David W. Biegler
President
Enserch Corp.
Dallas
Adapted from an Oct. 1 speech to a Natural Gas Week conference in Houston.
More and more, people are seeking some understanding of just what is happening in the U.S. natural gas industry.
I have attempted to put a framework around today's natural gas industry in the form of a dozen "laws" that provide some insight.
MANAGING THE FUTURE
- The future's not what it used to be.
Today you can determine accurately this industry's future, and tomorrow it will not be the same. Planning for the future has not become futile or impossible, but merely agonizingly difficult and forever and constantly evolving. In today's natural gas industry, if you are prepared only to manage in the future the conditions that exist today, you are going to fail.
- Age is no substitute for maturity.
This industry has not completed its evolution and is many years from exhibiting characteristics of a stable or mature industry. Changes in the last decade have given birth to a new industry with all of the characteristics of an infant industry: lack of pricing discipline, infighting, instability, uncertainty, and lack of cohesive support. In fact, we're worse off than an infant industry, because we still have many people operating as if this were the same industry of a decade ago.
- History is a lousy predictor.
Extrapolating history produces really lousy forecasts. Extrapolating annual sales volumes based on our industry's 33% share of the U.S. energy market in 1971 would have projected sales this year of about 27 tcf. Conversely, the trend during 1980-86 would provide an indicated sales level this year of only 14 tcf. That compares with demand estimated this year at 19 tcf.
While there has been much concern over reserve replacement since the price collapse in the early 1980s, the industry has done a good job of replacing reserves the past 5 years. Relying on a low drilling rig count as a predictor of lower supplies fueled an unrealistic expectation of price increases driven by low drilling levels.
Natural gas reserves at yearend 1990 are down only about 5% from the level at yearend 1981. Even ignoring revisions, reserves additions in 1990 were only slightly below those in 1982, with an average drilling rig count about 70% below 1982. Gas reserves added per active drilling rig are now more than 21/2 times the level of the early 1980s.
SUPPLY INFLUENCES
- Reserves discovered per dollar invested are inversely proportional to prosperity.
The simple explanation is that historic trends, ratios, and other statistics used to predict reserves and deliverability have ceased to be relevant to a dramatically changed industry-like trying to predict the U.S.S.R.'s GNP on the basis of performance the past 10 years.
Improving trends in reserves added per discovery and reserves added per well drilled have had a significant effect. In 1983, reserves added, excluding revisions, were about 800 MMcf/well. By 1990, this climbed to 1.45 bcf. Technological advances and simple improvements in the industry have produced dramatically more available gas than today's level of drilling would have indicated 5 years ago. We would like to claim it all comes from technological advances, but the truth is much of it stems from efficiency improvements required by poor economic circumstances.
- Government supply incentives are most effective during periods of oversupply.
An increasingly important factor has been tax incentives for tight sands and coal seam production. Not only is it influencing reserves, the characteristics of "produce it or lose it" in the tax code means it will not be shut in to adjust to seasonal demand. Consequently, if you hear cries for restrained production from these producers, they're always talking about someone else's production.
In the past 5 years, net imports about doubled and now make up about 8% of demand vs. 4.6% in 1986. Just incremental deliveries from imports added the equivalent of production from new discoveries of about 6-8 tcf. In other words, new import capacity made up for about one fourth of the shortfall between production and new discoveries since 1986.
In addition to unexpected reserve additions came improvements in deliverability. During 1973-85 annual production per gas well in the U.S. declined by 70%, but during 1985-91 it has remained essentially constant. In January 1990, the industry demonstrated the highest level of monthly production since 1984. In addition to technology improvements, industry also is doing a better job today of managing production and extracting more from existing properties.
However, structural change within industry on wellhead deliveries has had more to do with the anemic price recovery than any physical phenomenon. Wells that once may have produced only 50-80% of the year now have the opportunity to produce every day. Expiring or released contracts and the open market for gas have eliminated prior artificial constraints on production levels.
PRICE FACTORS
- Be careful what you ask for (open access and competition). You might get it (lowest real price in more than 15 years).
The only remaining constraint in many instances is the unwillingness of the producer to accept an unrealistically low price. Unfortunately for the industry, there has been little demonstration of this unwillingness. This perhaps was the greatest miscalculation of all, the assumption that an intelligent and knowledgeable seller would replace the formerly regulated structure with pricing discipline. Instead, the seller has demonstrated, within certain very low boundaries, to be almost totally driven by sales volumes vs. price.
This is not a "mom and pop" industry. Ten sellers control about a third of the production and 20 control 50%. This is not a fragmented industry but an undisciplined one. It too often views itself as the innocent victim of external forces, when in fact it would benefit most by constant reminders that it is the victim of its own collective misjudgments and actions.
Beyond wellhead supply, the other great change has been in the delivery system. Quite simply, it has become much more efficient. For an industry whose prices are dominated by the ability to meet peak day needs, the much higher storage deliverability now available has had a great influence. Pipeline system expansions are adding efficiency and flexibility to the system. Interconnectivity on the pipeline system is increasing dramatically. This is what the free market clamored for in the mid-1980s, not a plot to hold prices down.
- Too much of a good thing isn't necessarily wonderful.
