Growing Pains

Raymond “Scott” Stone

Stone House Investment Management, LLC

Managing Partner

rstone@stonehousemail.com

570-278-6926

Virtually every fast growing industry has growing pains and the shale gas industry is no different. From political hurdles to ecological concerns to underutilization of natural gas, the shale gas industry has had its fair share of bumps along the road. In this article, we will look primarily at the issue of demand for natural gas and how it will affect the growth of the industry in the short and long term. It has been hard not to notice the precipitous decline of natural gas prices over the past couple of years. The price of natural gas has declined more the 80% from its peak! This price decline occurred while oil prices have climbed to nearly $100/barrel. Why is natural gas falling in price while oil is climbing? Since they are both sources of energy and can replace one another for certain purposes, it would be reasonable to think that they would rise and fall in price together.

The difference in price is largely due to infrastructure, or lack thereof. Oil has been our national addiction of choice for many decades. There are gas stations in every town, home heating oil delivery companies serving every community and plenty of refineries, pipelines and transportation systems to get the oil and oil by-products from the suppliers to the people who want to use them.

This is not true of natural gas. The facilities and distribution systems needed to get all of this new natural gas supply to the places that want to use it are not in place. Consequently, we have more natural gas available than we currently need. When you have more of something than you need, the price falls and in the case of natural gas, prices dropped like a rock. Prices dropped by so much, in fact, that it may no longer be economical to drill for gas in some areas. Some companies are even scaling back development plans for natural gas in our area.

So what is the outlook for natural gas prices and the natural gas industry in our area? The lower prices go, the less incentive to bring new production online. When you think about it, the reason gas prices are going down is because there is too much natural gas on the market. Making more natural gas is just going to make things worse in the short-run. This will likely lead to slower development of leased properties, less natural gas being shipped to market from developed properties and may be bad news for unleased areas like those in NY State.

The ramifications may be seen in local job growth as companies reduce the amount of drilling rigs in the Marcellus and as mid-stream infrastructure projects get put on hold due to the decreased capacity growth expectations. It may be seen in reduced royalties to land owners as fewer wells will be produced and the wells that are produced may not be produced at full capacity. It may cause more wells to be shut-in and more acreage to be held by production as gas companies try to lock in their leaseholds. It may cause much lower lease bonuses and less favorable lease terms for acreage that is not currently leased or that may be up for a new lease. It makes lease extensions of acreage outside of core development areas less attractive and it may lead some companies to not extend some existing leases into a secondary term. It may also cause the value of mineral appraisals to decline as natural gas price is one of the main determinants of value.

That being said, the volume of production in the Marcellus is so significant that it may be enough to offset the fall in gas prices and mitigate some of the these effects. Additionally, each company has its own set of priorities and needs and each will weigh its long-term success with how it handles this short-term utilization issue. Ultimately, the growth rate of our local economy will be much smaller than if gas prices were still in the double digits.

There is a silver lining in the longer term. The cheaper natural gas is compared to oil, the more incentive there is for end users to switch to natural gas. There is also a tremendous potential to sell our natural gas to foreign countries. All we need in place is the infrastructure necessary to utilize the amazing resource right under our feet. Putting it in place, however, will take a degree of political will and for corporations to get behind projects focused on broadening the market for shale gas locally, domestically, and internationally. Over the coming decade, great advancements will be made in natural gas infrastructure with many projects already being planned. As the utilization of natural gas increases, so likely will the price. Until then, though the industry will continue to grow, create good paying jobs and producing significant wealth for leaseholders, it will be at a slower pace than if there were much greater demand for natural gas.

-Raymond “Scott” Stone