Art Berman spots distress in the natural gas industry

Michael Giberson

Apparently I’m just a hot-headed, temperamental guy unwilling to sit still and listen to a patient explanation of a contrary point of view. I’ve only read the first paragraph of Art Berman’s new post at the The Oil Drum and already I’m arguing with my computer screen and searching around for data to illustrate my rebuttal.

Here in the first paragraph in question, from a post entitled “After The Gold Rush: A Perspective on Future U.S. Natural Gas Supply and Price”:

On January 23, 2012, Chesapeake Energy announced that it would curtail drilling in shale gas plays in the United States. Subsequently, other operators have followed suit. While the outcome of this announcement is unclear, it is a signal that the industry is in distress. One can argue that this distress stems from a lack of discipline as market price began to decline.

Distressed? Chesapeake Energy is in the oil and gas business. The ratio of oil prices to natural gas prices is at historic highs. Chesapeake announces they are shifting their drilling activities away from natural gas resources and toward oil resources. Since when is responding to incentives a sign of distress?

Jump back six years ago and oil prices (quoted in barrels) were about 6 times the price of natural gas (quoted in million BTU), a ratio that happens to be near the relative energy contents of the two energy resources. Prices of both went up and then down together in 2007 and 2008, oil a little more than gas, but beginning in 2009 oil prices resumed an upward path while gas prices have drifted downward. The current oil-to-gas price ratio is an astounding 40 to 1.

The following EIA chart is from May 2011, but it shows that the oil and gas industry as a whole has been quite reasonably switching from natural gas drilling to oil drilling as the relative price differences began to change. The trends shown have continued over the last several months.

U.S. oil rig count overtakes natural gas rig count (Chart)

U.S. oil rig count overtakes natural gas rig count. Source: EIA (Link to EIA analysis and supporting data.)

If anything, to the extent Chesapeake stayed with natural gas drilling even as the oil-to-gas price ratio was shifting against gas, it signals one of three things: (1) their gas operations were exceptionally profitable, at least relative to their oil opportunities, but now prices have tipped their calculations toward oil, (2) they had contractual obligations that kept them in gas drilling longer than they would have preferred, given the way prices developed, or (3) they irrationally stuck to natural gas drilling well after incentives should have pushed them to oil, but they’ve recently regained their senses. Which of these three options reveal an industry in distress?

The reality is simpler. A few moments searching Google news turns up stories from 2011, 2010, and 2009 in which Chesapeake has said it was shifting from gas to oil drilling. Chesapeake has been slowly shifting from gas to oil drilling over the past few years just like the rest of the industry, perhaps the only change in the most recent announcement is that the company is increasing the pace of its shift.

Okay, later today I’ll have time to read the rest of Berman’s post. Maybe reading the rest of his reasoned analysis will enlighten me, will calm me down a bit.

How patents stifle innovation, Honeywell edition

Lynne Kiesling

In the comments on Mike’s post yesterday about the Honeywell patent lawsuit against Nest, Ed asks in the comments how it is that patents stifle innovation rather than promote it. The theoretical answer is that, as a government-granted monopoly, patents embed both incentives — at the margin they increase the incentive to create new patentable knowledge while also slowing or stifling the dissemination of that knowledge, and/or knowledge deemed too close to it. The fine balance of managing the tradeoff between those two effects is the objective of a “good” patent law, because to get net benefits the breadth and duration of the allowed patents has to be enough to be stimulative, but not so much that it deters other innovative activity. A good patent law allows differentiation of breadth and depth for different types of inventions in different areas/industries, and holds diligently to the “non-obvious” requirement that is written into U.S. patent law and is part of any economic theory of intellectual property.

It’s increasingly clear, particularly in technology, that the U.S. patent law is not striking that balance, and is instead doing more of what Michele Boldrin characterizes as using the political and patent process to protect monopoly rents (as per a post I wrote on the topic in 2009, with links worth pursuing). At least to me, some of Honeywell’s patents don’t pass the common sense/non-obvious test, such as their “natural language temperature range setting” patent.

