The US Department of Energy (DOE) released a report on 5 December, 2012 which examined the question of economic benefit to the US of natural gas exportation. Last December, Deloitte issued an independent report regarding exportation which had hauntingly similar conclusions. Interestingly enough, many of the conclusions in the Deloitte report are now known to be erroneous only one year later.
The NERA report claims favorable consequences for the US economy should natural gas be exported. But a closer look at both reports, its authors and the underlying economic assumptions is warranted due to inherent biases.
The DOE’s economic analysis released yesterday was conducted by a firm called NERA Economic Consulting. It must be noted that the principals of NERA including Dr. David Montgomery the lead author of the study, list as their credentials extensive work on behalf of the oil and gas industry including such particularly lucrative work as expert witnesses on behalf of petroleum companies. Such work is often times the bread and butter of these organizations. This inherent conflict of interest, however, constitutes the first red flag.
The second red flag follows closely on the heels of the first.
In the executive summary of the NERA report it is stated:
“NERA built on the earlier U.S. Energy Information Agency (EIA) study…calibrating its U.S. natural gas supply model to the results of the study by EIA”.
EIA data was used in the Deloitte report as well:
“U.S. gas demand growth rates are consistent with the U.S. Energy Information Administration’s…2011 projection”
Deloitte continued with the statement:
“…the [Deloitte] forecast of gas demand for power generation is considerably higher than the publicly available EIA forecast.”
These statements are of interest for the following reason.
In March, 2012, EIA did a retrospective study to determine just how often they had been correct in their forecasts.
The results were dismal. And eye-opening.
For instance, EIA, by its own admission, states that they had overestimated crude oil production 62% of the time; they had overestimated natural gas production 70.8% of the time; and they had overestimated natural gas consumption 69.6% of the time. Not the best track record by anyone’s estimation except perhaps EIA’s.
It is also noteworthy that EIA had overestimated the energy intensity ratio a whopping 96.5% of the time. This is a ratio of total energy consumption and GDP. They tended to overestimate energy consumption and underestimate growth in GDP.
In short, EIA is not very good at forecasting. But what is even more interesting is that Dr. Montgomery, the lead author of this new study, was once in charge of models and forecasts at EIA. Both NERA and Deloitte used EIA forecasts as the basis of their report models. Deloitte even stated that they considered EIA’s forecasts to be too conservative in spite of the fact that EIA has not projected natural gas demand accurately 70% of the time.
As any student of economics soon learns, economic models are only as good as their inputs. In fact, it is neither difficult nor unusual for models to be designed to favor one outcome over another. In other words, models can be essentially reverse engineered. This is especially true when the models have been commissioned by industries that stand to gain significantly in monetary terms. Or government agencies which are perhaps pushing a political agenda.
There are other anomalies in the reports. My personal favorite was the following from the NERA report:
“Different socioeconomic groups depend on different sources of income, though through retirement savings an increasingly large number of workers share in the benefits of higher income to natural resource companies whose shares they own.”
This appears to be a direct suggestion that it would be beneficial to own shares of energy companies in your retirement portfolio. I am sure that the Chesapeake Energy’s and ExxonMobil’s of the world were highly appreciative of this stock tip directly from the Department of Energy and NERA.
But not able to stop there, NERA went on to say:
“Nevertheless, impacts will not be positive for all groups in the economy. Households with income solely from wages or government transfers, in particular, might not participate in these benefits.”
In other words, if you cannot afford to own shares in energy companies, you will likely see a hit to your bottom line.
It is also interesting to note that the shale gas industry has taken a great deal of credit for the renaissance of manufacturing in the US. And yet, NERA states:
“Like other trade measures, LNG exports will cause shifts in industrial output and employment and in sources of income. Overall, both total labor compensation and income from investment are projected to decline, and income to owners of natural gas resources will increase.”
So jobs will apparently be sacrificed in such nascent manufacturing projects and income from investment in domestic plant and equipment will decline. Not to worry, however, as this will in turn be offset by a rise in income to natural gas companies.
Deloitte was prepared to go even farther in its prognostications. They stated unequivocally that the price impacts to the average U.S. consumer and manufacturing industries will be lessened by the huge resource potential of shales:
“Buffering the price impact of LNG exports is the large domestic resource base, particularly shale gas, which we project to be an increasingly important component of domestic supply… the Reference Case projects shale gas production, particularly in the Marcellus Shale…and the Haynesville Shale…to grow and eventually become the largest component of domestic gas supply. Increasing U.S. shale gas output bolsters total domestic gas production, which grows from about 64 Bcfd in 2011 to almost 80 Bcfd in 2018 before tapering off.”
This was an exceedingly optimistic assumption. Firstly, Deloitte mentions resource numbers to buffer impacts rather than reserve numbers. Resources and reserves are apples and oranges. But perhaps more troubling is the fact that Deloitte’s information has now been seriously called into question by the recent USGS report of all shale plays in the U.S. Based on actual production data, the USGS reserve estimates confirm that operators have significantly overestimated reserves by a minimum of at least 100% and at times as much as 400-500%. In other words the wells are not producing as well as operators claimed. Moreover, the Haynesville wells are already showing considerable declines.
“The projected growth in production from a large domestic resource base is a crucially important point. Many upstream gas industry observers today believe that there is a very large quantity of gas available to be produced in the shale regions of North America at a more or less constant price. This would imply that they also believe that natural gas supply is highly “elastic,” i.e., the supply curve is very flat.”
Shale gas supply is hardly “elastic”. It will take considerable additional drilling at a cost estimated at approximately $42 billion per annum just to maintain a flat production plateau in shales. And these costs will rise each year as the sweet spots are drilled out and lesser quality acreage is then pursued.
In short, shale exportation from the U.S. would be very beneficial indeed…to natural gas companies. Further, in the current price scenario, if exports could be effected today, the industry could extract, pipe, refine and ship to Asia for about $9/mcf and get paid $18/mcf. That is a very lucrative spread. Particularly for an industry which has drilled itself into a significant oversupply and is bleeding money all over their respective balance sheets.
“U.S. natural gas prices increase when the U.S. exports LNG.”
But they assure us that:
“…the global market limits how high U.S. natural gas prices can rise under pressure of LNG exports because importers will not purchase U.S. exports if U.S. wellhead price rises above the cost of competing supplies.”
We should examine that statement as well.
Less than one week ago, President Fernandez of Argentina announced incentives that would increase well head prices considerably in Argentina.
According to Business Recorder:
“Fernandez, who is keen to lure private investment to bring hefty shale energy resources on stream, said wellhead prices would rise to $7.50 per million British Thermal Units (BTU)…’We’ve decided to give incentives for gas production,’ Fernandez said, adding that the new price would be available for all energy companies that invest to develop new fields in the South American nation.”
The well head price in the U.S. currently is less than $4/mcf so there is considerable room for growth not just in the well head price but also for inflation. U.S. consumers will inevitably face higher costs for electricity and goods as international pricing pressures come to bear on the U.S. domestic natural gas price.
But hey, take heart. You can always purchase those shares of oil and gas companies to hopefully offset some of your losses.
And make sure you send a thank you note to the Department of Energy for not only providing such a great stock tip but also clearing the way for exorbitant profits for the oil and gas industry at the expense of chemical and plastic manufacturing jobs and investment in plant and equipment in the U.S. all based on numbers compliments of EIA.
I gotta ask! Just who is the designated driver at this party?