obtain in the new currency and debts transferred from the old one default.

Of course, on a BTU basis $9 gas is only $54 per BOE.

As noted below, 9 is not so high, just 54/boe. shale is likely quite profitable at 7, meanwhile wages are falling fast so costs are falling. I agree with others that US will probably not be able to compete for LNG, probably not even trinidad's, unless we see a sharp spike this fall. But we no longer have as much ability to reduce NG consumption, fertilizers etc now mostly off shore and industrial production already savaged, and anyway don't have to because it looks as if there is a lot of shale gas. I wonder if nuclear can compete with NG at 7-8, high enough for gassers to profit nicely.

I'm also much more optimistic re: PO. THAI might or might not work exactly as advertised, but that some way to extract oil economically from CA and venezuelan tar sands seems more and more likely... Hubbert never considered tar sands, but 150M for 10k/d production would bring a new Saudi to the north, usefully close and politically docile.

bringing me to the recession.
IMO we are not going further down than GD, and we recovered then. Fuels are currently affordable and available, there is, certainly at the moment, no restriction on growth other than the continuing credit contraction. This is in the process of being corrected on account of an active administration, no matter that bonuses continue being paid. Roubini thinks the bottom is year end, who am I to argue.

ANd on to investments... IMO we have at least another down leg, will at least test previous low, meanwhile oil is too high for 2Q weakness, will likely retrench. Best to get out now, better re-entry a month or so following the peak of the latest bear market rally, which could have been 3/26, and when we are moving into higher demand Q's.

And GW... accounts of methane bubbling from warming tundra are quite alarming. Things may, or may not, accelerate, we may lose coastal cities, etc, but years off. Meanwhile a warmer planet was pretty good for the dinosaurs, and there must have been a lot of flora, too, to support them. Anyway, if it comes, it comes, nobody is going to do anything about it.

JKissing I used the prices that made sense but if EROEI is negative price does not matter since the fundamental economic equation is different.

For housing I've argued the affordable price is going to zero since we have and oversupply and declining economy. Housing has no value. Notice the price of a lot of other goods and services are approaching zero as they are in oversupply and have a shrinking market.

Inflation of the energy price or what the price is does not change the overall economic balance paying more or less for NG if its profitable or not is irrelevant since if the EROEI is negative the economy has less money to pay going forward. Growind debt hid this and now transferring debt to the US government will hide the true situation but I'm asserting that once EROEI is negative your toast looking at the micro view of profits for energy is irrelevant and of no material consequence.

Understand that negative EROEI in my opinion offers a paradox that has to be solved the price of the declining resource will rise but you won't get a classic economic effect of increasing production somehow the overall system has to work to force investment to not enter the industry regardless of price. I believe I posted the correct answer to the paradox
and it actually works even without a fiat currency. You get deflation in most of the economy and a ever increasing amount of debt thats defaulted on for all intents and purposes generally the governments or whoever manages the money supply acts as the sink for debt that will never be repaid.

But the key is there simply is not enough capitol in the system to allow the customers of the resource to pay the current price and also expand production. If the energy industry expanded its customer base would shrink collapsing prices halting the expansion.
This is exactly what just happened actually and fits my EROEI being negative assertion.

The only workable solution is to minimize investment and maximize profits on the way down and turn these into ownership rights for a broad class of assets.

Given that we do have renewable energy sources and nuclear power at some point we can substitute for oil and you will have something left whatevers left is all the real assets that exist and the way things are working these will be controlled by a small group of people.

Unless you back up one level and consider that the customers of the energy industry and the energy industry itself share the same overall economy you can't see whats really happening.

All I can say is think about the paradox of EROEI being negative and high prices. They simply cannot have a traditional supply demand effect.

I think this is a key insight. We can make up for declining EROI through increasing volume (assuming EROI drops slowly enough) and I think that might be happening with unconventional natural gas (conventional is dying). But the basic model is true, as the energy industry delivers less and less energy, there are fewer and fewer consumers. And I think that will show up as the energy industry walking down the back of the Hubbert curve with equivalent declines in the economy. I don't have a good way to formalize it.

