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Dan Dicker: Aubrey McClendon and the Destruction of the Natural Gas Market

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Yves here. I’ve read Dicker only occasionally, mainly when I was watching and blogging on the early 2008 oil bubble (on the “yes this IS a bubble” side of that controversy). I’ve found him to be sensible and often points to pieces of the picture that are important yet most commentators are missing.

This post on the near term outlook for natural gas may give environmentalists cheer. Dicker’s description of how Chesapeake Energy has created a glut that will delay further investment means fracking foes may have more time to organize their opposition than they had thought originally. The initial development rush and the sense of inevitability created by the media has likely created the impression that the initial pace of drilling will continue, when that is just not in the cards.

By Dan Dicker, an energy analyst and a floor trader at the New York Mercantile Exchange with more than 25 years of oil trading experience. Cross posted from OilPrice’s premium service

Aubrey McClendon is gone – or at least he’s on his way out from Chesapeake Energy (CHK). But the destruction of the natural gas market, where he was the ringleader in the shale gas land grab and cratering well price, is his real legacy, and not likely to be recovered from anytime soon. While Aubrey will now go into a very wealthy retirement, he leaves behind a decimated market and a long road to making natural gas a true transition fuel to energy independence and a renewable future.

The market failed us, failed all of us as a nation – because it couldn’t prevent McClendon and Chesapeake from poking holes randomly through Texas and Western Pennsylvania in search of shale gas and ultimately flooding the market with it, cratering the price and its profitability. And it is margins and profitability that make markets work.

And while McClendon made himself the best paid CEO in the nation, he assured us that our necessary and important transition to natural gas would be made much more difficult, if not impossible: you just cannot support innovation without profits. It is not just “cheap gas” that is the answer to spurring economic growth, grow manufacturing and sell natural gas as a transport fuel or even as an export fuel here in the US – it is margins and it is profits.

And Chesapeake destroyed that for everyone in the gas game (and destroyed themselves too), with forced development of leases, multiple joint ventures with foreign oil companies, over leverage, over production and destruction of shareholder value to the benefit of the CEO. Natural gas is no longer a good business to be in, there are too many players, too many wells and no ready demand sources to soak up the surplus. We are further away from a natural gas future, a cleaner, greener and more independent future, and we have Aubrey McClendon to thank.

So, good riddance to the “Bernie Ebbers of Energy” – but where does that leave us in natural gas? We have a surplus not likely to end anytime soon and a price that will languish well under “excitement” levels for those that explore and produce. Without that excitement, you’ll not see any incentive to fundamentally move any closer to a natural gas future, either as a transport or as a further supplement into the electrical grid. It may be counterintuitive but true: cheap gas hasn’t done anything to promote gas. Recent proposals to convert LNG import terminals into export plants are a bizarre market reaction to a natural gas BUST – and a silly solution to what really is a US natural resource bonanza.

But that legacy is what we’re saddled with now, and makes practically everything in the natural gas space difficult to invest in. I haven’t recommended a natural gas company (save for EnCana at an opportune low) and won’t until the numbers in the market can generate some excitement again. I have no interest in E+P in natural gas, or even transport and do not believe in much in the projected export business, save for Cheniere (LNG), the lone working export terminal here in the US.

For 2013 at least and perhaps through 2014 as well, natural gas will greatly underperform almost everyone in the rest of the energy sector – and that’s the unfortunate legacy of Aubrey McClendon.

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17 comments

  1. American Slave

    Nat gas was just as cheap in the 90′s it will go up again as soon as we buy and get stuck with natural gas cars and power plants, Ive seen this play before.

    1. American Slave

      Maybe I should have said natural gas went down to $3 in the 90′s but rapidly shot up soon after.

  2. reslez

    It seems strange to see fracked natural gas referred to as “a US natural resource bonanza”. Fracking isn’t (and won’t be) unique to the United States. It just started here sooner because of our infrastructure, lack of meaningful environmental protection, and insatiable greed for energy and fake profits.

  3. from Mexico

    Dan Dicker said:

    The market failed us, failed all of us as a nation…

    That is the most profound insight in this entire article.

    Something as important to the life of the nation as energy cannot be left to the irrationality and stupidity of markets.

    1. Tiresias

      I disagree. The most telling observation is:

      “And Chesapeake destroyed that for everyone … to the benefit of the CEO.”

      I’d never heard of McClendon before reading this article and never want to hear of him again – but it seems to me this isn’t a failure of the market. It’s the failure of a system that allows low-lives like McClendon to put personal greed and self-advancement above all else including the shareholders and investors who are notionally employing him, the nation that sheltered him, brought him up and gave him an education – and freedom – and the human race he is nominally a member of.

      It is, of course, the same system that also gives us the Blankfeins and Moynihans and suchlike parasites that are so often the subject of NC revelations.

      1. from Mexico

        Tiresias said:

        It’s the failure of a system that allows low-lives like McClendon to put personal greed and self-advancement above all else…

        That “system” is the free market.

