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Ronald Stoeferle

Ronald Stoeferle

Ronald is a metals analyst at Erste Group. Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4…

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A Golden Future for Natural Gas in the US

The combination of still sharply rising US production, a mild winter in the US, and high inventories caused the Henry Hub price to fall to its lowest level since 2002. We believe, that at the current price level, the risk/return profile is very attractive.

US natural gas (Henry Hub) since 1990
US Natural Gas since 1990
Sources: Erste Group Research, Datastream

In relation to oil, natural gas has fallen to the lowest level since 1970.

Oil/gas ratio 
Oil/Gas Ratio
Sources: Erste Group Research, Datastream

It seems as if the natural gas prices are about to find a bottom. We believe that, at the current level, the sector can no longer work profitably. Numerous production and investment cuts for 2012 and beyond confirm this. For example, Chesapeake Energy announced that it would cut production by 0.5 bcf/d. If the prices were to remain at this level, the company would cut its output by a total of 1 bcf/d. In addition, CAPEX would be reduced from USD 3bn to USD 900mn. Exploration expenditure would be cut by 50%, which would represent a drastic u-turn from the aggressive expansion programme in the past years. And CHK, the second-biggest natural gas producer in the US, reported a decline in production of almost 10%. We expect numerous producers to follow suit, which would lead to further cutbacks and a further decline in drilling activity.

The rig count of natural gas has recently fallen to the lowest value since October 2009. This is particularly interesting since the rig count in the oil sector (and here mainly shale oil) has been on the rise in the past months. The current rig count has a lead time of about three to six months with regard to future production.

NatGas rig count (left scale) vs. NatGas future (right scale)
Natural Gas RIg Count v Natural Gas Futures
Sources: Bloomberg, Erste Group Research

It seems that the American shale gas euphoria is currently slowing down. The actual costs of the production of shale gas seem to exceed the costs accounted for by a substantial degree. Generous bank loans, joint ventures, and attractive hedge positions often veil the actual production costs. The drastic increase in the demand for special fracking drills and skilled personnel has of course had an impact on the cost side. Therefore we expect the growth rate of shale gas supply to decline in the medium term.

Estimated break-even price for various US natural gas fields
Break Even Price for US Gas Fields
Sources: First Energy, Company Reports, Erste Group Research

We see largely positive signals in connection with the development of the gas price in the medium to long term. On the one hand, we expect the US shale gas boom to slow down, as a result of a more sober assessment on the basis of economic facts taking hold. On the other hand, the demand side should experience a positive development. Natural gas demand is supposed to grow by 2.1% per year until 2030, according to BP. The main source of the rapid growth of natural gas is its rising relevance in the generation of electric power. According to BP, the demand will increase by 2030, from currently 19bn cubic feet to 35bn cubic feet. Commerzbank points out that 80% of the newly created capacities in the past ten years have been gas-fired power plants.

Current capacity by initial year of operation and fuel type
Current Capactiy by Year of Initiation and Fuel Type
Source: EIA

Renewable forms of energy still tend to be too irrelevant, expensive, and without any substantial governmental subsidies and are thus often unprofitable. The Obama Cabinet seems to promote natural gas, as a speech he gave at the University of Georgetown confirmed. President Obama talked about shale gas reserves that could satisfy the demand for more than 100 years, and he pointed out a cross-party agreement about promoting natural gas as fuel for vehicles. The Energy Outlook by IEA also highlights the growing importance of shale gas for the US. In the World Energy Outlook the agency mentions a “Golden Age of natural gas”. Shale gas is expected to account for 46% of the American gas production by 2035. On top of this BP expects the US to export at least 5 bcf/day of LNG by 2030.

At the moment IEA expects global gas demand to increase by 1.8bn cubic metres to a total of 5.1bn cubic metres by 2035. During this time, the share in the global energy mix should have grown from 21% to 25%. In line with this development, the IEA expects the share of coal to gradually fall and gas to pass coal as energy carrier by 2030.

Development of various energy carriers 2010 vs. 2040 
Development of Energy Carriers 2010 v 2040
Sources: Exxon, Erste Group Research

US gas seems clearly undervalued. We believe that the “fair price”, i.e. a level where on the one hand a rise in demand is possible, and on the other hand there is sufficient incentive for producers and explorers to introduce new products, is clearly higher. We expect a possible final trend acceleration downwards that should bottom out at USD 2. From the risk/return point of view investments in the gas sector seem attractive.

China wants to significantly step up the share of natural gas in the energy mix as well. Plans are to cut back especially on the environmentally harmful coal firing. Currently coal covers about 80% of the energy demand, whereas gas only accounts for 1%. Beijing has realised that both CO2 and sulphur emissions have to be reduced drastically and that the focus should be shifted to gas. Unconventional gas should play an important role in this respect; it is supposed to cover 30% of Chinese gas demand. Current estimates put the shale gas reserves at 36 trillion cubic metres.


Global shale gas reserves 
Global Shale Gas Reserves
Source: Reuters

According to the 12th five-year plan gas is supposed to account for at least 8.3% of total consumption by the year 2015. This would require more than a doubling since 2007. According to IEA, gas consumption is expected to rise by 7.6% annually until 2030 in China. The agency expects China to step up the import from 20bn cubic metres to 330bn cubic metres by 2035. This would make the country the second-largest importer worldwide behind Europe. IEA expects annual imports of 110bn cubic metres even until 2015. According to Wood Mackenzie natural gas consumption in China should rise by a factor of almost five from 9bcf/day today to 43bcf/day in 2030. China wants to achieve this by increasing domestic production on the one hand and by expanding the pipeline capacities from central Asia and stepping up LNG imports on the other hand.

Per capita consumption in a global comparison
Global Comparison of per Capita Consumption
Sources: Erste Group Research, Bloomberg

By. Ronald Stoeferle of Erste Group

Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%

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