Dr. Hall has made public his paper on declining EROI 20:1 down to 5:1 and what that looks like to the non-energy economy. (basically, all the auto workers become drilling rig hands).

Peak Oil, EROI, investments, in an uncertain future.

His Biophysical Economics papers are all very good.

Thanks I think its important to understand that this effect seems to apply anytime you hit a critical resource constraint. If its wages or labor for example you get a traditional wage price spiral. This classic spiral works for example to limit investment in production expansion as wages increases and prices increase to compensate. Eventually assuming that resources remain constant the system collapses in some manner.

Recessions for various reasons can be seen as when one of a myriad of critical economic conditions change such that they are relatively negative. Negative EROEI is simply a case where the system is permanently negative and classical economic changes cannot alter the condition. Bottom line once the system is fundamentally negative in a critical resource no economic game on earth can change the situation its physically constrained. This does not mean that the dwindling remaining wealth cannot flow in various directions but the overall system is in contraction and in general it will do its best to minimize the contraction rate. Attempts to alter this simply cause collapse to occur somewhere in the system.

Thus its 100% certain that if the oil industry actually tried to expand significantly under the conditions of negative EROEI regardless of the price of oil it will simply cause the economy to collapse elsewhere to pay for the expansion. The direct link may be difficult to ascertain because the real link is via a shared financial network and thus shared economic structure. Exactly how the system modifies itself is not clear this is simply because the repeated conversions of real wealth into money and debt serve to cloud and transfer the effects throughout the economy.

However since this is fundamental you can ignore money its simply not relevant.

Consider the case of the chicken farmer and the feed seller. The exchange is pure barter x chickens for x amount of feed.

Lets say at first the chicken farm can trade 5 chickens for enough feed for 10.
He then grows ten and trades for enough feed for 15 and so on.

Eventually lets say the feed provides actually produces less feed.
Then the table turns the first trade lets say the feed seller demands 25 chickens for feed for 20.

Next trade he has less feed so he demands 15 chickens for enough feed for 10.

Its obvious how the balance works and its obvious that although the feed seller made more chickens for less feed the overall system declines.

The feed seller could demanded as many chickens as he wished if we add in the ability of the chicken farmer to borrow chickens in trade then you can play the game a bit longer. But it should be obvious it does not matter. Bottom line if you have less feed you have less chickens its a fundamental physical fact and its impossible to game the trade to change the situation in any meaningful way. People that only take the view point of the feed seller or the chicken seller completely miss the overall situation I assert your forced to look at the overall balance to correctly determine the economic condition if one of the critical resources is in decline any other viewpoint is simply ignoring the real problem.

Finally as and addition you can see that if the feed farmer needs 20 chickens to produce feed for 15 it simply ain't gonna happen thats what people claim will happen when prices increase. Sure the feed seller can do what ever he wishes he could require 50 chickens in exchange for feed for one and then produce feed for 20 but demand 100 chickens all possible ways to game the system simply are that games.

I really like that analogy. I had been trying to think one up, but you caught the essence. I think my garden growing friends could get it in an instant. Thanks!

If the energy industry expanded, it's customer base would shrink collapsing prices halting the expansion.
This is exactly what just happened actually and fits my EROEI being negative assertion.

I agree with this general premise, and given time it will repeat in several cycles.

But EROEI is not the real story - it is total energy gain which is EROEI x scale - there is probably a decent amount of nat gas and some oil domestically that has pretty high EROEI numbers still, but the TOTAL energy gain is declining, and possibly rapidly. Average EROEI will actually probably increase as the real crappy stuff will be left alone and only the best drilling sites will be pursued. But we just don't know because we haven't the data - all we can do is hope people start realizing that dollars are only markers for real wealth.

