Sitter Drilling

ARTICLE 07/14/08
Natural Gas Special Report: "What's feeding the bull?"

There are new factors in play that support T. Boone Pickens recent assertions that the traditional 6:1 price ratio between oil and gas will be restored, driving natural gas prices beyond $20/mcf based on $120/bbl oil.

Pickens said recently that the historic 6:1 price ratio of oil to gas would have to be reestablished within the next year or so. The rationale is based on the fact that one unit (barrel) of oil produces as much energy as 6 units (mcf) of natural gas. Thus the 4% or so of companies able to switch fuels will do so if there is sufficient economic advantage. Except for the period immediately after hurricanes Katrina and Rita, oil prices have been consistently more than 6 times the price of gas and lately more than 12 times the price of gas, depending on what grade and price of oil you compare against. Even against recent increases, natural gas is cheap relative to oil. By now, most industrial users who can switch to gas have done so, yet demand is flat... but the Bull is ready to feed!

Enter the Gas Bull: Government subsidies. The Energy Bill just signed into law by President Bush includes massive federal subsidies for expanding biofuels production. Natural gas is the second highest expense in the manufacture of biofuels, second only to the cost of feedstock itself, and the number one expense when feedstock is not corn or sugar. The new energy law calls for 2.3 million bbls/oil per day from renewable fuels by 2022. That's about 23% of US gasoline consumption even after adjusting for energy conservation, a huge amount by any measure. It will likely require most if not all of the US corn production to achieve certainty in the short term, pending technological breaththroughs in other biofuels.

Should one wonder why the president and the congress, and the last congress are so enamored with biofuels perhaps the appropriate explanation is good old fashioned vote buying in the cornbelt states. In fact the Republicans and Democrats are playing a brisk game of one-upmanship to see who can spend the most taxpayer money and pass the most pro-biofuel legislation. These new laws and approved spending plans will not likely go away anytime soon.

Although bad news for the majority, this is terrific for the natural gas investor, for exploration, drilling, employment in the energy sector and for producers. Now consider this:

The Congressional Research Service issued a report last December, titled "Selected Issues Related to an Expansion of the Renewable Fuels Standard (RFS)". Using that data, if only one half of the RFS mandate was met by using ethanol,-and it will almost certainly be more than that - natural gas consumption would increase 0.9 trillion CF per year. This is equivalent of 4.49% of the entire US supply for 2006. No one really knows where we will go to get the gas. Expensive LNG imports could be a stop gap but we will compete with China, India and the rest of the world for that gas. Expect much higher natural gas prices, higher electricity and higher food prices.

As I finish writing this, I am listening to candidate Obama pledge to not expand drilling and exploration in the US and to provide $15 billion dollars for renewable fuel research. This seems like the equivalent of pressing hard on the brakes while pushing the gas pedal to the floor. You might want to develop a strong position in natural gas, while you watch your food and energy prices skyrocket. Oh, and welcome the Gas Bull!