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June 26, 2011

Great News! There’s a Natural Gas Bubble

The New York Times lead story today is "Insiders Raise Alarm Amid a Rush for Natural Gas". This is wonderful news although the NYTimes doesn't think so. Nothing great ever happens without irrational exuberance. A bubble means that private money is flooding into drilling wells and building natural gas infrastructure; the flood of investment dollars assures that the price of natural gas will stay low compared to oil for years to come and America can have the trifecta of a stronger economy because of lower energy prices, less dependence on foreign oil from bad places, and less pollution.

Will some investors lose money? You betcha. That's the way a free market works. Some wells won't be worth the price of drilling, very disturbing to the Times but the way that every business works. Once a well is drilled, however, it is likely to be kept in production even if its yield is low and its owners wish they hadn't drilled it. Gas from the wells which turned out with hindsight to have been a mistake is still cheap gas for the economy. Poorly run and unlucky companies will go broke; their gas and assets will be marked down in the market. Good for the economy.

Remember Internet bubble one. Everyone and his brother built fiber: "as long as you're laying one strand might as well do 144". There was a fiber glut. Companies went bankrupt. The modern Internet was born based on the plummeting price of data transport. The economy won even though some investors lost. Now there is so much data that more fiber is needed. May have another bubble; fine if we do.

Same thing with many railroad bubbles: a spate of overbuilding, plummeting transportation costs, and the modern industrial economy based on cheap transport of raw materials and goods was born. Higher standards of living all around (with some rough spots). More goods shipped; more opportunities for railroads; more capital spurred by irrational exuberance; more overbuilding; even cheaper transport.

One very disturbing line in the NYTimes story: "Federal and state lawmakers are considering drastically increasing subsidies for the natural gas business in the hope that it will provide low-cost energy for decades to come." The last thing we need is subsidies – especially when private money is flooding in. Private money is and should take the risk; public money should not. Remember ethanol. Remember housing. Bubbles inflated with public money pop much more destructively than those containing just private money because government keeps inflating them even when it's clear a mistake has been made. The only financial help government should give the natural gas industry is to strip away subsidies from nuclear, oil, solar, wind etc. etc. and let different energy sources compete for capital and market share.

Government's role as a regulator is important during a bubble. Irrational exuberance can lead to shortcuts; governments need to make sure drilling is done safely – as Pennsylvania and Texas are (but New York State is busy placating luddites and protecting competing forms of industry with "moratoriums"). Irrational enthusiasm is also fertile ground for investor fraud and Ponzi schemes; the NYTimes is right to worry about this, Again government has a proper role to play as regulator and enforcer, a role it will play much better if it is not also an investor.

There is some bad economic logic in the Times story. Author Ian Urbina argues that some natural gas producers are not making as much as they expected because 1) there is less natural gas per well than they expected; and 2) the price of natural gas is lower than they expected. However, unless the price of oil drops precipitously, it is impossible that both of these conditions will remain true at the same time. If there is less natural gas available at today's prices than investors expect, the price of natural gas will go up until costs and revenue are in line (unless the economics are screwed up by government intervention). There is plenty of room for NG prices to rise since it is much cheaper on an energy basis than oil. If the total oil forecasts are correct or low, prices will stay low but efficient producers'll make money on volume. There can't be both a production shortfall AND continued low prices.

Nice to get good news this Sunday morning even if the NYTimes doesn't see it that way.

Related posts:

Why we need bubbles

Good and Bad News about the Safety of Natural Gas Fracking

The Pickens Plan Bill: The Wrong Way to Get the Right Result

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