Also, dollar break even will happen before energy breakeven, because even the best biophysical analysis can't parse everything into energy. But EROEI breakeven isn't the issue - as in the paper you referenced below something like 3-5:1 in aggregate we can't support modern civilization (at least in terms of numbers and living standards).

It is possible that aggregate energy gain can be made up for with a combo of the best NG plus cheaper wind...but that still will result in a large consolidation in NG industry and much of resource being left in..then we get into TIMING of EROI flows, which is another story altogether (currently market prefers 75% first year depleting moderate EROI to 20 year equal flow high EROI (large wind).

(By the way, EROEI is a ratio so can't go negative, it can go sub-unity.)

To be clear by negative EROEI I mean negative vs the needs of the society. This happens well before EROEI drops to 1:1 or less I'd suggest it depends on the complexity of the society at what level it enters a situation that it can no longer sustain itself.

Simpler societies can probably get away with very low EROEI's since simplicity simply means most members of society are themselves involved in energy/food procurement. Then net gain or complexity level is trivial to determine its the amount of food/energy they produce in excess of what they can consume. More complex societies both make the required net gain larger and make it more difficult to calculate the minimum. I've tried using the concept of the typical support pyramid for a core industry to calculate the minimum EROEI. The idea is that you take a key industry say for example farmers and determine how many people are needed to directly support the modern farmer. The simple calculation of how many people are involved in actually planting and harvesting that leads to and assertion that 1-2% of the population are farmers is simply bullshit. It does not include the gene engineers at monsanto or the fertilzer or tractor manufactures nor does it include the prepared food industry needed to process the centralized food stores etc etc etc. My best guess is at least 30% of the population is indirectly involved in the food industry from frozen foods to actual farming. We changed the nature of the work but I'd argue it has not really fallen from its low of 40% just the work has changed from direct planting. On top of this you have additional support industries such as housing for those in the food industry and cars and doctors etc every modern person uses a very generic set of services regardless of what the core industry is that creates the initial wealth. I make a WAG that this adds 10-20% to the total bring the number of people that make a living off of food up close to 50% of the population.

So if everyone else supported the energy and other commodity industries like metals you need at least a 2:1 EROEI to break even. Of course outside of food the rest of the various core industries have their own support pyramids just guess that they are 10% each.
This leads to a ballpark figure of 10:1 for the minimum energy industry direct EROEI before the society structure as a whole is negative. You can cut down my estimate for food but I worked pretty hard at it and was surprised how much of the worlds economy is directly then indirectly related to supplying food. And I don't think its wrong. And even if I'm off its easy to imagine that other industries can certainly command a bigger part of the economic pie then I've allocated bottom line is you can come up with about 10:1 or 15:1 repeatedly using various estimates of our support pyramid for our modern economies.

If right and your paper is right and we have dropped into the 3-5:1 range then one would expect that the economy would fall into a collapse rivaling the Great Depression in magnitude.

Ohh wait ..

And GW... accounts of methane bubbling from warming tundra are quite alarming. Things may, or may not, accelerate, we may lose coastal cities, etc, but years off. Meanwhile a warmer planet was pretty good for the dinosaurs, and there must have been a lot of flora, too, to support them. Anyway, if it comes, it comes, nobody is going to do anything about it.

I am alarmed by ground water pollution from coal bed methane production
We should use more natural gas for all transportation Pakistan does it. and find new ways to make fertilizer and hydrogen. we should make an effort to capture tundra methane and control cow belches. I would like to do carbon negative farming

"...we cut our UNG rig count from 18 to 3."

that claim that the shale gas rig count is flat with q108 seems dubious.

the other claim i find questionable is the 4bcfd oversupply. i dont think the storage figures support the estimate.

How would you recommend estimating the oversupply? What I hope comes out of these posts is a sharing of knowledge and improved ideas about forecasting.

gas in storage increased by 372 bcf in the year, that would imply a 1 bcfd "oversupply".


It doesn't work that simply. In late summer I expected storage to be down about 200 Bcf y-o-y at the end of the withdrawal season. In fact it will be up by => 400 Bcf. This is a swing of maybe 700 Bcf in less than 6 months, or about 4 Bcf/d.