In following up on their extensive reporting at Earth2Tech yesterday, which Mike linked to in his post, Katie Fehrenbacher today offers several reasons why she thinks this Honeywell lawsuit will in fact deter innovation. She agrees with me that the natural language patent does not pass the “non-obvious” test, and she also discusses the cost of a patent war, the David/Goliath nature of this lawsuit, and some other important reasons why this lawsuit may bode poorly for robust innovation in the home energy technology space.

Will the gas boom go bust?

Michael Giberson

Over at the Oil Drum appears an article under the heading, “Gas Boom Goes Bust.” The author compiles many data charts – big picture, close-up, long run and short, etc. – quotes a few other writers and a few headlines, and eventually arrives at this conclusion:

The bottom line is that natural gas is a cyclical industry which recently enjoyed a very large boom. As night follows day, a bust is sure to come. Based on the information presented above, I would humbly submit that it has just arrived.

Among all of the charts and graphs, I take the essential points to be that some natural gas developers, including some important ones, have employed financial strategies enabling them to avoid the harmful consequences of low gas prices so far, but gas prices are now so low and projected to stay low for so long that these strategies are no longer available. The author expects to see some developers in bankruptcy court this year – evidence of the bust.

But this diagnosis seems to confuse the fortunes of a few (or even many) businesses with the outlook for the market. The natural gas boom was never about the fortunes of individual natural gas developers, it was about the ample supplies of natural gas coming into the market.

Companies may well go bust, but the gas boom itself continues.

Honeywell International Inc. claims Nest thermostat infringes on patents in federal court lawsuit

Michael Giberson

Economist Alex Tabarrok, author of Launching the Innovation Renaissance and Marginal Revolution blogger, worries that the proliferation of patents is stifling innovation, particularly patents for business processes. In an interview with Russ Roberts for EconTalk, Tabarrok remarked that large companies like Apple, Microsoft and Google building up massive numbers of patents mostly to insulate themselves from costly patent battles. One side effect of this defensive effort is that smaller innovators can themselves end up in costly patent battles when trying to innovate in the same product space.

Maybe Tabarrok has another example on his hands.

This morning Honeywell International, Inc. (market capitalization of more than $46 billion) filed a patent infringement lawsuit against little Nest Labs, Inc. (unknown capitalization, but backed by a number of venture capital firms). Honeywell is also suing retailer Best Buy which has a marketing arrangement with Nest Lab. (Prior link goes to the lawsuit. More: news release, reports by GigaOm, Mashable Tech, GreenWire, Dow Jones Newswires, and CNet.)

Honeywell asserts Nest infringed several patents: one for methods that use natural language to decrease the time and complexity of programming a thermostat, another for thermostats that indicate how long it will take to reach a desired temperature, another for a thermostat that relies on remotely stored data to manage energy costs, another three patents related to having a rotating portion of the thermostat set one or more parameters of the device, and finally, a patent for powering a thermostat by drawing power from one or more of the circuits controlled by the thermostat. All of the patents have been issued since 2005.

I have no insights into the workings of the intellectual property system, and I’ll spare you my unrefined attitudes on the matter. My only interest is in encouraging innovation that supports energy users.

RELATED, from Quora: What is it like to own a Nest thermostat?

BELOW, image of a Honeywell thermostat app running on a tablet computer.

Honeywell Total Connect Comfort Systems.

With a Honeywell Total Connect Comfort System you can sit in your dining room and adjust the room temperature settings for the master bedroom!

ALSO: Previously on KP, “Nest’s elegant learning thermostat — but is it transactive?

Super Bowl price gouging complaints

Michael Giberson

If you follow price gouging headlines, you become accustomed to seeing price gouging stories around big sports events: the Rugby World Cup, NASCAR races, NCAA basketball finals, and always the Olympics (a selection: Barcelona 1992, Atlanta 1996, Sydney 2000, Salt Lake City 2002, Athens 2004Vancouver 2010, London 2012, and finally this extreme example).

All of which serves as context to reports of Super Bowl price gouging.

