A nervous investor recently asked me, "What could upset the shale gas story?"
Like being right-handed, my brain was instinctively drawn to putting his energy question into a supply side context. There are plenty of potentially upsetting risk factors from a producer's point of view: Anti-fracking legislation, unexpected asset degradation, carbon taxes and escalating costs are among the oft-stated antagonists.
But my answer was hidden in the demand side. "A hot summer," I answered finally. "A hot summer is the one thing that could disturb the fortunes of those who are betting on the future of shale gas – investors, producers, policy makers, Canadian liquefied natural gas (LNG) proponents and champions of American energy independence, to name a few.
"A hot summer?"
Yes, a hot summer would not be good for the natural gas business.
Anyone in sales knows that it's their customers who adjudicate the success and growth of a new product. Savvy retailers know not to upset a buyer, because convincing them to come back means going back to the starting gates of building trust. Crappy quality, poor service and inaccessibility are real turn-offs for consumers. But few things anger a reluctant customer more than a steep jump in price.
And so it is with recently spiking natural gas prices. A commodity that, for the last half dozen years, has been up-sold to skeptical, large-scale North American buyers as the cheap, clean, abundant fuel of the future. There was good reason to believe the story. New technologies liberated a surge of production growth not seen since the 1950s. Prices retreated to near 1990 levels with economies of scale. Importantly, the wild price volatility that was a hallmark of natural gas between 2001 and 2007 diminished too.
Shale gas growth really took off in 2007, coincidentally the same year the first iPhone came out. Who said the energy industry couldn't revolutionize a market just like those Silicon Valley guys? It took the natural gas industry and its proponents at least three years to convince the likes of large power utilities, petrochemical plants, truck fleet operators and LNG exporters that spending capital on natural gas as a feedstock was the golden, low-cost and stable opportunity of the future.
Weather has a way of disrupting stability. A good old-fashioned winter fired up a lot of furnaces. Electrical demand from gas-fired power plants was at an all-time high rolling into February. Anyone watching AECO Hub prices in Canada did a double take last week: A few customers without parkas had to pay an intraday high of $35 (Canadian) a gigajoule in the cash market. East Coast American prices spiked up too: In late January, Boston closed as high as $75 (U.S.) per one million British thermal units; Chicago $40 and New York $100.
Big industrial gas consumers, especially those planning on investing a lot more capital to hook into new shale gas supply lines, will be throwing up some sobering PowerPoint slides at their quarterly meetings. On average, natural gas prices at Henry Hub, the U.S. benchmark, have doubled since mid-2013. Customers hate a double, and price volatility is really off-putting.
Surely, someone sitting at a boardroom table is going to stare down an analyst and say, "I thought you said this was the cheap, abundant fuel of the future?"
Yet, let's hold the drama for a moment. Natural gas prices are already starting to moderate. As of last week we passed the peak of the winter cold. Demand will slide quickly into the "shoulder season," the time when neither furnaces nor air conditioners are spinning their bearings. Producers will tie in every spare gas well in inventory to take advantage of the high prices. Some may even start drilling dry gas wells again. That's what the markets still believe, because the long end of the futures curve hasn't budged – you can still contract natural gas for delivery two years out for $4.30 (at Henry Hub), just like you could before the bitter cold sucked all the gas out of the storage caverns.
St\orage levels should rebuild in time for next winter, quickly tempering prices in the process. That's assuming, of course, this summer isn't an abnormally hot one. Cold winter plus hot summer will equal more price volatility, which in the minds of customers will instill greater uncertainty about natural gas as a low-cost growth fuel.
Ongoing price turbulence in the markets can destroy the "abundant and cheap" brand that the natural gas industry has worked so hard to build over the past several years. What could upset the shale gas story? A lot of upset customers.
Peter Tertzakian is chief energy economist at ARC Financial Corp. in Calgary and the author of two best-selling books, A Thousand Barrels a Second and The End of Energy Obesity.
Peter Tertzakian