Drillers could take lesson from Dust Bowl
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The early 1920s were a good time for wheat, but by the 1930s, dust and drought were choking the Great Plains, depression was gripping the world and of particular interest to grain farmers -- and perhaps to today's natural gas producers -- the price of wheat was bottoming out.
Producers in the Marcellus Shale natural gas play, in turns out, could learn something from wheat farmers in the 1930s. How farmers responded and the simple math of Dust Bowl wheat prices, as well as their exuberance toward exciting new technological advances, roughly correlate with what's happening now in the domestic natural gas market.
"It's a plain old supply-and-demand picture," said Stephen Koontz, a commodities expert at Colorado State University.
When everybody is drilling for gas all at once -- without a growing consumption of the product -- supply rises, prices drop and profit margins are trimmed.
Then, throw in unexpected weather and economic events, and stir.
In the 1930s, it was a vicious drought and the Great Depression; today, it's unseasonably warm weather in the Northeast and anemic energy demand due to the 2008 recession. Because of that high supply and low demand, natural gas prices bottomed at around $2.60 per 1,000 cubic feet in January, 40 percent lower than a year ago.
It's the lowest price in a decade.
"I don't think the production side of the industry is keen on prices remaining as low as they are," said Tyson Slocum, director of energy research at Public Citizen, the consumer advocacy and environmental group founded by Ralph Nader.
But "the explosion of accessible reserves due to fracking in your neck of the world, and elsewhere," means that prices were facing irresistible downward pressure, Mr. Slocum said.
Faced with a similar situation in the late 1920s and the 1930s, farmers had two options:
Take one for the team and quit planting wheat, which -- farmer by farmer, farm by farm -- would reduce the wheat glut and help lift prices. That's a difficult decision to make, easier said than done for a farmer who's invested so much time, money and effort in his life's work.
Many took the second option: double down. If wheat is only netting half of what it did four years ago, the easy mathematical solution is to plant twice as much wheat.
For most, it was a no-brainer:
"Across the Southern plains, the response was overwhelming: The farmers tore up more grass," writes Timothy Egan in "The Worst Hard Time," his book about the Dust Bowl. "They had debts to meet on those [new] tractors, plows, combines, and land. ... The only way for someone who made $10,000 in 1925 to duplicate his earnings in 1929 was to plant twice the amount."
The result was predictable, in hindsight: Wheat sold for $2 a bushel at the beginning of the 1920s. By 1928, it was at a $1. In 1931, the U.S. produced more wheat than ever, thanks to all the increased planting -- and prices hit rock bottom.
That's a greatly simplified version of what caused the wheat crash and, by extension, the Dust Bowl. Clearly, there were other forces at play -- post-WWI economics, weather patterns, public agricultural policy.
But the more wheat you plant without a corresponding increase in demand, the lower wheat prices go. The more gas wells you plant -- well, same thing happens, especially in an insulated domestic market.
In both cases, excitement over new technologies helped create the gluts. With natural gas, it's the ability to drill deeper, and drill a greater distance horizontally, that has made gas reserves more easily accessible today.
In the 1920s and '30s, as agriculture became increasingly mechanized, tractors and combine harvesters greatly improved efficiency and production.
So what happens next? Large drillers are relaxing production, just like some of the farmers did.
Nationally, smaller drillers won't always have that option because they have so much capital tied up in the process. The only way they make money is to sell natural gas. Problem is, with prices so low, smaller, independent drillers still can't turn a profit, no matter how much they sell.
Eventually, some get weeded out, selling acreage and assets to larger producers -- and the companies that survive are the big, diversified energy firms that were able to sit on their land for a few years without much production, subsidizing the low gas revenues with profits in oil and coal.
"For a smaller entity, they're going to be struggling," Mr. Slocum said. "But I don't chalk this up to some big conspiracy" on the part of large energy producers, trying to gin up demand and drive out competition.
Rather, they're all rushing in at the same time because "they all understand they're going to make a killing at some point, even if it's not right now."
Closer to home, Venango County offers a similar history lesson -- 19th-century oil gushers produced an investment rush not unlike the one being carried out today by shale gas drillers and energy companies.
So many drillers arrived in Titusville so quickly that, within months of the famous 1859 oil strike, the nascent petroleum market had already seen its first glut-driven price crash. More oil was being produced than could be stored and shipped, so much so that smaller operators were forced to store oil in whatever containers they could find, including household bathtubs.
"The oil being produced absolutely flooded the market. It was more oil than the region was prepared to use and, therefore, prices dropped" to 10 cents a barrel by the end of 1861, said Barbara T. Zolli, director of the Drake Well Museum, in an article in Pennsylvania Heritage magazine.
Coopers, still making barrels by hand, couldn't produce them fast enough. And, absent a robust rail system that didn't arrive in the Oil Creek Valley until after the Civil War, there was no easy way to move those barrels to the Allegheny River, then down to Pittsburgh.
It's a more primitive, though still analogous, version of what's ailing natural gas today -- storage and transport issues, brought on by new technologies that improved production.
"Nobody expected that the [oil] well was going to come in at 1,000 barrels a day," said Susan Beates, historian at the Drake Well Museum. "The high cost of storage and transportation" created a hyper-regional market, and led to a local glut of oil that was selling for pennies on the dollar.
The Drake Well, in fact, was never profitable.
Small operators, again, weren't able to survive the low prices, and doubling down on production solved nothing. So they left, selling land and equipment to larger companies such as Clark & Rockefeller (which would soon become John D. Rockefeller's Standard Oil).
Boom towns became ghost towns and bargains abounded: "Prices of land collapsed," writes Bill Bryson in "At Home," his book on domestic life. "In 1878, a plot of land in Pithole City [near Oil City] sold for $4.37. Thirteen years earlier, it had fetched $2 million."
Expect some small operators in the natural gas industry to have troubles now, too. It's an industry that -- for the time being -- remains more fragmented than oil and coal.
With low natural gas prices, "From a business strategy standpoint, it makes sense [for larger producers] to stake out your turf and hold off your competitors," said Mr. Koontz, the Colorado State professor.
"There's a lot of relatively small natural gas producers, and I'd have to think they'd be [extremely] nervous" right now, he said.
First Published February 3, 2012 12:00 am