Shale Gas Arbitrage

The Financial Times takes a detailed look at the shale gas boom in the region spanning Western PA, Eastern Ohio, and Northern West Virginia. The geography is important to the story, which looks at the overall economic impact of the fracking revolution in that area. There are other plays, but this one is the biggest. The key is the isolation and the tremendous arbitrage opportunity that it generates:

Shale gas is particularly important because it is stranded in US, with no facilities to sell it on world markets, although the country’s first liquefaction plant to enable the gas to be exported is now under development. As a result, gas is much cheaper in North America than in other leading economies. The US price of about $3.60 per million British thermal units compares with about $8 in the UK and $16 in Japan.

The cost comparison is even more favourable for US manufacturers of petrochemicals that use gas as a raw material and compete with international rivals using oil-based feedstocks. The US gas price works out at the equivalent of $22 a barrel, about one-fifth of the Brent crude price of more than $100.

I've also read, on numerous occasions, that the shale gas in the Marcellus is particularly cheap to extract. I've also posted before that happenstance has resulted in old school economic geography. Proximity to a raw resource drives industry location decisions. More from the Financial Times:

The Pennsylvania-based US Steel is another company investing in Ohio to make tubes for oil and gas wells, committing $100m to a new facility to revitalise a plant that first started production in 1905. As well as benefiting from supplying shale gas producers, it is making growing use of their product as a raw material.

John Surma, US Steel chief executive, explained recently how the company has been substituting cheap gas for expensive coal in its blast furnaces, saving tens of millions of dollars a year, and is exploring techniques to yield even bigger savings. “We are thankful”, he said in a speech to industry executives last month, for “the natural gas your revolutionary work is helping to bring to market”. ...

... “Natural gas is to the chemicals industry as flour is to a bakery,” says Cal Dooley, president of the American Chemistry Council, an industry group. “Cheap gas means both international and American companies are now looking at the US as the preferred location for new investment.”

The big prize in this competition is ethylene, an essential intermediate product used to make many plastics. Dow said this week that while Middle Eastern ethylene producers had the lowest costs of all, the US was now lower-cost than south-east Asia and well below western Europe or north-east Asia. Those calculations have inspired the company to restart one ethylene plant in Louisiana next year and to build a new one in the US to start operating in 2017.

Other companies are reaching similar conclusions. Royal Dutch Shell has said it plans to build an ethylene plant in the Appalachia region, meaning Pennsylvania, Ohio or West Virginia. Other oil and gas groups, including Chevron and ConocoPhillips, are also looking at possible new plants. LyondellBasell, the chemicals company, and Williams, which operates gas pipelines, are looking at adding to their US production capacity.

For the first decade of the millennium, high and volatile gas prices made US production uncompetitive relative to producers in emerging economies. Jeffrey Lipton, a former chief executive of Canada’s Nova Chemicals who now spreads the shale gas gospel, says the balance of power has shifted back to North America. Unlike in some industrial sectors, China has no competitive advantage in chemicals, because it is an importer of gas and oil.

As the effect of cheaper American raw materials works through the value chain, Mr Dooley says, other manufacturers will also be encouraged back to the US to take advantage. “Even in the auto industry we are starting to see a response,” he says. “There are composite and plastic components presently being made outside the US, because it has been cheaper. That competitive advantage no longer exists. In the future the US will be in a far stronger position to be a supplier to the auto industry.” The ACC estimated in March that a 25 per cent increase in ethane production could create 400,000 jobs.

This is the jobs boom. To date, those gains show up in extraction (see this graph). That's great for Texas, Oklahoma, and Colorado in the near term. Long term will see Pittsburgh emerge a global center for energy related industries as long as the shale gas can't find a way to the rest of the world.