January 11, 2012 § 6 Comments
An interesting post in the New Republic discusses the merits of a policy permitting export of natural gas in the form of liquefied natural gas (LNG). The author Mark Muro of the Brookings Institution also cites a letter written by US Rep. Ed Markey to Energy Secretary Chu arguing against approval of export. As it stands export of natural gas requires an explicit approval, as is currently granted to ConocoPhillips for the limited export of LNG from the Cook Inlet in Alaska.
They both make the same principal arguments. One is that even with shale gas resources the supply is limited and so massive exports will increase the price for the consumer and industry. Markey is quoted as being particularly concerned regarding the possible deleterious effect on replacing coal in power plants. Here we shall address these concerns and then end on the note of the policy actions most beneficial for the nation.
A report on January 7, 2011 indicates that the DOE has made the decision to grant Cheniere Energy a permit to export up to 803 billion cubic feet (bcf) per annum sourced from domestic gas. They already were permitted to re-export LNG from other countries. This is a company that got caught flat footed by the emergence of shale gas. Their business premise had been imported LNG for a gas deficient country. Having competency in the arena they decided to liquefy and export. Now they appear permitted to do that.
Effect on price and coal substitution: The latest annual figures available on natural gas production are from 2010. The U.S. marketed production was 22.6 trillion cubic feet (tcf) net of imports of 2200 bcf. In other words, we were importing 10% of our needs just a year ago. The 2011 figures are almost certainly in the direction of higher net marketed production. But even with using 2010 figures one sees that the Cheniere permit is for 3.5% of the net production. Four units will be added sequentially starting in 2015, ending in the 803 bcf figure in about two years. The economists amongst you be the judges, but it seems to me this tail is not wagging the pricing dog. Besides, all the projected growth in shale gas production dwarfs these figures.
Just for the sake of argument, let us say the price did go up due to the exports, and examine Rep. Markey’s quoted concern regarding affecting coal substitution. We have reported earlier our model showing that the breakeven price of natural gas versus coal is $8 per million BTU (MMBTU) against the backdrop of price today (January 11, 2012) of $3. This is for newer design efficient supercritical combustion coal plants meeting emissions specifications. Also, this breakeven does not take into account any price on carbon. If coal plant carbon dioxide was reduced to natural gas plant levels, this would add at least $3 to the above figure.
LNG export is not in the national interest: The foregoing notwithstanding, we must not export natural gas in any form in favor of producing and exporting a higher value product. The single most valuable such high volume product is ammonia based fertilizer. (Carbon black would be higher value but is a smaller market) Until recently, the U.S. imported half the fertilizer consumed. This is because variable and high prices in the early part of the century caused many manufacturers to relocate abroad to areas of cheap gas such as the Middle East. Now with the prospect of cheap and stable shale gas, many of these are returning. No doubt the chemical industry is skittish about LNG export concepts because it could vitiate the business assumptions of low cost, were the prices to rise due to massive export of gas. We have discussed that the one Cheniere permit is unlikely to have a big effect, but many such could.
Aside from the pricing issue, another reason to export product rather than gas is simple economics. Take the example of anhydrous ammonia, the basic building block for nitrogen fertilizer manufacture. About 33.3 mcf gas converts to 1 ton of anhydrous ammonia. The gas value, using $4 per mcf is $134. The value of the anhydrous ammonia is in the vicinity of $800. Also, domestic labor was used to get it to that state. Sure the landed price of the gas as LNG is higher; about double that of the gas, but all that value add does not contribute to the domestic economy. Even the ship was probably made in Korea.
Cheap and plentiful shale gas has transformed the US chemical industry. They are in a position to go from a major importer to exporter of essential chemicals such as fertilizer and ethylene and derivative products. Limiting that potential would be a mistake. Exports should comprise high value processed products rather than the raw gas, retaining the value created and the jobs in this country.
December 20, 2011 § Leave a Comment
A recent NY Times story has a very interesting take on the environmental movement and changes therein. These organizations in the past have taken national or even global approaches to the issues. The rise of global ambient temperatures caused by greenhouse gases is a case in point.
The general public can be left cold at two levels. One is that global issues do not resonate with a lot of folks, local ones do. The other is the discounting of future privation. This is not unlike discounting future earnings in finance; a discount rate is applied which gives a lower present value. Similarly, future suffering is discounted, especially when it is 40 years out, as are most global warming warnings. Rising water levels on a Florida beach 40 years hence (and only a maybe at that) has little resonance with the public in Wyoming. One could call it two degrees of separation.
The Times story draws a clever analogy. If a consumer is walking down a grocery store aisle and she sees a box with a delectable brownie on the face, she may be attracted to it. Some might look at the back of the box detailing the information indicative of an obese future for the consumer of the goods. Even though the future in this case is more in the short term than the aforementioned global warming one, the choice of looking at the back is personal and will not happen all the time.