More than anything else, it is the structural change that has challenged our paradigms, rendered our forecasts obsolete, erased almost 20 years of progress on gas prices, and made so many of us look like fools. It is a delightful contradiction that many in the industry to this day lament low prices at the wellhead but rejoice in the producer's role in making nondiscriminatory open access transportation a reality.
While the ideas of deregulation and open competition are American institutions, there are some realities with which we need to deal. First, this industry has not been deregulated but has only gone from full to partial deregulation, a worse condition. There will not be stability, peace, and progress until the transition to a true deregulated industry is behind us. Second, it is time we admitted we weren't ready for competition. We are not yet an industry but a collection of individuals, most of whom still think competition is just underpricing the next guy.
- Natural gas prices vary inversely with the number of gas marketers. Corollary: Marketers in majors count double.
In this environment, companies have alternative agendas. Differing portfolios of income stream, such as upstream vs. downstream and gas vs. oil, are going to affect prices. It is going to be driven, however, by business plans and cultures of the majors and large independents.
- Fighting over a pie usually wins out over working together to bake a larger pie.
My greatest concern regarding the gas industry today is its inability to develop itself into a cohesive industry that can balance competition with cooperation. We have been talking about baking a larger pie for many years, but with only a few exceptions, there is little to show for it.
It has been my contention since 1986 that we have never had a gas bubble. There has never been an oversupply, but there has been a devastating underdemand. The notion of a supply bubble was one of the worst ideas ever to permeate the gas industry. It promoted the idea that we were victims of being too proficient at supply and not participants in causing the hard times. It was bunk. We allowed consumption to decline by 18% in 1980-86. We are now talking about congratulating ourselves for the projection of moving gas demand up to about 21 tcf by 2000, which, incidentally, only restores it to the level it had during 1969-74.
MARKETING GAS
- Most complaining loudest about lack of gas marketing don't have gas lights in their yards.
Some of the loudest complaints about lack of marketing come from those who are doing the least. Those who think marketing is competing at the end user level to displace other gas sellers are missing the point. Only an increase in total gas use will produce true economic gain for everyone in the industry.
In contrast with the electricity and coal industries, in which all segments share responsibility for creating demand, the gas industry remains a segmented, noncooperating industry. There is still too much reliance on distribution and pipeline segments to carry demand creation.
The natural gas vehicle market is long term growth, but it is real market growth. Support could come through participation in refueling station infrastructure and support of dedicated vehicle manufacturing through commitments. I cannot imagine anyone whose future is tied to the gas industry not doing everything possible to proceed rapidly to convert company vehicles. Relatively few industry participants are carrying this load.
Other market opportunities include advancing commercial cooling, advanced residential air conditioning, fuel cells, and cofiring with coal. Unless we get all segments of industry competing to cause this growth, our share of the national energy market will at best remain stagnant. The true competition is alternate suppliers of energy, and they are organized, efficient, experienced, and well financed.
- The ability of the gas industry to self-destruct is always underestimated.
Producers have rightfully criticized today's overreliance on spot market purchases. They have been strong advocates of contracting for long term supply, premium prices for security of supply, and the benefits of natural gas for the residential customer. With these benefits, is the producing community uniting behind and supporting the distribution segment? No. Instead, you've had open criticism of prices at the consumer level.
The decline in the mean average price of gas to all customers during 1984-90 was 940, or exactly the same as the decline in the average wellhead price during the same period. In other words, all of the decline in average wellhead price has been passed on to consumers.
During 1984-90, margins charged by natural gas distributors and pipelines have held constant in nominal dollars. In constant dollars, they have declined by more than 18%. This demonstrates productivity improvements and cost cutting in these segments of the industry as well.
The benefits of price decline are being distributed by market realities that are eroding subsidization of residential margins by industrial customers. Industrial purchasers who lacked political power to lower rates are now achieving it through market power and are accomplishing rates and margins more nearly equal to their class cost of service. While average wellhead prices declined by 940 over this period, prices charged to residential customers declined by 450, but the much greater volumes sold to industrial customers declined by 970 and those to electric generation customers by $1.32.
OUTLOOK
- Structural change does not require low prices.
The good news is that pessimism is unfounded. Now that structural change is being more widely discussed, there has been a tendency to become too pessimistic because of it. The structural change in the industry did not cause low prices. It prolonged the effects of events already set in motion.
Just as many extrapolated erroneously the previous history, many are misreading current changes. Deliverability added by discoveries will adjust to demand. Production increases from old wells due to structural change will not be sustained. Even the rate of increase in imports will not continue.
We are now in a period of returning to a balance of supply and demand and will have continuing price improvement. Price response during the peak winter period establishes purchasers' and sellers' perceptions of the following year's prices. We have not had such a response the past several winters. Those who think they can judge that perception with statistics are overextending the data. Given the right weather, the rate of improvement in prices will surprise many people.
We have an extremely bright future-a good product, increased demand, a gradually improving regulatory picture and a maturing, more stable industry. Making this prospect a reality is going to require cohesion, cooperation, a little intelligence, and a lot of hard work.
Copyright 1991 Oil & Gas Journal. All Rights Reserved.
