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Q3 2009 Quarterly Commentary

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Weekly Economic Commentary

On the Other Hand Weekly Economic Commentary November 9, 2009 – November 13, 2009 Economic Commentary by Principal Global Investors Economic Committee Download this issue (PDF: 122 KB)   Archives

Natural Gas – A Quiet Revolution
Going Unconventional
Impact of Expanded Gas Supplies
Indexes at Glance

Natural Gas – A Quiet Revolution

The International Energy Agency (IEA) released its 2009 World Energy Outlook this week with little fanfare, but it does contain some interesting material (the report can be found on their Web site at www.iea.org). They point out one thing that we already knew, namely that global energy use is set to fall in 2009 for the first time since 1981 as a result of the global financial and economic crises. However, the drop in demand, which is mostly focused on crude oil, appears to be set to quickly resume its long-term upward trend once economic recovery is firmly underway. With an enormous appetite for new electricity power generation as part of the future world energy landscape, coal will of course be a major beneficiary since it is currently the backbone of the power generation sector, especially in developing nations. However, its share of global electric power generation should rise only slightly, to 44%.

This brings us back to natural gas as a potential new and vital solution in a low carbon world. Constraints on the rate at which the trendier low-carbon technologies can be deployed, especially in developed countries, combined with the low carbon content of natural gas relative to coal and oil, means that gas demand should expand rapidly. The IEA projects growth in demand of 2.5% per year between now and 2030. Demand growth would likely be more rapid, but the issue is supply. 

While the world's resources of conventionally recoverable natural gas appear ample, the cost of tapping these reserves is set to go up sharply, inhibiting demand in the process. A large share of the supply problem is that over half of the reserves are in three countries: Iran, Russia, and Qatar. Other than Qatar, there is a lack of capital to develop gas reserves and to transport them (not to mention the political/diplomatic problems with the present government in Iran).

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Going Unconventional

While we previously discussed the global oil outlook at some length ("On The Other Hand" Economic Insights, October 19-23, 2009), the biggest energy innovation of this decade is natural gas…more specifically what is known as "unconventional" natural gas. The breakthrough technology is occurring in the United States without much publicity (in fact the news is just arriving in Washington D.C.), but unconventional gas, which is gas produced from shale formations, coal-bed methane, and other so-called "tight" formations, is now 40% of total U.S. production and growing rapidly.

At present demand levels, the United States has an estimated 90 years of proven and potential supply… a number that is going up, not down (as opposed to crude oil, where demand is increasing faster than reserves). According to the IEA, the supply impact has already been noticeable. This unexpected boom in U.S. unconventional gas production, together with the current recession's depressive effect on demand, in causing talk of a glut in natural gas during the next few years!

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Impact of Expanded Gas Supplies

The prospect of a sudden and dramatic expansion of such an important resource base in the United States and Canada is most assuredly a "game-changer," but what is getting changed? We offer a few possibilities:

• In the face of new climate regulations, the enhanced availability of gas will boost its direct use in generating electricity. 
• Ample natural gas supplies may also facilitate the development of renewable resources. For example, wind and solar are "intermittent" sources; when the sun doesn't shine and the wind doesn't blow, something such as natural gas, which can be brought on line quickly, needs to pick up the generation slack. We think natural gas will be very complementary to the growing mandates for renewable electric power.
• Gas used as a transportation fuel may also grow in more heavily populated urban areas… lower in price and more abundant means it's more attractive for urban bus, truck, and delivery vehicle fleets – much less carbon!
• Areas such as New York and Pennsylvania have the potential to become electric energy producers rather than importers.
• One loser is the Liquefied Natural Gas (LNG) facilities that have been built in the United States. These can't compete in price with abundant domestic supplies of natural gas, so there may be a growing base of under-utilized terminals and pipelines.

If unconventional natural gas production spreads, as expected, outside the United States and Canada, it will lead to more supply at a lower cost globally than is now the case.

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Indexes at a Glance

Information provided by Principal Global Investor

Performance of indexes reflects the unmanaged result for the market segment the selected index represents. The index is not available for direct investment.

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The commentary represents the opinions of Principal Global Investors and may not come to pass.

The S&P 500 is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market.

The S&P MidCap 400 Index includes approximately 10% of the capitalization of U.S. equity securities.
These are comprised of stocks in the middle capitalization range.

The S&P SmallCap 600 Index is a small-cap index that consists of 600 domestic stocks chosen for market size, liquidity, and industry group representation.

The Dow Jones Industrial Average is an index of 30 blue-chip U.S. stocks.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada.

The NASDAQ Composite Index is a broad-based index that measures all NASDAQ domestic and international based common type stocks listed on the NASDAQ Stock Market.

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