Environmental organizations are credited with focusing simply on the back of the box. This stuff is bad for you, we want saturated fat detailed, and we want the warnings to be explicit, and so on. Interestingly the smoking hazard warnings are in front of the box and likely work better. In this example, the context is local, so that problem is not there. You simply may not get the attention of the consumer.
According to the story, some of these organizations are getting the message. They are going local and in front of the box. The first is simply a matter of organization, but the second is a bit harder, because the messaging has to hit at the value system. Ocean rise 40 years hence will not play. Asthma risk now for their children will. So, the Sierra Club is focusing on individual coal burning power plants and their presumed effects upon the local population. Shutting these older plants down one by one is the strategy. They have had considerable success and operate in 46 states.
About 40% of coal plants not expected to conform to upcoming EPA standards are over 50 years old. If the Sierra Club and others have their way, it will not matter whether the EPA rules come down. The arguments in Congress over this could put off that day. But if the ill effects of the polluting plants are placed in front of the box for the public, the plants will likely get shut. Thirteen such are currently slated for this fate by Progress Energy in North Carolina. If shut down effectively through local action, the electricity will still have to be generated in some way. Natural gas is the only viable short to medium term option. The carbon emissions are about half that of coal, and the front of the box arguments regarding particulate emissions, mercury and NOx attributed to coal do not apply. The other option, that of a newer and cleaner coal plant, is not economically justifiable if gas remains relatively cheap. Plentiful shale gas will assure that.
However, shale gas is the target of many activists who are fundamentally opposed to all fossil fuel. The back of the box issues of fugitive emissions of methane will not get much traction, especially because of the esoteric arguments involved in the modeling. So they have taken to the matter of methane contamination of water wells, with the powerful backing of a couple of Duke University professors. This is not ideal front of the box material because methane in drinking water is not believed to be a health hazard. But any perceived taint to drinking water is powerful stuff.
The unfortunate aspect to all of this is that it distracts from the real issues, which are use of fresh water and most importantly, the potential for polluting discharge of flow back water from fracturing operations. The methane contamination of water wells, while possible, is easily correctable by best practices, voluntary or forced by rules and penalties. The other two issues require more effort, technical and organizational, and should be the focus of local community action. In the end the combination of effective legislation, technology, and industry cooperation can deliver cheap gas in an environmentally secure fashion. We just need to take the steps to make that happen. Then the side of the box will not matter.
Thanks to Christa WagnerVinson for bringing the NY Times story to my attention
November 19, 2011 § 1 Comment
On January 7, 2009, Russia shut off the natural gas flowing through the main European pipeline in the Ukraine. This was a particularly cold winter and 20 European countries encountered serious shortfalls. Discussed below are the reasons given by all of the players. But the principal point was, and continues to be, that Russia can use natural gas supplies as a weapon to achieve political objectives. In late 2008, Russia threatened to form a gas based OPEC (dubbed OGEC) with Iran and Qatar with the express intent of manipulating world gas prices. Has shale gas dampened their ardor? More on that below.
Unilateral fuel cut off as an instrument of political will would be essentially not possible with oil. Oil is more fungible, and alternative supplies can be brought to bear if a major supplier falters, deliberately or otherwise. It may cost more but you could get it.
Natural gas is a regional commodity. Bulk transport across land can only be through pipelines, and these are expensive and have long lead times. Transport across the ocean is feasible only if the gas is liquefied. For shorter distances there are exceptions, where gas pipelines cross bodies of water, such as in the North Sea. The liquid product is known as Liquefied Natural Gas (LNG). This process entails cooling the gas to -160° C into a liquid that is 600 times as dense as free gas. This is then transported at near-atmospheric pressure. The low temperatures are maintained by auto-refrigeration by allowing small amounts to boil off, which chills the remaining liquid. An everyday analog is cooling of our skin by a fan or a breeze causing evaporation of our perspiration.
While LNG is a viable alternative to a domestic gas supply, it can only be delivered to a port location, and in fact only one with a re-gas terminal. This high capital cost is unlikely to justify a capability merely to be available for upset conditions. So, as a practical matter withholding of a domestic source is a powerful weapon, LNG alternatives notwithstanding. Also, LNG is more costly. Typically the added cost over the price of the gaseous version is about $3-4 per million British Thermal Units (MMBTU). Transport distance is the determinant of where you are in that range. As a frame of reference, that is roughly the price of natural gas in the US today. So, LNG would essentially double that. This is why cheap shale gas in North America has rendered imported LNG passé.
