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Shale Gas Glut: An Object Lesson In Basic Economics

Supply and demand is at the heart of basic economics and that applies equally to commodities markets. Nowhere is that currently more apparent than in the shale gas market.

An excess in the supply of natural gas has led three of Britain’s biggest companies to write down $6.2bn (£4bn) of assets in the last two weeks. Given the significant expansion plans being pursued by mining companies across a wide range of commodities, it’s worth asking whether the supply surfeit problem is going to be replicated elsewhere.

On Friday, BHP Billiton became the latest UK blue chip to slash the value of its US shale gas business, taking a $2.84bn hit. The resources giant only bought the assets last year – spending $4.75bn buying Fayetteville from Chesapeake Energy. Shale gas prices have plunged by about 50pc since the purchase and Marius Kloppers, BHP’s chief executive, has forgone his bonus as penance.

BHP’s move to slash the value of the assets was not a surprise, following on from a $2.1bn writedown from BP and $1.3bn from BG Group over the last fortnight.

The problem is an excess of supply. Large companies including Exxon and Chevron bought a series of shale assets from independent companies, with a view to using their superior financial firepower to develop the assets quickly.

The majors delivered on their promises, resulting in a glut of gas that has kept prices low. In effect, shale gas producers have been a victim of their own success and the country does not have the infrastructure in place to export the gas to Asian markets in the form of liquified natural gas (LNG). That will be several years in the making.

US natural gas prices, as measured at the Henry Hub in Louisiana, peaked at $14 per thousand cubic feet in 2005. Earlier this year the price slumped to a lowly $1.80 after a warm US winter, but has since recovered to about $3.

Gas

Essentially the rush for shale gas assets turned into a classic bubble. A bubble that has now gone pop.

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