Wednesday, January 18, 2012

Why Cleantech Investors Should Be Wary of Natural Gas Trends

I'm heading up to New York to have our quarterly strategy session, and a big topic for discussion will be the impact of the natural gas market on renewables. Greentech media recently ran a good piece on this, but as cleantech investors, it has been a concern for us at Novus for quite some time.

The era of low natural gas prices in North America is here, driven by the shale phenomenon in the U.S. Think of it as the opposite of "Peak Oil" theory: every year we are finding more gas and extracting at lower cost.

Prices have dipped below $3/mmbtu, and may be below $2 by the end of the year given the oversupply of the market and the record storage numbers we are likely to see coming out of a mild winter (natural gas is commonly stored in the "shoulder seasons" when demand/pricing is weaker, and withdrawn during summer and winter seasons when demand/pricing is higher). For comparison, prices were $6/mmbtu as recently as January 2010 and were at a high of $13 back in 2008.

The supply side impact of the shale equation can be understood by looking at well statistics for one major operator, Southwestern Energy, in the Fayetteville Shale from 2007-2010.

(Source: Schlumberger)

The data is illustrative of why shale gas production in the U.S. increased 4.5x from 2007-2010: costs have been cut in half, directional drilling technologies have gotten more sophisticated, and fracking technologies have enhanced recoverability.

The U.S. has been the testing ground for many of these techniques, but as the map below shows, many countries have a huge vested interest in coming up the shale gas learning curve to exploit their own resources (At today's demand levels, the known global gas reserves represent 250 years of production).

This will drive foreign investment in U.S. E&P assets and operators, as has already been seen with Total's $2.3Bn JV with Chesapeake and China Sinopec's $2Bn investment in Devon's shale projects. These firms will surely export the knowledge gained from these investments to exploit more local resources. If China can figure this out, it will go a long way to meet it's coming energy needs and displacing coal, as many are already predicting:

(Source: Exxon 2012 energy study)

So what is the impact of all of this for cleantech:
  • Natural gas has a direct effect on electricity prices. Ultimately, renewable power producers are in a commodity business of selling electrons and they have to be able to compete (Ability to compete on price will be even more paramount as Europe re-thinks it's feed-in tariffs amidst austerity measures)
  • While low natural gas prices have been a North American phenomena, the export of shale gas technology (along with the export of North American LNG) will put downward pressure on global prices as well
  • At Novus, we have shifted away from investing in power generation and focused more of our efforts on sectors with less leverage to power prices such as energy efficiency, lighting, grid intelligence, and solar services
  • We are big believers in the solar market, but we expect 2012 to be another difficult year for cell/module manufacturers with intense price pressure and consolidation (as someone once said: "consolidation is a nice sounding word for very bad things happening in the market")
  • Lastly, the explosion in shale drilling is creating a huge issue around water usage and environmental impact and remediation, which is likely to be another area of opportunity.

As always, we may be completely wrong, but the main point here is that if you're investing in cleantech, you should have a view on how oil and gas market dynamics are affecting your space.

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