Shale gas still an object lesson for miners
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 gas market.
By Garry White
8:00PM BST 05 Aug 2012
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.
Essentially the rush for shale gas assets turned into a classic bubble. A bubble that has now gone pop.
So, with miners all over the world ramping up production of everything from iron ore to coal to copper, is the supply situation for all these commodities going to get ahead of itself in the next few years?
Mining companies say no. They believe that, unlike natural gas in the US, demand will remain amid the urbanisation of China, India and other Asian nations.
Iron ore in particular has seen heavy investment. Rio Tinto plans to spend more than $15bn over the next five years to expand its operations in the Pilbara region of Western Australia. BHP itself produced 159.5m tonnes of iron ore last year and aims to increase this to 220m by 2014 and 350m by 2020.
Last week, Brazil’s Vale received a preliminary environmental license for an $8bn project to double output at Carajas, the world’s largest iron-ore mine, in northern Brazil.
There is no doubt that supply of iron ore – crucial for making steel – will increase sharply in the next few years should all the projects proceed. However, there are increasing signs that miners are reining in their spending. This has been prompted by a slump in commodity prices, as fears of a slowdown in China mounts. China imports 60pc of the world’s supply of iron ore and the spot price has fallen by a third over the last year, as concerns about the health of the Asian nation’s economy increased. Some shipments of ore into Chinese ports have also started to be deferred.
However, iron ore bulls believe current price falls are just a blip and point to the fact that demand for metals increases in line with increasing income. Global wealth per capita is expected to rise substantially over the next few years as developing economies mature, so demand for iron ore should remain strong.
Urbanisation is also a key driver, with data from Rio Tinto suggesting a Chinese urban household requires 10 to 15 times more steel than a Chinese rural household.
Urbanisation is not only going on in China. The UN estimates that by 2050, 6.3bn people will be living in cities, the equivalent of the whole global population today. The UN reckons Tokyo will be largest city in the world by then, followed by Delhi, Shanghai, Mumbai and Mexico City.
But the reason why commodity prices have been in a supercycle since 2002 is not just that there was a surprise upturn in demand from China, but also because there had been limited investment in mines and new supply prior to that.
If supply increases more than the increase in volumes sold over the next few years, miners could face falling prices at a time of increasing demand.
It seems increasingly likely that a number of projects will be shelved instead – no chief executive wants to see a repeat of the shale gas issue.