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What the Shale Gas Boom Means for American Chemical Manufacturers

http://www.fool.com/investing/general/2012/12/08/what-the-shale-gas-boom-means-for-american-chemica.aspx

Arjun Sreekumar
December 8, 2012

It's abundantly clear that a major energy boom, fueled by rapid growth in unconventional energy production, is now under way in the United States. Thanks to the commercialization of advanced drilling technologies, such as horizontal drilling and hydraulic fracturing, domestic natural gas production has reached all-time highs.

This remarkable level of production has kept natural gas prices severely depressed over the past couple of years. Consumers, who use gas to heat and power their homes have benefited, while those that explore for and produce natural gas have languished.

But there's another major beneficiary of the shale gas boom -- the American chemical manufacturer. In fact, some have argued, low natural gas prices may be enough to spark a "manufacturing renaissance." Is this hype or reality?

The shale gas boom
Just five years ago, conventional wisdom held that the U.S. would become a major importer of liquefied natural gas  (LNG). But one major unexpected development has completely changed that view.

That event has been the rapid development of horizontal drilling and hydraulic fracturing, advanced techniques that have made it possible to unlock vast reserves of oil and gas trapped underneath sedimentary rocks, or shales. As a result, domestic oil and gas production has soared.

This has led to a gross oversupply in the U.S. natural gas market, which has contributed to decade-low prices for the commodity. The glut has caused major U.S. gas producers such as EOG Resources (NYSE: EOG), Encana (NYSE: ECA), and Chesapeake Energy (NYSE: CHK) to severely curtail gas drilling and instead focus on more profitable liquids drilling. But despite their efforts, total U.S. gas production remains strong and is expected to stay that way for decades to come.

Recently, the U.S. Energy Information Administration (EIA) said it anticipates production this year to rise by almost 4% from last year's record levels. Going forward, the agency projects that domestic gas production will rise from 23 trillion cubic feet last year to a projected 33.1 trillion cubic feet in 2040, representing a sizable 44% increase.

Shale gas production, which already accounts for a tenth of total U.S. energy  supply, is expected to be the primary driver. EIA anticipates shale gas production to double over the next three decades, going from 7.8 trillion cubic feet last year to 16.7 trillion cubic feet in 2040.

The shale gas boom has already created -- and will continue to create -- winners and losers. If natural gas prices remain depressed, some of the biggest winners should be American chemical manufacturers.

How shale gas affects U.S. chemical manufacturers
The U.S. chemical industry has two primary uses for natural gas -- as a raw material, or "feedstock," and as a way to power  its facilities. As prices have declined, natural gas has become increasingly attractive for both purposes. In fact, cost advantages have led several U.S. chemical manufacturers to relocate plants that had been moved offshore back to the United States.

There's a sense of irony here. Just over five years ago, natural gas was a major impediment to the U.S. chemical industry. Now, it's a lifesaver.

Back in the mid-2000s, when natural gas and NGL prices spiked, many domestic chemical firms lost competitiveness  and were forced to idle their plants. But after several years of coping with high and volatile natural gas prices, current low prices have provided them with a significant competitive advantage over their foreign counterparts.

Feedstock price disparities
For instance, consider the relative pricing of ethane versus naphtha. U.S. chemical companies are heavy users of ethane, a shale gas-derived natural gas liquid (NGL), which is used to produce ethylene -- a substance used to make plastics. On the other hand, European and other foreign chemical companies use naphtha, a more expensive feedstock derived from oil, to manufacture similar products.

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