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The shale gas "miracle" is overhyped and
bound to disappoint. That's what energy expert Bill Powers argues in his
upcoming book. But Powers tells The Energy
Report that this could be a very good thing for oil and
gas companies and their shareholders, and he is placing his bets accordingly.
The Energy
Report: Bill, you
have a new book coming out next spring entitled "Cold, Hungry and in the
Dark: Exploding the Natural Gas Supply Myth." What is your basic
argument?
Bill
Powers: My thesis
is that the importance of shale gas has been grossly overstated; the U.S. has
nowhere close to a 100-year supply. This myth has been perpetuated by
self-interested industry, media and politicians. Their mantra is that
exploiting shale gas resources will promote untold economic growth, new jobs
and lead us toward energy independence.
In the
book, I take a very hard look at the facts. And I conclude that the U.S. has
between a five- to seven-year supply of shale gas, and not 100 years. That is
far lower than the rosy estimates put out by the U.S. Energy Information
Administration and others. In the real world, many companies are taking
write-downs of their reserves.
Importantly,
I give examples of how certain people and institutions are promoting the
shale gas myth even as they benefit from it economically. This book will
change a lot of opinions about how large the shale gas resources really are
in the U.S. and around the planet.
TER: How did you obtain your information?
BP: I spent three years doggedly researching this book.
Most of the information came from publicly available sources. I used a fair
amount of work done by Art Berman, who has written the forward for the book.
Art is a leading expert on determining the productivity of shale gas plays. I
contacted a lot of other geologists and petroleum engineering professionals
and had them review my conclusions about declining production.
Put
simply: There is production decline in the Haynesville and Barnett shales. Output is declining in the Woodford Shale in
Oklahoma. Some of the older shale plays, such as the Fayetteville Shale, are
starting to roll over. As these shale plays reverse
direction and the Marcellus Shale slows down its production growth, overall
U.S. production will fall. At the same time, Canadian production is falling.
And Canada has historically been the main natural gas import source for the
U.S. In fact, Canada has already experienced a significant decline in gas
production—about 25%, since a peak in 2002—and has dramatically
slowed its exports to the United States.
TER: What does this mean for investors?
BP: The decline is a set-up for a gas crisis, a supply
crunch that will lead to much higher prices similar to what we saw in the
1970s.
Interestingly,
during the lead-up to that crisis, the gas industry mounted a significant
advertising campaign trumpeting the theme, "There's plenty of gas!"
Now, it is true that there was a huge ramp-up for gas during the post-World
War II period that lasted through the late 1960s as demand for gas for the
U.S. manufacturing base grew rapidly. But we hit a production peak in the
early 1970s during a time of rapidly growing demand. This led to a huge spike
in prices that lasted until 1984.
It was
very difficult to destroy demand, so the crisis was resolved by building
hundreds of coal-fired power plants and dozens of nuclear power plants. But
today, gas-fired plants are popular as we try to turn away from coal. This
time around, those options are no longer available. Nuclear plants are still
an option, but the time and money involved in keeping our aging nuclear power
plant fleet operational, let alone building new plants, will be quite
significant.
TER: How will the contraction of the natural gas supply
affect its price?
BP: We will see a new equilibrium price for gas at much
higher levels than the present. I vehemently disagree with industry observers
who say that the U.S. is the next big exporter of liquefied natural gas
(LNG). I believe that the U.S. will soon be increasing LNG imports, and
that U.S. prices will move back to world levels.
We are
currently seeing between $13 per thousand cubic feet (Mcf)
and $15/Mcf in South America as Brazil and
Argentina import LNG. We're seeing $17/Mcf in Japan
and similar prices in Korea. The only place that is not increasing its LNG
imports right now is Europe, and that is being made up for by increasing
demand in Asia.
TER: How will a contracting supply affect the prospects
of companies that are exploring and developing gas fields in North America
today?
BP: The companies that can find new reserves of oil and
gas will enter a golden era as prices skyrocket. There has been a lot of
consolidation in the industry over the last five years. In Canada, very few
juniors have started up since 2007. This is the fifth anniversary of the
Halloween Massacre, when the Canadian government changed the laws regarding
trusts, which really shrank the amount of capital going into junior
companies.