        Theologically speaking, the fundamental tenet of the free market religion is the abiding faith that Utopia can be achieved by everyone striving to maximize their individual self-interest.

  4. ebear

    Not everyone is hurting in this space. Pull up a 5 year chart of TGP. Also take a peek at WPT.T. Some of the air has come out, but over five years, still not bad.

    As for NG itself, knowing where a lot of it IS isn’t in itself a bad thing, especially if you’re anticipating shortages of conventional oil in the not too distant future. Infrastructure is the weak link right now, but that can be ramped up in an emergency, which is where I think we’re headed.

    I worked in the oil industry for ten years, and have studied it as an investor for at least that long. I still don’t fully understand it, and I question anyone that thinks they do – there are just too many variables. One thing scares me though, and that’s the complete lack of knowledge on the part of the voting public and politicos who pander to them. Most people have no idea how important oil really is – they think it’s something you put in your car that should be cheaper. We’ve already had one false start thanks to that – ethanol. I’m sure they’ll get in the way of future nuclear development as well.

    If you’re looking far enough ahead you can’t help but see NG as the bridge fuel that gets us to the real nuclear age – one based on thorium. I don’t expect US leadership in this area though. Japan’s a more likely candidate since they’re up against it right now, whereas the US still has a few years of happy motoring left before they hit the wall. China is the dark horse in the race. Some electric trains are going in, but their commitment to the automobile is more like a Soviet 5 Year plan than a real vision of the future.

    OK, back in character now for some deep artistic stuff.

    The future is electric!

    http://www.youtube.com/watch?v=Ewhfe19B25E

    now watch how they handle bears:

    http://www.youtube.com/watch?v=-S6LFaciNjk

    1. from Mexico

      ebear said:

      I still don’t fully understand it, and I question anyone that thinks they do – there are just too many variables.

      What’s so difficult to understand? It’s just another example of free markets run amok, another outbreak of bubble economics fueled by speculative fever and fast-talking Wall Street salesmen.

      It’s almost as bad as the ethanol scam was. In that deal you put in 1.2 energy units to get 1.0 energy units in return. Shale gas is better, maybe you invest 1.0 energy units to get 3.0 back, but the EROEI is still dismall.

      There’s a complete disconnect between the asset prices and the underlying income producing potential. Despite all the financial hocus pocus, it’s impossible to evade the basic wellhead economics: you sell an MCF of gas for $3 that it costs $6 to $8 to produce. All the beautiful promises of bounteous well reserves didn’t come true. It’s a pyramid scheme, pure and simple. The only thing that’s kept the bubble in drilling activity inflated so long is the fact that the vast majority of the gas drilled in the pre-2009 era of $10 gas was hedged with long-term derivatives. Those are now running out. Hedges may allow one to defy gravity for a while, but not forever.

      1. Scylla

        I would expect low natural gas prices for the next year or two, but then I think we will see a significant rebound. The wells drilled into these shale/source rock formations have incredibly steep decline curves. Many approach 90% depleted at around 2 years. Another thing that is not mentioned is that the “sweet spots” are typically drilled first. After the sweet spots, on average, each successive well depletes at a faster rate than the previously drilled well. What this means is that, going forward the well completion rate has to increase just to offset current depletion. Currently there are alot of wells that have been spudded that are waiting for connection to pipelines to carry the gas to market. Once these wells are brought into production, they too will begin their rapid decline, and there will be a scramble to bring rigs back into place to ramp up the well completion rate again as prices begin to rise. I would not count them to be able to do it fast enough to offset declines in production.

      2. American Slave

        “It’s almost as bad as the ethanol scam was. In that deal you put in 1.2 energy units to get 1.0 energy units in return.”

        Im not sure where that joke of a theory came from but if its from that idiot professor who isn’t diligent or proactive enough to say the least with his half baked experiment on a level lower than a moonshine maker than the world is in a worse place than I thought, he didn’t account for modern day ethanol refineries that use vacuum distillation with plate heat exchangers or membrane separation with the input corn going through dry or wet milling that can specifically separate starch for fermentation while creating distillers grains for animal feed at the same time since all ethanol is is oxygenated ethane and only contains hydrogen, carbon and oxygen atoms. It doesn’t contain any magnesium or potassium or anything in the original input which makes distillers grans the perfect animal feed.

        http://www.valero.com/products/renewables/Pages/Home.aspx

      3. American Slave

        In the end all I can say is that that idiot professor and his team should never be in charge of anything more advanced than sorting rocks and even that might be a public hazard. So instead of making ethanol and exporting gasoline we have this nightmare energy system in place.

      4. ebear

        “What’s so difficult to understand? It’s just another example of free markets run amok, another outbreak of bubble economics fueled by speculative fever and fast-talking Wall Street salesmen.”

        Ah, so not as many variables as I thought? OK. Thanks for clearing that up.

