Today, I'm flying back from Houston. . .again.
It seems I've been spending quite a bit of time in Texas these days—and for good reason. The rollout of Money Map Project #1 - our exciting 25-well oil and gas project—is one.
But another revolves around the tremendous changes in the industry itself, especially when it comes to natural gas.
In fact, I just presented the keynote address before the annual meeting of the Gas Compressor Association at the Moody Gardens Convention Center in Galveston.
Here's what I told those assembled about the new, "gas-driven" world. . .
The Emergence of an Unstoppable Trend
My key point was simple: We are witnessing the rapid emergence of a global gas market.
Of course, such a "revelation" would hardly be news if this were an oil gathering. Oil transport from one end of the world to the other is commonplace. You could see the tankers awaiting passage into port outside the windows of the hotel.
But what's happening in natural gas is something else entirely.
Given its limitations in transport (as long as it remains in a gaseous state), natural gas has always been a localized energy source with its deliveries essentially limited by where the pipelines go.
That created a very important pricing reality. Local spot markets were usually not possible except at a few "hubs" or main intersections in the primary trunk pipeline systems.
"Henry Hub" (actually named for a school that used to be in Erath, La. and the location where NYMEX gas futures prices are set) is one such primary hub. Baumgarten in Austria would be another. There are also smaller versions elsewhere providing more constricted local spot pricing.
But without significant exposure to spot pricing, most locations' prices are based on longer-term supply contracts. Internationally, especially in Europe, these are usually 20-year, "take or pay" agreements with the price based on a basket of oil and oil product prices. In this case, the end user is obliged to take a minimum amount monthly—usually 70% or more—or pay as if it had.
This arrangement comes with a noticeable downside that has been magnified these days: the higher the cost of oil, the higher the cost of natural gas.
Spot markets, on the other hand, provide for quicker ad hoc sales, usually over and done in 72 hours. If a regular supply can be assured, these short-term purchases will almost always undercut the multi-year pipeline contract prices of "take or pay."
That is why the emerging trade in liquefied natural gas (LNG) is such a game changer.
And yes, I know that phrase is overused these days. But in this case, it really fits.
After years of being forced to operate the old way, LNG is going to allow for the global movement of natural gas and the establishment of numerous local spot markets.
That means lower prices for big portions of the rest of the world.
Waking up to a "Gas-Driven" World
Now, we are about a year or so from the start of U.S. LNG exports. But when they do begin, a minimum of 6% to 8% of the world's LNG traffic will come from America. Currently, that figure is zero.
Obviously, these exports will allow for additional production in shale and tight gas, as well as coal bed methane. This will require a balance between production and distribution, combining exports and domestic use.
In turn, the domestic side will experience significant demand increases as well, spread across four categories.
Of those four, natural gas for vehicle fuel will take the longest to develop. It is already here for top-range trucks and mass transit, where LNG and compressed natural gas (CNG) are already seeing a rapid increase in truck and bus fleet retrofits. It is the average passenger vehicle where this transition has been the slowest. Much like the advent of hybrids, the cost of these engines is still not competitive. But that will also eventually come to pass.
Meanwhile, the second and third uses are already in full swing. These involve increasing industrial use and as feeder stock for petrochemicals. There are some new applications on the industrial side and major chemical producers are seriously considering moving operations closer to shale gas supply. But most of this is simply the last phase of an economic recovery kicking in.
The growth in petrochemicals, on the other hand, is a result of plans for expanded gas crackers to service the constituent elements of plastics and related products, replacing oil products like naphtha. This transition has been underway for a while now and the intense competition over where these new multi-billion dollar cracker installations will be located is a testament to the upward curve in petrochemicals as a demand-side absorber of gas supply.
However, it is the final domestic usage that is now causing the biggest transformation for gas moving forward. The shift from coal to natural gas as the fuel of choice in generating electricity is now well underway. And while coal still has a place in the overall energy balance, its days of controlling the domestic power sector are long gone.
I regularly analyze and revise these conversion figures for one simple reason: They tell us something truly remarkable.
By 2020, it is estimated that U.S. will be replacing 90 gigawatts (GW) of capacity, virtually all of that coal-fueled. Most of this is simply due to facility age. Yet there will likely be additions to the total coming from new Environmental Protection Agency (EPA) regulations.
Forget for the moment about whether stricter carbon emission standards will be introduced anytime soon. The phase-in of non-carbon standards is having an immediate impact, involving the cutting of mercury, sulfurous, and nitrous oxide emissions. These alone may well add another 20 to 30 GW to the capacity transition.
Now here's the point. My initial read two years ago was a 1 billion cubic foot per day increase in gas needs for each 10 GW of electricity transitioned. That estimate turned out to be low. The current level is now 1.2 billion.
In addition, the move from coal to gas is happening faster than I had anticipated. Of the new plants on the drawing board and at the FEED (front end engineering and design) stage, there are no new coal-fueled or even coal/gas co-fueled plants of any appreciable size planned.
It means the gas-driven world is coming fast.
Big Opportunities for Retail Investors
Putting this in perspective from only a domestic standpoint, we arrive at a remarkable conclusion. If only half of the capacity I expect to move from coal to gas actually does so, it would eliminate four times the current national gas storage volume.
So the market has plenty of room for the expansion of production without adversely impacting price levels—from only one of the four increases headed our way domestically.
Now, add the LNG exports that will be coming on line. As a major player almost overnight in the global LNG trade, the U.S. will also add another ingredient. How contracts are traded internationally will undergo massive changes. Gas will become progressively less limited to local supplies ushering in new arbitrage and swap practices. You will no longer need to be at a gas hub to influence prices.
That dramatically improves opportunities for retail investors.
I touched on this as well in Galveston, but I kept some of things I'm currently working on in this space under my hat.
Rest assured, when these are ready to release, you will be the first to know about them.
Oil & Energy Investor