By The Peak Energy Strategist Research Team

Natural gas.

It’s in the news a lot these days in some way, shape, or form, especially with oil prices climbing so high and politicians so focused on alternate energy sources. But just because natural gas has been a hot topic in the last few years, doesn’t mean that the general public really understands its significance in their daily lives or in the larger economy.

While they can probably point out that natural gas is vital to the modern era, most people don’t really know what it actually is.

The name “natural gas” might make the substance sound easily explainable, and it certainly makes it seem like a much safer form of energy. But the truth is that oil is just as “natural” a substance, despite the bad name it’s been getting over the last few decades. Both fuel sources result from regular earth cycles and processes that change solids into other kinds of matter.

Oil (or mineral or crude oil, as it’s more technically known) is made when plant and animal matter break down under extreme temperatures and pressure over a long period of time. This usually happens in deposits of solid rock or under ocean floors.

Similarly, natural gas is formed under intense pressure under the earth’s crust. In fact, oil’s prerequisite material – plant and animal matter – are exactly what natural gas requires. The need for similar factors is a large part of the reason why oil and natural gas are found together so often.

Yet despite their similarities, one is considered much more desirable than the other for a variety of reasons, including current supply estimates and the emission levels each produce when burned as fuel.

Accuval, which specializes in corporate valuation and advisory services, explains the material further on its website:

“Natural gas consists primarily of methane and is considered the cleanest of all the fossil fuels. Natural gas is used for heating, electricity generation, resins, chemicals and fertilizers. It can be found isolated in natural gas fields, mixed into coal beds and oil fields, and trapped in dense rocks. According to the Statistical Review of World Energy, in 2009, natural gas accounted for 24% of energy consumption worldwide and 27% of energy consumption in the U.S.”

With that kind of importance, it would make sense if natural gas was consistently priced about a third to a half of what oil costs. But a look at historical prices shows a very different reality.

Two decades ago, natural gas was bouncing around between $1.50 and $3 (per 10,000 million British thermal units or MMBtu). And it stayed that way until around 1997, when it spiked above $4. Yet it shot right back down again, largely settling into a $2-to-$2.50 range until the new millennium, when it began experiencing drastic periodic volatility.

Blasting past the precedent set over the last decade or so, natural gas hit a new high at around $10 between the end of 2000 and the beginning of 2001, and then still another one – this time well past $15 – in 2006. But both highs were almost immediately followed by sharp dips that balanced the market out.

Between 1990 and 2012, natural gas futures prices averaged just $4.00.

And while it had a final spike upward in 2008, the recession essentially killed the commodity’s chances of making anybody any money off of it for the foreseeable future, setting a downward trend that it hasn’t really been able to break out of for a while now.

While most commodities quickly recovered after the 2008-2009 bear market, natural gas has most definitely not. And it makes sense if you know all of the details…

Readily Available and Easily Obtained Commodities Don’t Make a Good Seller’s Market

There are a number of ways to extract natural gas from its rocky prisons. A few popular methods in the past (and, to some degree, still today) include:

  • Percussion Drilling: An oldie but a goodie, percussion drilling is largely only used in shallow wells these days, though it was a predominant technique for deeper sites in past eras. After drilling, teams drop a heavy metal bit into the well until it literally hits pay dirt.
  • Rotary Drilling: A newer advancement as compared to percussion drilling, the rotary method is able to cover a wider area in a single effort. NaturalGas.org explains how it “uses a sharp, rotating drill bit to dig down through the Earth’s crust. Much like a common hand held drill, the spinning of the drill bit allows for penetration of even the hardest rock.”
  • Rigs and Platforms: In a growing global population with expanding needs, energy companies are prepared to go wherever they can to get the raw sources they need. This includes into shallow waters (defined as less than 500 feet) and beyond. Depending on the depth (as well as a few other factors), natural gas and oil explorers utilize barges, jack-up rigs and platforms that actually lie on the ocean floor to get at the natural gas embedded below.

But those are all expensive methods that required a lot of time and specialized equipment. This made natural gas a difficult commodity to extract in many ways, that was until hydraulic fracturing, or fracking, was invented.

The new technique changed the game significantly enough to suddenly make natural gas relatively easy to acquire… and therefore exceedingly cheap.

Accuval explains the ins and outs of fracking, and its implications on supply and demand:

Advances in shale natural gas extraction boosting production

 Recent advances in horizontal drilling have unlocked large reserves of natural gas trapped in shale basins. Using high pressure water to splinter the rock, miners drill horizontally — deep under the earth — increasing its permeability and releasing natural gas to the surface. The shale lies 10,000 feet under the ground where temperatures reach over 300-degrees Farenheit, making the extraction of the gas costly and dangerous, but new technology has made getting to the gas feasible.