The next issue is that we have no place to store all that oversupply. Assuming we average 2 Bcf/d during 2009, we will have an extra 600+ Bcf to inject into a storage that starts the injection season with 300 or so Bcf extra already in storage. With balanced supply we could probably manage 200 Bcf of the starting oversupply. There is no place to put the rest. Expect to see low prices for several months at least, and NG replacing coal for a significant portion of base load electricity supply. To aggravate things, LNG could be twice what was projected above for at least a few months. Murray

i dont know of any reason why storage gain is not a metric for "oversupply". basic material balance, the amount remaining is the beginning amount +/(-) amount added/(subtracted). what could be simpler than that ?

i dont doubt that low ng prices will reduce supply and increase demand, if not capacity.

at the same time, what does your expectation of (future) gas storage volumes have to do with oversupply ?

But as I stated a few days ago elsewhere, I’m optimistic for the long term deliverability of NG to the US economy. While the UNG players have been shoved to the sidelines today, we’ve developed the technology to tap a huge resource base WHEN THE PRICE SUPPORTS RETURN. The amount of NG locked up in the gas shales truly is great. But how much gets developed will float with the price. At $3.50/mcf the reserve base is rather small. Run prices back to $9/mcf and we’ve added trillions of cf of NG assets. It is there.

There is no doubt in my mind that Nat Gas and Coal trading at far less per BTU than oil is what is powering our economy and giving us the ability to trade for expensive oil. Unconventional gas has been like finding a new Prudhoe Bay right under our feet. It would be a shame to squander this chance not changing (as we did the Alaskan oil).

Slowly rising prices might be one way. I would still like to see a cartel formed and prices held a bit higher with slightly higher taxes recycled as highly efficient buildings and other efficiency improvements.

A good way to accomplish that reduced rig count would be to remove the tax deductions from drilling costs. All that would mean is that we get to use up the rest of the worlds nat gas for a little bit until the prices go up, after which we'd be sitting on a whole lot more resource.

Anybody else think that it's ridiculous for a producer to have the majority of their expenses as a tax deduction.

I would be careful taking industrial production drops from the 1970's and 1980's and pulling them forward to today. For example what is the precentage of NG used for Electric Utilites vs other industrial uses today vs in the 1970's and 1980's. What about home heating ?

One of the big reasons that oil has remained relatively low prices is that NG has worked as and increasing partial substitute for oil in a myriad of use cases many of these represent what I call intrinsic demand and are difficult to change dramatically. This means a larger precentage of our NG use cases are no longer really discretionary.

Instead of assuming a 1.0 bcfd drop for industrialization a 0.5 bcfd drop may be a better estimate and even better would be an understanding of the NG market today vs previous downturns. A large NG customer not present in the past for example are the complex refineries to process heavy sour crudes and processes to produce low sulfur diesel. Certainly refineries can burn internally produced lighter fractions but this simply removes them as products for other markets.

Next for LNG I'd say given what I've read about Gazprom any assumption about stability in the European markets is questionable better to assume that they will aggressively compete for LNG. For this year Gazprom takes center stage if they really are in steep decline then LNG demand from Europe could grow substantially. Regardless assumptions that the US can successfully compete for LNG globally unless their is a clear glut in LNG are questionable.
Lets assume we less than projected in this report. How much less is unknown to many variables.

Next my understanding of the reason that the Barnett play is dropping rigs is that its best areas are played out other shale plays offer better returns so the remaining NG in the Barnett play will not be tapped until much later. This is why its so much more sensitive to prices vs the other plays in fact you can read off the graph the status of each play.
Barnett is played out Fayetteville and Wood are not doing well and Haynesville is just taking off. If this is correct we could well see rig counts drop rapidly in Woods and Fayetteville in the near future. Certainly this is something to watch if you have the data on a monthly basis. While Haynesville should continue robust to increasing.

