January 17, 2012 • Current Events, Energy Innovation, Natural Gas

2011: The year in energy (Part 4: Extreme Production)

by Eric Bickel

So far in this series, we’ve focused on global themes from the economy to governmental upheaval, and then circled back to how they’ve affected the U.S. In this final post, we’re going to focus on a recurring theme in the U.S. energy market and how this theme could affect the global market in years to come. And that theme is none other than U.S. natural gas production.

Last year proved to be a ridiculously strong year for gas production, as shale gas – extracted from shale rock formations, typically through hydraulic fracturing – proved to be the game-changer that just about everyone thought it would be.  However, the strength in shale production wasn’t really the surprise of 2011. The surprise came from the fact that production grew even as natural gas prices remained well below the $4 mark. Many thought that this level would be where producers would begin to cut back on production, as “break-even costs” – the cost at which producers start to lose profit – were believed to be around this level.

Gas production ballooned in 2011 through October (most recent data from the EIA).

Along with the lack of winter demand from above-normal temperatures in the fourth quarter of the year, the continued strength of natural gas production helped prices to further test lower boundaries, and these two factors pushed prices down below $3 for the first time since September 2009. Matt Smith compares shale gas to Luke Skywalker on the Energy Burrito, and personally, I like the comparison. It hints at the ability for this resource to change the way the game is played in the world of natural gas (and all-around energy) in many ways.

First off, the ability to produce at low prices incentivizes producers to find new and more efficient methods to get gas out of the ground. It creates a competitive environment and promotes innovation. This further reinforces production to continue at low prices as producers take advantage of efficiency gains and ensures that the players continue to develop new techniques. We’ve seen this take shape as production increases while the number of gas-drilling rigs does not – implying that the amount of gas-per-rig is increasing (see below). This is beneficial, as it pushes that break-even cost lower for producers.

Regional horizontal rigs (a proxy for shale-directed rigs) remained steady through 2011 as production soared.

The actual economics of this is somewhat murky, however, as some producers are actually able to produce what is known as “associated gas” from wells that are actually drilling for crude oil and natural gas liquids. (In essence, natural gas production in these cases is just a side-effect of sorts.) However, this doesn’t account for the lion’s share of the growth in 2011’s production, as gains in efficiency are by and large the most significant factor here.

Secondly, the cycle of strong production->lower prices->increased efficiency->stronger production promotes a competitive advantage for the U.S. as we come closer and closer to LNG (liquefied natural gas) export capabilities (aka “Princess Leia,” in Matt’s analogy). With the potential for Europe and Asia to look to natural gas as a bridge fuel for power generation (offsetting declines in nuclear maintenance), the LNG market is very attractive today. The U.S.  is poised to take full advantage of this, given the growing impact of shale.

So, 2011 proved that not only is the U.S. able to produce natural gas at a level that was previously considered unprofitable, but it is also able to do so at increasing volumes. The immediate implication of this (coupled with lackluster demand) has been record storage levels. The long-term implication (coupled with even normal demand) is that the U.S. can be a competitive supplier of a growing global commodity – natural gas. No matter how you cut it, unconventional production is not just a game-changer for the U.S., but also on a global scale. And there’s not a great deal to stand in its way (as exemplified by 2011).

So, there you have it. Four posts on four topics that changed energy markets in 2011. With a new year comes new potential for even more game-changers in energy. And, as always, Summit will be there every step of the way to analyze the market impact.

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