The bigger
North American companies are consolidating, because it is harder to acquire
prospective land. Plus, the cost of drilling wells has gone up. But juniors
that can find new reserves and that can increase production per share and
cash-flow per share will have a wonderful rise over the next three to five
years. Companies are helped by the upward trend of ever-higher oil prices and
we will soon see much higher gas prices. And remember, all of this is
happening at a time of historically low interest rates. So companies that can
get to critical size and borrow money at today's low rates have a chance to
deploy that capital into some very high-return projects. Good companies are
trading at historically low multiples of cash flow or multiples of NAV (net
asset value). So there are some great values out there that really make the
energy sector attractive.
TER: What names do you like in the shale oil and gas
space?
BP: Among larger U.S. companies, I like a $7 billion
($7B) company called Denbury Resources Inc. (DNR:NYSE). It is the second-largest producer of carbon dioxide (CO2)-flooded
oil—or enhanced oil recovery using CO2. Denbury
just sold its Bakken assets to Exxon Mobil Corp. (XOM:NYSE) for $1.5 billion (B). It has a very, very large resource base and
growing production from its CO2 fields. It is very well managed and well
capitalized.
Oil sands
producers will benefit, such as MEG Energy (MEG:TSX), which is ramping up production. There has not been
a lot of interest in the oil sands over the last couple of years because of
the price differential between what the oil sands producers are getting and
the higher price of WTI or Brent. But the differential has started to narrow
during the last few weeks, and that is really going to benefit oil sands
firms.
Another
company that is very well positioned in the process of splitting itself apart
is Petrobank
Energy & Resources Ltd. (PBG:TSX). It is divesting ownership of its Petro Bakken assets to shareholders. Petro Bakken
has a very unique set of assets. Even though it has had operational issues
over the last couple of years, it will still be producing over 50,000 barrels
a day going into year-end. It also pays a very substantial dividend, so
investors in that company are getting paid to wait.
On the gas
side, Advantage
Oil and Gas Ltd. (AAV:NYSE; AAV:TSX) is very well managed and has a fine asset base. It
is a very low-cost producer, and has a lot of room to grow profitably in a
higher gas price environment—which is where we are headed.
PetroQuest Energy Inc. (PQ:NYSE) has good assets in the Mississippi Lime and
significant offshore assets with high-production wells. Management has done a
good job during a period of low gas prices by bringing in partners and
hedging their risks. The company has kept its balance sheet intact and is
well positioned to take advantage of a turn in gas prices.
TER: Does your analysis about the looming contraction in
the supply of shale gas apply to shale oil?
BP: Shale oil is a significant resource, of course, but
it is not a "game changer." It is in the same category with shale
gas. The Bakken is a very material resource and it
will provide decades of production. However, Bakken
production has peaked in Saskatchewan. It has peaked in Montana. It is
approaching its peak in North Dakota. This does not mean that we are running
out of drilling locations, or that production is going to fall off a cliff
tomorrow. However, I expect production to plateau before long. Something
similar is happening in the Eagle Ford in Texas. A lot of the wells there
have extremely high decline rates and production may be hitting a plateau. In
the overall context of the United States, we see a continuous decline in the
Gulf of Mexico and California. There is significant decline in Alaska. Those
producers are struggling to keep up the flow through the Alyeska
pipeline without having to do a major retrofit of the pipeline to put in more
pumps due to the low throughput pressure. We are seeing a decline in
California of about 15,000 barrels every year. The overall increase in oil
production in the U.S. in the last few years has been wonderful, but many oil
fields are getting long in the tooth, and I would expect a plateau to soon
emerge.
TER: Will decline spur investment in alternative energy
sources?
BP: Yes, absolutely. Electricity prices are often set
by the highest-cost producer. Until recently, those electricity producers
used natural gas as their feedstock. Low natural gas prices have depressed
electricity prices in some areas. This makes the economics of a lot of
alternative energy projects very difficult. But as gas prices rise,
electricity prices will also rise. This will make solar and wind projects
more viable. For example, in California, electricity prices rose
significantly over the last decade despite falling gas prices. But as the
efficiency of solar panels has improved, solar costs have declined and
reached grid parity. Residential solar makes a lot of sense in California.
And as solar efficiencies continue to improve, costs will continue to fall.