The estimates are staggering as to the amount of gas that domestic shale basins contain: According to a recent article published by The Wall Street Journal, Shale Gas Will Rock the World, some researchers believe that approximately 1,000 to 2,000 trillion cubic feet of natural gas can be extracted. This would be enough to meet domestic natural gas needs for the next 45 years. Europe is also believed to have nearly 200 trillion cubic feet of shale gas within its borders, according to the European interdisciplinary shale gas research initiative.

Number of natural gas rigs increasing; production may be dampened by tropical storm forecast

 Natural gas production is expected to increase, as reported by the EIA. The number of natural gas rigs has already increased from 759 to 941 during the first quarter of 2010 and are expected to continue to increase to more than 970 by mid-year. Production would be much higher overall were it not for the increased tropical storm forecast from June to November. In 2009, an estimated 19 billion-cubic-feet of production was stopped due to tropical storms; this year, 166 billion-cubic-feet is expected to be shut down.

Industry mergers and acquisitions on the rise

 Corporate activity has confirmed the momentous opportunity that natural gas represents. Within the past two years, many of the major energy companies, some of the largest private equity firms and powerful sovereign wealth funds have invested in natural gas. In late 2009, Exxon-Mobile announced a $41 billion dollar buyout of XTO; on May 28, 2010, Shell acquired East Resources; and private equity firm KKR recently announced a $400 million joint venture with Hilcorp Energy to develop in South Texas. India’s largest private oil company Reliance Industries has already invested $1.7 billion in Atlas Energy and is believed to be in discussions with Pioneer Natural Resources for additional developments in Texas.

DEMAND

Consumer consumption of natural gas continues to decrease

According to the EIA, residential consumers account for approximately 21% of consumption of natural gas. The amount of natural gas consumed residentially has been declining steadily for the past 16 years. This decline is attributed to several factors, including energy efficiency improvements in home construction and appliances. Homes constructed between 1990 and 2005 consume approximately 25% less natural gas than homes built prior to 1990. EnergyStar® qualified homes are considered to be 15% more efficient and in 2008, about 110,00 were built and preliminary data for 2009 indicates that the number of EnergyStar® qualified homes built exceeds that of 2008.

Demand for electricity generation increasing

Natural gas is also used to generate electric power. Natural gas is advantageous because the power plants are flexible enough to be economical on both a small and large scale and can easily be turned on and off during peak usage times. Natural gas for electric power generation has grown 3.8% annually for the past 10 years and accounts for approximately 31% of the natural gas used. There is some debate over whether or not it is financially feasible to continue burning natural gas to generate electricity since the efficiency rate varies from plant to plant, usually between 30% and 60%. To put this in perspective, home appliances achieve an efficiency rate range of 80% to 96%.

Exports down

 The U.S. exported $2.8 billion dollars worth of natural gas in 2009, a drop of 35.6% compared to 2008. Liquefied natural gas accounted for $291.5 million, or about 10%, of 2009 U.S. exports. Japan is by far the largest importer of U.S. natural gas, buying 88% of exports. They were followed by Canada and South Korea who imported 5.9% and 5.3%, respectively. According to Mikhail Malgin, head of Gazprom Export Department for Northwestern Markets, export deliveries in the first four months of 2010 were considerably higher than the same period last year. However, Gazprom did lower its 2010 gas export forecast from 161 billion cubic meters to 145 billion cubic meters.

Politics At Play

Since nothing much has changed since then, it seems a likely bet that the situation is hopelessly stagnant for the foreseeable future. And that might very well prove true in the end.

But there’s one final twist to the story that might change the game significantly before the year is out.

Just last month, the American Petroleum Institute completed an extensive study, which included an analysis of current and future EPA mandates and their effects on the energy sector. One particular ruling designed to reduce emissions from drilling sites could especially hit the natural gas industry.

The Washington Times reported: The natural gas extraction technique known as “fracking” would be hardest hit, and fuel extracted via the popular process would drop by about 52%… Total gas production would decrease by about 11%, while domestic oil production could fall by as much a 37%, the report says.

Those are the kind of reductions that could easily affect industry pricing. In fact, if those EPA restrictions are implemented like they’re apparently supposed to be and natural gas businesses do have to shut down large portions of their operations, it’ll take an utter miracle for the commodity not to go through the roof.

Then again, in an election year, anything can go, including these upcoming regulations. President Obama won’t want high energy prices to cost him his reelection bid, which means that he might delay or even cancel the EPA actions altogether.

The bottom line is this: Natural gas prices will very likely stay stagnant for months to come. And more than likely, that isn’t going to change any time soon.