Nat Gas, Nukes & Implications

Shale gas, and the huge increase in natural gas reserves brought about by the shale gas revolution, have many implications:

1. They make the energy needed to produce the higher-value crude and synthetic crude oil at the Canadian and Venezuelan heavy oil plants much more economical. Another concern, that those reserves would not be long lasting, is no longer present; these reserves are now over 100 years of North American consumption. Also, because Venezuela is effectively socialist, a confiscatory kleptocracy — just ask the robbed drillers Helmrich and Payne (HP) — and is not a propitious environment to explore for or develop and exploit shale gas, Canada is the only current viable location for substantially increasing oil production.

2. They actually reverse the most logical direction of potential LNG shipments; now it will be from
North America to Asia and elsewhere, displacing the LNG that was to be shipped from Russia and the Middle East to Asia and Europe and North America.

3. This ultra-cheap, abundant, very clean and domestically produced natural gas will very soon make irresistible the planning and construction of power plants and even gas-to-liquids (‘GTL’) plants in the U.S. and Canada, relieving the shortage of oil and removing the recent build-up of support for nuclear power that, until the Japanese debacle, had been shaping up strongly. The U.S. government — and all political parties there — have been very anxious to reduce the nation’s reliance on foreign oil sources, especially those from the Middle East. They will be happy to eliminate legal and practical difficulties that impede the greatly expanded use of natural gas.

4. Power utilities have been reluctant to commit to natural gas-based power plants, even though they are cheaper and quicker to build, because they have never been sure that the natural gas reserves that they need will be there, and that the price will not escalate dramatically on them, as it has in the past. Those fears are now nearly all gone.

5. Gas-to-liquids (GTL) plants, like the ones Shell (RDS.A) and ExxonMobil (XOM) were criticized for in Qatar, are highly capital-intensive, and also consume about 40% of the natural gas in their process which turns gas into diesel and naptha, the constituents of motor, maritime, and jet fuel. However, which such a high-energy differential as exists today, the capital expense and production expense are much lower than that price gap. Please remember: 1,000 cu.ft. nat gas = 1 ‘mcf’ = 1 GJoule = 1 M BTU = 1/6 bbl light oil. At ~US$4/mcf, the energy equivalent of 1 light oil barrel costs 6 times that, or ~US$24. Oil is now trading internationally (Brent) at $115, and, within the U.S. (WTI), at ~$105. So, even were natural gas prices to be considerably higher, GTL development is still attractive. Some companies in Canada and the U.S. are already doing preliminary studies.

6. Nuclear power plants still make some sense, in some places. They have low marginal cash costs of production, even if their capital costs are much more than those of coal- or gas-fired plants. However, they have a number of real or perceived problems: very long lead times from planning and permitting to actual construction and going online; reluctance of local hosting by local citizens; increased wariness of new facilities, particularly in geologically active zones; decommissioning of old reactors is expensive and hazardous; nuclear waste storage is still an issue, although spent fuel rods are actually small and can be stored onsite for many years, or even reprocessed to extract more fuel; finite and declining reserves of high-grade ‘yellowcake’ uranium oxide for processing into fuel; security and other concerns regarding terrorist and other threats to fuel and reactors. When compared to natural gas, and the short permitting construction time, and low capital cost of natural-gas fired plants, and NOW the hugely improved outlook for immense, growing, low-cost shale gas supply for many years to come, nuclear power looks uneconomical and problematic. Existing plants, and adding capacity at existing plants looks viable; new ones, except in fast-growing places in Asia and Africa, do not.

7. If the Fukushima-Daiichi plant is replaced by a natural gas-based one, it will be a huge validation to the whole thesis of such a gas-based energy economy. Since they desperately need the power now, gas is the only fast way to get there, and may be the only environmentally and publicly, popularly supported way to do it, given the disaster at the existing plant.

8. Shale gas exploration has only just, tentatively, started outside North America. Europe, Asia, and many other places look prospective for at least a few large formations, and could create abundant supply in those regions, which will begin to radically change energy dynamics around the world. LNG plants may make less and less sense, and GTL more and more sense.

9. The immense new supply of shale gas not only makes extraction of oil from oil sands in Alberta more economical and gives greater assurance of payback and the security on and of long-lead-time projects, it also enhances the rate of return on the upgraders that are sometimes attached to those projects, or use their output. These upgraders use natural gas to effectively ‘hydrogenate’ the long-carbon-chain heavy molecules in the ‘bitumen,’ or heavy crude, and turn it into high-value, very light synthetic crude oil, which enjoys a very lucrative ‘spread’ over heavy oil or bitumen cost, and also has the advantage of not requiring the additional expense of NGL or LPG diluent to send it via pipeline all over North America from northern Alberta.

10. The greater abundance of shale gas brings along with it more NGL’s, used as diluent in the aforementioned pipelines to ship bitumen or other heavy grades of oil, and that greater supply of NGL’s will thus make shipping the heavy crude grades via pipeline more economical, even if they are not upgraded, further enhancing the cost profiles of the oil sands projects, ensuring greater production from those sources.

11. Assurance of abundant, cheap natural gas will make more nitrogen fertilizer plants economic, and, thus, increase the supply of fertilizer, helping to damp down the increasing costs of producing the extra food supply a growing and more affluent global population wants and needs. As most food prices have been rising dramatically in recent years, this will benefit everyone, everywhere.

12. If natural gas supplies more electric power in the U.S., and, either directly, or through GTL or electric power substitution in transportation or elsewhere, displaces more foreign oil imports, this development could have a major, transformative effect on the U.S. trade balance and balance of payments deficit, just as the discovery of huge new natural gas fields offshore Israel in the Mediterranean Sea is having on that country. If it were not for importing more than 60% of its oil needs, the U.S. trade deficit would be much lower and nearly a non-issue.

13. It will be hard to make money investing in natural gas producers for a few more years, at least. There will be a reduction in the rate of growth of production and reserves, as it just does not pay enough, given the decline in prices, to keep reinvesting at the current levels. Carbo Ceramics (CRR) is the only pure play in ‘fracking’. They are also more ‘portable’ than the oil and gas drillers, and thus can exploit European and other overseas shale gas opportunities. It is not clear what the ‘bottom’ for natural gas prices may be; it could be even lower than the ~$3.85 per mcf it hit a few weeks ago. Investors should likely be careful in buying gas-heavy producers when the price moves well into the $4.30+ area, as it has recently. When everyone is in absolute despair about gas prices, and the industry, contrarians should definitely look more closely at well-capitalized, strong growers.

One caution: The shale gas industry will have to do a much better job at convincing the public, and politicians, that the high-pressure water and chemical processes they use to fracture, or ‘frack’ the shale formations that hold the ‘tight gas’ are safe; that is, non-toxic, and do not contaminate groundwater or other environmentally sensitive locations. New York State and the Province of Quebec in Canada have already put moratoriums on new drilling until further study shows that the fracking processes are reliably and extremely safe. Sloppy work by one firm in the Marcellus Shale formation in the Appalachians, and a separate instance of coincidentally, naturally occurring gas in domestic water pipes, have damaged the reputation of the industry, at least temporarily.

Final conclusion: Political factors, especially chaos and revolution in the Middle East, or Central Asia, would dramatically increase the price of oil and plunge the world into another bad recession. If Saudi Arabia is disrupted, the price would soar. Even without any special major event, I expect that there will be turmoil for several more years. The price at which the U.S. would go into recession is debatable, but anything prolonged over ~US$140/bbl would certainly do it; it did so in 2008. Shale gas and liquids cannot do much to mitigate this, in the very short term, but could do so within a few years’ time.

By: Ian Madsen

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