America's Amazing Gas Business Makes Less Than It Did in 2000
(Bloomberg Opinion) -- After a November to remember, America’s natural gas producers are settling back into more-familiar feelings of wistfulness at what might have been. Benchmark gas prices are down 21 percent so far this month as winter has taken less of a bite out of our collective hide than anticipated (so far anyway).
Leaving aside the vagaries of the weather, there is some cheery news. With production at a record and benchmark Henry Hub prices up versus last year, producers’ implied revenue looks set to top $100 billion for the first time since 2008. But there’s a more sobering calculation lurking underneath: They’ll make less revenue this year than they did in 2000 in real terms:
(Before going any further: This is a very rough calculation that doesn’t take account of things like gas pricing at different hubs around the U.S. or hedging effects. Purely illustrative, folks.)
That shrinkage in real revenue is even more striking when you consider that, one shale boom later, U.S. gas production has expanded by 62 percent since W won the presidency:
Of course, the shale boom is the whole story here. By moving the U.S. from apparent shortages of natural gas to having more than it knows what to do with, prices collapsed. Real revenue this year is less than half what it was in 2008, when Chesapeake Energy was worth more than $35 billion and its co-founder Aubrey McClendon, who died in 2016, was one of the highest-paid CEOs in America. That there are still dedicated gas producers like Chesapeake out there — it’s worth only about $2 billion now, however — and production continues to surge is a testament to innovation and efficiency, but also sunk costs and cheap capital.
It’s also a function of not really caring that much about gas.
Another effect of the shale boom is that a rising proportion of gas comes as a by-product of fracking for oil. Just five years ago, such gas was less than 15 percent of supply; now it’s more than a quarter and accounts for the majority of growth for the foreseeable future. If I do the same back-of-the-envelope math for oil (using West Texas Intermediate crude prices, with all the same caveats), the picture is just as volatile but far happier for producers:
Oil, with its far stronger links to higher global pricing and relative lack of competition in its core transportation market, has helped fill much of the gap in upstream natural gas revenue. There’s a reason Chesapeake’s oil production went from 8 percent of its output in 2008 to 17 percent in 2017. Remarkably, while the implied gas revenue outweighed that of oil up until 2009, the latter now accounts for 72 percent of the total:
This is an epic tale of industry renewal, but also an epic example of deflation on the gas side (part of a wider phenomenon in energy). Oil has compensated as fracking has migrated to that part of the business. Yet, as any member of OPEC will tell you, fracking’s deflationary tendency is also being felt in this market, too.
It is possible that the recent outbreak of discipline in E&P strategy-setting will work to lift prices as production output increases moderate. On the other hand, the impulse to chase growth is strong in this industry (see: natural gas). And any discipline would tend to limit cost inflation as oilfield services firms struggle to regain pricing power. One thing is clear, though: The shrunken gas market’s fortunes rest to a large degree on the oil market — which, just like the weather, is largely beyond its control.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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