Economy of scale is the advantage that firms obtained though increasing the scale of production or operation. Under economy of scale, enterprises have less product marginal cost and more outputs, thus there will be less fixed cost per unit because the fixed costs will be separated to more products. This advantage helps firms to improve efficiency and earn more profit.
However, this rule in economy is not fit in natural gas industry in US.
Reported in WSJ, A new breed of Energy Company is a hit with investors using a mantra long scorned in the oil-and-gas business: Small is beautiful. Actually many years ago, energy firms in US still believed in the economy of scale. At that time the Shale Boom happened thus gas extractors hunted for more and more large scale gas fields. They believed that more reserves and production they owned, the lower their marginal cost and more profits would they have. However, we all know what happened next, the huge amount of natural gas reduce the prices dramatically without much changes in marginal cost. Those big gas companies earned revenues that cannot even cover their marginal costs.
Now the investment opinion is reversed. Investors trust that the “quality” is more important than “sheer number”. This is to say, they gave up the old believes of economy of scale, now the cost of certain gas extractor is more notable. “It’s quality over quantity. We don’t have one million acres and we don’t strive to have one million acres,” says Daniel Rice IV, the 33-year-old chief executive of Rice Energy Inc.
The good news is that US government is preparing for its natural gas export terminals. According to WSJ, the Obama administration’s approval of a seventh application to export natural gas. Some lawmakers agreed with such a decision because the domestic natural gas companies are hungering for increasing in natural gas prices. The exportation can decrease the domestic supply thus raise the prices. Others who disagree this decision said that some jobs could be affected, also the domestic electricity price could also raise.
The reason why economy of scale failed in this market is that supply exceeded demand, so the effective choice for gas companies is to reduce their supply. Reported in WSJ, natural-gas prices on Thursday posted their biggest one-day gain in two months after a smaller-than-expected increase in U.S. inventories reignited fears that supplies are too low. This fear was caused by two reasons: first after this long winter, the gas supplies appeared to be scarce; second the export plan made gas supplies to be less than expected.
It’s essential for those firms to find a way to earn profits and make their business sustainable. We can wait to what will happen in the future about this industry.