Shale gas production is projected to increase to the point where it becomes the dominant domestic gas supply over the next two decades, but it brings with it the "greatest source of uncertainty" facing North American gas markets, according to the Deloitte Center for Energy Solutions.
In a new report, Deloitte researchers found that shale gas production requires a "heavy investment" that has to be supported by sufficiently high prices. Also, significant cost differences exist across shale gas fields, and prices typically reflect the costs of the marginal fields. "Navigating a Fractured Future: Insights into the future of the North American Natural Gas Market," used the consultant's world gas model, which analyzed global gas markets over the next 20 years.
"Some see shale gas, with existing advanced technologies, as now being cheaper to produce than conventional supplies," said the authors. "In contrast, others suspect the claims made by some shale producers and analysts are wildly optimistic."
To reach a consensus, the Deloitte team created a reference case that portrayed shale gas as a diverse resource with overall costs ranging from under $5/MMBtu to more than $8. Because some speculate that continued technology advancements will allow shale gas to be available for under $5/MMBtu well into the future, the researchers tested "lower shale costs" scenario in which the costs required to find and produce the shale gas are reduced by almost 50%.
"The resulting projections are quite informative and even surprising," the authors said.
Prices at the Henry Hub are projected to fall by almost $2/MMBtu from 2016 to 2030, they said. "The impact is more acutely felt in New York where prices fall by almost $3/MMBtu during this period. The Mid-Atlantic market, including New York, is projected to become heavily dependent on shale gas production, especially from the Marcellus, and therefore benefits more from lower shale gas production costs."
These findings raised a question of why the impacts would not be more. "If we have a massive reduction in the cost of a major supply, shouldn't there be a massive reduction in price, assuming all else is equal?" the researchers asked. "The answer is that all else is not equal. Markets react to change. If the cost of a marginal supply drops dramatically, then it no longer is the marginal source and something else moves to the margin and sets the price."
The price impact they found, would be determined by the difference between the marginal costs rather than the price decrease of the once marginal supply.
The researchers also questioned how lower production costs might affect shale production. Shale gas production would surge as expected, "but non-shale gas production decreases as it increasingly becomes the marginal source that sets the price." Over the long-term, the "other shales," which include plays in the Rockies and in the Midwest, would be most affected by the cost reduction because these areas were projected to be the marginal shale gas resources.
The increase in the volumes of shale gas production would be more than the reduction in non-shale gas production, which would imply a net increase in U.S. output, the report said.
"In fact, under this scenario, the projected net increase in U.S. production reaches about 20 Bcf/d by 2025. About half of the net increase in production goes to serve a projected increase in gas consumption for power generation. Lower natural gas price would be a huge boon to gas-fired electricity generation and leads to more gas burned in the electricity sector. Under this scenario, gas demand for power generation doubles from current levels by 2030, compared to a little less than 50% increase in the reference case."
The lower domestic gas prices also would drive out U.S. imports of liquefied natural gas (LNG) as well, they said. "With huge, low cost shale gas maintaining downward pressure on domestic prices, LNG supplies find other higher priced markets and LNG imports to the U.S. fail to significantly ramp up despite the projected increase in world LNG supplies."
Production costs would play a critical role in determining the value of individual natural gas resources, according to the Deloitte report. The models found that domestic gas prices would rise beyond current market expectations to about 50% between 2011 and 2020, or about 4% a year to surpass $8/MMBtu.
Deloitte's modeling scenarios also determined that North American basis differentials would diverge from historical relationships as new supply basins grow in prominence. Prices in different regions would grow different rates, altering pipeline flows and capacity values, with the biggest change taking place in the East, "where increased production from the Marcellus Shale is expected to displace supplies from the Gulf and other regions -- a displacement that is projected to reverse some regional pipeline flows."
The Marcellus Shale already is wreaking havoc with traditional basis on some pipelines, including El Paso Corp.'s Tennessee Gas Pipeline, according to a recent study by(see Shale Daily, Sept. 7).
Deloitte's projections of Henry Hub prices rise above current levels under all of its modeling scenarios. "In an absolute sense, relative to the reference scenario, the price impact of the lower shale gas cost scenario is much greater than the impact of the higher gas demand scenario."