THE KING IS DEAD, LONG LIVE THE KING

A recent story notes that natural gas drilling in 2018 has dropped by 87.7 %, from a peak in 2008.  Over the same period, natural gas production has increased by 58%.  Natural gas drilling is down to a whimper, but natural gas production continues to grow, year on year.  Had the gas production been from conventional offshore reservoirs, one could have hypothesized that a few large gas fields dominated production, despite fewer wells being drilled.  But most of the drilling for natural gas in this decadal period has been in shale, which does not produce high volumes, but each well is relatively inexpensive.  Before we launch into the explanation of the seeming anomaly, consider the impact of the result.

Natural gas production, largely from shale, was arguably the single biggest reason for lifting the US out of the last recession.  In the decade prior to the recession, US gas prices had fluctuated wildly from USD 2 per million BTU (MM BTU) to as much as USD 15 per MM BTU.  Nothing dampens the spirit of investors in capital driven industries more than unpredictability in the price of the key raw material.  Consequently, major industries, methanol producers for one, fled to countries with sustained low gas prices, such as Trinidad.  When shale gas went on the market in high volume, prices dropped, and stayed low, in the vicinity of USD 3 per MM BTU.  With predictions of sustained low prices, predictions which have held up now eight years later, industry returned to the US.  Liquified natural gas (LNG) imports were no longer necessary, and shortly thereafter, the US became an exporter of LNG.  For every citizen in the US, a lower fraction (sizable for many) of take-home pay went towards transportation and home heating and cooling.  The savings were spent on goods and services.  The recession was in retreat.

Shale oil picked up and became a major force by about 2013.  In 2015, the high production halved the world oil price and OPEC was marginalized.  The low oil price, together with the low natural gas price, contributed to the economic gains and a record stock market.  But gas prices stayed low despite steep reduction in gas exploitation, because gas supply continued to be high.  Curiously, and seemingly paradoxically, the reason is the steeply increasing oil production over the decade.  Over roughly the same period as the decline in gas drilling, oil production has increased from 5.0 MM bpd in 2008 to 11.6 MM bpd in 2018.  Now for the explanation as to why that caused gas production to rise.

Crude oil comprises of a mixture of molecules, with the bulk of them conforming to the formula CnH2n+2, where n is an integer.  Oil molecules break down over time in the host environment of high pressure and temperature.  The most thermally mature state is methane, with n=1.  Ethane, propane and butane, with n=2,3 and 4, respectively are the next more immature.  Shale oil is very light, as defined by API gravity.  Accordingly, the n’s are low numbers relative to heavier oils.  One could reasonably expect shale oil to be associated with some molecules at higher thermal maturities.  This is known as associated gas, and usually comprises methane in the main, together with the somewhat larger molecules with n=2-4 and more. Canadian heavy oil, on the other hand, could be expected to have little or no associated gas.  More shale oil production automatically means more shale gas production.

Recent data from the Permian, the hottest oil play in the US today, indicates that every MM Bpd of oil would have associated with it 2.2 billion cubic feet per day (bcfd) of gas.  If this statistic is taken to apply to all shale oil, as a first approximation, on would expect gas production to be 14.5 bcfd greater in 2018 than in 2008, from this source alone.  That translates into 5.3 tcf per year.  With no let up in shale oil production in sight, natural gas will continue to be produced.  Expect, therefore, for natural gas prices to remain at low to moderate levels, and a boon to the economy.  Shale gas drilling is, metaphorically speaking, if not dead, a shadow of its former self.  But natural gas remains the reigning monarch in assuring a healthy economy.

Vikram Rao