The sheer distance between producer and user is the reason why natural gas prices are so variable across the world. The price in Europe is about double that in the U.S., and in Japan, about triple. This is in part because costly LNG is the marginal cubic foot, and so sets the price.
Russian Use of Gas as Weapon: Unlike in the Soviet era, Russia can no longer impose its political will through threatened military action. Russian gas is a significant source for most European countries. It is the dominant source for nine countries, including Greece, Finland, Hungary and the Czech Republic. This monopoly allows unilateral action against any one of the countries. Action against too many would result in loss of needed revenue. As a parenthetical point, the Arab Oil Embargo in 1973 had a profound and lasting effect on the price of oil, aside from the short-term privation. But the original political objective was not realized, that of causing a significant shift in support away from Israel. Interestingly, though, the lasting price escalation that was a direct result of the embargo swelled, producing country coffers. This allowed financing of politically motivated actions in other countries, including the funding of Islamic schools known as madrasas in Indonesia and other countries. These are believed by some to be linked to militancy. In any case, there is little doubt that oil money is behind militant Islamism.
In an odd twist, the embargo driven sustained higher prices opened up exploration in promising but costly areas such as ultra deep water and the Arctic, thus reducing dependency on OPEC. Since then, Norway and Brazil have become important players, on the backs of deepwater development.
The Russian action in 2009 was allegedly driven by a dispute with the Ukrainians with respect to poaching on the gas line. While there may have been merit to this, most believe the action was intended to injure the Ukrainian Orange Revolution, which was seen by Russian President Dmitry Medvedev as not commensurate with Russian interests. That the Revolution was suppressed is not in question. The temporal connection strongly implies causality with the gas cut off action. In many ways this act was more effective than would have been a military one. It also undoubtedly sent a message to other European states. Even Western Europe was affected, with southern Germany losing about 60% of its imported gas.
Shale Gas Could Change That: As discussed in a previous chapter, the mechanism by which shale gas accumulates makes it likely to be ubiquitous. So the likelihood of substantial deposits in Europe is high. Initial estimates by the Energy Information Administration (EIA) show large deposits in Poland and France, with smaller amounts elsewhere, including the UK and the Ukraine. Poland is actively exploring and the U.K. is following suit. France currently has a moratorium on fracturing, but is also not as much in strategic need due to low dependency on coal-based power. U.S. efforts to produce gas with a minimal environmental impact will be important in widespread exploitation in Europe. Poland is certainly resolute on the matter. Furthermore, in the U.S., as exploration proceeds, the resource estimates are bound to increase. All new hydrocarbon resource plays follow that pattern.
Gazprom, the mammoth Russian company operating gas assets, has publicly expressed concerns regarding the effect of shale gas on future pricing. The fact that Russia too will have large deposits is irrelevant. A further increase in their resource base is interesting, but not a factor in the concern regarding domestic sources in client countries.
An interesting possibility is that U.S. shale gas could be exported as LNG. Until European deposits are developed, U.S. sourced LNG could be a factor in offsetting Russian supply. If U.S. prices remain low, as is expected, landed LNG in Europe could profitably be at below $9 per MMBTU for some years and closer to $7 today. From a Russian standpoint, this will not be a pricing concern, but certainly the gas as weapon argument is affected. Strictly from an economic perspective, the best sources for North American LNG are Alaska and British Columbia gas, and the most logical target customer is Japan.
OGEC is dead: 60% of the conventional gas reserves reside in Russia, Iran and Qatar. Operating costs are very low, especially in Iran and Qatar. In late 2008, the three announced an intent to form a gas based OPEC, which was dubbed OGEC. (Note: the P in OPEC is Petroleum and by definition, albeit not by common usage, gas is included in the term petroleum, so the acronym OPEC could have applied to gas as well in theory; but with a different cast of characters that would not have made sense.) Alexey Miller, chairman of Russia’s Gazprom, said they were forming a “big gas troika.” He also predicted an end to the era of cheap hydrocarbons, thus signaling the intent of the gas cartel to raise prices and keep them high. OPEC accomplishes this despite supplying only about a quarter of the world’s oil. The Troika would likely have been pretty effective, in part because Russian markets are Europe and China over land, and the other two are much more LNG dependent. So, unlike current OPEC members, at least the senior partner Russia, will be essentially non-compete with the other two except for LNG relief valves for Russian force majeure, contrived or otherwise.
Shale gas over time will kill attempts at OGEC. China is expected to have even more shale gas resource than the U.S. and will exploit it quickly. China National Offshore Oil Corporation (CNOOC) has already taken positions in two U.S. shale gas plays and in the first large one in the U.K. There is little doubt that part of the intent is to transfer technology to China deposits. European shale gas will certainly be a factor. There is reason to believe most of the countries currently importing LNG, including India, have shale gas opportunities. Finally, there is the specter of U.S. as an LNG export player. All of this adds up to a world with a lot of gas in consuming countries and more options. When consumers have options, cartels are ineffective. Gas has always been harder to manipulate than oil. Transportation needs can only be met by oil-derived products. Gas on the other hand can be replaced by coal, wind and solar for power. OGEC can be pronounced DOA, and we have shale gas to thank for that.