And last but not least I suspect that the price of NG will remain depressed longer than fundamentals would indicate in a sense I think it will overshoot its minimum and fundamentals will need to change more dramatically then in the past before price begins climbing. This is important because I suspect it means that the rest of the world will succeed in procuring LNG shipments before the US and the depressed US market will keep LNG rates low at first. So if you assume NG prices don't rebound rapidly as the fundamentals deteriorate then you can assume the LNG won't show up in a timely fashion which sets the stage for a potentially sharp price increase heading into next winter. So prices should both remain depressed for longer and the LNG market could become very interesting heading into winter. I expect that the US will in general find it difficult to import LNG on one hand and that prices for NG should eventually rise enough to finally spur shale development but we could be in for a fairly long period of strained NG supplies as a result.

And last but not least we probably have seen peak production from the expansion into UNG. I expect continued declines in conventional production coupled with a late and slower expansion of UNG following price increases to result in a tight and expensive NG market unless we really have a flood of LNG hitting the US shores but even if we have this flood domestic NG production would surely have peak as this implies that LNG imports are cheaper than domestic UNG production. So either way we probably hit our second peak.

And last but not least we also could see the US briefly attract LNG imports suppressing UNG production then loose them to higher bidders this could well be worse than not getting them at all. If this scenario plays out there is a reasonable chance that NG prices could remain depressed until early next year rise briefly then decline as we enter summer. This would make the situation even worse in 2010. A situation like this could readily arise if Gazprom makes promises then fails to deliver lulling Europe into not importing enough LNG.

memmel -- I've heard the same about the Barnett economics getting slim. I'm not sure how the Fayetteville will hold up. SW Energy was a big player there and with their captured market (they are THE NG utility of AK) activity may stay up a bit. We and others are focusing on the Haynesville because of the unimaginable success of some early wells (Petrohawk made over 700 million cf the first month...probably a 2 or 3 month payout). But every play has its sweet spot and they may have found it early in the Hv Shale. How far (or not) that sweet spot expends remains to be seen.

And speaking of Gazprom I've seen some early reports that they are chatting with Azerbaijan about getting in between their NG and the EU. Just a guess but I've seen this ploy before on both a small and large scale: Company A (Gazprom) pays Company B (Azb) a premium so they don't sell it to Company C (the EU). Then A sells NG to C at a higher price to recover the premium (and then some) they paid B. Just good ole fashion horse trading.

Or Gazprom production is declining and they need the Azerbaijan gas to cover existing contracts even if the price increases.
Its good horse trading I agree but the question is why ? Overall Gazproms actions fit someone who is in the merger and acquisition phase I outlined in my longer post to cover inability to expand. Regardless I think the LNG market and what Gazprom does are tightly intertwined and that at least for 2009 and 2010 the European NG market is going to be the key player in defining the global LNG market and thus eventually exactly what happens in the US. LNG is now needed in basically every market and thus the world now has for really the first time a true global NG market that fairly tightly coupled. One can expect that this emerging coupling will not proceed smoothly and that predictions based on our old market dynamics may or may not work over the coming years. I'll freely admit I don't know whats going to happen but I suspect that things won't work like people in general expect. It really depends on if I'm right about how EROEI exerts its economic effect and if we really are below the EROEI to run our society. One of the biggest problems with Nates EROEI theory is its not been translated into economics. One of the cornerstones is that rising prices will fail to elicit the traditional supply and demand response thus the system no longer obeys classical economics. We have seen classical theories fail spectacularly in other fields of course :) I think that our global economy has reached this point that "quantum" effects in the form of EROEI destroy the classical fiat growth model. And I do mean destroy in the sense that it becomes completely non functional as EROEI drives the system.

Also I don't see it as a black swan event just a simple collapse because the rules have undergone a fundamental change a former small discounted effect becomes the primary driver.

In Figure 4 they give an estimate of Estimated Ultimate Recovery (EUR) of 2.3 Bcf per well in Barnett.

