On the Cusp of the Natural Gas Era

Stephen DeAngelis

July 13, 2010

News about energy in the U.S. media has recently been dominated by stories about the BP oil spill in the Gulf of Mexico. The spill has outraged most people and the environmental consequences of the spill will be felt for years if not decades. The eventual financial and public relations costs to BP will be enormous. The spill has once again sharpened the debate about energy security and the need to reduce America’s reliance on oil. President Obama is hoping that the spill will help him get a comprehensive energy bill passed through Congress. Environmentalists hope the spill will spark greater enthusiasm for green technologies. People living along the Gulf Coast are just hoping that life will eventually get back to normal.

 

Amid all the clamor about the spill and discussions about the future of oil, big changes have been quietly taking place in the natural gas sector. Daniel Yergin and Robert Ineson, well-known energy analysts, claim, “The biggest energy innovation of the decade is natural gas.” [“America’s Natural Gas Revolution,” Wall Street Journal, 2 November 2009]. They note that some people have even claimed that what is happening in the natural gas sector is a “revolution.” The focus of all of this hyperbole is what Yergin and Ineson call “unconventional natural gas.” They explain:

“The natural gas revolution has unfolded with no great fanfare, no grand opening ceremony, no ribbon cutting. It just crept up. In 1990, unconventional gas—from shales, coal-bed methane and so-called ‘tight’ formations—was about 10% of total U.S. production. Today it is around 40%, and growing fast, with shale gas by far the biggest part. The potential of this ‘shale gale’ only really became clear around 2007. In Washington, D.C., the discovery has come later—only in the last few months. Yet it is already changing the national energy dialogue and overall energy outlook in the U.S.—and could change the global natural gas balance.”

When you are talking about the “global natural gas balance,” Russia must immediately enter the discussion. Russia holds the world’s largest natural gas reserves and is the world’s largest exporter of natural gas. If the world is about to enter the natural gas era, Russia’s future is bright indeed. Yergin and Ineson, however, are looking closer to home (i.e., the U.S.) when they talk about changing the global natural gas balance. They continue:

“From the time of the California energy crisis at the beginning of this decade, it appeared that the U.S. was headed for an extended period of tight supplies, even shortages, of natural gas. While gas has many favorable attributes—as a clean, relatively low-carbon fuel—abundance did not appear to be one of them. Prices had gone up, but increased drilling failed to bring forth additional supplies. The U.S., it seemed, was destined to become much more integrated into the global gas market, with increasing imports of liquefied natural gas (LNG). But a few companies were trying to solve a perennial problem: how to liberate shale gas—the plentiful natural gas supplies locked away in the impermeable shale. The experimental lab was a sprawling area called the Barnett Shale in the environs of Fort Worth, Texas. The companies were experimenting with two technologies. One was horizontal drilling. Instead of merely drilling straight down into the resource, horizontal wells go sideways after a certain depth, opening up a much larger area of the resource-bearing formation. The other technology is known as hydraulic fracturing, or ‘fracking.’ Here, the producer injects a mixture of water and sand at high pressure to create multiple fractures throughout the rock, liberating the trapped gas to flow into the well. The critical but little-recognized breakthrough was early in this decade—finding a way to meld together these two increasingly complex technologies to finally crack the shale rock, and thus crack the code for a major new resource. It was not a single eureka moment, but rather the result of incremental experimentation and technical skill. The success freed the gas to flow in greater volumes and at a much lower unit cost than previously thought possible.”

This “breakthrough,” however, has not been universally welcomed. There are a number of concerns about the practice of hydraulic fracturing. To learn more, read my post entitled Concern Growing Over Energy, Water, and Hydraulic Fracturing. The EPA has now joined those concerned about how new drilling could affect water supplies [“EPA to study natural-gas drilling’s effect on water,” by Juliet Eilperin, Washington Post, 19 March 2010]. Drilling for natural gas has also caused angst amongst environmentalists. Most environmentalists would prefer to see electricity generated by natural gas-powered plants rather than coal-powered plants. Natural gas is less carbon-intensive than coal (by about 50 per cent) and less carbon-intensive than oil by about 30 per cent. Infrastructure exists to carry natural gas throughout the country, which gives it an edge over renewables. On the other hand, environmentalists are concerned about unforeseen consequences of increased drilling [“Sierra Club’s Pro-Gas Dilemma,” by Ben Casselman, Wall Street Journal, 22 December 2009]. Casselman’s article was particularly focused on new drilling taking place in New York. As Yergin and Ineson report, natural gas is now being recovered from shale deposits in Louisiana, Arkansas, and British Columbia as well as Texas and New York. They continue:

“The supply impact has been dramatic. In the lower 48, states thought to be in decline as a natural gas source, production surged an astonishing 15% from the beginning of 2007 to mid-2008. This increase is more than most other countries produce in total. Equally dramatic is the effect on U.S. reserves. 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 by the Potential Gas Committee, representing both academic and industry experts, is in itself equivalent to more than half of the total proved reserves of Qatar, the new LNG powerhouse. With more drilling experience, U.S. estimates are likely to rise dramatically in the next few years. At current levels of demand, the U.S. has about 90 years of proven and potential supply—a number that is bound to go up as more and more shale gas is found.”

