Executive Agenda

With Fortunes to Be Made

or Lost, Will Natural Gas
Find Its Footing?
The U.S. shale gas market is out of balance with
production outstripping demand. But when the glut
ends, how will the market shake out? All signs point
to a rebalance by 2020, when the free market kicks in.

With Fortunes to Be Made or Lost, Will Natural Gas Find Its Footing?

Executive Agenda

Despite all the talk about shale gas developmentthe potential environmental consequences of
hydraulic fracturing, the potential to replace coal with gas for generating electricity, the potential
for the United States to export liquefied natural gas (LNG)none of it addresses the bigger
picture: The market is structurally out of balance, and it cant stay this way. The technological
triumph of shale gas has led to production that far outstrips demand, and if this were a normal
market, price and demand shifts would have already delivered a quick rebalancing.
But shale gas is not a normal market and a rebalancing is not likely in this complex ecosystem
where a wide array of players have diverging incentives and investment horizons. Over the past 20
years, gas prices have fluctuated between $2 and $15 per million BTU. At the low end, the producers are not viable, and at the high end, potential users of gas cannot afford to use it. Will we face
more years of such fluctuations before achieving balance, especially since numerous decisions
affecting that balance are still up in the air? And yet, bets must be placed now. Infrastructure must
be built. With fortunes to be made or lost, these decisions must be as informed as possible.

A Quest for Balance

The hydrocarbon business is all about balance. Balance among production, refining and
converting, and marketing has been a vaunted but elusive goal for more than a century, as
Daniel Yergin chronicles in The Prize, a Pulitzer Prize-winning history of the global oil industry.
An investment in one industry sector (for example, upstream exploration and production) may
be useless unless paired with appropriate investments in other sectors (such as downstream
selling and marketing). In the oil industry, factors encouraging balance include vertical
integrationglobal companies that control everything from exploration to deliveryand
regulation of production, either overtly through organizations such as OPEC or more naturally
through high barriers to entry. In the gas industry, those factors are lacking.
So the relevant questions are not so much Is the shale gas boom real? Or Is it here to stay?
(The short answer is yes.) The question companies should be asking is How will the natural
gas glut rebalance in the long term? As an analogy, consider the U.S. deregulation of natural
gas wellhead prices in 1989. Was it real? Was it here to stay? Yes, but after a brief period of
sustained low prices in the 1990s, the industry has been plagued with volatility. Prices have
bounced up and down, sometimes benefitting producers, sometimes end users. The problem
has been balance. When prices were low, up went the infrastructure of gas-fired power plants
and pipelines. After the investments were locked in, all that demand sent gas prices so high
that much of it could not be used.
Will the same thing happen again? We cant say for sure because the factors are different and
some of them are yet to be determined. But we can say this: The industry is still not structured to
achieve win-win scenarios. It is not integrated, which means that big trends in one area can go
almost unnoticed in another. Understanding whats going to happen requires first understanding
who all the players are.

An Uncoordinated Set of Actors

The U.S. shale gas ecosystem comprises a set of players with different incentives and investment
horizons that have grown up mostly independent of each other and are generally not inclined to
understand the motivations of the other players. The shale gas family includes a variety of actors:
With Fortunes to Be Made or Lost, Will Natural Gas Find Its Footing?

Executive Agenda

Independent producers focus on short-term plays and have an investment time horizon
of just a few years. They are not afraid to take risks, have few barriers to entry, and can bring
on capacity quickly and inexpensively. But if gas prices stay below $4 per million BTU, many
players with predominantly dry gas portfolios will continue to struggle and possibly go out
of business.
Super majors and global producers take a longer view on their investments and can afford to
delay investment in certain parts of the world if local conditions are not favorable.
Midstream players have a longer view on investments, but they take advantage of geographic
and capacity-based market differentials to invest in pipelines, gas processing, and fractionation.
Gas exporters are eyeing liquefaction facilities on the coasts that could competitively export
LNG and take advantage of high prices abroad if the price spread between the United States
and overseas markets stays above $5. Although 4.5 trillion cubic feet of capacity has been
proposed, these facilities could cost up to $10 billion per trillion cubic foot and take a minimum
of five years to permit and build.
Chemical companies are looking at natural gas liquids (NGL) as feedstock. Low-cost ethane
(as a substitute for byproducts of crude oil refining), for example, makes polyethylene cheaper
to produce in the United States than anywhere in the world except the Middle East. So the
industry could build eight to 10 (or more) new gas crackers at approximately $2 billion apiece,
including some downstream investments, but it would need confidence in ethane prices
being competitive for 10 or more years.