Arthur Berman at World Oil wrote that 1.2 Bcf was the average for all horizontals. If his assumptions are correct, that would explain why Barnett is falling much faster than the IRR table in Figure 4 would predict.

Mr. Berman also reports that the USGS estimates Barnett has about 30 Tcf. And that 4.4 Tcf has been produced to date. So we could roughly say 1/6th was recoverable at $4.00 - $6.00 per Mbtu. What is the price curve going into the future? How much gas at $6.00 - $9.00? Another 5 Tcf?

It seems to come down to the question of 1) how much is recovered by each well 2) how deep do we have to drill to hit the source rock?

Does anyone have data on changing EUR over time?

Another new industrial user is the ethanol refineries. And it could well be that industrial demand is shifting to electricity instead of directly burned NG.

It will be interesting to see what happens this upcoming winter to residential demand. Utilities have been issuing record numbers of disconnects. If prices return to the $9.00 level I think we will see a fair amount of demand destruction. I have not yet thought up a way to estimate that drop. I spoke with our local utility and they don't have a model for predicting demand either.

The United Arab Emirates (UAE) is an interesting case.

“The country's rapid growth has created demand for water that is 100 times greater than its natural fresh water supply. The UAE desalinates water using natural gas plants, but a look into the future shows this isn't a sustainable path.…

According to the CIA World Fact Book, natural gas production in 2006 in the UAE was estimated at 48.79 billion cubic feet and domestic consumption in the UAE was estimated at 88% of that amount or 43.11 billion cubic feet. A mere 6.8 billion cubic feet is available for export or for domestic growth. The country actually imported an additional 1.3 billion cubic feet of natural gas the same year. At the current rate of production and growth, the country’s known reserves of natural gas will be gone in about 60 years. ..

Demand for electricity in the UAE is currently about 15 GWe, but is projected to nearly triple in just 12 years. Natural gas is the fuel of choice for peak power and half of base load demand in the UAE. Oil provides the rest. No coal is burned in the UAE for electricity…

One of the last foreign policy acts of the Bush Administration was to sign a nuclear cooperation agreement with the United Arab Emirates (UAE)…

Sec. Rice said the key to the deal is the UAE’s willingness to import, rather than produce, fuel that would be used in its proposed reactors. The UAE would also return all spent nuclear fuel rather than develop the technical capabilities to reprocess it.

In fact the deal is not hare-brained and, unlike Iran, has no Frankenstein motives to build nuclear bombs behind it…

If the UAE wanted weapons, it would not have become the first nation "to forgo enrichment and reprocessing,"”

In fact the deal is not hare-brained and, unlike Iran, has no Frankenstein motives to build nuclear bombs behind it…

But our own intelligence agencies (NIE) have said Iran is not building weapons, nor has anyone else found any proof of intent. This is propaganda that continues to exert pressure on Iran. It's like the WMDs -- deja vu all over again.

Back to listening to NG people.


Great stuff!

Thanks for sharing this.

Export Land theory will one day apply to LNG and perhaps piped gas. Current NG producers are squandering it for desalination and electrical generation. Under a stable gas price a fast build rate of combined cycle plant occurs because of
1) lower capital cost than nuclear
2) balancing of a mandated wind build
3) half the CO2 per mwh of coal
4) population growth
which is all good until the gas price rises or local supply is tight. When that happens the domestic user gets priority, not the export customer.

Any country that imports a lot of gas should have a Plan B either for its equivalent replacement or at least getting by without LNG.

I think, increasingly, the energy return on water invested, is going to be an important question asked in policy circles, which suggests if you include both energy and water requirements as costs, it will be hard to beat wind. The current discussions are based on dollar and carbon costs and largely exclude any long term water concerns. Adding water to the cost makes many of these nat gas plays even less affordable. It is unclear what the status is of some First Nation and local civic complaints into ground water and fishing water impact from Marcellus drilling - my guess is it will be a non-zero figure.

Hey Jon, good stuff!