Since Yergin and Ineson brought Qatar into the conversation, it is worth noting that Qatar is trying to be as creative as possible promoting its natural gas reserves. In addition to providing LNG to customers, Qatar is experimenting with turning gas into liquid oil [“Qatar on the Cusp,” by By Stanley Reed and Robert Tuttle, Bloomberg BusinessWeek, 11 March 2010]. The reason is simple, oil (at the moment) is worth more than natural gas. Reed and Tuttle report:

“Crude sells at a 300% per-Btu premium to gas, almost double the average spread of the past five years. Qatar’s gas is especially hard to monetize because it lies far from Europe and Asia. So the Qataris are now completing the last two of 14 plants, several of which are larger than any elsewhere in the world, that cool natural gas into a liquid that can be transported by ship to distant markets. And Royal Dutch Shell is aiming for an even more splendid alchemy with a $19 billion project that turns gas into liquid oil products such as jet fuel. These oil spin-offs fetch as much as $90 a barrel and form a hedge against low gas prices.”

To prove the viability of liquid oil obtained from natural gas, “Qatar Airways said it has completed the world’s first commercial passenger flight powered by kerosene made from natural gas” [“Qatar Flies Natural-Gas-Fueled Plane,” by Stefania Bianchi, Wall Street Journal, 14 October 2009]. According to Bianchi, “analysts questioned whether the fuel can significantly further the aviation industry’s efforts to reduce its dependency on oil-based kerosene.” Qatar, however, is interested in revenue not necessarily in saving the aviation industry. Qatar holds the world’s third largest natural gas reserves behind Russia and Iran. To learn more about the Qatar/Shell effort to transform gas into liquid oil, read a companion article by Reed and Tuttle [“Gas into Oil: Shell’s Water-into-Wine Project,” Bloomberg BusinessWeek, 11 March 2010].

Yergin and Ineson claim that America’s newfound reserves are “a game changer” and they rhetorically ask, “But what is getting changed?” Their answer:

“It transforms the debate over generating electricity. The U.S. electric power industry faces very big questions about fuel choice and what kind of new generating capacity to build. In the face of new climate regulations, the increased availability of gas will likely lead to more natural gas consumption in electric power because of gas’s relatively lower CO2 emissions. Natural gas power plants can also be built more quickly than coal-fired plants. Some areas like Pennsylvania and New York, traditionally importers of the bulk of their energy from elsewhere, will instead become energy producers. It could also mean that more buses and truck fleets will be converted to natural gas. Energy-intensive manufacturing companies, which have been moving overseas in search of cheaper energy in order to remain globally competitive, may now stay home. But these industrial users and the utilities with their long investment horizons—both of which have been whipsawed by recurrent cycles of shortage and surplus in natural gas over several decades—are inherently skeptical and will require further confirmation of a sustained shale gale before committing. More abundant gas will have another, not so well recognized effect—facilitating renewable development. Sources like wind and solar are ‘intermittent.’ When the wind doesn’t blow and the sun doesn’t shine, something has to pick up the slack, and that something is likely to be natural-gas fired electric generation. This need will become more acute as the mandates for renewable electric power grow.”

Yergin and Ineson do acknowledge that fears over how renewed drilling could affect water supplies are a “serious obstacle” to natural gas’ future in the U.S. They believe, however, the concern is overblown:

“The most visible concern is the fear in some quarters that hydrocarbons or chemicals used in fracking might flow into aquifers that supply drinking water. However, in most instances, the gas-bearing and water-bearing layers are widely separated by thousands of vertical feet, as well as by rock, with the gas being much deeper. Therefore, the hydraulic fracturing of gas shales is unlikely to contaminate drinking water. The risks of contamination from surface handling of wastes, common to all industrial processes, requires continued care. While fracking uses a good deal of water, it is actually less water-intensive than many other types of energy production.”

