There is only one energy source in the world right now with declining marginal production costs, soaring reserves and extraction rates, and compelling cost competitiveness with crude oil. Unsurprisingly, it has emerged not as the result of subsidized government 'green energy' initiatives, but from a handful of entrepreneurial small US exploration companies whose technical innovation has transformed the US gas market, to the extent that multi-billion dollar LNG import terminals built over the last decade lie unused as surging local supply has supplanted foreign.  Could crude oil follow the fate of LNG imports, as the US moves to energy independence? Conceivably, if Washington stops wasting resources on hopelessly immature alternative energy technologies and focuses on rapidly transforming the country's truck and car fleet to natural gas in compressed form.

Mandated corn ethanol use has been one of the most ludicrous and wasteful policies to ever emanate from Washington, and that takes some doing. Not only is the energy return on investment marginal to negative (i.e. you use more fossil fuel energy in its production that you get back in biofuel energy) but it will act to boost food inflation globally. Solar and wind are not only hopelessly uncompetitive  at much less than $200 oil, but without a revolution in large-scale energy storage and a digital transmission grid, their contribution will be marginal both to cutting carbon emissions and improving energy security. Gas has none of these issues, and its use in both power generation and as a vehicle fuel is based on proven and easily scalable technologies. There is a real urgency to a rational and coherent US energy policy, as non-OPEC production has failed to respond to soaring prices over the last 6 years, as seen in the chart below. Russian production now seems to be peaking, partly because of re-nationalization of key producers like Yukos. This underpins the secular rise in the real cost of oil, with discovery costs alone up from $4 to $24 in a decade, and the marginal production costs of key new discoveries at $70 plus.

The key to the gas production revolution has been hydraulic fracturing, or “fracking”, a technique to force liquids through a drill hole at high pressure to create cracks in gas or oil-bearing rock. The gas or oil flows through those artificial cracks to the wellbore. To keep the cracks open, the operator may mix in “proppant”, such as tiny ceramic spheres. It all requires a lot of expensive equipment and skilled operators. There is some controversy over well depletion rates and potential water table contamination, but I've seen little to convince me that this isn't a huge additional energy source for decades to come. Proven reserves have risen to 245 trillion cubic feet (Tcf) in 2008 from 177 Tcf in 2000, despite having produced nearly 165 Tcf during those years. The recent increase in estimated U.S. gas reserves is equivalent to more than half of the total proved reserves of Qatar, the new LNG powerhouse. At current levels of demand, the U.S. has about 90 years of proven and potential supply,a level likely to rise as more and more shale gas is found. It makes gas the most obvious 'green' fuel for next generation power plants to replace coal.

Right now, US gas inventories are at all time highs, and storage is near full capacity; gas needs an unusually cold winter to support the recent rally from sub $3 to above $5/mcf. The clearing price near-term will be set by the industry's cost structure, which is in the $5-6 range. Medium term, the dramatic fall in gas rigs from 1600 a year ago to 700 odd now should support a rally to $7-9/mcf by mid 2010. If winter demand doesn't eat into excess supplies, another couple of quarters of 3.5-4% US GDP growth should help do so. I was bullish on gas stocks in late Spring and they had a great run through Summer, but there are few obvious value plays at the moment. Nonetheless, for the wider US economy those gutsy Texan gas drillers have provided the basis for an escape from the OPEC stranglehold, if politicians have the vision to seize it.