Lessons From Past Natural Gas Import Fiascos Suggest A Cautious Approach to Natural Gas Exports

The U.S. should take a cautious approach to exporting natural gas.

That’s the clear lesson of three decades of bad guesses by analysts about natural gas prices and supplies. If pro-export advocates are wrong this time, consumers and businesses will be the ones who suffer from higher domestic gas prices.

Several recent studies concluded that domestic price increases from exports would be small. This conclusion, however, is based on unrealistic assumptions about the size of U.S. gas supplies and the true cost of producing shale gas.

In fact, supplies are likely substantially smaller than predicted, while costs are higher.

History should provide ample reasons for the U.S. to look before it leaps into large-scale exports. Two cycles of investment fiasco involving natural gas imports to the U.S. have occurred in the past 30 years, first in the 1970s, and again just a few years ago, when more than 47 applications for natural gas import terminals were pending at one point.

Both of these were due to incorrect predictions about domestic supply. The supply models that past gas import decisions were based on had widespread support by experts. But they were wrong.

The lesson: gas supply estimates are much more uncertain than experts and conventional wisdom assumes.

Now, a new supply model has replaced the previous one and analysts again agree upon natural gas abundance at low prices for decades to come. Our analysis - which we plan to publish on in coming days - suggests that they are wrong again.

We do not dispute that the shale gas resource is large; we question the near- to medium-term supply, the amount of shale gas that is available on demand. The number of gas-directed drilling rigs has plummeted in the past year because of low price and we fear that demand may exceed supply unless this trend is reversed.

All oil and gas wells display production decline rates over time. The decline rate is simply the change in flow over time. Shale gas wells have especially high decline rates, meaning U.S. supplies are likely shorter-lived than many are predicting. For example, conventional gas wells decline at annual rates of about 20% per year but the production from shale gas wells declines at rates of at least 33% per year and often higher.

Furthermore, the cost of production is likely more than the prevailing market price based on company filings to the government.

Thousands of wells that have been drilled have not been turned on yet. As these wells come on line, supply rates will be maintained at high levels despite decreased drilling for a while. When this excess capacity is reduced over the next year or so, U.S. supply will decrease unless gas drilling resumes and this will not happen until prices rise.

Production from shale is a new phenomenon and prediction about future well performance is speculative. However, recent studies by the U.S. Geological Survey, the University of Texas, Louisiana State University and other industry groups show that commercially recoverable per-well shale gas reserves may be considerably smaller than some believe.

Despite assumptions that gas prices will remain low, ExxonMobil Chief Executive Rex Tillerson says that his company is making "no money" on U.S. natural gas due to low prices that have fallen well below the cost of production.

“We are losing our shirts,” Mr. Tillerson told MarketWatch last June.

In recent weeks, a coalition of gas users that include Dow Chemical Company warned that gas exports would increase domestic prices and that in turn would cause a loss of competitive advantage for U.S. business. They are correct.

Energy from domestic gas is a strategic natural resource and, therefore, should be given special attention before approving its export. Just because we have abundant natural gas, why should we race to use it up as fast as we can?

We recommend allowing spot cargo exports on a trial basis for two years. This pilot project should not contractually bind export volumes of more than 3.0 billion cubic feet per day, approximately 4% of daily U.S. consumption. In two years, we should have a much clearer understanding of the capacity of shale gas to support internal supply.

Past ExxonMobil CEO Lee Raymond cautioned last year, “There is going to be a big debate in the U.S. as to whether or not they’re going to permit the export of liquefied natural gas. Even if you get past the politics, you have to test whether or not the resource base is sufficient.”

We agree. Approving long-term export contracts before confirming the true size of U.S. natural gas supplies would be reckless. Policymakers should take the time to get it right, so the rest of the country does not pay the price for another cycle of bad guesses about the natural gas market.

-Arthur E. Berman, Petroleum Geologist
-J. Michael Bodell, Oil and Gas Price Stucture Specialist and Petroleum Geologist
-Henry Groppe, Chemical Engineer and Founder, Groppe, Long and Littell, Oil and Gas Supply Demand and Price Analysts
-Rune Likvern, Natural Gas and Oil Supply and Demand and Systems Analyst and Economist
-Tadeusz Patzek, Petroleum Engineer and Chairman of the Department of Petroleum & Geosystems Engineering at The University of Texas at Austin
-Lyndon F. Pittinger, Petroleum Engineer

"The lesson: gas supply estimates are much more uncertain than experts and conventional wisdom assumes."

That is why it is so important to use the techniques of uncertainty quantification on the analysis and any models that are applied.

We did that in this report: http://www.npc.org/Prudent_Development-Topic_Papers/1-8_Onshore_Natural_...

The natgas resource supply discussion starts on page 22. See Appendix C for a discussion on data handling.

Impressive document, happy to see lots of analysis being done.

First pass through, I see a reliance on using Hubbert Linearization (HL) on resource estimates.
For natural gas, HL should never have been applied.

