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Why Increased Demand Will Save Natural Gas


Without the ability to access natural gas shale plays, the United States must continue to rely on the politically volatile crude oil market and fear the wrath of OPEC.

Shale plays? Don't let the ambiguous name take away from its rising importance to the natural gas industry. Names like Bakken, Barnett, Fayetteville and Marcellus will soon become a part of our daily vocabulary. Finally, the race for American energy independence is on. But before the official can fire the starter pistol, he's got to hold off for a bit. Prices are in the dumps due to a glut of supply (the December futures contract settled at $3.583/MMBTU on Friday). For the past two months,10:30 a.m. on Thursdays have been celebratory times for natural gas bears -- this is when the weekly natural gas storage data is released. Nine straight inventory injections above estimates have built total gas in storage to 3.831 trillion cubic feet (Tcf), just below last year's all-time record of 3.84 Tcf. Analysts expect this Thursday's data to yield a figure around 3.864 Tcf, surpassing the record.

Aren't lower prices a good thing? Well, when it comes to extracting natural gas from shale, nothing comes cheap. For companies with significant drilling presence in shale plays, such as Chesapeake Energy (CHK) and ExxonMobil's (XOM) subsidiary, XTO Energy, the costs of hydraulic fracturing are much too high for the current market. In addition, strict regulations from several state governments regarding the environmental impact of the chemically-intensive procedure constrain some companies from drilling for the hydrocarbon. Without the ability to take advantage of such massive resources of natural gas, the country must continue to depend on the politically volatile crude oil market and fear the wrath of OPEC. Greater access to such natural gas reserves requires an impetus to drive up demand, subsequently resulting in increased prices and also a greater willingness of drilling companies to obtain the commodity.

As for conventional demand, in the United States, about 25% of electricity is generated by burning natural gas in power plants. Despite a summer of record heat across several states, including a couple days in July that left Electric Reliability Council of Texas (ERCOT) officials considering rolling blackouts in Texas' electricity grid, natural gas prices still could not be propped up. So when will prices rise? One thing is for sure: Record highs in the summer and record lows in the winter that require electricity to cool or heat households are not going to aid in pushing demand to match the pace of massive supply growth.

Short of setting fire to existing gas in storage, supply is not going away any time soon. In order for American energy independence to become a reality, a concerted effort from the government and the drilling industry is necessary to increase demand.

Where is there demand that does not already exist? Exports, especially to China. Yes, you read correctly – that is a "to" and not a "from." In a region where natural gas trades at approximately $16/MMBTU, more than four times the price at the Henry Hub in Louisiana, there is certainly a desire for cheaper sources of energy. In fact, Cheniere Energy (LNG) recently secured a deal with BG Group (BG.L), allowing it to export LNG out of the United States. But the speed of the process is much too slow -- it may be 2015 before the terminal at Sabine Pass in Louisiana is ready for delivery. The government must swiftly approve the six remaining export proposals as well as encourage future proposals in order to increase the volume of exports. As of now, LNG exports are the only viable option to prevent natural gas prices from slipping even further towards the $3/MMBTU level.

In order to prop up domestic demand, stricter regulation regarding the Cross State Air Pollution Rule (CSAPR) must be enforced. The rule will restrict nitrogen oxide (NOx) and sulfur dioxide (SO2) levels in 27 states beginning on January 1, 2012, consequently reducing reliance on oil and coal power plants and leading energy companies to turn to natural gas. But despite a failed Senate vote on Thursday regarding a proposal by Senator Rand Paul (R-KY) to repeal CSAPR, such dissonance opens the door for postponements of the planned compliance date.

For those who believe that the government should only incentivize the widespread usage of renewable energy sources, it is important to understand that natural gas is not the end-all and be-all of innovation in the industry. It will simply serve as a bridge between the days of dirtier fossil fuels like oil and coal and the future of ubiquitous wind and solar energy use, when long-term and large-scale storage of electricity is a reality. Without a strong natural gas presence in America's energy architecture, the road to energy independence is muttered, inconveniently dependent and full of potholes.

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