Shale Gas: The Demand Side of the Equation
Natural gas has traditionally served the needs of three major types of customers: manufacturers, power generators, and residents using gas for heating and cooking. The transportation industry now considers expanding the use of natural gas to power automotive vehicles; this creates another avenue for natural gas application.
Among all uses, those for residential customers’ are most predictable. Heating needs are affected largely by seasonal changes in weather (good weather forecasts make it easy to adjust gas supply) and less to the state of economy; hence, the impact of heating on demand for natural gas can be foreseen with more certainty, especially in the long term. Meanwhile, increased use of natural gas by the power industry and manufacturers is driven primarily by economics: the price of gas. The price is not the only factor affecting decisions on expanding its use: power utilities have to consider environmental regulations and other power resources in their generation portfolio, and manufacturers ponder over sustainability of expanding production capacity.
Manufacturers rely heavily on fossil fuels to be used as fuel or feedstock. Currently, low natural gas prices are good news for steelmakers, producers of chemicals, plastics, and fertilizers. In most processes, natural gas can be used interchangeably with oil or coal. When plants can switch between these fuels, at a time of low prices, natural gas becomes a fuel of choice displacing other fossils.
Steelmakers use gas as fuel primarily to fire blast and non-blast furnaces. Switching from coal to natural gas can result in production cost saving of 1-2%. Steel plants have already started replacing coal with natural gas to keep furnaces running. As the last several years have marked a rather dark time for steelmakers, such a turn of events is creating a good incentive, not only to use natural gas as a fuel to improve current financial statements, but also to expand production capacities for longer term benefits.
Natural gas is used as a base feedstock by the chemical industry: more than 80% of chemicals are derived from it. Some fertilizers, such as ammonia-based products, attribute 90% of production cost to natural gas. As a feedstock, natural gas can be switched with crude oil. Users are indifferent to the source of these two fuels when crude is at parity with the price of natural gas in heating equivalent, which happens when the ratio between two prices is maintained at around 7:1. With oil prices floating around $100/Bbl and natural gas not even reaching $4/MMBtu over an extended period of time, no deep financial analysis is needed to see that such a price relation makes natural gas an undisputed favourite.
Increasing profits make manufacturers rise above the simple joy derived from healthy financial statements; nowadays, consideration is being given to expanding production capacities. Lower natural gas prices have been motivating manufacturers to reconsider what became a tendency of closing operations or moving to countries with lower production and labour costs.
Only several years ago, factories, especially in the chemical and fertilizer sectors, joined an exodus to Latin America and South Asia. About 40% of fertilizer production capacity in the U.S. closed down in the first decade of 2000. Now, it seems like we might find ourselves on the brink of a reverse migration as some investors have started demonstrating interest in building more domestic industrial capacity.
- An ammonia facility of 366,000 tons/year of LSB Industries reopened in Pryor, Oklahoma, in 2009. Two more units with projected capacity of 60,000 tons/year at Pryor are under regulatory review.
- Orascom Construction reopened a 250,000 tons/year ammonia plant in Beaumont, Texas.
- A 525,000 tons/year plant in Geismar, Louisiana, by PCS Corporation, is being considered for restarting. The corporation is also reviewing expansion of plants in Lima, Ohio, and Augusta, Georgia.
- CF Industries has revived parts of its Donaldsonville, Louisiana, complex capable of producing more than three million tons/year of ammonia. The company also announced investing up to $60 million to complete an expansion of this facility and $1.5 billion over the next four years to grow its projects in ammonia and other products.
- Methanex Corp. announced plans to move its methanol plant from Chile to Louisiana.
- Santana Textiles LLC decided to build a denim plant in Texas instead of its originally planned destination, Mexico.
Encouraged by government support of shale gas expansion, manufacturers are looking forward to sustained growth in their profit margins. Meanwhile, not everybody in the manufacturing community is on the same playing field. Many remain doubtful that the current trend of low natural gas prices is sustainable. Manufacturers are facing a dilemma: should they capitalize on the current natural gas oversupply and revitalize the abandoned plants in the U.S. (and in many cases move plants back home from international locations), or should they remain on the cautious side and retain what has been very stable, at least from the perspective of costs. Their decision will be based on expectations of whether current low gas prices will be sustained over an extended period of time, and what factors might tilt the current shortage of domestic demand and push prices up.
Disagreement among industrials comes as no surprise — the same events often evoke dissimilar views by different parties leading to a variety or conclusions and courses of action. Thus, some believe that a pending increase in gas exports will lead to growth in the domestic price as a result of equalization with prices in foreign markets (discussed in more details in the July 2012 In-Depth article). Such an increase will diminish benefits for U.S. manufacturers. Those who are certain of this course of events call for government to set restrictions on natural gas exports. Others believe that government interference in the open market can be detrimental, not only from the perspective of creating a case of government meddling with free market forces, but also because reduction in overseas LNG deliveries will affect financial statements and make gas producers unhappy, which will lead to potential cuts in gas production and consequently domestic price increases.
The current state of the market is very favourable to those with gas as a major cost affecting their income statements; however, for longer term investments, especially those involving billions of dollars, the quality of natural gas price projections is of paramount importance. Multiple uncertainties make it very difficult to arrive at a definite conclusion. A lack of clarity creates a looped logic; investment decisions are based on expectations about future natural gas prices, which in their turn are affected by demand being a direct derivative of these decisions.
To learn more about the impact on power generation and the automotive industry, click here to continue to our in-depth study.