Instead of asking Is the shale gas boom

here to stay?, we should be asking How
will the natural gas glut rebalance in
the long term?
Power generators want low-cost gas to generate electricity. Before the shale boom, existing
gas plants were operating at less than 50 percent of capacity. However, they can ramp up
quickly and squeeze out other forms of power generation, primarily coal. If power generators
knew gas prices would stay below $6, they could begin replacing existing coal plants with gas
plants that take just two to three years to build.
The advocates of new usessuch as T. Boone Pickens, Chesapeake, and GEwill look at
compressed natural gas (CNG) to fuel cars and trucks if gas prices are low compared to oil.
Such plans will require huge investments over long timeframes to build CNG infrastructure,
fueling stations, and vehicle fleets.
Some of these players are already pairing up. Chemical companies are signing long-term ethane
supply agreements with shale NGL producers and midstream companies. LNG companies are
doing the same with their suppliers and their customers. Others are staying single for now, at
least until there is more (or a narrower range) price certainty and fewer wildcards.

With Fortunes to Be Made or Lost, Will Natural Gas Find Its Footing?

Executive Agenda

Five Possible Futures, One Likely Scenario

If supply and demand were stable and investment cycles were shorter, it would be easy for
market forces to align them. But the U.S. market for natural gas and NGLs is driven by several
diverse and unpredictable variables: the global economy, oil prices, energy and environmental
policies, a rise in the global gas supply, or technological advances that are still unknown (see
sidebar: Predicting the Unpredictable). Although these variables could interact in any number of
permutations, our analysis finds five scenarios that could capture a range of potential outcomes.
The most likely scenario, which we call free markets, involves the least dramatic changes from
current conditions. In this scenario, GDP growth is modest, oil prices remain within current
trading ranges, LNG export becomes a reality, and no major global natural gas production or
technological advance affects the balance of forces seen today.
We believe the price of natural gas in the free-markets scenario will find equilibrium by 2020 in
the $6 to $7 range. Any lower than that and production from dry-gas wells would not be
profitable and would not increase sufficiently to meet demand; any higher and demand from
power plants will wane. But in this range, demand is high in all major sectors, leading to high
margins for producers and strong capital investments.

Predicting the Unpredictable

If supply and demand were stable
and investment cycles were
shorter, it would be easy for market
forces to align them. But the U.S.
market for natural gas and NGL
is unpredictable, with several
diverse and volatile factors.
Theres the global economy.
Global growth will drive demand
for energy and materials. If the
recovery gains momentum and
global gross domestic product
(GDP) rises by 3 to 5 percent
annually, demand will be high. But
if global GDP stagnates and global
trade drops, lower demand for
electricity, chemicals, and natural
gas in other markets could drop
prices across the board. Oil prices
are also unpredictable. At the
current price spread between oil
and natural gas, chemical
production from NGLs is
attractive. But if oil prices drop to
$60 per barrel and are forecasted
to remain there, gas production
falls and chemical companies
delay investments in gas crackers.

Energy and environmental

policies could upset industry
dynamics. Environmental policy
on hydraulic fracturing will
drive the cost of drilling and
completion of wells and could
stop it altogether if there are
major incidents. Or the United
States could restrict LNG exports
to foster energy independence
or to support jobs and economic
growth through a cost-competitive energy advantage, or it
could allow LNG exports in
a more free-markets policy.
Also, environmental regulators
concerned about greenhouse
gas emissions might impose
carbon taxes, air quality
restrictions, and carbon dioxide
emission regulations that make
coal-fired options more
expensive, pushing power
generators to substitute coal
with natural gas.

shale gas advantage, making

LNG exports less attractive.
And if the new shale plays are
rich in NGLs, U.S. chemical
company exports will suffer.
Finally, we dont know where the
next technological advance will
come from. Will it be in exploration
technologies to unlock stranded
resources such as gas hydrates or
to further lower production costs
of existing plays? Will it be in
breakthrough innovation that will
alter the economics of processes
such as gas-to-liquid conversion?
It is hard to predict, but if the next
advance is in solar, wind, oil, or
coal carbon capture and storage,
one of those competing energy
sources might leapfrog gas and
gain advantage.

Increased gas supply, with rapid

development of gas in other
countries could halt the U.S.