    2. mainmati

      …and why don’t we have the thorium reactor now especially since its valuable propoewrties havbe been known since the end of WWII. Thank DOD: thorium does not produce much high-level radioactive waste and so is no good for making nuclear weapons so the world was left with a lot of dangerous nukes and a lot of dangerous uranium-powered nuclear power plants. Brought to you by the US National Insecurity State.

      1. Mel

        Interesting book I read a while ago: _Internal Combustion_, perhaps by Edwin Black, about the development of the auto industry at the beginning of the 20th century. One sidebar is an account of patent-troll-ism. A bigger subject is the story of the electric auto. Edison and Ford were building working prototypes with iron/nickel batteries; what happened then was World War I. Armies urgently wanted mechanized transport NOW (i.e. THEN.) Gasoline technology was ready, and it was adequate, and the build-up for war production gave it a dominant place for another 100 years. Just like it has been good enough to do nuclear power as a spin-off from bomb development.

  5. AbyNormal

    exporting/importing from a Global view:

    Domino effect

    Even if they’re not exported, the deep U.S. natural gas reserves have rocked the global market, squeezing out many big LNG exporters who had planned to ship here.

    Qatar, the world’s largest LNG exporter with the world’s biggest LNG tanker fleet, had counted on the U.S. market. In its 2007 annual report, Exxon Mobil said that Qatar was building an export facility capable of shipping 1 billion cubic feet a day just for the U.S. market. In Texas, Qatar Petroleum took a 70 percent stake and Exxon Mobil a minority stake in the Golden Pass terminal, with a capacity to import 2 billion cubic feet a day, primarily from Qatar. Now the terminal is idle, and Golden Pass is asking the Energy Department to permit a $10 billion conversion to exports.

    Qatar and other gas-rich countries — which only four years ago talked about forming a cartel modeled on OPEC — need to find new homes for their shipments. And they’re doing that at a time whengas demand in Europe is collapsing, falling 9 percent below the levels of 2009, at the depths of the Great Recession.

    Asia remains a major destination — and has kept global gas prices high. Demand in China is growing steadily, and its current five-year plan calls for expanding gas use. And Japan’s appetite for LNG soared after it closed its nuclear plants in the wake of the tsunami that destroyed the Fukushima Daiichi nuclear complex. With new supplies coming online, however, even Japanese companies have been pressing to link their payments to the low spot price for U.S. natural gas at Louisiana’s Henry Hub, the U.S. benchmark.

    The decline in Europe has put pressure on Russia and its state-owned gas monopoly, Gazprom.

    Russian gas pipelines — built in Soviet days — are still the principal suppliers to Europe. When built, they were criticized by President Ronald Reagan, who said they would allow the Soviet Union to blackmail Western Europe. In recent years, strategists and companies have worked to diversify supplies by building new pipelines from the Caspian Sea through Turkey. And Poland, heavily dependent on Russian gas, has been trying — albeit with disappointing results — to tap its own shale deposits.

    But Europe is now adding LNG importing facilities. Just as important, it has recently used cheap U.S. coal for electricity generation. That coal, displaced by cheap U.S. natural gas, is replacing expensive Russian gas. Gazprom’s share of European gas imports has dropped from half a decade ago to about a third. In response, Russia has renegotiated gas contracts — previously linked to the price of oil — and reduced prices to Germany, Italy and Poland. Gazprom also has told some independent Russian gas producers that it would no longer guarantee the same level of pur­chases. Russia’s gas exports will drop 4 to 5 percent this year, Energy Minister Alexander Novak, according to the newsletter Petroleum Argus.

    “The United States gave a gift to European importers, deliberately or not,” said Fatih Birol, chief economist of the International Energy Agency. “It is making importers’ hands stronger.”

    Birol notes that by 2015, the United States will overtake Russia as the world’s biggest natural gas producer. In the past four years alone, he said, U.S. natural gas production increased by an amount equal to total Russian exports today.
    http://articles.washingtonpost.com/2012-12-07/business/35673759_1_surge-in-shale-gas-natural-gas-cove-point

    (when countries compete at this level, people without a heads-up Freeze to Death…it’s already taken place in the last couple years)

  6. Jardinero1

    I live down in Houston. People in Houston are intrigued by rants such as this. When prices are high, we hear bitching because prices are too high. When supply outstrips demand and prices drop you bitch again how the market failed. WTF? There is no certainty in life. You got to roll with the punches.

  7. PeterP

    The article reads a bit like an emblem of stereotypical “leftist” or “tree hugger” thinking. High gas prices bad, low gas prices also bad! Any prices bad!!!

    The author moans that low margins mean no innovation, by do we need innovation again? Why, because it can bring us lower prices. Well, consider it done. Still unhappy!

    The author seems to complain that the innovation process was too rapid so that he cannot make more money while “innovating”. What is this “green future” he is talking about? What should the process of getting there look like? He doesn’t say. Is gas supposed to expensive or cheap? If expensive for the sake of the environment, then why do you decry low innovation? innovation leads to low prices and easy availability. We got just that.

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