How Will The Rising Natural Gas Output Impact The Ongoing Commodity Slump?

With the increased popularity and use of cleaner and environment-friendly sources of energy, natural gas has emerged as a safe and economical alternative for industrial use as well as for non-commercial activities. As a result, the demand for natural gas has seen a steady growth of more than 3% annually over the last decade. Given the continued focus on climate change, this trend is expected to continue in the future. According to the International Energy Agency (IEA), the global gas demand is likely to grow by 1.6% annually for the next five years. Of this, the US is expected to produce 890 billion cubic meters (bcm) of gas by 2022, accounting for more than one-fifth of the global gas output. Since the country is both the largest consumer as well as producer of gas, it is likely to contribute about 40% of the world’s extra gas production by 2022, backed by the remarkable growth in its domestic shale industry. This surge in the US gas production will be largely driven by the Marcellus basin, which is one of the world’s largest gas fields due to the high quality of reserves in the region.

Although the US natural gas production had dropped notably in the last couple of years due to the commodity slump, the recent rebound in crude oil prices due to production cuts implemented by the Organization of Petroleum Exporting Countries (OPEC) has led to a sharp jump in the country’s gas output. While this sudden spike in the gas production will allow the US to meet the rising demand for gas in the coming years, it is likely to be become a cause of serious concern for the oil prices in the coming months. This is because the pipelines, storage facilities, and export terminals used to transport natural gas to the Gulf Coast are all currently operating at full capacity. In addition, the Canadian producers are already over-supplying the northern and western markets, competing with the US producers for logistics as well as market share.

The only resort that these US producers have are the pipelines that transport gas to Mexico, which has emerged as a major market for US gas. There are currently about 20 gas pipelines, 4 of which are under construction, that transport gas from the US to Mexico. While these pipelines could have helped in easing the growing gas glut in the US, unfortunately the gas distribution infrastructure and power plants in Mexico, that are likely to absorb the excess gas from the US, have not been completely built yet. So, while the over-supplied gas markets are using up all the existing pipelines and storage capacities, the newly drilled wells continue to generate more gas as a byproduct of crude oil drilling.

As new pipelines and storage facilities come online around 2019, this gush of gas supply may be absorbed by the rising demand in the long term. However, in the short term, the oversupplied gas markets due to restricted channels to transport and store gas, could pull down the benchmark natural gas prices further in the coming weeks. Also, if the oversupply situation persists for long, it might become difficult for US oil and gas producers to continue with their aggressive plans to ramp up their oil production. As a remedy, these producers may be forced to take drastic measures, such as capping wells and/or curtailing oil drilling, until new pipelines to the Gulf Coast are built and planned power plants come online in Mexico. Consequently, the US producers are likely to face another setback, as lower oil production, coupled with lower gas prices could severely hamper their upstream operations.

While a drop in US oil supply could lead to a jump in global crude oil prices, it could also work counter-intuitively, as lower gas prices may divert industrial oil demand towards gas, pulling down the oil prices in the short term. Thus, we will be closely watching the dynamics of the natural gas markets to access their impact on the US oil and gas companies and their valuation.

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