Production has always been limited by the ability to transport it, which essentially wipes out the assumptions of a parabolic peak required for HL.

For oil, HL works a bit better, but is far from ideal.

King Hubbert missed when he made this prediction for NG, in comparison to the one for USA oil:

The HL approach works ok as a "top-down" approach if history is treated as a matter of superposition, although it is certainly not perfect. New natgas sources will impact the slope as they are enabled by step changes in price and technology. Sort of like finding a whole new basin or country, just in the same geography. That is a point to note on Figures 16, 19, C4 et al. This "top-down" approach was used as a reasonability check on the "bottom-up" figures from MIT (ICF), the NPC survey, and other sources.

Remember, natgas was more-or-less a nuisance or waste product in Hubbert's time (and apparently still is in N.D.!). Clearly what we're doing today was not in scope, as evidenced on your graph. In the paper, you can imply this from the prices plotted on Figure 17 and elsewhere.

All in all it looks like Hubbert may have gotten the date of the all time US NG peak right. We'll have to see whether the current production rise keeps on going though.

From EIA, the last few years

2008 	2009 	2010 	2011
20,159 	20,624 	21,316 	22,902

It really has been about maintaining about the same level since the peak in 1970.
They just go right through a succession of fields according to the plan, when one field depletes, they move on to the next one.

One can see that from this kind of chart:

Notice how the new wells replace the depletion of the previous years wells. This kind of stratification is nowhere as clear with oil, where everything is being tapped in parallel. Except perhaps for Bakken oil, where the individual wells have such a short lifetime that the same type of succession is taking place.

The vertical striations represent the Red Queen graphically. The more vertical the lines become, the faster that successors have to be drilled. If there are no successors, it falls off a graphical cliff.

Hubbert just didn't have a good estimate of the ultimate conventional NG, and had no idea of shale gas.

What's the source of that chart/document?

Some good charts there.

The other one is taken from Steven Gorelick's book on oil depletion.

Thank you Art and colleagues for posting a sensitive and serious letter here on TOD. I would hope this letter gets posted as a page in some serious publications like the NYT or WSJ where it gets the attention of the PTB.

“Approving long-term export contracts before confirming the true size of U.S. natural gas supplies would be reckless.” Pointing out a factor that Art et al know: as a general rule when it comes to big capex projects like LNG plants/terminals and major pipelines rarely are monies spent without a volume guaranteed. And by guaranteed I don’t mean just Company X saying they are legally obligated to supply A cu ft for B years. Often a bond (including some sort of insurance coverage) is required. All Company X has to do is file bankruptcy and disappear and that legal obligation disappears. In the case of pipelines often a potential builder will pay for a third party analysis of a company’s “proved” reserves.

Given how volatile the various markets are (such as Chenier switching from LNG importer to exporter in just a few years) it’s difficult imagine investors are more cautious and require more “proof” of future volumes.

US concerns over gas export are mirrored in Australia. Currently all LNG comes from Western Australia which has a state policy of reserving 15% of gas production for domestic consumers. I'm not sure how that would work if Shell's floating LNG plant goes ahead and there is no pipe to shore. As we speak several LNG processing plants ('trains') are under construction on the east coast at Gladstone Queensland. It was thought Australian LNG exports from the east and west coast could eventually overtake those of Qatar.

Some key events have happened since the LNG export mania
- carbon tax
- protests over fracking (CSG more than shale) and tighter regulation
- industry requests for guaranteed low cost supply
- emergency pipeline construction to a beleaguered mining firm.

Billions of dollars of carbon tax revenue were to be used to replace older coal fired generation with combined cycle gas, the so-called 'contracts for closure'. Fears of gas price escalation have largely nixed that. Power companies and nitrogen fertiliser makers (including Dow) have lobbied for preferential supply below the LNG equivalent price. Just recently a company in the Northern Territory that processes bauxite into alumina has pleaded to build a 500km gas pipe to its remote plant. That gas originates in offshore WA and was already contracted so the NT government released some its share to preserve jobs.

The heavy hitters are holding a conference in April to discuss this. However the Federal government has said it won't intervene. East coast LNG exports start late 2014. I suggest there is another price shock waiting for domestic gas, namely a major shift to CNG as a diesel substitute. It all says save plenty for later.

Thanks a lot for this, and waiting for the coming analysis.

Another piece of propaganda hot off the press :

Relayed by the Frankfurter Allgemeine Zeitung (amongst many others) :

If Art was even remotely correct with posts like this it would be pretty easy to make a fortune on the futures market, where long term contracts are expecting gas in the 4.5-5 range.

It seems pretty clear to everyone (except Art and some diehards) that there is quite a bit of gas to be had in that price range.

Perhaps Art doesn't consider 4.50 gas to be cheap. But the reality is gas is still cheap at that price. People have perhaps forgotten what expensive gas looks like. Ask the Euros, ask the Japanese. We won't see prices like those for quite some time, perhaps 3 decades or more.