Natural gas prices in the US are likely to increase 30-40% over the next 2 years according to BP PLC's Chief Economist Christof Ruehl. In an interview with OGJ, Ruehl explained that the low-price environment in the US is being reinforced by the expanding oil-gas price differential. Ruehl said this phenomenon has led to many operators moving away from dry shale gas production to producing tight oil. This move, however, has not reduced gas production overall since there is significant gas associated with tight oil production.
But Ruehl said with the US expected to become an exporter of gas by 2015-16, he forecasts gas demand to increase and, with it, gas prices. Ruehl said he expects to see demand for gas picking up from carbon-consuming industries, particularly from electric power generation.
The upward movement of gas prices, Ruehl said, is being driven by the US electric power sector. Last year, for example, there was a record increase in the use of gas in electric power generation, replacing coal. He argued that the price of coal also will be a factor in determining gas demand and therefore, gas prices.
"Last year in the power sector, what we saw was the largest increase in a single fuel for at least 40 years. Last year natural gas in the power sector increased 20%, coal decreased 12%, and that came on the back of the last 5 years where natural gas in power generation increased on average by 6.5%," he said, adding, "Last year there was a large supply of natural gas and that brought the prices down to $1.81[/MMbtu] and that made it competitive with coal."
Ruehl said if the price of gas continues to increase it could lead to a slowdown in the replacement of coal by the power sector. He also revealed that he did not think the world will experience massive shocks in crude prices as occurred in the 1980s and 1990s. "So we will think [gas] prices are set to move a bit higher than where they are today. But I will not expect a return to what we saw in the 1990s." Ruehl said.
He pointed out that in the last 2 years, the US increased its crude production by nearly 2.5 million b/d due its success in drilling and producing tight oil. He forecasts that the US will eventually produce more than 10 million bo/d. He said this would mean that the world's largest consumer of energy and energy products would find itself meeting most of its needs and that had implications for global supplies.
Ruehl said should there not be supply curtailment due to geopolitical factors, he thinks that the world could have as high as 6 million bo/d in spare capacity but insisted the circumstances were different now to the 1980s-90s and will not lead to a free fall of crude prices.
He said, "The normal reaction of a market to additional supplies in the order and magnitude which we have seen with tight oil would of course be that prices go down. But the oil market is not an ordinary market. And why not? Because it has in it the Organization of Petroleum Exporting Countries, and OPEC acts as a cartel, which has its own ideas about how to manage supplies. So in oil markets the question of the price impact of tight oil, when you take out all the geopolitical factors, translates smoothly into how OPEC will react. I think on balance we have reasons to assume that OPEC is capable, willing and able to cut supplies to neutralize this additional supply."
Ruehl said he was aware that the spare capacity will put tremendous pressure on OPEC's ability to be cohesive because both the US and Russia will be the two countries other than Saudi Arabia that produces in excess of 10 million bo/d and only Saudi Arabia will be prepared to cut back in an effort to keep the prices high. He said neither Iraq nor Iran were likely to do this.
Ruehl also explained that there was another line of defense: the nature of tight oil. "Many people from this situation have jumped to the conclusion that we are likely to see another severe price decline similar to what happened first in the 80s and then in the 1990s, I would disagree with that and the reason for this I think lies in the nature of this tight oil supplies."
He explained in the 1980s and '90s additional supplies were coming onstream in non-OPEC countries—notably from the North Sea and Alaska—and companies chose to continue to pump oil rather than shut-in production. He said in some respect it was difficult to control the rates of production, but with respect to tight oil, it is much easier.
Because of the extremely high valve intensity of tight oil, production is very scalable and there should be a hypersensitivity to price swings. And how that will work? "You have seen recently in the case of shale gas when prices came down so much, shale production started to fall. When you take out the associated gas with tight oil, shale gas production has come down and you can expect this to happen with tight oil should prices fall."