The U.S. natural gas market quandary won't go away.
Demand growth potential remains huge for what some call the fuel of the future. But prices at the wellhead seem never to get the message.
Kenneth L. Lay, chairman and chief executive officer of Enron Corp., has an explanation: predatory pricing by large companies.
"I strongly doubt that it has been intentional," he told a Cambridge Energy Research Associates seminar in Houston this month.
Intentional or not, "irrational pricing behavior" has helped reduce the number of independent producers by about 25% in the past 5 years. If the trend continues, Lay said, competition will suffer, and the industry may not be able to find and develop supplies needed to meet projected demand.
Gas price torpor will continue at least through the rest of this year, a CERA researcher says. James Newcomb, CERA director of natural gas, said gas prices later this year will be lower than they were in 1990-"perhaps significantly so."
PREDATORY PRICING
Lay said gas prices at the wellhead have languished below economic replacement costs for most of the past 5 years because "we are not as economically rational in this business as most of us believe we are in our other businesses."
He defined "economic replacement cost" as the cost of finding and developing or purchasing reserves, plus production and operating costs, plus a "nominal" after tax return on investment.
Normal explanations for selling below replacement costs don't apply to gas, Lay said. Demand is rising, and producers aren't intentionally liquidating their companies. Gas sells at a discount to alternative fuels, and the market is constrained by pipeline capacity, not deliverability from reserves.
Furthermore, the deliverability surplus doesn't fully explain why prices have stayed below replacement costs. Lay partly blamed undue optimism about gas prices.
"We tell our exploration and production people to continue drilling for and acquiring new reserves at the same time we tell our marketing people to keep expanding sales, even if the prices are below economic replacement cost," he said.
The practice becomes predatory, however unintentional, when it drives competitors out of business.
"Some producers, most notably the large oil companies, are able to sell natural gas below economic replacement cost because of their large profits and cash flows from oil, both domestically and overseas," Lay said. "The smaller independents do not have this luxury."
ENRON'S OUTLOOK
But the outlook keeps brightening for gas supply and demand.
Enron, updating a 2 year old market projection, has added almost 200 tcf to its estimate of the U.S. economically recoverable resource base. Its reasons: economic and technological improvements.
The addition pushes the resource total to 850 tcf, which doesn't include 160 tcf of current reserves. About two thirds of the resource increase comes from tight and very tight" sands.
Lay said tight sands, Devonian shale, and coalbed methane will account for as much as 11 % of Enron's production in 2010, compared with 3% in 1990.
Enron expects U.S. supply and demand to increase to 21-23 tcf/year in 2000 from about 19 tcf in 1990.
The projection assumes prices, in 1990 dollars, of $30/bbl for oil and $4/Mcf for gas in 2000. It accounts for recent amendments to the Clean Air Act and gas market share gains for economic and environmental reasons.
Most natural gas demand growth will occur in the electricity generation and commercial markets.
The number of residential gas customers is growing, but efficiency gains are keeping demand in that market steady at 4.6 tcf/year.
Industrial demand also is steady, at 6.1-6.3 tcf/year. In that market, however, demand is shifting from boilers able to switch to other fuels to nonboiler, nonswitchable uses that are somewhat less sensitive to price.
As in the industrial market, gas demand in the electricity generation market is growing in nonswitchable areas, such as cogeneration, combined cycle turbines, and gas cofiring and reburn for environmental reasons. Utilities are retiring old, less efficient gas/oil steam boilers.
To capture these markets, Lay said, the gas industry must provide greater price and supply certainty to the power industry than it has before. He said Enron is warranting supplies and prices for as long as 15 years.
Gas demand for electricity generation will grow by 36% during the 1990s to more than 5 tcf, Enron projects.
Lay said commercial demand growth will be strong, with gas replacing dirtier fuels, but didn't estimate the rate. He did predict "a significant market" for gas as vehicle fuel, beginning in the latter half of the decade. Demand in this sector might reach at least 500 bcf/year by early in the next decade.
CERA'S VIEW
CERA's Newcomb said increasing gas supply and decreasing demand might push prices to as low as $1/Mcf later this year.
Recession and mild weather will reduce demand by 250-300 bcf this year from last year's level.
And supply will increase by comparable volumes from storage, new production, and imports.
As a consequence, shut-in deliverability will increase by 1-2 bcfd, Newcomb told a conference session. At a press conference, Arthur Andersen partner Everett S. Gibbs estimated currently shut-in deliverability at 1.3 bcfd.
Newcomb said gas in storage in January exceeded its year ago level by 600 bcf. To reduce storage to normal levels by March would require a 5 bcfd increase in withdrawals, which won't happen.
So the market will enter the low demand summer with an inventory overhang, Newcomb said.
In the longer term, however, new gas market flexibility, production technology improvements, and demand growth will create an attractive environment to do business in, he predicted.
The potential for gas to replace oil remains large, although many of the easy opportunities for displacement were taken in the last decade, when resid demand dropped by nearly 1.5 million b/d during 1979-89.
There's still 1.4 million b/d of nontransportation distillate demand and more than 900,000 b/d of utility resid demand representing potential markets for gas.
Copyright 1991 Oil & Gas Journal. All Rights Reserved.