I noticed you plotted the futures of Natural Gas, you must have used data from the middle of last week. Just for discussion purposes, here is a plot of the same contracts where they settled on the 27th. Front months are substantially lower.

The recent move lower was fairly significant, and I would be interested to hear your comments on the state of the differential, now.

All the best,
Jeff McLarty

Jeff would you be so kind to post the same strip for oil?

Hey Nate,

No problem. Only takes about two seconds.

Also - it is interesting to note what that strip looked like 2.5 years ago, right after the Amaranth goose, then fall, which was written about in A Tale of Two Markets
Here is Sep 01 strip (yellow) vs Sep 06 strip (blue)

link to larger

I'm am absolutely fascinated by all the historic curves...don't know why.

More fun with gas futures strips in the latest Guinness Atkinson report (see p. 9), relating 12-mo gas strip to deviation from 5-yr avg in storage.

Hi Jeff,

Unfortunately, I just reported on the futures data JRCO put into their report. But if you can create a similar strip for UK BNP converted to $ then we could compare.

The key is that if the UK is willing to pay more than $0.25 per Mcf then Trinidad's gas will go to Europe. If not, then it will come here.

Great site by the way. Are you thinking of adding currency conversions as a feature?

Your chart is interesting because the average production cost in the US (last fall) was over $8.00. Some of that has fallen as pressure on drill pipe and rig availability has eased. Yet futures run under that value all the way out to 2018.

I don't have access to data for the, no I can't plot it. If you know of anywhere online that posts it in a text/csv/xml format, I could do it pretty easily. Currency could be done pretty easily. Will add it to the To Do list.

Back on topic, isn't the network of production and consumption more complicated? I mean, there are more than just two destinations. Even considering the larger network, the price equilibrium should find itself. It will be interesting to watch.

I hear a lot of optimism shale gas, but I'm wondering how significant these reserves are in terms of years' supply or TCF? And what is the current share of total NG supplied by shale? I believe I read that 40% of gas was U.C., but I don’t know how much of U.C. is shale.

The reason I’m asking is because I was thinking that shale resources may be about 250 TCF, and I believe the USA consumes about 24 TCF annually. If so, we may be at peak shale gas in a few years.

What happened to the 25% natural decline rate in existing production?

The "Treadmill" is there, but how fast is it? It appears it is only 8% instead of 25%?

It is up in the 20%-30%. However the NG producers found a way to unlock 2-6 Bcf per well when before they were getting 1 Bcf. So it is a huge burst in productivity. Kind of like finding Prudhoe bay was to oil.

The question is how long with the turn around run? I have some numbers upthread for Barnett, which is currently showing a falling rig count because it's EUR per well is falling back towards Texas average already.

Difficult to estimate Farmer. Take a single good shale gas well. It might start at 10 million cf/day. Decline for the first couple of years may be 60% or greater. But by year 6 or 7 the DR maybe 5%. Of course, the rate will be considerably lower at this point. But these wells can produce commercially for 10 to 20 years. So while you might have 10 new high rate wells coming online in a period, there may be 200 older wells producing a significant amount of NG at low decline rate. So when someone say unconventional NG are declining at X% are they talking about all the UNG every drilled or the ones recently drilled? To come up with a meaningful “overall DR” you have to have a weighted average. Thus when someone says the “natural decline rate is 25%” you have to ask exactly what wells they are talking about. Shale gas wells drilled in the last 12 months are probably showing a 40% to 60% DR. SHG wells drilled 5 years ago have a 5% DR. Older conventional NG fields might be doing 10% DR except of course for the Deep Water GOM NG which are producing huge volumes but might be showing a 30% DR.

To a degree it’s almost meaningless when some offers a DR unless they give very specific definitions of what they are talking about.

Here's the EIA projected Nat Gas prices and production. More charts from the 2009 outlook out today posted in the drumbeat here and here

FYI, my latest article Natty Dread references this post, and attempts to offer a supply outlook for the US. I think it's time to go long gas!