Natural Gas Q&A: Lies, Damn Lies, and Statistics
It has been a while since I responded to your many emails.
So, as we await the latest developments in the European debt mess, today seems like a good time to answer a few. This time around, I am addressing some of your questions and comments that deal with natural gas.
By the way, my staff and I read all of the input and feedback you send our way, and we're very grateful for it. Please email me at firstname.lastname@example.org. (I can't offer any personalized investment advice, but I can address your questions and comments in future broadcasts.)
Let's get started…
Q: I've just read recently several articles stating that the EIA has revised downward its estimate of our natural gas shale reserve potential by deciding to accept, unconditionally, the most recent U.S. Geological Survey stating that the Marcellus, Eagle Ford, Barnett, and other shale formations hold only 20% of the heretofore accepted reserves. This is an 80% reduction! This changes everything if true.
That's the question – is this bogus, or is there factual evidence to conclusively support this new estimate? ~ Howard B.
A: Howard, this reminds me of a famous statement from the 19th-century British Prime Minister Benjamin Disraeli (though the comment is also variously ascribed to Mark Twain, Alfred Marshall, and many others): “There are three ways to hoodwink the masses – lies, damn lies, and statistics.”
The Energy Information Administration (EIA) – a unit of the U.S. Department of Energy – continues to wrestle with the distinction between reserves and extractable reserves.
The first is the volume of gas indicated by field tests and analysis. The second is gas available for extraction at current methods. I would also stipulate as “extractable” reserves only the volume that market conditions allow.
When you equate the two, we are still in the same ballpark.
Current estimates put no more than 20% of known reserves as “extractable.” As technologies improve, that figure could improve, too.
For now, the EIA estimate falls in line with most others.
So to answer your question, nothing much has changed here, aside from some government bureaucrats wanting their figures to be more accurate.
Q: Kent, your work appears to be expanding into areas of advisement that could affect the future profitability and well-being of nations and their business relationships with existing partners. A delicate balancing act if there ever was one! If such arrangements are not handled carefully, could sanctions and/or military skirmishes be the outcome? Are we facing the possibilities of “gas wars”? ~ Fred P.
A: Well, Fred, there are some flashpoints – such as the periodical problems between Russia and Ukraine on the movement of gas into Western Europe, or the ongoing tension over allowing Iran to pipe gas across Afghanistan and Pakistan to India.
But these are not likely to generate more than political conflicts.
Mostly because, with the advent of unconventional sources, such as shale gas and coal bed methane, there are now far more available sources than there were 10 years ago.
Certainly, significant questions remain: How much volume is actually extractable? What capital infusion is required to develop or upgrade processing and transport infrastructures?
Nonetheless, the added volume and ease of availability is changing the picture.
The latest multi-year survey puts the known global reserves of shale gas alone at over 6.6 quadrillion cubic feet, contained in 688 identified plays in 162 basins, with some 10% to 20% extractable at current methods. And only about half of the world's territory was even included in these studies!
These basins are located throughout the world, making the “new age” of natural gas one that carries the prospect of providing more energy to more countries. That will require exporters to revise how they calculate contracts, especially with the volume coming into Europe. (That means you, Gazprom, as we consider with the next question…)
This, combined with the rapid rise in liquefied natural gas (LNG) trade, allows for the rise of a more balanced and price-contained market.
We still have significant concerns over the environmental impact of fracking, and whether some countries (such as Ukraine) with such an immediate need for the energy can set up adequate regulations to oversee the extractions.
But on balance, the widespread availability of new sources is the best defense against the use of military or political or other pressure on the energy front.
Q: I own Gazprom, as it is the cheapest large gas company in the world. However, they have yet to move to spot market pricing for gas, like the rest of the world. (The European and Asian gas prices are one-half the value of oil, while America prices are one-quarter, a much better price for us!) We Gazprom shareholders voted the government off of the board earlier this year, but the Russian government still has a controlling interest. ~ Eric T.
A: Westerners who own Gazprom shares usually do so via depositary receipts that trade at a premium to the domestic shares available in Moscow.
While Gazprom is the largest natural gas company in the world, they have stubbornly resisted moving from a standard pipeline contract for their gas exports.
That contract model is long-term, has a take-or-pay provision (the customer must accept a certain amount of gas or pay for it anyway), and has its pricing determined by a basket of crude oil and oil products.
That means, as oil prices increase, so does the price of gas.
Gazprom remains the primary exporter to Europe, although that position is not as secure as it once was, for two reasons.
First, we've seen a rush of LNG into Europe from Qatar (the first major gas producer in the world to commit all of its exports to LNG only) and Algeria, with the likelihood of U.S. volume coming in a few years. This has established a local spot market that typically significantly undercuts the price specified by Gazprom's pricing formula.
Second, the prospects of Western European shale have altered Gazprom's thinking. While the Russian giant still flatly dismisses shale as a “flash in the pan,” it has quietly begun to discuss revising its own approach to contracts. But that will take time.
The LNG spot market has actually resulted in Gazprom providing “temporary” changes to its 20-year long contracts, in which a percentage of the volume is actually priced at the spot rather than pipeline price. Gazprom insists these revisions will not last long – that they are “exceptions.” Of course, when such exceptions are provided to any one European customer, they will be demanded by all, or else the Stockholm Arbitration Court is likely to get involved, and Gazprom is hardly likely to win.
Spot markets tend to stabilize prices by providing a floor, since spot transactions are usually accomplished at a cheaper price.
The LNG factor allows that market to expand, since the ability to move liquefied gas by tanker means a pipeline confluence – such as Henry Hub or Baumgarten – is no longer required to set the price.
It is true that the government is not entirely out of the picture. It still controls the board and a majority of the company's voting shares. The board chair is no longer a sitting minister (it had earlier been Deputy Prime Minister Victor Zubkov), but that was not a decision of the stockholders.
Russian President Dmitri Medvedev ordered all ministers to vacate chairmanships of all corporate boards, leaving the impression that the Russian government is still firmly in charge.