Is that a Bubble in Your Natural Gas? Interview with Jim Lucier

Location: New York
Author: IRA Staff
Date: Tuesday, November 24, 2009
 

Over the weekend, we spent the usual time perusing the financial press. One comment in particular caught our eye and not surprisingly it was written by our friend John Dizard of the Financial Times. With the notable exception of Martin Wolf, John is among the few columnists at the FT who regularly tell you something that you don't know. The editors of the FT still have yet to grasp this fact and routinely bury John's column in the back of the Saturday edition of the paper, but we're working on it.

The gist of John's November 22 column was that the investor frenzy regarding shale gas deposits in the US may be badly overdone. He writes that "it does seem clear to me that Wall Street has underestimated the real cost of shale gas, and overestimated how fast its production can be expanded."

John's column tells the tale of the shale gas gold rush in the US and how the criticism of a lone dissident, Arthur Berman, caused a fuss among the major exploration and development firms such as Chesapeake Energy (NYSE:CHK) and Devon Energy (NYSE:DVN).

It seems that Mr. Berman has questioned whether the gas shale potential in the U.S. is really as attractive as many investors have been led to believe. His reward for this candor, which Dizard attributes to industry pressure, was to be banned from writing for a well-known industry publication called World Oil .

You may recall that last year we featured an interview with Jim Lucier about the energy outlook in the US. In that discussion, James focused on electricity and the huge supply of gas hydrates off the coast of the US, sufficient supply to meet the needs of the US economy for centuries. But the fact of offshore gas deposits has been overshadowed by reports of a technology breakthrough that would make existing onshore gas fields productive for decades longer. This made the outlook for gas supplies brighten even further and forced gas prices lower.

But now Dizard believes that much of the hoopla concerning the viability of extracting gas from shale deposits is leading investors to a dry hole. Specifically, he cites another industry expert, Ben Dell of Bernstein Research, who says that while E&P companies have been pouring billions into new technology to fracture shale deposits, this in order to increase gas production, actual production is flat. That is, even though producers are pouring billions into equipment to fracture shale deposits, "the increase in fracs has hidden an underlying deterioration in well results," says Dell.

Dizard opines with his usual understatement: "By now, close to half of the gas rigs in the US, and most of the development money for the fuel, is going to shale plays. If the companies and investors are wrong, there may be tens of billions of dollars of over-investment, that might be more productively spent on conventional onshore gas, or on drilling US offshore prospects. This is not just an investors' bet, but a core national energy policy."

We contacted Jim Lucier over the weekend to see what he thinks about all of this.

The IRA: So Jim, what is the situation with shale gas and the overall outlook for natural gas in the US generally?

Lucier: The shale story is actually about three, going on four years old. When I talked about abundant gas supplies in our interview last year, I should have been clear that shale is the near-term story.

The IRA: Do you think that the published reports about cost and other production problems with shale oil modify you rosy outlook on overall gas supplies for North America?

Lucier: I think most investors are adequately cautious -- for now -- about high-cost gas in a $4 price environment. The real problem will come when investors perceive that Washington is making a bet itself and is putting a thumb on the scale in favor of the shale developers, who have been throwing around some pretty serious political muscle in DC of late. Then hedging be darned and everyone will want to ride the shale plays right up to the peak of the next cycle -- if they can bail out in time. No one can predict natural gas prices, but the iron law of forecasting is that Washington makes the boom-bust cycle worse.

The IRA: What are the risks to investors posed by Washington's posture on natural gas? Is the US government promoting an investment bubble in gas shale technology?

Lucier: There is no question that Washington has come late to the shale story. Much of our current energy policy debate is premised on the notion circa 2003 that tight supplies and declining gas production mean that we must meet incremental power demand from renewables and "clean" coal technologies that have yet to be proven, regardless of the economic cost. Now the prospect of abundant gas from shale plays offers policy makers the shimmering mirage of an easy way to low cost energy, without going to the trouble if a balanced strategy that includes the conventional onshore, the offshore, nukes, advances coal and renewables in a genuine "all of the above" strategy.

The IRA: What do you think of the report by John Dizard over the weekend in the FT? Is the shale gas bubble already expanded to the breaking point?

Lucier: It's debatable. Dizard has a point about high decline rates and huge expense. I tend to believe in the technology myself and in the ability of technology to bring costs down. The drilling technology is truly revolutionary. However, the supply glut and low prices are a very real problem. That's why we are seeing such an effort in Washington these days by the gas guys to put the coal guys out of business. CHK CEO and co-founder Aubrey McClendon talks a very big game and has no problem body-slamming people who disagree with him. That's a game you can play well when you are on top of the market, but you can face real exposure on the downside.

The IRA: Any final thoughts?

Lucier: The odd thing about natural gas is that scarcity and failure to produce is actually a good thing for stock valuations because price is extremely elastic and volatile. Gas was $13 a year ago. Now it's about $4.25, because of mild weather, slow economy, industrial demand destruction, and supply glut. The shale play NOT working would actually be a good thing for many gas investors, especially those leveraged to conventional gas. Less production from shale would actually benefit the shale guys to some degree.

The IRA: Thanks Jim

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