What if it was all a bubble? Until recently, the media and politicians, not to mention the energy industry, have gone on and on about the new era of energy independence.
Free from the yoke of dependence on foreign imported oil, America would see an economic revival, more energy security, fewer terrorism concerns, and great increases in profits, employment, and tax bases.
The shale oil and gas boom was supposed to be a transformative moment for the country, one that would, like the 90s tech expansion, send the country in a whole new direction.
Horizontal drilling, combined with hydraulic fracturing, aka fracking, allowed oil and gas producers to use revolutionary new techniques to access fields that had previously been out of reach or uneconomic. The immediate effects were extraordinary.
US oil production peaked in the early 1970s, and fell by roughly half, even with the exploitation of large fields in Alaska in the interim. Natural gas production also peaked in the 1970s and fell modestly afterward.
But by 2010, natural gas production had exploded, launching 50% over the previous decade to hit new highs. Oil production also revved up, and has now nearly reached the previous peak from the 1970s.
Until 2014, this was great for everyone involved. The oil companies had a fat new profit stream.
In late 2014, as the Fed moved from easing toward tightening policy, the energy boom suddenly began to show its darker side. The prices of both oil and natural gas began to collapse.
Oil fell from 100 to 50 initially, rebounded to 60 this summer, and is now grinding lower, likely heading to the 30s by Christmas.
Natural gas, a few weather-related deviations aside, traded steadily around $4 per unit. It began to fall last year as well, heading down to 3. Recently, it’s taken another leg lower, and is now in danger of breaching 2, a 50% decline from the old steady price.
The thinking had been that global oil demand would absorb the new US supply. But international producers have also been increasing their production, notably Iran now with the export ban being lifted. And international demand has failed to meet expectations largely due to the Chinese slowdown.
Natural gas prices were supposed to remain stable, regardless of world economic conditions. Natural gas could (and has) replaced a great deal of coal usage for domestic electricity production as nat gas prices have fallen. Natural gas usage has also soared for usage in powering manufacturing plants and as an input for petrochemical applications.
These new uses were supposed to provide nearly unlimited demand, allowing the natural gas producers to create new supply with abandon.
However, it didn’t quite work out that way. On the one hand, the prices of other energy supplies, such as coal and uranium also collapsed, causing utilities not to switch to natural gas electricity production after all. More widespread adoption than expected of solar has also interfered with the natural gas industry’s plans.
And finally, the industry trump card, liquefied natural gas (LNG) exports, didn’t work out. Until recently, overseas natural gas prices were $10-15 per unit, far in excess of domestic prices.
Companies such as Cheniere Energy built export terminals that would allow the natural gas to be shipped to foreign customers. Even including the sizable costs of freezing, shipping, and then thawing highly volatile natural gas to far afield locales, the endeavor would have been profitable.
But the collapse in oil prices has dragged down international LNG prices to the point where it is no longer practical to ship LNG to other countries in most cases.
As such, there’s now way too much natural gas in the US domestic market, and too much oil in the overall global market. With the price of both goods down 50% or more, energy companies that just two years ago had the world as their oyster are now facing annihilation.
In part two, we’ll discuss the ramifications and trades for investors based on the collapse of the domestic energy industry.