The North American natural gas industry is in the process of reinventing itself. Only recently, it was a land-locked business that had to sell aggressively to find customers for its plentiful fuel. It is increasingly becoming a global business that will continue to push itself to meet burgeoning demand. But this is no quick fix; it will take years for this transformation to be completed.

What a turnaround. Just a decade ago, the natural gas industry was entering the second decade of a supply surplus colloquially known as the “Gas Bubble.” Oversupply meant chronically low prices. The price of delivered natural gas fell 42 percent in real terms from the mid 1980s to the mid 1990s–to $1.72 per thousand cubic feet by 1995–even though consumption had grown by 30 percent during that period.

These low prices put the industry into survival mode. In those days, producers who drilled a dry hole would say that the bad news was that they didn’t find oil, but the good news was that they didn’t find gas.

The late 1990s brought a series of changes that began the industry’s transformation. Natural gas started to become the fuel of choice in electric generation. Improved turbine technology increased the efficiency of gas-fired electric power plants, which were also cheaper to build and–because of the environmental benefits of gas–easier to get approved than power plants that used other fuels. At the same time, gas was inexpensive and plentiful. In this climate, the electric power industry embarked on a major building campaign, ultimately adding over 200 gigawatts of new gas-fired electric generating capacity, a 25 percent jump in total power capacity. But underlying this was a crucial assumption that natural gas would remain cheap and plentiful. More homes and businesses turned to natural gas for heating and cooking, as well.

Yet, even as the construction boom was in full swing, the supply side of the industry began to undergo a dramatic change. By the late 1990s, a decade of steadily rising production had whittled away the overhang of capacity. Supply, which had been chronically in surplus, was now just in balance with demand. Mild winters in 1997-98 and 1998-99 forestalled the inevitable refinery price adjustment. But in 2000, a hot summer triggered surging prices nationwide and exacerbated a power crisis in California. Since then, the market has continued to tighten and prices have generally risen, reaching $8.80 per thousand cubic feet in hurricane-ravaged 2005, more than five times the price of a decade earlier. A year of benign weather allowed prices to ease to about $7.00 in early 2007–still well above the levels of the 1990s. With the recent cold weather, they have bounced back.

Why have prices risen so much over the past decade? There are two reasons. On the supply side, it’s geology. And on the demand side, it’s the growing importance of gas-fired power generation.

Since 1999, drilling activity in the U.S. has risen more than 300 percent. Despite this, production has remained flat. This perplexing result is rooted in the maturity of the gas resource base in North America. Although gas remains available and new fields are continually being identified and developed, many of these deposits are deeper, smaller, embedded in harder rock from which gas is more difficult to extract or far from the pipelines that can carry the gas to market. These more difficult deposits are also more expensive to develop, which puts a squeeze on project profitability, even with higher gas prices. On top of that, costs of the services used to find and develop new fields have risen substantially.

While production stays flat, demand is poised to continue growing–primarily because increasing consumption in the power sector is virtually locked in. Much of the recently installed gas-fired generation is utilized at low rates today. But most of the non-gas power plants are operating near full capacity. So as power demand grows in tandem with economic growth, utilization rates for gas-fired generation are set to grow as well.

Rising demand in the face of flat supply looks like an intractable situation. That’s why the North American gas business is globalizing. Overseas resources, chilled to become liquefied natural gas (LNG), can be shipped from anywhere in the world and then re-gasified where they will be used. There are substantial, and in some cases huge, natural gas supplies outside of North America and Western Europe. The difficulty lies in creating the infrastructure that can make it accessible to consumers. Moving “stranded” gas to North America requires new liquefaction plants at the source, a growing number of LNG tankers, and new re-gasification plants at the receiving end. Despite the high price tag for this infrastructure–estimated at $2-4 billion to provide gas equivalent to just one percent of U.S. demand–large volumes make LNG competitive on a per-unit basis. In fact, we calculate that LNG is now cheaper on a unit basis than half of the natural gas produced in North America. The lead time for LNG facilities can be five years or more but the current LNG boom has already been years in the making, and global LNG supplies are set to grow sharply over the next few years.

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As LNG becomes a larger portion of the North American supply mix, it will transform industry dynamics. Gas from the Rockies will compete with Middle Eastern LNG. A winter cold wave in Europe or in Northeast Asia–or a political crisis in a producing country–will find an echo in North American natural gas prices. Time will tell if LNG will lead to an absolute reduction from current price levels. The benefit to consumers, however, is clear. Natural gas prices with LNG will be lower that they would be without LNG.

But this new source still needs to be kept in perspective. Even with growing LNG imports, the domestic natural gas industry will continue to provide the lion’s share of supply–as much as 80 percent a decade from now. But the domestic industry will also have to adapt. In the past, the successful natural gas producer was the one that made the biggest discoveries. This required insight into the geology, a dash of courage and more than a little luck.

It will take a new breed of producer to participate in an increasingly global business. The new industry will look more like manufacturing, and the successful producer will be the company that can control costs and harness technology to produce domestic supply efficiently. This will be quite a makeover from the way the industry used to look.

Author Box Daniel Yergin has 1 articles online
Daniel Yergin, chairman of CERA, received the Pulitzer Prize for “The Prize: The Epic Quest for Oil, Money ” class=”printbt”> Print article Report Add New Comment Making Over an Industry – North American Natural Gas
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