November 13, 2011 § Leave a Comment
Few will dispute that shale gas has changed the very make up of the petroleum industry. At every twist and turn new resource estimates appear, each vastly greater than the previous. The estimate in 2008 exceeded the one from 2006 by 38%. As with all resource estimates, be they for rare earth metals or gas, disputes abound. But through all the murk is the inescapable fact: there certainly is a lot of the stuff. How could this suddenly be so? The last such momentous fossil fuel find in North America was the discovery of Alaskan oil. But a discovery out in the nether regions is understandable. In this case we were asked to believe that all this was happening literally in our backyard.
To appreciate what happened we first need to understand how oil and gas is formed and recovered. Millions of years ago marine organisms perished in layers of sediment comprising largely silt and clay. Over time additional layers were deposited and the organic matter comprising the animals and vegetation was subjected to heat and pressure. This converted the matter into immature oil known as kerogen. Further burial continued the transformation to oil and the most mature final form would be methane. By and large the only real difference between oil and gas is the size of the molecule. Methane is the smallest with just one carbon atom. One of the lightest oil components, gasoline, averages about eight carbon atoms. Diesel averages about twelve. So, although we refer to them as oil and gas, chemically they are part of a continuum. So, it is easy to understand that they could come from a single source.
The key word is source. The rock in which the oil or gas originally formed is known as source rock. The figure shows a schematic representation of the location of one such source rock. This is almost always shale, which we told you was some mixture of silt and clay and sometimes some carbonates. Conventionally, the fluid in this rock will migrate to a more porous body.
This is depicted as the sandstone shown, which is predominantly silica, an oxide of silicon. It may also be a carbonate, predominantly calcium carbonate. These two minerals are host to just about every conventional reservoir fluid in the world. The fluid (and by the way gas is a fluid, although not a liquid) migrates “updip” as shown to the upper right. This is because the hydrocarbon is less dense than the water saturated rock and essentially floats up, not unlike oily sheens on your cup of coffee.* This migration continues until stopped by a layer of rock through which fluid does not easily permeate. This is known as a seal, and more colloquially, a cap rock. Ironically this is most usually a shale, not unlike where the fluid originated. The trapped fluid is then tapped for production.
The trap is often a dome as shown in the upper left. It can also be a fault. This is when earth movements cause a portion of the formation to break away and either rise or fall relative to the mating part it just separated from. In some instances a porous fluid filled rock will now butt up against an impermeable one, and a seal is formed laterally.
In the schematic shown the yellow zone would be the sandstone, and the updip fluid shown in red now finds itself abutting an impermeable zone shown in green.
In the early days of prospecting they looked for surface topography indicative of a dome type trap below. These days sound waves reflected back produce excellent images of the subsurface.
Unconventional Gas: We have described how conventional gas, and oil for that matter, are found and produced. The current flurry of activity in shale gas is concerned with going directly to the source. This was previously considered impractical, primarily because the rock has very poor permeability, which is the ease with which fluid will flow in the rock. The permeability of shale is about a million times worse than conventional gas reservoir rock. In fact, as we observed earlier, shale acts as a seal for conventional reservoirs. The breakthrough was the use of hydraulic fracturing. Water is pumped at high pressures, causing a system of fractures. These are then propped open with some ceramic material to hold the cracks open. Without this the sheer weight of the thousands of feet of rock above would close the cracks. The propped open fractures now comprise a network of artificially induced permeability, allowing the gas to be produced. This is akin to pillars and beams used in underground mines.
The sheer ability to extract gas from source rock is now well understood as feasible. But some still doubt the magnitude of the estimated resource. Here is the explanation of why one would expect this resource to be plentiful. Consider that for a conventional reservoir to be formed one needed a confluence of two events. First there needed to be a proximal porous and permeable rock and second, a trap mechanism had to exist. So it would be easy to believe that more source rock did not have these conditions than did. In other words the probability of source rock without a release mechanism was greater than with. This is why it is reasonable to conjecture that the total resource trapped in source rock is greater than the resource that escaped into permeable trapped rock. Further adding to the potential is that this is fresh territory, relatively unexploited. Decades of exploitation have denuded conventional reserves, while the source rock remains relatively untapped.
