A Catalyst for a Bull Market in Natural Gas? - May 2nd

A Catalyst for a Bull Market in Natural Gas?

May 2^nd, 2011

Natural gas has been stuck in a protracted bear market after making a significant high in 2008.  One of the biggest factors weighing on the price of natural gas is the continued expansion of shale-gas production in the United States.  Insignificant several years ago, domestic production of natural gas from unconventional sources, now possible thanks to hydraulic fracturing coupled with horizontal drilling techniques, represents a significant portion of U.S. gas supply.  By 2009, the last year with complete data available, shale-gas composed 19 percent of total production.  The Energy Information Agency’s Annual Energy Outlook 2011 forecasts U.S. gas production to swell to 26.3 trillion cubic feet by 2035, with nearly half coming from shale developments.

Nymex Natural Gas Futures

Courtesy of Bloomberg

It has been my view for some time that the proliferation of shale-gas development would keep a ceiling on natural gas prices in North America, with a few possible developments that could spark a sustainable rally.  One of which would be significant investment in LNG export capacity, which would provide a link between domestic prices and the world market.  Currently, the North American benchmark is around $4.50 versus around $8.00 in international markets.  Another potential catalyst for a bull market in natural gas would be legislation that hampers the development of shale gas resources, possibly due to environmental or health concerns.  Some recent developments in the U.S. may put this on the radar screens of energy traders in the near future. 

The FRAC Act

The Fracturing Responsibility and Awareness of Chemicals (FRAC) Act, introduced in June 2009, would require public disclosure of the chemicals used in the hydrofracking process.  Hydraulic fracturing involves pumping heated and pressurized water, mixed with a cocktail of chemicals, into shale formations, separating the rock and allowing the gas to escape.  Under current regulation, companies are exempted from disclosing which chemicals are used, arguing that they must maintain the secrecy of the ingredients for proprietary reasons.  The Energy Policy Act of 2005 exempted the process from regulation by the EPA under the Safe Drinking Water Act, a rule commonly called the ‘Halliburton Loophole’.  Since its introduction, the FRAC Act has been under review by the Subcommittee on Energy and Environment but never came up for debate.  Under Congressional rules, any legislation that did not come up for debate is cleared from the books once the session ends.  As a result, this Bill is no longer under consideration, though members often reintroduce bills once the new session begins.  Recent developments seem to support the notion of this legislation making a comeback, though its ultimate fate is far from certain.

Diesel Fuel Discovered

The aforementioned ‘Halliburton Loophole’ does not exempt the process from regulation in cases where diesel fuel is used, due to the high level of toxicity and risk it poses to drinking water supplies.  A year-long investigation that released its findings in January of this year found that between 2005 and 2009, at least 32.2 million gallons of diesel fuel was pumped into the ground as part of fracking operations in 19 states, in violation of the mutually binding agreement between the government and the energy companies.  Diana DeGette, who first introduced the FRAC Act, and who is currently a ranking member of the Subcommittee on Oversight and Investigations said in a statement, “Our investigation has shown that for the past several years, the fracking industry has ignored federal regulations and a mutually binding agreement, and injected over 30 million gallons of one of the most toxic chemicals into the ground, potentially contaminating drinking water aquifers in communities nationwide,”.  This could help open the door to further regulation.

Most Recent Findings

On April 18^th, 2011, a report from the democratic members of the House Energy and Commerce Committee and House Natural Resources Committee revealed the use of 29 different chemicals regulated under the Safe Drinking Water Act as potential human carcinogens.  The report highlights the potentially harmful effects of the hydrofracking process on human health, and could help build support for a re-emergence of the FRAC Act in the current congressional session. 

Any move to tighten regulation of hydraulic fracturing may have a significant impact on future natural gas supplies, and could be the catalyst to mark the bottom in this protracted bear market.

-Jaime Macrae, CIM

Account Executive, Friedberg Mercantile Group

jmacrae@friedberg.ca