Interesting call on inventories and price.

A contrarian makes another call – this time natural gas

David Parkinson

When it comes to predicting the price of oil, Henry Groppe has made a long career out of zigging when others were zagging. So why should he be any different when talking about natural gas?

Mr. Groppe – the octogenarian patriarch of Texas petroleum industry analysts Groppe Long & Littell – doesn't buy the prevailing wisdom that New York Mercantile Exchange natural gas prices are dead in the water, stuck around $4 to $5 (U.S.) per million British thermal units even as demand recovers, awash in supplies and with much more on the way.

No, his analysis (and more than 50 years of experience) tells him that gas inventories are about to get a lot tighter, that new supplies are overstated, and that prices are headed north of $8 by the end of summer.

Why is he so sure he's got it right and most everyone else has it wrong?

Because, he contends, shale gas – the previously unattainable source of vast gas supplies that has been unlocked by new high-tech horizontal drilling advancements – is not the holy grail it's been cracked up to be. Not even close.

“Everyone thinks [shale gas] is going to solve all of our problems. There are very optimistic estimates about the economically recoverable volumes of gas from this new resource,” he said in an interview last week in the Toronto offices of boutique fund manager Middlefield Capital Corp., where he's a long-time consultant and is special adviser to the nine-month-old Middlefield Groppe Tactical Energy mutual fund.

“That's dominating everyone's views about the gas supply picture – that we're going to be flooded with gas.”

The reality, he argues, is that shale gas deposits are a tiny part of the North American production pool – and they are already depleting fast.

Mr. Groppe says that while the average depletion rate in conventional gas wells is about 25 per cent (in other words, if you didn't drill at all for new wells, production would decline by a quarter each year), shale gas shows even more rapid depletion – output tumbles, on average, 45 per cent in the first year for shale wells.

Drilling of shale plays has recovered rapidly from the slowdown during the recession – indeed, the count of active horizontal drill rigs in the United States has ramped up to record levels – which, because of the high initial production volumes that are characteristic of shale wells, has flooded the market with supplies and fuelled expectations of continued rapid growth. But given Mr. Groppe's depletion numbers, the high drilling pace may also be serving to drain the resource in the major shale pools even faster than they would otherwise.

As for the shorter-term supply picture, Mr. Groppe notes that for all that horizontal drilling frenzy, shale gas accounts for just 6 per cent of U.S. natural gas production.

In the other 94 per cent – conventional gas – the rig count is 70 per cent below the pre-financial-crisis levels of September, 2008, as low prices and high inventory levels have convinced producers to keep drills idled.

“With that extraordinary drop in drilling, the [production] decline rate from all these [non-shale] sources is accelerating – and will be much more than offset whatever increases you get in shale.”

Add to that the fact that consumption continues to grow as the economy recovers, and he believes the glut in gas will prove strikingly short-lived.

“We think that we're now having a continuous, rapid decline of gas in storage,” he says. “By summer, it could get to be alarming.”

“We would expect gas prices to get above $8 in the August-September range.”

Why should we believe Henry Groppe? Well, he has a habit of disagreeing with the consensus view – and being right.

In 1980, when oil approached $40 a barrel and forecasters predicted $100 oil was inevitable, Mr. Groppe said crude would fall below $15 by the mid-1980s. It did.

In 1998, when crude dipped to barely above $10 and some prognosticators were hailing a new era of cheap energy, Mr. Groppe said oil was set to soar. By early 2000, it had topped $30 a barrel.

And two years ago, when it threatened to reach $150 a barrel and forecasters said $200 and more were just over the horizon, Mr. Groppe predicted we'd be back at $60-$70 in the second half of the year. By October, he was right again.

Now, he says, a slow-but-gradual decline in North American natural gas reserves – regardless of shale – means an average price in the $8 range is inevitable to trigger the “demand destruction” necessary to keep the supply-demand picture in balance. Eventually, he says, that price will creep up toward $10 by the end of the decade, as gas production slowly depletes.

Mr. Groppe credits his successes on a meticulous study of supply-and-demand details – something, he says, many of the people who disagree with him fail to do. He believes this is again the case in his critics' misplaced faith that shale plays will permanently alter the trajectory of North American natural gas supplies.

“When you take apart all the pieces from the bottom, there's absolutely no way for that to take place,” he says. “We don't think any of them have done a detailed dissection of what's going on.”




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