When is a $40 swing in oil prices just background noise?

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By Peter Abt, Managing Director, Black & Veatch Management Consulting

For the answer, look no further than long-term U.S. consumers of natural gas. For more than two weeks, news of oil’s march below $75 a barrel and its subsequent bounce has dominated coverage of the energy sector, swaying global financial markets. Dire predictions of prices tumbling into the $60 range stirred numerous “what-if” scenarios for the production sector and overall economy, from curtailed output and the consolidation of smaller players to outright recession.

However, Black & Veatch’s long-term projections and overall view of the U.S. natural gas market suggest the impact to large-scale customers of domestic natural gas such as power plants, industrial users and local distribution companies (LDCs) will be at the margins. This, despite palpable uncertainty consuming the energy sector.

Driving this optimism the comprehensive nature of the U.S. shale gas revolution. Specifically, the combination of abundant resources and the speed at which natural gas production can shift between “wet gas” plays such as the Bakken and Eagle Ford formations and “dry gas” plays such as Marcellus and Haynesville shales.

Without question, falling oil prices will impact overall energy prices in the short term. Lower prices will impact cash flows for domestic producers, which in turn affect future drilling budgets. Those with higher costs or higher debt loads are hurt at the sub-$75 range as the percentage of cash flow shifts from exploration to debt service. Yet, even at prices in the $70 range, domestic production will likely remain constant, with material declines not felt until the $65 threshold is crossed.

Even at that point (on the gas front) Black & Veatch does not see a significant decline in gas production or medium to long-term increase in pricing. There remains associated gas from oil production that will continue to hit the market as growth in oil production may slow, but ultimately, will not stop. Second, there are currently several billion cubic feet per day of natural gas shut-in that awaits interconnection. Should other production areas halt, these sites could rapidly be brought online to fill any decline in production. This will push any production decline out into the future.

Finally, and perhaps most critically, should natural gas prices consistently reach the $5 to $6 price point, we expect to see a material shift to dry gas production. For example, the economics of the dry gas Haynesville shale play found in Arkansas, Louisiana and Eastern Texas do not support production in the $3-$4 range. But, above $5, a price conceivable given natural gas’ historic volatility to production declines, these untapped resources become profitable. And, with advances in fracking technology and horizontal drilling, these plays can be rapidly brought online to meet customer demand.

To be fair to market forecasters, five years ago few saw the potential for oil and gas output to reach levels that now rank the United States number one  among total hydrocarbon producers. And, the slow pace of natural gas transportation infrastructure development may leave certain regions, particularly the Northeast, open to significant spot market volatility. But in general, Black & Veatch concludes that long-term domestic gas customers should be confident that pricing will point toward the low end of the historic price curve for years to come.

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