A word on the nomenclature of resource estimation. A resource estimate indicates the quantity of estimated hydrocarbon accumulation, whether economically recoverable or not. A subset of that is a reserves estimate. Reserves are the portion of the resource that one could recover economically and bring to market. Typically in a new play one would expect reserves to keep getting revised upwards. This is because every new well put on production increases the certainty of the extent and quality of the reservoir, and the reserves can confidently be increased. In reading the popular literature it would be well to keep the distinctions in mind; they are often confused.
*Darker roasts produce more oil. One way to minimize oily sheen is to brew with cold water; also results in a “sweeter” coffee. This is analogous to “sun tea”.
August 12, 2011 § 2 Comments
This statement has the makings of an oxymoron. In many settings it certainly is. So, for example there can be no discernible virtue of being late for your own nuptials. Being late for one’s own funeral, if that could be pulled off, has decided good points.
Being late is not precisely the same as coming in second. Nobody knows that Tom Bourdillon and Charles Evans were within 300 feet of the summit of
Everest three days before the second team of Edmund Hillary and Tenzing Norgay got to the top. Bourdillon and Evans likely did not even make it into Trivial Pursuit.
In the business of innovation there is a body of literature on the value of being first. “First mover advantage” is firmly in the business lexicon. But so is the “fast follower” principle. Indubitably, fast followers could be faced with patents preventing that from happening. Intel went out in front early and was never materially threatened. But many businesses have been built on the premise of letting somebody else build the market and make the mistakes. There is that old adage: the people in the front get shot.
So, what does all of this have to do with energy? The history of development of shale gas is instructive. After the realization that horizontal wells and fracturing enabled gas production from these tight rocks, the early attempts employed methods previously used. In particular, those involved in using sugars as thickening agents to easily fracture the rock. The sugar residue impaired production. Newer techniques, in areas such as in the Marcellus, use “slick water”. The results have been dramatic, albeit at the expense of higher volumes of water.
All of the foregoing is just plain building on the experience of the past. This post on the virtue of being late keys on the point that if fate has dealt you a hand that causes you to be late to the party, find ways to make that a positive. This is the opportunity presented to the areas of the east coast that have not yet materially been swept up by the shale gale. These include Ohio, West Virginia, Maryland and North Carolina. These states must institute measures whereby the exploitation of the resource is done in an environmentally sound fashion while still maximizing the realization of economic value for the communities affected.
The important measures required fall in the following categories:
- Ensuring that the water related issues are dealt with from the start. The foremost is the requirement to re-use all the fracturing water, because improper discharge has plagued parts of Pennsylvania. Fresh water usage must be replaced, over time, by saline water. This is technically feasible and simply needs execution. Water wells proximal to intended drilling should be tested prior to drilling and then routinely thereafter. The cost of this must be borne by the operator. Chemicals used must be publicly disclosed with very few exceptions, and even in those cases, full disclosure must be made to the authorities. The use of toxic chemicals such as the BTEX family and diesel in the fracturing fluid is technically unnecessary and should be expressly disallowed.
- The latest technologies to minimize environmental impact should be employed. These include the use of pad drilling to minimize road traffic and measures to prevent fugitive methane emissions. Enabling rule-making, such as unitization schemes to allow pad drilling and mandatory sensing for emissions and indications of casing leakage, must be instituted.
- A significant fraction of royalties collected should be ploughed back into giving relief to the affected communities. This includes hardening of farm roads unsuited to the heavy vehicles associated with the exploitation, and the water handling infrastructure.
- The public must be educated on all the issues and opportunities for dialog should be created. A clearing house of information is needed for affected parties such as potential land leasers and homeowners proximal to production activity.
The Secretary of Energy commissioned a study whose findings have just been published for public comment. This is a balanced report with a very positive attitude that is in keeping with the position we have been taking: shale gas is a game changer and it is incumbent on us to enable it responsibly. Produced in a scant 90 days, the report is necessarily short on some detail. But the message is clear and there is an air of optimism. For this it will undoubtedly be pilloried by some interest groups.
July 4, 2011 § Leave a Comment
A The New York Times piece on June 26, 2011 discusses this proposition and is very bearish on the prospects. We acknowledge the principal points: some in the industry worry about the profitability especially given the low prices in the last year or two. We present here a case for optimism. These are early days in the exploitation of a completely new type of reservoir. Continuous improvement, as in any industrial endeavor, can be expected. In the case of shale gas the learning curve is likely to be steep. In part this is because of the sheer volume of activity. Each well will drill and produce in as few as twenty one days. The setting is almost akin to a factory, which we all know is the type of setting amenable to rapid learning curves.
Production from shale gas wells declines rapidly: The decline is steep, with a drop of 60% to 80% in the first year. (Conventional reservoirs decline 25% to 40%) After year two there is a gradual decline. The mechanism is likely premature closure of the fractures. This could be due to insufficient penetration of proppant into the formation. (Proppant is sand or other ceramic material injected into the hydraulically created fractures to “prop” them open to allow gas to flow; absent this natural stresses would close the fractures) Industry is working on materials and techniques to cause improved and more sustained flow. A Rice University originated product sourced from nanomaterial is in early stages of commercialization.