With Fortunes to Be Made or Lost, Will Natural Gas Find Its Footing?

Executive Agenda

Although the free-markets scenario is the most likely in our analysis, the outcome of global
events and governmental actions could lead us down other paths. There are four other
possible scenarios:
Troubled times. A geopolitical event triggers a disruption in oil supply, sending oil prices up
and the global economy into a double-dip recession. Natural gas demand collapses to 20
percent below the free-market scenario level.
Limited export. The U.S. government decides to limit natural gas exports and provides support
for other fuels in an effort to achieve energy independence, thus depressing natural gas demand.
Global gas competition. Other major economies are successful in developing wet shale plays.
As a result, demand falls for both LNG exports and ethane-based chemicals from the United
States, challenging the overall economics of shale gas plays in North America.
High output. Robust global GDP growth and lack of global shale developments lead to the
highest level of U.S. natural gas demand.
These scenarios represent a combination of various, and sometimes drastic, supply and
demand discontinuities. Nevertheless, the resulting gas prices are spread across a surprisingly
narrow range of $5 to $8 per thousand cubic feet (mcf) (see figure). We believe market trends
point to a strong future for natural gas and its ability to pull prices up structurally, with upstream
production economics determining the floor price and competition between coal and gas
defining the ceiling price.

Figure
Natural gas 2020 price scenarios
Natural gas price ($/MMBtu)
$12
$11
$10

Global economies
collapsing
Demand for natural
gas slowing

Natural gas
restrictions increasing to stimulate
domestic economy

Global gas development putting pricing

pressure on NGLs and
U.S.-based chemicals

Competition from
coal-fired power
generation

Domestic demand
moderating at high
NG prices

$9
$8
$7
$6
$5
$4
$3
$2
$1
$0

Gas more attractive

than coal
Supply being
rationalized to
eliminate wasteful
production

Gas more attractive

than coal
Modest global GDP
sustaining NGL
prices
Supply being
rationalized

Troubled times

Limited export

Demand for NGL

falling, forcing more
supply rationalization
GDP sustaining
domestic demand
Gas equaling coal

Global gas
competition

Demand for natural

gas rising as LNG
is exported and
global shale
development falls
GDP rising
Supply being
rationalized

Free markets

CO2 regulations
favoring gas
No major global
shale developments
GDP growing
New demand
channels emerging
for GTL and CNG

High output

Notes: MMBtu is one million British thermal units, GDP is gross domestic product, NGL is natural gas liquids, LNG is liquefied natural gas,
GTL is gas to liquids, and CNG is compressed natural gas.
Source: A.T. Kearney analysis

With Fortunes to Be Made or Lost, Will Natural Gas Find Its Footing?

Executive Agenda

Finding Balance
One of the biggest difficulties in looking forward is knowing when a current trend represents
lasting change and when it is merely a bump in the road. Shale gas represents lasting change,
but every change has many paths to balance. And on the road from here to long-term balance,
there will undoubtedly be many short-term irritationsa mild winter, a Middle East crisisthat
will send some analysts to wrong conclusions.

In our free-market scenario, the price of

natural gas finds equilibrium by 2020 in
the $6 to $7 range.
The regulatory certainty and more balanced pricing reflected in the free-market scenario could
provide a foundation of stabilized demand on which to build investments. Thats a likely path to
long-term balance, but even it would be filled with both short-term bumps and more serious
detours caused by players with different incentives.
Because of those bumps, prices during the transition will be volatile. When they are low, some
producers may be forced out of the market. When they are high, capacity investments may be
delayed. Disruptive events such as an oil-price collapse or a safety or environmental incident
may dramatically reduce supply. Any one of these detours could be devastating to an individual
player. If bigger than expected, one or more could transform the industry in unexpected ways,
leading to a different path and a different result.
But the same could be said about any unexpected event. More fundamentally, we can say that in
the long run, despite temporary blips, the natural gas industry will find balance. The path to get
there will take advantage of the reduced costs and expanded supplies resulting from shale gas.
It will also take advantage of the smart investments of well-informed players throughout the
complex industry ecosystem.

Authors
Patrick Haischer, partner, New York
patrick.haischer@atkearney.com

Andrew Walberer, partner, Chicago

andrew.walberer@atkearney.com

Herve Wilczynski, partner, Houston

herve.wilczynski@atkearney.com

With Fortunes to Be Made or Lost, Will Natural Gas Find Its Footing?

Executive Agenda

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