The Domino Effect: New Hydrocarbon Interdependencies

Yesterday ICE next-day gas at Henry Hub posted at $1.85/MMbtu, down a penny from Wednesday.  The CME/Nymex May contract settled at still another 10 year low (how many more 10 year lows could there be?) at $1.907, down 4.4 cnts. But May WTI crude oil at Cushing is still above one hundred bucks a barrel, closing at $102.27/bbl, off 40 cnts.  Our favorite measure of fundamental market disparity – the ratio of prompt crude futures to cash gas is now up to 55X (simply 102.27/1.85). 

There is no more important measure of value in today’s energy market than the crude/gas ratio.  Not only because dry gas producers have abandoned all hope of positive returns, but also because it is driving unprecedented change through all parts of the economy dependent on the price of energy.  If the hydrocarbon is in a gaseous state, it is dirt cheap.  If it is in a liquid state, it is a high-dollar product.  That is NOT the natural order of the universe.

Due to the important implications of this disparity, it seemed to be a good topic for my presentation on Wednesday at the LDC Gas Forum Southeast in Atlanta, GA.  This is a conference for local distribution companies (natural gas distributor utilities) and their suppliers.  Traditionally these companies have been able to consider their gas supply decisions in isolation, oblivious of what happened to be going on in the markets for crude oil and natural gas liquids (NGLs). But that’s all changed.  Now what happens in one hydrocarbons market has a direct impact on the others.   

It took me 30 minutes to lay out this case and provide evidence for the new kinds of interdependencies between energy commodities.  Fortunately for followers of this RBN Energy blog, it will not be necessary for you to absorb that much detail.  That’s because my last slide of the presentation boils the entire interrelated hydrocarbon marketplace down to a single powerpoint slide.  Everything you need to know in one simple graphic.  Provided here, free of charge.

As with most of my presentations, it is an animated graphic – titled the Domino Effect.   Download it below and then open it as a powerpoint show (.ppsx format).  Here’s the color commentary:

  1. In the beginning, shale technologies hit the natural gas markets - driving new efficiencies and productivity throughout the industry
  2. This productivity stimulates natural gas production – by an astronomical 15.8 Bcf/d of growth in pipeline quality gas from 2005 to the present
  3. Rising gas production results in a supply overhang, depressing natural gas prices.  Like the $1.85 in the cash market today
  4. Such low prices are bad news for producers.  To avoid low returns for dry gas wells, producers shift drilling budgets to wet (high BTU) gas and crude oil plays (with significant production of associated gas).   NGLs from high BTU gas and crude oil prices enjoy much higher prices established in global markets.
  5. This development then gets us to three tracks, one for each of the three commodity groups


6)   In the NGL market, increasing volumes of wet and associated gas produce greater volumes of natural gas liquids.  That pushes the relative price of natural gas liquids down.  With NGL prices low, petrochemical companies make huge profits converting NGLs to petrochemical products like ethylene and propylene.  This motivates the Petchems to plan to spend billions in new plant construction.

7)   In the crude oil markets, production in the Rockies and midcontinent increases dramatically, well beyond the ability of the pipeline infrastructure to move the barrels to market.  Thus much more expensive rail and truck transportation comes into play.  Higher costs and constrained takeaway capacity results in lower local prices, which means that crude input costs to local refineries is much lower than such costs in other parts of the country.  But product prices (gasoline, diesel, etc). have been only marginally impacted.  Consequently refineries in the Rockies and midcontinent are experiencing extremely high margins and very healthy profits.

8)   In the natural gas sector, wet and associated gas drilling have kept gas production strong.  So natural gas prices remain weak, and users of gas – power generators, industrials, commercials and residential customers are making and/or saving a lot of money. 

What a wonderful world.  Is everyone a winner?  As usual, it doesn’t work like that. Dry gas producers are under water.  You can’t make money drilling for $1.85/MMbtu gas.  Coal producers are in trouble.  Gas is below coal on a btu basis in most markets and coal’s market share is dropping like a rock.   LNG import terminals are ghost towns.  The only residents are lawyers and lobbyists trying to get them converted to export terminals.  Natural gas basis trading shops are pretty quiet these days since the difference between the highest and lowest prices in the country is about 50 cnts with little volatility. And the poor fuel oil and propane distributors have to explain to their customers why their bills are 3X-4X the cost of natural gas. Just before their customers terminate services.

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