HardAssetsInvestor

Norman: Now we’ve seen the effect on price, at least in terms of natural gas, as a result of the fracking and the new technologies, and the new drilling. We have a huge, enormous surplus of natural gas. Price has come down to levels that many of the so-called experts in the industry said we would never see again. Does it portend the same thing for crude oil? Are we going to see this enormous new increase in supply that’ll bring the price down?

Faulkner: There's two sides to that debate. One side says, “Look, we now have shifted from natural gas to liquids plays. And now everyone is drilling liquids. So the supply is going to overrun the market.” The problem that I have with that is simply that we have increased our daily production in the United States to about 6 million barrels of oil with all of our efforts in the last decade. Now we’re still burning through 19 million barrels of oil. And that delta is supplied by the Middle East, by Canada and by Mexico.

So we have a long way to go to where we can start saying, “OK, we have so much oil now, a certain amount over here; it’s because we have kind of an unquenchable thirst for crude oil in this country.” The one difference between that and natural gas is that natural gas demand has been flat. We’re not using it for transportation or power generation. And so we’ve had no demand drivers in the market, and a huge amount of supply.

In 2005, we had forecasted, as an industry, we were going to be 80 billion cubic feet short of natural gas. Today, that number is zero. And we have an excess of it. So we’ve done an about-face. And that’s why the commodity price now is so cheap, we can't even bring it out of the ground and make money selling it.

Norman: But yet there are companies still bringing it out of the ground, and at least trying to sell it. How long can they stay in business with a price well below their breakeven price?

Faulkner: Well, it’s different for each company, because a lot of these companies have already paid for their acreage. And they're just now trying to drill out additional production. But if you have a company out there trying to hold acreage, they have to drill these wells in order to kick in the held-by-production clause in these leases. If not, they lose the leases. And they’ve paid a great deal of money. Back in the heyday in Louisiana, we were paying $15,000 for a single acre. We needed 1,280 acres just to drill one well. So it was a huge amount of money just before you start doing anything in the ground.

So you're trying to hold that acreage. But at the end of the day, most of the basins right now … folks will tell you the breakeven points fully loaded are $3.50 or $4 or even higher. So those companies have got to shift a part of their capex, in my mind, or the majority, toward liquids—atural gas liquids or crude—because they can't continue drilling dry gas and losing money. Even today, it’s at $3.20; so, still probably below the breakeven point of most areas.

Norman: What about outside the United States? Fracking, horizontal drilling? Are there other parts of the world where we see this happening now?

Faulkner: It’s emerging in a lot of areas. When you look at some of the Northern African countries—in Algeria, in Tunisia—these places have a lot of shale gas deposits. We’re also seeing it in South Africa, in the Karoo Basin, a ton of deposits there. Poland is out in front of, I think, what I call the international shale gas race. Poland has already drilled through shale gas. They have a government who’s very keen on fracking. They have a big need to get away from their marriage to Gazprom and the piped gas from Russia. They have been held hostage over the past decades with the pricing model from Gazprom. So they want to have an independent domestic solution for Europe. And Poland is leading that game.

And you could also bet the second leader in the game here is China. They're out ahead with possibly reserve estimates, now coming in double that of the entire United States. Now they have a big demand, obviously; a 7 percent GDP from their soft landing. They need all the oil and gas they can get. And they're one of the biggest importers, right now—right behind us—of hydrocarbon products. Now if they can get in the driver’s seat, they certainly want to have a domestic supply for all of those folks over there in China who need oil and gas.