Last week, the Federal Energy Regulatory Commission (FERC) that regulates natural gas pipelines approved the application of Cheniere Energy (LNG-NYSE) to build a facility to liquefy natural gas (LNG) for export to global markets. That approval will enable Cheniere to secure project financing to construct the facility after the company has worked diligently to secure off-take contracts for 2.1 billion cubic feet (Bcf) per day of gas to be shipped to customers in Europe and Asia. There are an additional four applications for LNG export facilities to be constructed in the United States, but exactly how many may be approved is a question mark. If we truly have not just 100 years, but rather 200 years of natural gas supply in the United States as Steve Farris, CEO of Apache (APA-NYSE) suggested at the recent CERA conference, then agreeing to export this resource may be appropriate from an economic perspective. But do we really have 200 years of supply? Moreover, do we have 200 years of supply at an economical cost?
On the crude oil front, the roaring success of the development of oil shale plays in the Bakken basin of North Dakota and Montana, the Niobrara formation in Colorado and the Eagle Ford region of South Texas has people justifiably excited. But is it appropriate to be extending the recent monthly gains in U.S. oil production due to these new fields into a long-term national growth trend?
Eoin Treacy's view As anyone familiar with price charts is aware, they tend to move in long-term bull and bear market cycles. The logical corollary is that secular price trends affect the actions of consumers and suppliers.
High prices force consumers to find an alternative by either using less of the resource or substituting it for something cheaper. High prices also act as an incentive for producers to increase capacity and explore for new resources. In this regard the old commodity market adage “The best cure for high prices is high prices” is as true today as it ever was.
At the other end of the cycle low prices encourage consumption as the competitive advantage versus alternatives becomes more compelling. The supply side contracts as more production becomes uneconomic. As exploration budgets are cut, technological innovation becomes a necessity.
Right now the energy complex offers perhaps the best example in a decade of changes to long-term supply and demand interaction.
High prices are forcing consumers to consider alternatives, especially natural gas. Suppliers who have increasingly lost access to the most promising discoveries internationally have employed technology developed at the low end of the cycle to tap newly accessible oil and gas reserves. These patterns play out over decades but it is becoming increasingly clear that the technology used to increase supply in the USA will be internationalised and the trend to consume less energy will continue at least until prices for oil recede.
The West Texas Intermediate / Natural Gas and Coal / Natural Gas ratios hit at least near-term peaks two weeks ago, near 54 and 30 times the prices of gas respectively. They have since posted their largest reactions since 2009 suggesting that natural gas is more likely that not to outperform oil and coal as the ratio reverts towards the mean.
There are currently a number of arguments for why natural gas prices are too low on an absolute basis, not least because a great deal of unconventional supply is uneconomic below $4 and drilling rigs are migrating to shale oil deposits. However the downtrend remains intact. A sustained move above $2.50 and higher reaction low on a subsequent pullback, are required to confirm demand has returned to dominance beyond the short term.
The development of a US LNG export terminal represents perhaps the most direct attempt yet to benefit from low natural gas prices. A significant arbitrage exists between US prices and those in Europe and Asia. For example, the UK natural gas price trades at 57.9p per therm, which when converted to US Dollars and MMBtu equates to $9.35. With that spread it is little wonder companies are eager to export.
Cheniere Energy collapsed in 2008 before forming a two-year base. It broke upwards in late 2010 but retraced the entire advance from mid-2011 as questions about its ability to fund development mounted. The company announced off-take agreements with BG Group among others in October and prices have trended higher. Since the company's business model is based on natural gas arbitrage, the share may be susceptible to a decline should US natural gas prices rally. It pulled back sharply yesterday but a sustained move below $15 would be required to question the progression of higher reaction lows and medium-term uptrend consistency. (Also see Comment of the Day on November 22nd).
Chesapeake Energy has a sizeable debt load and has been pressured by the fall in natural gas prices. The share has returned to the April 2009 lows near $17.30 and while oversold in the short-term a sustained move above $20 would be required to suggest a return to demand dominance beyond the short term.