Refracturing: This is where new fractures are initiated in existing well bores, often directly on top of the old ones. In the few cases that it has already been attempted in the Barnett, the results have been dramatic. Initial production rates have reached and exceeded the original starting production. And sometimes they decline at the same rate as before. This is indicative of the possibility that new rock pores are being accessed. Research, at the University of Texas to name one, is ongoing and one could expect results to be variable for some time. At present research indicates that the optimal time to refracture is two to three years after initial production.
Somewhat ironically, a shortcoming of the resource, the poor permeability (a measure of the ability of fluids to flow in the rock), may be why this technique works. Ordinarily, poor permeability means less flow, and hence less production. Fracturing improves that. But if the fracture paths are impaired as explained above, the gas does not get fully drained. But it is available for new fractures, and is for all practical purposes from new rock despite being proximal. From the standpoint of economics of the prospect, all that matters is that each operation causes enough production to assure a rate of return. The fast declines are not highly material if this economic threshold is met. One final point: refracturing is at a fraction of the cost of the original well because no new well bore is drilled. So the newer gas has a cost basis that could be a third or less of the initial gas. Does wonders for prospect economics.
Wet Gas: There is a passing allusion to this in the NY Times piece but it deserves serious attention because of the dramatic effect on profitability. Wet gas is defined as natural gas with a significant component of hydrocarbon species other than methane. The economic significance lies in the spread between natural gas and oil prices. Gas on the basis of energy content is currently priced at about a fourth of oil. Decades ago these used to be in parity. Natural gas liquids, the “wet” part of wet gas, are priced in relationship to the price of oil. Condensate is at or somewhat higher than oil price, butane is definitely higher than oil because it is essentially a drop-in replacement for gasoline. Propane is at a discount to oil, as is ethane. Ethane is the least costly, at about half the price of oil. But all these are vast improvements over the price of methane. A typical Marcellus wet gas prices out about 70% over dry gas. Range Resources reports that at a flat $4 per million British Thermal Units (MMBTU) gas price (incidentally the average for 2010 was around this figure), their Internal Rate of Return would be 60%. That is way more profitable than any conventional gas prospect.
Marcellus, the largest and most prolific of the North American deposits, has a wet character on its western side. The as-yet not important producing states of West Virginia and Ohio are advantaged in this regard, as is western Pennsylvania.
How things will play out: Given the facts above, expect the wet gas prospects to be produced first. Over the next few years, the price of methane will rise because of demand. Massive switching from coal fired electricity to gas will occur. This is because even without a price on carbon, the all-in cost of electricity from gas is less than from coal at gas prices below $8 per MMBTU. In a recent publication we present a model predicting gas prices as having a lid at about $8. This stability will contribute to switching of oil to gas. The switches will include methane propulsion of vehicles and gas-to-liquids derived diesel and gasoline. Over time this plus electric vehicles will make a significant dent in our $400 billion annual imported oil bill, and hence our balance of payments. Importantly, gas prices will be less subject to the whims of the weather because heating and cooling will be an ever decreasing component of gas usage.
The demand creation will allow a gradual return to dry gas production. Some of the earlier plays are profitable at $4 already. But a rise in the floor price will ensure the supply that will be dictated when the trends described above mature.
And one day the NY Times will have a page one above the fold piece on how shale gas transformed the US economy. Then I will wake up.
June 18, 2011 § Leave a Comment
A recent story posted by the Worldwatch Institute addresses this issue. The story in of itself has nothing new, in that it discusses the various elements in play but offers no new insights. But it does cause us to mull the issue, because it has come up repeatedly at lectures I have given on natural gas-related matters.
We have blogged on and published the view that shale gas production will keep gas prices low. This is largely due to shale gas wells being on land and shallow by industry standards. These wells can be in production in 30 to 60 days after commencement. This short duration effectively keeps a lid on the price. If the three month strip is seen as going up, new wells can be in production well within three months. This sort of certitude will also discourage speculative investment in the commodity. The floor price will get set by the conversion from coal to gas for electricity. 50 percent of coal plants not expected to meet the latest EPA standards on mercury and NOx are over 40 years old. So these fully depreciated plants will not be refurbished. The only options are new coal, nuclear and natural gas. New coal is disadvantaged on price alone until a natural gas price of $8 per million BTU. Today that price is $4.40. So, with the aforementioned ceiling, coal is not the economic choice. Nuclear has suffered a blow due to the Fukushima Daiichi disaster. So, natural gas will be the fuel of choice. Eventually, the shift to gas will cause the price to rise, but the lid will still be around $8.
