Revolution Sweeps Natural Gas Industry

“Amara’s Law”, named for the scientist and futurist Roy Amara states, “We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.” This is a good concept and at Contra the Heard we try it keep in mind when evaluating the tide of change emanating from the natural gas industry.

When the shale gas story broke a few years ago it was greeted with a tremendous burst of enthusiasm. It led to a rush to exploit the resource in areas such as the Bakken field in North Dakota. So intense is the rig activity there that this once lonely and dark area of the U.S. Midwest is now lit up like a Christmas tree, visible from orbit.

The mania quickly got hosed down as the production boom led to a crash in the price of natural gas. Banks that were eager to fund burgeoning development programs suddenly saw their business models burn up like a gas flare. Many wells showed an unusually rapid rate of depletion. A public backlash developed regarding the potential environmental effects of hydraulic fracturing: the fouling of aquifers, methane leaks and earthquakes. The newly coined term “fracking”, joined the lexicon as a dirty word.

All of this controversy is obscuring the fact that the fossil fuel equation on this planet has fundamentally changed. The amount of unconventional gas in these types of formations is staggering. According to the International Energy Agency there is now sufficient recoverable resource to sustain current levels of supply for 250 years. Industry sources consider the IEA estimate far too low, they see the resource at least ten times larger.

Even the adjective “unconventional” is being rendered meaningless. If you produce the majority of a product using so-called unconventional means rather than conventional, hasn’t the unconventional become conventional? That is happening right now in the U.S. where the former makes up over 60 percent of total gas produced.

For investors, trying to participate in this revolution is like trying to grab the tiger by the tail. Junior producers have been pummelled as they throw assets overboard to reduce debt. Majors like Encana (ECA-NYSE) and Chesapeake Energy (CHK-NYSE) have done somewhat better, ramping up production of liquid rich fields, but the stock price is mired at lows not seen in a decade. Pipelines like TransCanada (TRP- NYSE) are somewhat insulated as they enjoy regulated rates of return on portions of their business, but nonetheless guidance was sharply revised down this month. Utilities like Trans-Alta (TA-TSX) have been whacked as they are stuck with long running coal contracts while competitors burn cheap gas.

The alternative energy sector has been turned upside down. Billionaire T. Boone Pickens was once a champion of wind energy, but he has thrown in the towel, switching his allegiance to gas. Leading turbine manufacturer Vesta (VWDRY-OTC) was trading in the mid-$20 range in 2009, now its going for about $1.75 a share. Solar has also been eclipsed, Chinese panel producers JA Solar (JASIO-Nasdaq) and Suntech Power (STP-NYSE) are trading at pennies on the dollar of their former valuations.

At this point, the winners’ circle is small. Golar (GMLP-NASDAQ) is a standout in a moribund shipping sector because their LNG carriers are highly coveted. Westport Innovations’ (TPRT-NASDAQ) stock price has been strong due to interest in their CNG engines, but growing revenues haven’t translated to profitability as the company lost $17.9-million last year.

Good or bad, short-term share prices are a poor indicator of what will happen long term. That’s because the sudden increase in the availability of gas is a highly disruptive force that the market has been unable to absorb. The time lag to build new ships, LNG terminals, pipelines and power plants is long. It will be difficult to convince consumers that CNG is cheaper and has higher octane than super premium gasoline. Government has a critical role to play, as the energy sector is already highly regulated. Leadership is needed to drive efficiency and jump over the “chicken and egg” hurdles.

The long-term impact of the natural gas revolution is comprehensive and far reaching. As the primary component of nitrogen fertilizer, natural gas will help to feed billions of hungry mouths. As an alternative to coal and oil, it will reduce CO2 emissions and increase air quality. As oil from the Middle East becomes relatively less important, the fabric of global politics will be altered. And as Amara’s law suggests, even these lofty predictions are apt to be superseded by repercussions that cannot yet be imagined.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Newsletter. Contra has a 10-year annualized return of 15.3 per cent.