In Focus: Fracking’s Unintended Consequences
Beware of what you wish for: you may get it.
The fundamental truth at the heart of that old adage is probably causing some misery within swathes of the energy industry, as large and steady gains in natural gas output and the rate at which exploration and development companies exploit newly discovered reserves, have caused natural gas prices to plunge. The reason: shale gas discoveries, which these companies have been able to extract using next-generation technology known as hydraulic fracturing or fracking: injecting a combination of water, sand and chemicals at high pressure into the well to force the gas out of the oddly-shaped pockets trapped in rock formations.
Fracking may arouse the wrath of environmentalists and others, who argue that the chemicals used can contaminate groundwater and soil in the neighborhood of the well. But the newest fracking innovations have enabled companies like NRG Energy (NRG.N) and Chesapeake Energy (CHK.N) to extract natural gas that simply wouldn’t have been accessible even a few years ago, with results that can be seen in the chart below. The fundamental economic laws of supply and demand kicked in as a result, and as supply shot up higher, prices fell. The nature of the commodity and the structure of the natural gas pipeline and storage network across North America has exacerbated the situation: a shortage of capacity to liquefy the gas and transport it to ports where it can be loaded onto ships and transported to other markets has had a similar impact.
Nonetheless, natural gas prices, at the time of writing, are surging, up almost 3% today to the highest levels they have seen in almost two months, capping a stealth rally that has taken the commodity’s price up by about a third in the last 30 days. Share prices of companies like Southwestern Energy (SWN.N), Cabot Oil & Gas (COG.N), Occidental Petroleum (OXY.N) and even the beleaguered Chesapeake (grappling with a corporate governance scandal) are bouncing off their lows. When NRG’s CEO, David Crane, discussed the company’s first quarter results (it posted a much larger loss than analysts had expected, of 92 cents a share rather than the forecast of 13 cents a share), he told listeners on the company’s conference call that he sees “an inflection point in the commodity price down cycles that have gripped the wholesale portion of our business since the great recession.”
Could he be right? Certainly, the Ira Sohn investment conference in New York earlier this week did reveal some natural gas bulls among the hedge fund managers and others who took to the stage to pitch their best ideas to the audience to raise funds for charity. Jeffrey Gundlach, founder of DoubleLine Capital LLC, reiterated his contrarian views on natural gas. Gundlach told attendees that he’s sticking to a long position he first discussed last month, when he described buying natural gas today (via futures or shares of production companies) as akin to purchasing gold back at its cyclical lows of the late 1990s.
Gundlach’s comments certainly improved market psychology, while moves by some big producers to shut in some gas reserves rather than keep boosting output to try to offset the price declines (a frantic race that most have found themselves losing). Still, for the bounce to be sustainable, several things need to happen. First of all, storage capacity at hubs needs to increase, so that tight capacity doesn’t contribute to the price declines. Demand needs to increase – whether it’s from natural gas vehicles, the conversion of coal-fired generation facilities to gas, or as a result of an increase in the ability to export LNG. None of that is likely to happen overnight, meaning that at the very least, natural gas prices will remain volatile.
Meanwhile, fracking has had another unintended consequence. Over in the food industry, the cost of purchasing guar gum – yes, guar gum – has soared, as seen in the chart below. Derived from a plant grown mostly in the Indian subcontinent, guar is used as a thickener in foodstuffs, such as ice-cream. The fact that it’s also used in a gel that is an additive to the fracking process appears to have created a guar gum bubble. In turn, that has the food industry almost panicking and complaining that energy companies keep outbidding them for supplies of the scarce and esoteric product.
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