WWW.IBISWORLD.COM November 2012 1 November 2012 Scenario Study: Natural Gas Prices Deflating By Antonio Danova What if the price of natural gas bucked its trend of steady growth? And what industries would lose out? With heavy supply and somewhat static demand for natural gas, the price of the commodity has been falling rapidly. From 2010 to 2011, the wellhead price of natural gas in the United States fell from about $4.48 to $3.95 per thousand cubic feet, according to the US Energy Information Association. To combat this price fall, firms have attempted to cut back production. The plan has been somewhat successful, with the EIA reporting a spot price increase in natural gas futures from $1.95 in April 2012 to about $2.85 in September 2012. Even so, natural gas prices are still at a historic high. Additionally, though many natural gas production firms have pulled back rigs in order to reduce output, the EIA reports that natural gas storage has reached roughly 3.8 billion cubic feet (BCf) in mid-october 2012, compared to roughly 3.6 BCf the year prior, a 5.0% increase that may ultimately further subdue price growth. What would a decrease in the world price of natural gas mean for the three key industries throughout the supply chain of this commodity? The natural gas sector in the United States has experienced a surge in the supply of the commodity as many firms within the sector increased natural gas production in recent years. According to $ per thousand cubic feet World price of natural gas 12 10 8 6 4 Year 03 05 07 09 11 13 15 a September 2012 report from the Natural Gas Supply Association (NGSA), the record levels of production in the United States can be attributed to various factors. For example, the Marcellus Shale boom and other recent discoveries of untapped natural gas deposits have led natural gas extraction companies to ramp up production. The field of natural gas deposits extends through Pennsylvania, New York, Ohio and West Virginia and is part of the Devonian Black Shale Field. Historically, the United States has produced roughly 30 trillion cubic feet (TCF) of natural gas each year. Industry experts estimate that the Marcellus Shale field holds almost 50 TCF of extractable 17 SOURCE: WWW.IBISWORLD.COM www.ibisworld.com 1-800-330-3772 info@ibisworld.com
WWW.IBISWORLD.COM November 2012 2 Baselinevs.scenario Baseline2012 Baseline2013 Scenario2013 Industry Overall Structure Growth Sensitvity Overall Structure Growth Sensitvity Overall Natural Gas Distribution 4.26 5.05 2.37 3.97 3.84 5.05 2.83 4.43 4.18 Oil Drilling & Gas Extraction 4.25 7.33 2.80 2.96 4.02 7.33 3.19 3.35 4.31 Coal & Natural Gas Power 4.14 4.32 5.02 3.37 4.02 4.32 5.34 3.69 4.26 SOURCE: WWW.IBISWORLD.COM natural gas. According to the same NGSA report, shale gas production grew 32.5% from 16.9 BCf per day in 2010 to roughly 22.4 BCf per day in 2011. Year-over year daily production growth fell to 2.1% from 2011 to 2012, though. On top of the vast amount of production of natural gas, skyrocketing crude oil prices have helped keep natural gas supplies high. According to an April 2012 article from Bloomberg Businessweek, crude oil regularly traded above $100 a barrel throughout the early stages of 2012. These sustained high oil prices facilitated an opportune time for oil drilling companies to ramp up production. Generally, drilling for crude oil produces an associated gas as a byproduct. Global research firm Barclays estimates that 75.0% of all natural gas production during 2012 will be the gas byproduct from oil drilling. Thus, with higher oil drilling, the resulting gas byproduct has helped sustain the United States supply of natural gas. Additionally, the particularly warm winter during 2011 and into 2012 lowered demand across the country for natural gas used for heating buildings and residences, another factor that buoyed the US supply of natural gas over the past year. Natural gas risk model In this study, IBISWorld profiles the US Oil Drilling and Gas Extraction industry (IBISWorld report 21111), Natural Gas Distribution industry (22121), and Coal and Natural Gas Power industry (22111a), discussing the implications that falling natural gas prices may have on profitability, revenue growth, demand and other aspects within each industry. Based on IBISWorld s Industry Risk Rating Model 1, the weighted average of the three natural gas price benchmarks (Germany, Japan and the United States), which defines IBISWorld s world price of natural gas metric, drops to $8.00 per thousand cubic feet from the baseline of $10.04 during 2013. The end goal is to show the change in IBISWorld risk-rating scores for the three industries during 2012 and 2013. To calculate the overall risk score, IBISWorld assesses the risks pertaining to industry structure (structural risk), expected future performance (growth risk) and economic forces (sensitivity risk). Risk scores are based on a scale of one to nine, where one represents the lowest risk and nine the highest. The three types of risk are scored separately, then weighted and combined to derive the overall risk score. 1 A joint effort with RMA with roots in the work of Michael Porter, the model is based on data from the highly granular five-digit North American Industry Classification System (NAICS). The precise theoretical underpinning is a marriage of Porter s Five Forces and a traditional macroeconomic-style top-down approach.