Super Bowls usually produce price gouging complaints. But, as a story about today’s Super Bowl reports, rates in Indianapolis may have a particularly strong mark-up because of the relatively small host city. “This is what happens when the NFL books the nation’s largest sporting event in a city with only 6,000 hotel rooms. … By population, Indianapolis is the smallest Super Bowl city since Jacksonville, Fla., which hosted a disastrous game in 2005.”

Rooms are not in perfectly inelastic supply, non-traditional spaces from spare bedrooms to whole houses are being rented out for the week. Nonetheless, supply is relatively inelastic, and it is only the relatively high prices visitors are willing to pay that brings many of these spaces into the market. A surge in demand and relatively inelastic supply: elementary economics predicts a substantial increase in price.

Host city officials, league officials, and fans often lament price gouging, but it is easy enough to predict the effect of any law or custom that prevented it: more people renting rooms one, two, or more hours away, fewer people at game weekend events and pre-game events, and more people stuck in worse traffic before and after the game. (Or, perhaps in a language more relevant to host city officials, an effective anti-price gouging campaign would mean a smaller bump tax in local tax receipts from folks attending the game.)

The fundamental issue is the relative scarcity of rooms during the game weekend, and the question is how to match fans and rooms. Letting prices work earns price gouging complaints, but failing to let prices work would surely create worse problems.

The “100 mpg prize” and other energy stories

Michael Giberson

Speed blogging a few stories:

“The ’100 mpg prize’: An idea whose time has passed?” by Ken Paulman

Earlier this week, California GOP Rep. Dan Lungren introduced a bill that would offer a $1 billion prize to the first automaker than can put 60,000 cars achieving 100 mpg on the road. Only requirement – the cars have to run on gasoline.

The bill is intended as an alternative to further government investment in electric and hybrid cars. And once you get past the irony that the party that excoriates “picking winners and losers” wants to predetermine what kind of fuel we’ll all be using in the future, it’s hard to argue with an effort to develop more efficient gasoline cars. After all, even by the rosiest of projections, the majority of cars on the road 20 years from now will still run on gas.

So can government bounties for innovation work?

Paulman takes a long at the 18th century history of The Longitude Prize. I wonder if the various X Prizes would be a better, since more recent, analog.

“Revolt Brews as Tepco Seeks Higher Rates” by Phred Dvorak and Mitsuru Obe in the Wall Street Journal. (Sub.)

TOKYO—Tokyo Electric Power Co. and other utilities are starting to see revolt by some of their biggest customers, as rising fuel costs and the shutdown of nuclear reactors push Japan’s already-steep electricity costs even higher.

A handful of companies, such as Tokyo Steel Co. and cosmetics maker Kose Corp., have said they are considering switching electricity providers if Tepco, Japan’s biggest utility, boosts corporate rates around 17% as proposed in January. Other customers have complained privately, Tepco said.

It is possible for large consumers to switch power providers in Japan, but complicated, and the tight supply market is making a switch even harder to arrange. I wonder if the challenges will push Japan toward a more regimented market or a more liberalized power market?

ALSO: Energy secretary backs natural gas exports at least for now, though the logic is a bit convoluted. (“The low price of natural gas is hurting domestic job growth” and “Exporting natural gas means wealth comes into the United States.” Okay, Mr. Secretary, so do you think the high price of oil is good for domestic job growth? Does importing oil mean wealth leaves the United States?

AND: Sierra Club took $26M from gas industry to fight coal-fired plants. So is this like one bootlegger funding a baptist campaign against the other bootleggers? The Sierra Club decided to stop taking the money in 2010 (mostly from Chesapeake Energy’s CEO Aubrey McClendon) after deciding it didn’t want money from fracked natural gas wealth.

FINALLY: Gasland‘s Josh Fox arrested at U.S. House hearing on fracking. Apparently his request to film was declined because his crew didn’t have Capitol media clearance, and he took his crew to the hearing anyway. The linked report says he knew there was a chance he’d be arrested, and it is likely the case that the arrest will be much more valuable to him than actually filming the hearing would have been. (Here is the House Science Committee subsequent statement on media coverage of the hearing; it mentions that the event was webcast and is now archived on the committee’s website. See link on this page. Unfortunately, all the fun happened before the meeting begun.)