Cheap natural gas will also cause a shift from oil to gas whenever possible. This additional demand will keep the price up in the medium term. So, let us assume a price of $8 as the stable price. At this price, electricity will be delivered at a little under 7 cents/kWh. This is the grid parity price that alternatives will have to meet on a direct economic basis.
This benchmark price is lower than the fully loaded price of new nuclear plants, which will be over 10 cents. Currently, wind delivers at 9 to 16 cents, depending on where it is. Offshore wind may be higher yet at this time. Wind also often suffers from the need to add transmission infrastructure. This is especially the case for offshore facilities. There is also the celebrated case of Boone Pickens terminating a major land-based investment due to absence of concrete plans to add transmission lines.
Strictly from a techno-economic standpoint wind still has an upside. Engineered solutions are likely to drop the price from current levels. But it continues to suffer from diurnality, and so needs to be companioned to another source or to storage mechanisms.
Policy Matters: Without a price on carbon, the carbon-free alternatives of wind, nuclear and solar are seriously disadvantaged. Taxes are anathema to the current Congress. Cap and trade has not worked particularly well in Europe, in part due to the uncertainty, which effectively increased the discount rate on investment. Also, any cap and trade conceived by Congress will undoubtedly have numerous exclusions and grandfathering. The province of Alberta in Canada has an interesting model. They tax high carbon footprint heavy oil production over a certain volume. The money is placed in a special fund expressly for the purpose of addressing environmental issues associated with oil and gas. Such directed use of tax proceeds is more palatable. Conceivably, the fund could subsidize renewables for a period of time.
Finally, one could resort to the current method of imposing a renewable portfolio standard. This in effect is a tax on the consuming public because the renewable energy costs more. The solar subsidy in Germany is passed on directly to the consumer as well. But that is largely possible due to the considerable influence of the Green Party. Short of taxing conventional oil and gas, consideration could be given to decreasing the incentives and redirecting those funds.
Conclusion: Cheap natural gas will place every other source of electricity production, including renewables, at a disadvantage for the short to medium term. Reliance on market forces alone will slow the introduction of renewable energy. Policy mechanisms are needed to level the playing field, at least from the standpoint of carbon neutrality. The most equitable methods may be a U.S. analog to the method used in Alberta. By all accounts, that policy is embraced by the public and industry alike.
April 10, 2011 § 1 Comment
High oil/gas price ratios will transform the petroleum derivatives industry
The recent unrest in the Middle East has caused a spike in the price of oil, with immediate impact on gasoline price, while the price of natural gas has remained stable. This underlines the principal difference in these two essential fuels. Oil is a world commodity while gas is regional. They also serve largely different segments of end use. Consequently, the fact that today’s gas is one-fourth the price of oil in terms of energy content has little relevance in the main. However, if the energy industry believes that this differential will hold for a long time, technology enabled switching will occur. In this blog post, we will predict a shale gas enabled future of gas at low to moderate price for a long time. At the same time, we subscribe to the view of an upcoming plateau in oil production, which will drive oil prices higher. These two trends taken together assure a high oil/gas price ratio. This will cause systematic switching where possible. We discuss two essential areas where this is likely: transport fuels and propylene, the latter being the precursor to many important industrial goods, principally polypropylene.
Why natural gas price will stay low to moderate: Shale gas has unique economic characteristics when compared with conventional gas. It is located on land and at relatively shallow depths. The exploitation of the resource does have environmental hurdles, but with the proper combination of technology, transparency and regulatory oversight, these can be traversed.
If allowed to be accessed, shale gas offers the promise of cheap gas for decades. If demand drives up price, this resource can be accessed within 90 days of the decision to do so, provided access and delivery infrastructure are available. This single fact will keep a lid on the price and discourage speculators. To give a frame of reference, conventional offshore gas has a lead time of at least four years. That is the sort of lead time this industry is accustomed to. So a fast response lid on prices is a new phenomenon, driven by this unusual new resource.
Natural gas prices can be expected to stay in a tight band between $4 and $6.50 per million BTU, with excursions to $8. The floor will be driven by demand and the ceiling by the aforementioned fast response to new production. At least two oil companies operating in the Marcellus in Pennsylvania have stated that at $4, they have strong profits. Newer technologies and further experience will continue to drive down production costs. One example is refracturing of existing wells after initial production tails off. A unique feature of this type of reservoir is that a properly designed refrac will deliver new gas approaching initial production numbers. This would be at a fraction of the original cost because the well already exists. This and other technological advances will, in most instances, more than offset the costs of better environmentally driven practices.