WWW.IBISWORLD.COM November 2012 3 Increasing risk Based on the risk model, the table shows that over the next two years the three industries within the natural gas sector will experience significant growth in their associated risk scores. Across all three industries, a drop in the price of natural gas during 2013 would cause a significant increase in growth and sensitivity risk. These industries rely on natural gas in different ways, but a fall in the price of the commodity would be detrimental to all three. Companies in the Oil Drilling and Gas Extraction industry operate and develop oil and gas field properties, explore and excavate for natural gas, mine and extract oil from shale and sands and explore for and produce crude petroleum. Natural gas accounts for roughly 41.6% of all extraction revenue within the industry, with crude oil consuming the remaining 58.4%. Given its higher prices, crude oil dominates the industry s landscape and has done so more prominently over the past five years. Compounding skyrocketing oil prices with falling natural gas prices, natural gas extraction revenue has fallen from about 51.0% in 2007. Based on the risk model, the two contrasting price trends would lure oil drilling and gas extraction firms away from natural gas fields, despite an abundant supply of the commodity. The inherent risk involved is rooted in consumer demand. If firms increase crude oil output but demand for crude oil falters, it would create a marked decline in industry revenue. Historically, this fall could be buoyed by natural gas; however, falling natural gas prices limit the ability of the natural gas segment to make up for a drop in crude oil revenue. All of these factors would combine to increase the industry s overall risk score by 0.29 points. Companies in the Natural Gas Distribution industry operate gas distribution systems consisting primarily of gas mains and meters that transport natural gas to end users. Many operators are also gas marketers that buy gas from the well and sell it to a distribution system, while others are gas brokers or agents that arrange for gas to be sold via operating distribution systems. Because they fall in the middle of the supply chain, natural gas distributors have significant interest in natural gas prices since they are the most significant and most direct determinant of industry profitability and revenue growth. Therefore, the Natural Gas Distribution industry would be most affected by a sustained fall in the price of natural gas, with its overall risk score increasing 0.34 points. In general, continually falling natural gas prices would cut into the industry s profitability as well as subdue its revenue growth potential. The Coal and Natural Gas Power industry operates fossil fuel-powered electricity generating plants that power turbines that generate electricity for households, the commercial sector and industrial firms. Currently, gas-fired electricity makes up about 33.6% of revenue for the industry and has grown significantly over the past five years in light of its availability and affordability. As natural gas-generated electricity becomes even more affordable due to falling natural gas prices, this segment will expand further. Like the Oil Drilling and Gas Extraction industry, consumer demand for gas-fired electricity would have the biggest implication on this industry s risk score, which would increase 0.24 points in 2013. If natural gas prices continued to fall, any significant decrease in consumer demand for gasfired electricity would suppress revenue growth and cut into industry profitability.
WWW.IBISWORLD.COM November 2012 4 About IBISWorld Inc. Recognized as the nation s most trusted independent source of industry and market research, IBISWorld offers a comprehensive database of unique information and analysis on every US industry. With an extensive online portfolio, valued for its depth and scope, the company equips clients with the insight necessary to make better business decisions. Headquartered in Los Angeles, IBISWorld serves a range of business, professional service and government organizations through more than 10 locations worldwide. For more information, visit www.ibisworld.com or call 1-800-330-3772. Conclusion The ability of each industry to remain less risky than anticipated in our model, should natural gas prices continue to fall, hinges on each industry s capacity to increase consumer demand for their products. The supply of natural gas is there, so the most important aspect for companies is to survey the market and meet consumer needs for natural gas in industrial and commercials markets as well as for heating, electricity generation and other uses in the residential market. Though the United States has been afforded a rich new supply of oil thanks to the discovery of untapped reserves and a high volume of natural gas byproduct from oil drilling, natural gas firms up and down the supply chain may ultimately remain bearish about the prospects of their sector should natural gas prices continue to plunge. Contact: Savannah Haspel VP, Public Relations IBISWorld Phone: 1-310-866-5044 savannahh@ibisworld.com www.ibisworld.com Sources: http://www.businessweek.com/articles/2012-04-19/high-oil-prices-cut-the-cost-of-natural-gas http://www.ngsa.org/assets/icf%20supply%20outlook%202012-2013%20final%20report.pdf http://www.eia.gov/naturalgas/reports.cfm
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