Natural Gas: Fueling the U.S. Energy Renaissance

We argued in our recent commentaries and newsletters that the U.S. is in the midst of a major technological revolution. The United States, staying (somewhat) true to her capitalist and entrepreneurial roots, is finally awakening–much like the way she awakened in the aftermath of the Pearl Harbor attack, as well as during all of the young Republic’s technological waves since her founding (starting with the construction of canals in the 1820s, railroads in the 1830s, and the telegraph in the 1840s).

For years–aside from more stringent CAFE Standards–the U.S. has had no official energy policy. By 2007, domestic oil production has sunk to a 60-year low, while American consumption rose to a new high. In 2005-2006, the U.S. imported a record high 13.7 million barrels/day, with a significant portion coming from unfriendly or politically unstable countries such as Venezuela, Russia,  Iraq, and Nigeria.

Thanks to innovative techniques such as horizontal drilling, hydraulic fracturing, and innovations in deep-water drilling (e.g. drilling in the Lower Tertiary), U.S. oil production has bounced by more than 2 million barrels/day over the last five years. At 7.3 million barrels/day (average daily production during April to May 2013), U.S. oil production is at its highest level since 1991. With oil  demand having peaked in 2005 (gasoline demand peaked in 2007), crude oil imports into the U.S. has now sunk to just 10 million barrels a day–its lowest level since 1997.

Meanwhile, more efficient technology, along with the immense discoveries of shale gas, has led to a boom in domestic natural gas production as well. While the amount of U.S. crude oil reserves has steadily risen since 2007, the amount of natural gas reserves–due to the Bakken, Marcellus, Fayetteville, Barnett, and Haynesville formations–has literally exploded, rising from just 225 Tcf to 350 Tcf during the same time frame (U.S. annual natural gas consumption is 25 Tcf).

This ongoing “U.S. Energy Renaissance” means that the U.S. now produces 87% of our own energy needs, its highest rate since 1985. Over the next 5 to 7 years, U.S. oil production is set to rise by another 2 million barrels/day–excluding the possibility of the commercialization of California’s Monterey Shale (which could propel California past Texas to become the country’s number one oil-producing state). At $100 a barrel, this would add an incremental $73 billion a year to the U.S. economy–effectively shaving off nearly 20% of our current account deficit. Along with less U.S. driving (aging population, increase in railroad usage, etc.), higher CAFE standards, and rising electrification of the U.S. vehicle fleet, the idea of “U.S. energy independence” suddenly does not seem so far-fetched.  In fact, the boom in oil production over the next 5 to 7 years is projected to surpass the increase in oil production that powered the post-WWII U.S. economic boom well into the mid-1960s (again, not including the potential commercialization of California’s Monterey Shale).

The EIA projects natural gas production to be flat over the next several years. But we know that the EIA also has a dismal prognostication record, and that it is not taking into account important events such as: 1) the inevitable growth of the LNG export industry; the DOE recently approved its third export facility, the Lake Charles Exports LLC in Louisiana (with a capacity of 2 Bcf/day); 2) ongoing fuel switching from coal to natural gas by power generation utilities as more coal plants are retired and as “greener” policies make further inroads into U.S. politics; assuming Henry Hub natural gas prices stay in the $3.50 to $5.00/MMBtu range, this will be one of the dominant demand trends over the next several years; 3) the EIA has no expertise nor does it keep track of major socio-economic trends, such as the U.S. manufacturing, in-sourcing renaissance; the combined forces of the commercialization of 3-D printing, advanced robotics, and rising EM wages will lead to a further shift of manufacturing back into the U.S. (already, Foxconn is replacing a substantial number of its workers with robots).

While the EIA projects zero growth in natural gas demand over the next several years, Goldman Sachs projects an incremental demand growth of as much as 20 Bcf/day–equivalent to a 30% jump in natural gas demand (including LNG exports) over the next five years. The below chart (courtesy Goldman Sachs) shows a break down of the sources of demand growth–with base industrial demand, coal plant retirements, new power generation capacity, and LNG exports dominating demand growth over the next five years.

naturalgasdemandproj

The surprising thing–as least to most Americans–is that the U.S. should have no trouble meeting this potential demand growth over the next five years. Already, Marcellus shale gas production is up 50% over that of last year–surpassing even the most optimistic forecasts. In the meantime, the ongoing rise in oil production is leading to increased production of “associated gas.” For example, over the last 18 months, one-third of all associated gas in North Dakota was flared or not marketed–resulting in a loss of $100 million a month to producers and the state. Both the state of North Dakota and producers are now working diligently to capture and transport this associated gas. The rise in Marcellus shale gas production, along with the increased production and capture of associated gas production, will drive U.S. natural gas production for at least the next five years. By 2018, we foresee the United States producing over 90% of her energy needs, with natural gas playing a substantial role. As such, it is not surprising to see U.S. stocks outperforming those of every major country (including Japan, on a US$ basis) on a YTD basis. We remain bullish on the prospects of the U.S. economy, especially if this energy revolution could be augmented by the electrification of the U.S. vehicle fleet, more stringent CAFE standards, increased efficiency in solar technologies, and breakthroughs in second-generation biofuels.

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