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Chesapeake Energy Wants $6 Gas

 

 

CNBC’s Jim Cramer invited Aubrey McClendon, the CEO of Chesapeake Energy, onto his Mad Money show on June 28, 2011 to talk about the recent Ian Urbina articles (June 26, June 27, and June 28) in the New York Times. Cramer wanted to give McClendon a chance to tell the natural gas story from a different point of view – the headline of the online article describing the interview is Chesapeake CEO McClendon Defends Natural Gas.

For the past year, Cramer has been fairly negative about investing in the stock of natural gas focused companies because their return on investment has not been competitive due to the temporarily low sales prices that their commodity is receiving in the energy market. As he explains it in his introduction to the segment, that is why he was confused by the Urbina articles – if gas prices are low (today), how can Urbina truthfully claim that natural gas producers are exaggerating their reserves?
 
As noted in the Atomic Insights post titled Good for ExxonMobil does not mean good for American public, the story is a little more subtle than the one that the oil&gas industry (all one word because it is all one industry) is telling the public. To fully comprehend the issue, you have to listen to the tales that the industry is telling the public in its advertising, telling large customers – electric utility companies, chemical companies, fertilizer manufacturers – during its marketing presentations, telling local governments, telling state governments, telling the federal government, telling investors, and, perhaps most importantly, telling each other.

Each one of the stories that the industry tells has a slightly different slant, depending on the audience. I do not want to get too involved in recounting them here, but one example can be found by listening carefully to what McClendon told Cramer’s audience, a segment of the investment community. He told them that there is plenty of gas out there, but that Chesapeake is moving more of its resources into drilling for hydrocarbon liquids while waiting for prices to move up into the $5 to $6 per million BTU range.

That might sound like a reasonable price to some people, but it is a 100% price increase over the level that existed just a year ago, when natural gas prices dropped below $3 per million BTU. McClendon probably expects that energy industry investors will be smart enough to realize that if an extraction company waits until after natural gas prices experience a sharp price increase to start a new drilling program, there will be an overshoot in the price, with good returns for many months before the new supply hits the market.

After listening to all of the stories that the industry is telling, you also have to watch their actions; those often provide a much better insight than listening to any selection of the various stories. One of the actions that the oil&gas industry has taken in recent years is to invest hundreds of billions of dollars into increasing its capacity to transport Liquified Natural Gas (LNG) around the world. From a long term perspective, it makes perfect investment sense for companies like Exxon, Shell, Chevron, and BP to overproduce shale gas in the US for a few years to keep prices low and build the market demand.

When production from the rapidly depleting “plays” falls off a cliff, the same multinational companies that influenced our entire political system because of an economic addiction to low extraction cost petroleum from the Middle East and Africa oil will add a dependence on Qatari, Australian, Azeri, Iranian, Russian and UAE natural gas.

The dependency relationship between supplier and customer when natural gas is the fuel is amplified compared to both oil and coal. Those fuels are energy dense enough so that most customers can maintain substantial inventories, giving them at least a little leverage and choice when they need to buy more fuel. With natural gas, it is close to impossible for an individual customer to keep more than a few days worth of supply on hand. For many non-utility customers, if there is any inventory at all, it is measured in minutes or hours.

I am fairly certain that readers will quickly pick up on the elephant that neither participant was willing to notice – the focus in the interview was on the cleanliness and economic competition between natural gas and coal. The ‘N’ word never came up. One of the biggest impacts that temporarily cheap natural gas has had in the energy market has been to provide utility company decision makers with an excuse for not aggressively pursuing new nuclear power plants.

I can testify from personal experience that planning and licensing a new nuclear project is hard, time-consuming work whose end date gets farther away the longer you wait to start the project. (I do not yet have personal experience in actually building, but that is coming soon, I hope.) There are plenty of people who are capable and interested in the work, but they all have a wealth of other opportunities. Building a productive nuclear project design team takes time, especially if some of the most talented members have been discouraged by going through several cycles of hiring and potential layoffs.

Cheap natural gas is a chimera. Shale gas may be exciting and could prove to be relatively abundant for several years, but never forget that the industry has moved in the direction of hydraulic fracturing out of necessity; conventional reservoirs are rapidly depleting. Fracking is a more capital and knowledge intensive way of producing gas than operating productive wells in more permeable formations, but it is a way to overcome inevitable depletion to keep production up so that it essentially matches the production level achieved 45 years ago – for a while.

As is natural for any extraction enterprise, the gas companies are drilling in the most productive areas first. They are also drilling in places that are close to existing transportation nodes. As those areas deplete, prices will HAVE to go up considerably to support the additional investment required to drill in slightly less productive areas as well as the investment needed to add transportation capacity. In a stark contrast with oil, transporting natural gas can double, triple or even quadruple the delivered price compared to the extraction cost at the well head. Moving material that is naturally a vapor is a physical challenge that requires high pressures, refrigeration, and expensive infrastructure that can require as much political interaction as building a new nuclear plant. Earning a return on those investments often requires 20 or more years of steady sales (take or pay contracts) at prices significantly higher than today’s market price.

Bottom line – the interests of a guy like McClendon, or even a guy like Jim Cramer are not aligned with the overall interests of the rest of the population. They like high priced energy that provides the people who invest in energy production companies with higher rates of return. The rest of us want clean, cheap, abundant energy that will remain available for our children, grandchildren and even great-great-great grandchildren.

I agree with both Cramer and McClendon that wind cannot do the job, but I am positive that atomic fission has demonstrated that it has the potential to provide the energy supply that society needs and desires.

Don’t expect to hear that from oil&gas company leadership.

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