TER: Let's talk about shifting patterns of supply and
demand for natural gas around the world. How will this impact the North
American producers?
BP: Let's start by looking at Trinidad and Tobago,
which supplies the United States with 50% of its LNG imports. The country has
taken huge write-down of its gas reserves. Production declined in 2011 and
will likely decline again in 2012. The country has only nine years of proven
reserves left. Trinidad and Tobago needs to find new sources of gas to feed
the very large fertilizer plants operating on the island and maintain
exports.
Another
example of declining gas exports is Indonesia. Historically, Indonesia has
been the largest exporter of LNG in Asia. In 2006, the Indonesian government
changed the law to focus more on internal consumption and to create jobs for
200 million (200M) people. It cut down on LNG exports beginning in 2007. I
expect that trend to continue as the country switches from being an oil
exporter to an oil importer.
In the
Middle East, the United Arab Emirates was an exporter of LNG for decades; it
is now an importer. Dubai imports LNG. Fujairah will soon become an importer.
Kuwait now imports LNG. Oman has reduced exports to focus on building its
steel industry. The trend of decline is happening everywhere. I discuss this
quite a bit in my book.
TER: Do you think that international markets pay enough
attention to finding and developing new oil and gas resources?
BP: It's a very difficult thing to explore as the world
becomes more and more resource mature and resource nationalism rises. It is
very difficult to explore off the coast of Nigeria or in Russia or in Iraq,
where the political situation is very unstable. Fifteen years ago, Exxon
Mobil was divesting its onshore U.S. assets. Now, Statoil ASA (STO:NYSE;
STL:OSE) has come
to the United States in a significant way for the Bakken.
BHP Billiton
Ltd. (BHP:NYSE; BHPLF:OTCPK) is buying into the shale gas and shale oil business
in the United States. Frankly, onshore in North America is not the easiest
place to operate. But there are not a lot of other options available right
now.
TER: What are the likely impacts in industrial and
residential demand in oil and gas prices for North America during the next
decade or so?
BP: Efficiency will improve. The U.S. has already
dropped its demand for oil by about 2M barrels from its peak in 2007. Part of
this was due to the recession; part of it is due to an increase in the
miles-per-gallon standard. The trend will continue as it becomes more and
more unaffordable for people to drive cars.
And we will
see efficiencies in the structure of the electricity grid. The U.S. currently
wastes around two-thirds of the consumable electricity that goes into the
power grid through energy source conversion and line loss. I envision a trend
toward distributed energy production. People will put solar panels on their
rooftops and sell sun power to their neighbors. The big utilities are
fighting this tooth and nail in California. But there is a movement toward
electricity co-ops. As electricity becomes more expensive, people will find
other ways to conserve. Demand will increase for residential geothermal
heating and cooling; the economics of geothermal home heating and cooling
systems have improved drastically in the last 20 years, and it continues to
get better. We will also see the emergence of an electric car industry. It's
had a rocky start, but it will move forward as gas prices in the U.S. go
north of $5 per gallon.
TER: How much weight do you suggest that investors put
on gas shares in their portfolios?
BP: It depends upon the individual investor's profile.
Everybody is different. But there are some great gas companies that are
fairly cheap. Ultra
Petroleum Corp. (UPL:NYSE) is a very inexpensive well run, low-cost producer.
The bottom line is that investing in things that are out of style at the
moment are often the greatest investments.
TER: It's been a very interesting talk, Bill, thank you.
BP: You are quite welcome.
Bill Powers is the editor of Powers Energy Investor and is also the author of
the upcoming book "Cold, Hungry and in the Dark: Exploding the Natural
Gas Supply Myth." Powers has devoted the last 15 years to studying and
analyzing the energy sector, driven by his desire to uncover unrecognized
trends in the industry and identify outstanding opportunities for retail and
institutional investors.
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DISCLOSURE:
1) Peter Byrne of The Energy Report conducted this interview. He
personally and/or his family own shares of the following companies mentioned
in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Energy Report: None.
3) Bill Powers: I personally own shares of the following companies mentioned
in this interview: None. I personally and/or my family am
paid by the following companies mentioned in this interview: None. I was not
paid by Streetwise Reports for participating in this story.
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