With Gas Prices Low, Shale Bargain Hunters Take Long-term View
Foreign investment in U.S. natural gas got off to a heady start this year when China's Sinopec and France's Total SA dumped billions into formations in Ohio, Michigan and the Gulf Coast. But now that the price of gas has tanked and reserve estimates have been modified, some financial analysts are wondering whether the companies paid too much for stakes in reservoirs that have yet to produce.
The news that China Petroleum & Chemical Corp., or Sinopec, and Total had targeted the U.S. market at nearly the same moment in early January was met, at the time, with more talk of a "golden age" of natural gas that would see shale development help the United States kick its addiction to coal and possibly create a lucrative export market.
The deals gave Sinopec, one of China's largest state-owned energy companies, a one-third stake in a number of plays owned by Oklahoma City-based Devon Energy, while ceding a 25 percent stake to Total in Chesapeake Energy's sprawling acreage in the Utica Shale.
But much has changed in the short time since the foreign incursion went public early last month. Since then, unseasonably warm weather on the East Coast, combined with a glut of gas production, has seen prices drop to a 10-year low, prompting companies like Chesapeake to suspend some production until the surplus eases or late-winter weather turns cold.
Add to that new data that appear to show earlier estimates of U.S. gas reserves may have been wildly inflated. According to a revision published last week by the U.S. Energy Information Administration, shale gas estimates may have been off by as much as 40 percent (Greenwire, Jan. 23).
In response, analysts say markets may have to wait at least 18 months for the price to recover and profits to rebound, with some suggesting that this bout of warm weather could be less of an anomaly than producers would like. In the short term, Herve Wilczynski, a partner in A.T. Kearney's energy practice, said the current dynamic could hurt independents that don't have the capital to survive the long haul.
That partly explains why companies like Exxon Mobil, Statoil and -- yes -- Sinopec and Total have taken positions in shale gas to bolster and possibly squeeze the smaller independents, which will have a harder time toughing out the price collapse, Wilczynski said.
"It's going to stay at a point that continuing to drill for shale gas is not going to make a lot of sense," he said.
In other words, Sinopec, Total and Exxon Mobil may be the smartest kids on the block. They can withstand the volatile world of commodity markets better than Chesapeake or Devon Energy and could be making bets that healthy capital reserves will force out smaller players. That likely explains why both Sinopec and Total opened their wallets to the tune of more than $2 billion each
"The price was steep ... but they have the money to make those bets," Wilczynski said. "They're in it for the long haul."
Bringing expertise back to China
With respect to the Chinese company, Wilczynski and others see a theme at work for the emerging economic power across the board. Sinopec and other Chinese firms are looking past the 24 months most analysts say it will take for gas to recover, to markets and resource availability decades in the future -- both to make money and to develop expertise in the field.
Andrew Lipow, president of Houston-based Lipow Oil Associates, noted that Chinese firms have lately pushed into Africa and Canada as well as the United States. This is part of what seems like a coordinated strategy to corner natural resources for an economy that most economists expect to one day soon pass the United States as the largest on the planet.
"Chinese investors are in for a very long period of time, for 10 or 20 years or longer," he said. "You might say [Sinopec's $2.2 billion entrance] is overvalued, but their horizon is far into the future."
Wilczynski agreed. "These are companies with strong balance sheets," he said, suggesting structural changes in the power and chemical sectors make the U.S. market that much more appealing. "It's the largest economy in the world, and it's tough to ignore."
He added: "There's clearly a push by Chinese companies."
Michael Zenker, a gas expert at Barclays Capital, agreed that companies like Total and Sinopec "are clearly in it for the long run, and for the technology transfer." And even if the latest analysis from Barclays released this week, called "Finding the New Coal Floor," confirms the notion that gas prices are likely to hover below $3 per 1,000 cubic feet for now, Zenker doubts the bigger players care, because they have a more global view.
"They may export those hydrocarbons via [liquefied natural gas]," he said.
Barclays' research, he noted, has U.S. storage surplus for gas in the United States and Canada as currently 20 percent higher than the five-year average. "There is little on the horizon that could meaningfully pull U.S. gas prices higher," the Barclays paper said.
As for the reservoirs at the heart of the Sinopec and Total deals, Wilczynski acknowledged that their "characterization" has not been completed, but he suspects both companies have "done some science" of their own to make sure those formations produce. He also believes the Chinese are looking at the experience as a kind of learning curve to catch up with U.S. engineers in the oil and gas industry.
"They are also trying to learn," he said. "They're learning how to do this in North America so they can do it at home."
To Lipow, that dynamic works just as well for U.S. firms as it does for the Chinese. Devon and Chesapeake have been able to spread out their risk and get some cash in the meantime, which could boost their profiles and lead to more development.
"They see an opportunity to monetize some of their acreage and perhaps invest the cash elsewhere," Lipow said. "They all have different reasons, and that's OK, that's what makes a market."
Connecting gas prices back to policy, renewables
As for the policy side, Wilczynski sees no reason for lawmakers to intervene to stabilize the price of gas. He would like more certainty to evolve when it comes to regulating, say, shale development, but otherwise he says policymakers should sit tight.
"The fact that the bigger companies are coming into the fray will stabilize prices," he said, predicting the price per 1,000 cubic feet will settle somewhere within the $3-to-$8 range over the next two years.
"Gas prices are going to go up," he said, "but it is going to come to an equilibrium."
An ancillary effect of all this gas development is a more difficult environment for renewable sources of power, which have essentially been priced out of competition with bargain gas prices. Wilczynski said it hurts wind development in particular.
"It is going to make adding capacity for renewables a little bit more challenging in terms of economics," he said.
Rachel Cleetus, a climate economist at the Union of Concerned Scientists, sees the same dynamic in play, but she wants Congress to intervene until the gas glut eases. This would help accelerate the transition to price parity for renewables, she said.
Cleetus noted that coal-fired plants in the United States are increasingly going dark, but rather than an influx of solar and wind, natural gas appears ready to fill the breach. She would prefer a more balanced transfer to renewables as well as gas, and she wants policymakers to take note.
"Because we have this situation of very low natural gas prices, gas is occupying this sort of outsized role," Cleetus said from her office in Cambridge, Mass. "The concern right now is renewables will get left behind, because we don't have a sustained policy."
So Cleetus would like to see a national renewable energy standard along with extension of production tax credits, with the low gas prices acting as a driver to justify their passage in Congress. She said the next five years are critical, so if gas prices are in the basement for a least half that time, she believes policy should react to keep renewables competitive.
"Natural gas is still a fossil fuel, though it does have a role to play," she said. "But there are very good reasons to diversify.
"This is the critical moment to make those decisions to scale up renewables."
With Thanks to Greenwire. Greenwire is published by Environment & Energy Publishing.