The remarkable recovery from the recent recession in many developing countries appears robust heading into 2010, and confidence is rising with developed countries also on the path to recovery.

Equity markets rallied with the earlier-than-expected reversal, and oil markets climbed along with them. However, North American gas markets have been left behind, and oversupply continues to dampen prices despite the positive economic news.

The new shale gas resource base and continued improvement in gas’s competitive position relative to other fuels sets the stage for significant market growth and opportunity in the years ahead, but for now, that rebound lags the economic recovery.

Gas lag lingers

Evidence of this lag is widespread. Even after the coldest December in a decade, North American gas storage inventories exceeded record end-of-year levels by 80 Bcf. Gas-related drilling remains depressed, with less than half of available rigs operating. Investment in the most promising shale plays continues, but the more technically challenging, higher-cost shales and tight gas plays that looked promising 18 months ago now wait for a delayed gas market rebound.

Given the fundamentals, Wood Mackenzie expects that rebound in price, demand, and drilling around 2012-2013, when gas’s improved competitive position relative to coal and oil spurs demand growth and tightening global markets draw LNG out of North America.

Longer term, US gas demand looks set to rise from 62 Bcf/d today to almost 80 Bcf/d in 2030. The repeatability now demonstrated in developing and delivering shale supplies should push production in the shales to more than 30 Bcf/d, comprising 40% of the supply mix.

Long-term price levels in the US $6-7 per million British thermal units (MMbtu) range are sufficient to spur the domestic supply and infrastructure development necessary to meet all of this growth. At that price, and with the reduced volatility offered by an expanding resource base, both the power and industrial sectors contribute to the resurgence. And policy decisions made during the next two years could further raise the bar for long-term market size, just as production from the next wave of shales — the Marcellus and the Haynesville — hits the market in force.

New developments

Marcellus production rose from very low levels at the start of last year to about 0.5 Bcf/d by 3Q 2009. Developers are targeting two core areas with potential for a third, and the permitting delays that challenged the Marcellus initially are now not quite as long. Significant progress has also been made on water disposal; several operators have achieved full water recycling, a breakthrough that both reduces costs and assuages environmental concerns. Given the positive early returns, acreage costs in northeast Pennsylvania more than doubled this year — despite continued low gas prices — from $2,200/acre to $5,500/acre. Royalty offers also improved. And although all of the shales will exhibit a range of costs, Anadarko Petroleum Corp. and Range Resources Corp. have both reported breakevens of less than $3/MMbtu on core acreage.

In northwest Louisiana, Haynesville deliveries have built up to more than 1.0 Bcf/d, with core areas established, as operators continue to climb the technological learning curve. Improvements in bit design and changes to the electronics in bottomhole drilling have both contributed to improved well economics.

Drilling programs that were previously supported by “hold-by-production” leases now look economic. Operators have also reduced costs in the highly prospective 100 Tcf Horn River play in British Columbia. The Eagle Ford shale play, Anadarko Woodford shale play, and several tight gas plays that are being developed with shale techniques also look set to enter the supply stack and grow as the market recovers.

Gas outlook

Over the next few years, however, demand for gas from the power sector will decline despite this resource abundance. About 20 gigawatts (GW) of new coal-fired generation capacity that was commissioned during the price spikes early this decade will serve about three years of power generation requirements, or 3 Bcf/d of gas demand.

Also, any rebound in gas prices will reverse coal displacement. Wood Mackenzie estimates that gas captured about 2 Bcf/d of power market demand from coal this year. These two factors — new coal generation capacity and reversal of coal displacement — suggest that the power sector’s pull on gas will not recover to 2009 levels until 2014.

And carbon legislation is not likely to change that near-term trend.

Ironically, the new paradigm offered by success in the shales now appears to be gaining national attention just as other legislative priorities have slowed progress on a federal carbon bill. Although the Boxer-Kerry bill stalled in the US Senate, it did feature more explicit terms for gas than the Waxman-Markey bill that passed the house in June. In addition, the proposed NAT GAS Act would extend and increase federal incentives designed to promote adoption of natural gas vehicles (and other alternative fuel vehicles).

Older coal-fired capacity is also under pressure, and growth in gas demand from the power sector could reach high levels if coal retirements accelerate. EPA enforcement of environmental issues that fall within its remit, state initiatives to limit carbon emissions, and low gas prices all contribute to the pressure. An additional 25 GW of retirements beyond Wood Mackenzie’s assumed 24 GW could boost gas demand by 3.5 Bcf/d by 2020; this represents a key upside risk for gas demand.

New gas resource availability also looks set to reverse industrial gas declines. Tremendous success in shale gas development has anchored long-term North American price expectations. Robust growth in emerging markets is expected to put continued pressure on global oil prices, and thus also on European and Asian gas prices. North American manufacturers, then, will have a sustained cost advantage compared to their competition in the rest of the developed world, which is expected to contribute to sustained growth in industrial gas demand. The wide gap between global oil prices and North American gas prices also allows gas to make inroads into oil’s transport market. By 2030, Wood Mackenzie assumes about 700 MMcf/d of gas demand for transport as some heavy-duty fleet trucking turns to gas.

The new economics and abundance of gas continue to suggest the potential for massive increases in gas market size and investment opportunities. Upstream growth and returns, infrastructure and storage development, and downstream investment would all follow a resurgent gas market, but hidden challenges could come in two forms: 1) the pace of the economic recovery, and 2) how quickly the industry is able to move from present production to meet an increase in domestic demand.

The rebound will have a twofold impact on gas markets, affecting both the economy itself and also the appetite for federal carbon legislation. The economy rebounded early in part because financial reforms have essentially been deferred. The world remains exposed to asset bubbles. A double-dip recession would undermine the power- and industry-driven recovery in demand that drives the next shift up in gas markets. And the resulting high unemployment rates and weak consumer confidence would also probably take Congressional focus away from carbon targets. However, if the economic recovery continues to strengthen, policy attention could turn back toward carbon legislation and environmental goals — a boost for gas versus coal.

The second challenge is one that addresses the industry’s ability to transition from today’s retrenchment to a period of steep requirements for domestic gas supply between 2012 and 2015. Even without carbon legislation, demand growth in this period would require an additional 400 rigs and the corresponding increases in upstream services. Federal carbon legislation or additional coal retirements could push demand up faster. If the industry transitions smoothly into this period of growth without severe upward cost pressures and price spikes, the stage will be set for gas to capture long-term market share.

Gas’s potential is gaining national and policy attention, but for now, the industry is not delivering new supplies. Furthermore, price spikes when more gas is eventually required could undermine this favorable perception.