Having dismissed what they see as the only major obstacle to further natural gas exploration and development, Yergin and Ineson discuss the future:

“Unconventional natural gas has already had a global impact. With the U.S. market now oversupplied, and storage filled to the brim, there’s been much less room for LNG. As a result more LNG is going into Europe, leading to lower spot prices and talk of modifying long-term contracts. But is unconventional natural gas going to go global? Preliminary estimates suggest that shale gas resources around the world could be equivalent to or even greater than current proven natural gas reserves. Perhaps much greater. But here in the U.S., our independent oil and gas sector, open markets and private ownership of mineral rights facilitated development. Elsewhere development will require negotiations with governments, and potentially complex regulatory processes. Existing long-term contracts, common in much of the natural gas industry outside the U.S., could be another obstacle. Extensive new networks of pipelines and infrastructure will have to be built. And many parts of the world still have ample conventional gas to develop first. Yet interest and activity are picking up smartly outside North America. A shale gas revolution in Europe and Asia would change the competitive dynamics of the globalized gas market, altering economic calculations and international politics. This new innovation will take time to establish its global credentials. The U.S. is really only beginning to grapple with the significance. It may be half a decade before the strength of the unconventional gas revolution outside North America can be properly assessed. But what has begun as the shale gale in the U.S. could end up being an increasingly powerful wind that blows through the world economy.”

Yergin and Ineson note, but downplay, the fact that “storage [is] filled to the brim.” Other analysts believe that the lack of natural gas storage could be a “knockout blow … lurking underground” [“US natural gas storage worries grow,” by Gregory Meyer, Financial Times, 27 August 2009]. Once gas producers have stuffed as much gas into salt caverns, aquifers and depleted oil wells as they can, their only alternative will be to involuntarily shut down production. Despite concerns over storage, others agree with Yergin and Ineson that shale gas is going to be a game changer [“Shale Gas Will Rock the World,” by Amy Myers Jaffe, Wall Street Journal, 10 May 2010; “Shale gas will change the world,” by Gideon Rachman, Financial Times, 25 May 2010; and “The ‘shale gale’ turns outlook on its head,” by Sheila McNulty, Financial Times, 26 May 2010].

Jaffe is the Wallace S. Wilson Fellow for Energy Studies at the James A. Baker III Institute for Public Policy at Rice University. She reflects a fairly wide-held American view about energy security. She writes:

“Political fallout from shale gas will … throw world politics for a loop—putting some longtime troublemakers in their place and possibly bringing some rivals into the Western fold. … What’s important to understand is that shale gas may be the key to solving some of our most pressing short-term crises, a way to bridge the gap to a more-secure energy and economic future. The trade deficit has crippled our economy and shows no signs of abating as long as we remain tethered to imported energy. Why ship dollars abroad where they can destabilize global financial markets—and then hit us back in lost jobs and savings—when we can develop the resources we have here in our own country? Shall we pay Vladimir Putin and Mahmoud Ahmadinejad to develop our natural gas—or the citizens of Pennsylvania and Louisiana?”

Rachman reports that “this year, the US overtook Russia to become the world’s biggest gas producer for the first time in a decade.” He agrees with Jaffe that shale gas has produced siginificant political fallout, especially with regards to European/Russia relations. He concludes:

“There are shale gas sceptics. Some veterans of the energy industry point out that there have been false dawns before – miraculous new sources of energy that disappointed in the end. It is true enough that most miracle cures fail – in energy, as in most other walks of life. But it is also true that predictions in the 1970s that the world was ‘running out’ of fuel were disproved by a combination of technological advances and new discoveries – precisely the combination offered by shale gas. … In the short term, increased use of gas will make it much easier for the US and Europe to cut emissions of carbon dioxide, because gas is much less polluting than coal. On the other hand, shale gas is still a fossil fuel and produces greenhouse gases. For those environmentalists who dream of a future powered by windmills and solar panels, the dash for gas is a distinctly mixed blessing. Of course, shale gas cannot be a complete answer to the west’s energy security problems – far less to climate change. But in a world that is not short of bad tidings at the moment, shale gas is a welcome piece of genuinely good news.”

McNulty reports that enthusiasm for shale gas doesn’t seem to have spread to Washington; but, she does note that “negative publicity about shale seems to have slowed.” She concludes, “With the offshore industry coming under increasing pressure amid the oil leak in the Gulf of Mexico, shale gas might finally find a way to move to the top of lawmakers’ agendas.” Even if shale gas does rise to top of the agenda, however, proponents are going to find fierce opposition from lawmakers in coal-producing states. Clifford Krauss reports, “For all its pronouncements that gas could be used to replace aging, inefficient coal-fired power plants — and reduce greenhouse gas emissions in the process — lawmakers from coal-producing states appear committed to keeping coal as the nation’s primary producer of power.” [“Natural Gas Hits a Roadblock in New Energy Bill,” New York Times, 6 September 2009]. Those lawmakers have found allies among analysts who believe that economic arguments about shale don’t add up [“A glimpse through the smoke and mirrors of shale economics,” by John Dizard, Financial Times, 20 March 2010]. Dizard writes:

