US natural gas producers don't have much to worry about in the near term. Even if gas prices soften in the months ahead in case a warm winter and ample storage combine to squelch any prospect of a tight market in 2004, no one is predicting a return to sub-$3/Mcf levels soon.
Some have raised the spectre of rising service and supply costs putting a crimp in the US gas drilling surge. But even that prospect isn't likely to end the party soon, according to a recent research report by J. Marshall Adkins, the Houston-based analyst with Raymond James & Associates Inc., St. Petersburg, Fla.
Service-supply costs
Adkins notes that the average internal rate of return on a US gas drilling project currently is more than 50% with gas prices at $5/Mcf.
He also foresees the possibility of service-supply costs spiking up by 15-20% or more in 2004.
Would such an impressive IRR then be deflated by a spike in service costs? Adkins contends that prospect isn't likely because drilling and equipping costs actually have a surprisingly small impact upon exploration and production returns—only about 45% of all finding and developing costs, according to US Energy Information Administration data.
"When we include lifting costs, oil field service costs represent less than 30% of the total cost of finding and producing natural gas in the US," he said. "That means that even with a 50% increase in oil field service pricing, E&P companies still would generate over a 30% rate of return at $5/Mcf natural gas prices."
Even with gas prices at only $4/Mcf and service price increases of 25%, gas E&P investment can garner a return of 20% or more. It is only with a $3/Mcf price that returns dwindle to breakeven levels.
LNG threat?
A much more worrisome spectre looms on the horizon for US E&P companies, however: the prospect of a boom in LNG imports.
As LNG becomes an integral part of US natural gas supply over the next 20 years, imports will have a dramatic effect on market dynamics, supply volumes, and price volatility, according to a new study by Energy Security Analysis Inc., Wakefield, Mass.
ESAI's study reckons that aggressive invesments in four new Gulf of Mexico area LNG terminals will give importers substantial pricing power over the most influential North American gas trading region.
"At key points such as the Henry HubUdomestic gas players stand to lose up to 30% of their market share by 2010, diluting the value of indigneous production assets," said ESAI analyst Scott DePasquale. "The ultimate deliverability and interruptibility associated with LNG imports will also give way to significant changes in natural gas cash and futures markets."
The chief change is greater volatility in gas prices as LNG imports gradually become more of a baseload supply alternative, with the variability of shipments significantly altering the daily flows of gas to US distribution hubs, the study concludes.
This phenomenon will increase price volatility in spot and futures markets—an increase tough to predict because of the opaque natural of spot cargo trading.
Eventually, the big jump in US LNG import capacity will lead to the country becoming the "sink" for any spillover global LNG supply, he contends.
Domestic producers threatened
DePasquale sees domestic E&P companies becoming threatened by LNG as the relatively cheaper supply of imports begins to displace local gas supplies. ESAI pegs the landed of cost of LNG at $2.75/MMbtu and projects a long-term domestic price floor of $3/MMbtu.
"While domestic LNG infrastructure is developed, Gulf [of Mexico] producers will have even less incentive to aggressively develop the North American resource base," he concluded.
All of which begs the question: If imported LNG can undermine gas production from the Gulf of Mexico, what will it do to the market prospects for gas from Alaska's North Slope and Canada's Mackenzie Delta?
One can already hear the calls for a domestic natural gas import fee.
(Online Nov. 29, 2003; author's e-mail: [email protected])