Impact of predictably low gas prices: High oil/gas price ratios will drive oil substitution. Here we will discuss just two areas of impact. The obvious high volume one is a replacement of the oil derivatives for transport. Technology exists today to convert natural gas to gasoline, diesel or jet fuel. Predictably low cost natural gas will spur further improvements regarding the economics of these processes. Also, Liquefied Natural Gas (LNG) for long haul transport and Compressed Natural Gas (CNG) for buses, taxis and even cars will be strongly enabled.
An interesting analysis is the impact on petrochemicals such as propylene. One of the derivatives, polypropylene, is ubiquitous in our lives: roofing, carpets, bottles and bendable plastics, to name a few. For years when oil and gas pricing was in greater parity, propylene was a bi-product of ethylene production in oil refineries. It is also produced by tweaking the catalytic cracking process, at the cost of a smaller gasoline fraction. A refinery can change the mix essentially at will, presumably based on the relative profit potential.
But with a worsening oil/gas price ratio, ethylene production increasingly switched to a gas feed stock. Unfortunately, this process produces very little propylene as a bi-product. So, as reported recently in the Economist, in the last two years propylene price has gone up 150%.
A predictably low price for gas will allow for plants dedicated to propylene production from gas. At least three companies, Lurgi, Total and UOP, have the technology at an advanced state. This would make the greatest sense for gas that is otherwise stranded – Prudhoe Bay gas comes to mind. The gas pipeline from Alaska is no longer viable if shale gas production in the US and Canada continues apace. Produced gas continues to be reinjected. The real price for this gas is well below the price in the Lower 48. The economics of conversion to transport fuel or plastics feed stock is compelling.
Sustained high oil/gas price ratios are predicted. This will drive a secular shift from oil to gas.
July 24, 2010 § 4 Comments
Basking in a Bangalore breeze, with a mango tree swaying outside the window, I am reminded of a fairly recent article concerning liquefied natural gas (LNG) imports into India. This story discussed a plan to import LNG from Qatar. There were a couple of points of note that are grist for this particular posting mill. First was the contemplated price of about $13 per mmBTU and the second was the mechanism for arriving at that price.
But first some background relative to Qatari motivation for long term deals such as this. The abundance of shale gas in the US has essentially taken that country out of the running as a Qatari LNG destination. Europe continues to be a valid target, but shale gas will likely be a factor there as well. Russia could well react to domestic shale gas in Poland and elsewhere with price drops. LNG may face lower prices but unlikely to see a US type debacle. Relatively close markets such as India shave 50 cents or more off a US delivered price. So, India could be important.
The truly curious aspect to the story cited is that the landed price is tagged to a Japanese crude oil basket price. For a few years now there has been a disconnect between oil and gas prices based on calorific value. Curiously, the more environmentally challenged one, oil, is currently priced at roughly three times gas price. That is commodity pricing. The disparity is even greater when one factors in refining costs. Transportation is something of a wash, although gas is cheaper to move than crude oil or refined products, at least on land. All of this is singularly premised upon the internal combustion engine being the workhorse of transportation.
Natural gas pricing is regional, largely due to the high cost of ocean transport. If local gas price is low, it is difficult for LNG to compete, which is why the US will be off limits unless demand takes a huge jump. Even then the abundance of the shale gas will likely keep the status quo. Local gas price in India was under $3 per mmBTU until recently. It is now $4.20, close to current prices in the US. That is the controlled price paid to domestic producers of gas. So, to contemplate imported gas at three times the price is the sort of action possible only in settings such as these: government control on commodity pricing. But pegging the price to an oil market basket, a Japanese one no less, is where logic takes flight.
Oil prices in coming years are likely to see sustained increases. Natural gas, on the other hand, will see a moderation in the US due to shale gas. If shale gas resources are found in other countries, one could expect similar pricing behavior. So, pegging any natural gas price, LNG or otherwise, to oil prices will result in a windfall for the producer and one that is not justified by supply and demand arguments.
Consequently, the main problem with the contemplated Qatari deal is not even the current high price. It is the possibility of up to a doubling in ten years. At anything close to that the incentive to use natural gas evaporates. Entire industries will shift offshore. It will be cheaper to make fertilizer, polypropylene and the like abroad and import the finished product. This will have a lasting negative impact on domestic jobs and the balance of trade.
An interesting subplot in the Qatari deal is the statement by them that they supplied cheap gas in India’s hour of need a few years ago. It was landed at $2.53 and has crept up to around $7 more recently based on whatever oil linked formula was used. The implication is that they should be rewarded now with a better deal. A fairly high fixed price would fit that scenario while still being unfair to domestic production. Pegging to oil defies logic and is simply bad business. The story is now four months old. Perhaps sanity prevailed. It nevertheless gave us an opportunity to discuss the underlying fallacies.