“There is a grim argument in the energy industry over how much it really costs to produce natural gas from shale rock. The advocates of favorable shale gas economics seem to be winning, for now. That means energy bankers are kept busy selling interests in shale assets. You would think this is an easy question to answer. Industry or government accountants could add up commonly agreed numbers for the nation’s additions of gas reserves from shale, total the bills of shale gas exploration and production companies, and divide the one figure with the other, discounted for net present value. You would be wrong. The data and analytic methods are not commonly agreed. This is disturbing. If more shale gas can only be produced with much greater difficulty, at far higher prices than believed, the clean energy future will be far less sunny than we see in all those advertisements and conference programs.”

Dizard notes that “today’s spot price [for natural gas] is around $4.50 per mcf (thousand cubic foot). Three years out this creeps close to $6.” Using the best data he can find, he estimates that “the shale gas industry really needs a price of $7.50-$8 to break even on its all-in costs of finding and producing the stuff, which would be a 60 per cent price rise.” He admits that some people argue his numbers are wrong, but he sticks by them. He writes, “My industry sources’ numbers all converged close to $8 per mcf.” He doesn’t believe the industry will really start making money until the current spot price is doubled to around $10 per mcf. Faced with a global glut of natural gas, that doesn’t seem likely to happen unless natural gas usage dramatically increases demand. Faced with those numbers, the natural gas industry has to be encouraged by a recent study that predicts the demand for natural gas is going to double over the next several decades [“Study Says Natural Gas Use Likely to Double,” by Matthew L. Wald, New York Times, 24 June 2010]. Wald reports:

“Natural gas will provide an increasing share of America’s energy needs over the next several decades, doubling its share of the energy market to 40 percent, from 20 percent, according to a report to be released Friday by the Massachusetts Institute of Technology. The increase, the report concluded, will come largely at the expense of coal and will be driven both by abundant supplies of natural gas — made more available by shale drilling — and by measures to restrict the carbon dioxide emissions that are linked to climate change.”

There is a caveat to this otherwise rosy report and that is that “the future may be dimmer for natural gas if stricter regulations are put in place to cut greenhouse gas emissions by 80 percent below 1990 levels by 2050 — a goal set by President Obama.” The reason is that even though natural gas is less carbon intensive than coal it can’t achieve the stated gas emission goal by itself. Some method of carbon capture would have to be used and coal producers claim that if carbon capture has to be used, coal is a cheaper way forward. Wald continues:

“Gas will eventually replace some of the coal used to make electricity, the study predicts, and gas will be the benchmark against which other carbon-saving technologies like wind or nuclear will be measured. But those other technologies will eventually be needed. Some companies that make equipment for coal- and gas-fired generating stations say that the switch to gas from coal has already begun. One reason is that switching to gas will make it easier to meet air quality standards for conventional pollutants, like smog and mercury. The study noted that the only natural gas car sold by a major car company in the United States, the Honda GX, costs an extra $5,500, while the VW Passat TSI Eco-fuel, sold only in Europe, costs only $3,700 extra. Converting a gasoline vehicle to natural gas is also much more expensive here than in Europe, the report said, and it suggests that the reasons be examined. High-mileage fleet vehicles, like taxis, could be economically converted to natural gas, the study said. But the recent history of natural gas vehicles in the United States suggests that buses and small delivery vehicles are more likely candidates for conversion than the great mass of privately owned vehicles. Natural gas vehicles emit about three-quarters as much carbon dioxide per mile as gasoline-powered ones. The switch would not have a large impact on carbon — only about a ton per vehicle per year for a typical American car, according to the report.”

America’s leading proponent of a switch to a natural gas economy, T. Boone Pickens, “said that the study paid too much attention to the electricity sector and not enough to using natural gas as a substitute for gasoline and diesel in transportation. Wald continues:

“Natural gas has an erratic price history, which has made some American electric utilities nervous about overreliance. But ‘abundant global natural gas resources imply greatly expanded natural gas use,’ the study concluded. Globally, the average projection of the amount of recoverable gas represents about a century and a half’s supply at current rates of consumption, the report noted. In the United States, the amount of recoverable gas is equal to 92 times the consumption last year, the study said. Especially in the United States, one reason for new optimism about supplies is the success that drillers have had exploring shale formations for natural gas.”

Without having read the report, it appears that it accepts the arguments of the natural gas industry that it can recover and sell shale gas at an affordable cost. If Dizard’s numbers are correct, that might not be a good assumption. The final chapter of the shale gas story has yet to be written. How it unfolds will be very interesting and the stakes will remain high.