Energy Deflation Cometh: Plentiful Shale Gas, LNG, Ethanol, Nuclear, Geothermal

Consumers rejoice.  Investors beware.  Environmentalists lament. 

Fossil fuel prices are just about to nose dive.  Massive new supplies of energy are coming on stream worldwide.  Shale gas has flipped the United States from gas importer to gas surplus.  Liquid natural gas (LNG) supplies from Qatar, Algeria and Russia are flooding European and Asian markets.  Ethanol production in the US is outstripping demands. 

Huge new oil fields in Iraq, Saudi Arabia, Brazil and Ghana will cause an intermediate-term surge in crude oil production.  Iraq alone will be producing 5 million more barrels of oil per day within just five years; Brazil will become an oil exporting nation.

The sudden ‘political correctness’ of nuclear power in Germany and the United States, coupled with new plants in China and perhaps Iran, will further shift the energy equilibrium toward ‘cheap’.  Water source or geo-thermal technologies like the residential heat pumps offered by FHP Manufacturing are cutting home heating bills by 70%.  All of these new ‘conventional’ sources don’t bode well for expensive renewal resources like solar and wind. 

 To get a sense of where the future energy price equilibrium will be, consider that natural gas is selling for $5.09 MMBtu at the Henry Hub in Oklahoma.  This compares with a global price for natural gas of about $13.00 MMBtu, according to the Energy Information Administration, Department of Energy.   $13.00 per MMBtu only makes sense as an energy equivalent of crude oil which currently sells for $76.00 per barrel (the energy content of a barrel of crude oil is estimated at 5.8 MMBtu; 76 divided by 5.8 = $13.10).

The global price for natural gas is still set by long-term contracts linked to oil prices.  These contracts between Russia and Europe/Japan were negotiated before the global recession reduced demand and, more importantly, before the United States flipped from a gas shortage to a gas surplus based on advances in dry gas or shale gas technology.  At the same time, long-term LNG projects LNG in North Africa, Qatar and Russia finally went into production with the net effect that the global market is flooded with cheap natural gas.  Looking ahead, new pipelines like the North Stream connecting Russia and Germany will contributed to global oversupply of natural gas in the coming decades. 

In Europe, the natural gas benchmark price is shifting from long-term contracts linked to oil to spot markets like the British National Balancing Point (currently pricing natural gas at about $5.53 per MMBtu).   Other spot markets are sprouting up across the Continent:  Zeebrugge in Belgium, TTF in the Netherlands, PEG Nord in France, BEB VP in Germany and PSV in Italy.  This decoupling of natural gas prices from oil was one of the reasons behind last winter’s pipeline stand-off between Russia and the Ukraine.  Among other things, the Ukrainians wanted to pay ‘market prices’ which meant the Russians would get ½ as much for their precious commodity.

Experts on the cost of generating electricity, e.g., The World Bank, are now saying that natural gas is the cheapest way to generate electricity in the United States – cheaper and obviously cleaner than coal.  Last week, Progress Energy, an electricity generator in North Carolina, announced plans to close all of its old coal plants and switch to natural gas.  Such a press release would have been implausible just 18 months ago when gas prices peaked at more $13.00 per MMBtu.

In energy markets, there is always a rush to the bottom in terms of price.  That means that natural gas is going to start setting the global price of energy.  When the Saudi Oil Minister says that crude oil prices are ‘perfect’ and the Mexican Finance Minister is buying a hedge at $57.00 per barrel for the entire 2010 production of Pemex, it is certain that crude oil prices are under downward pressure.   Based on the spot price at the Henry Hub, crude oil is headed back toward $30.00 per barrel.