What the Shale Gas Boom Means for American Chemical Manufacturers

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 , Encana , and Chesapeake Energy 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.

Because of relatively high oil prices, it costs naphtha-based plants up to $1,200 a ton to produce ethylene. In sharp contrast, ethane-based plants can produce ethylene for roughly half that amount. Just this year, ethane prices have fallen nearly 70% since the beginning of the year and recently slipped to their lowest level in at least five years.

This wide price disparity between ethane and naphtha has provided U.S. chemical firms with a massive cost advantage and plenty of incentive to relocate back to the United States. For instance, Dow Chemical is planning to construct a new ethylene unit along the U.S. Gulf Coast by 2017, reopen an idled ethylene plant in Louisiana this year, and build a new propylene facility in Texas by 2015. The company hopes to benefit from cheap feedstock sourced from the Marcellus and Eagle Ford shales.

Similarly, Shell is constructing a petrochemical refinery in the Appalachian region, also aiming to capitalize on cheap feedstock from  the Marcellus shale. Shell Chemicals also recently announced plans to build an ethane cracker in Pennsylvania.

Final thoughts
Besides the obvious benefits to U.S. chemical companies, the price disparity between ethane and naphtha is also likely to have a knock-on positive impact on NGL processors  such as DCP Midstream Partners , Oneok Partners , and MarkWest Energy Partners .

While the shale gas boom has eroded profitability among U.S. natural gas producers, it has been a boon to U.S. manufacturers, especially those whose energy usage is a substantial share of overall costs. For U.S. chemical companies, low natural gas prices have translated to cost savings for both raw materials and energy usage.

Going forward, low natural gas prices should continue to provide a strong incentive for domestic manufacturers to relocate facilities that were previously shipped offshore back to the United States. In addition to boosting employment, the shale gas boom should continue to improve the competitive position of U.S. chemical companies and other domestic manufacturers.

As one of the nation's largest gas producers, Chesapeake Energy has found it tough to cope with sustained low prices for the commodity. The company's share price fell after negative news surfaced concerning the company's management and spiraling debt picture. While these issues still persist, giant steps have been taken to help mitigate the problems. To learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand new premium report on the company. Simply click here now to access your copy, and as an added bonus, you'll receive a full year of key updates and expert guidance as news continues to develop.

The article What the Shale Gas Boom Means for American Chemical Manufacturers originally appeared on Fool.com.

Fool contributor Arjun Sreekumar has no positions in the stocks mentioned above. The Motley Fool has options on Chesapeake Energy. Motley Fool newsletter services recommend DCP Midstream Partners and ONEOK Partners. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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