Research Triangle Energy Consortium

Perhaps the question ought to be how well we are being allowed to manage the transition.  When President Biden attempted to put the arm on OPEC+ (Organization of Petroleum Exporting Countries plus Russia) to increase production to dampen oil prices, he was accused in some progressive circles of acting in opposition to his avowed climate change goals.  No matter that in a country beset by inflationary pressures, any relief for the consumer ought to be welcome.  The oil market is elastic.  Only increased supply, at constant demand, will reduce prices.  Unable to persuade OPEC+, President Biden took the unprecedented step of coordinating with several net importing nations in releasing oil from strategic reserves.  The US will release 50 million barrels, only about 8% of the reserve.  This too was criticized from many angles. 

The one criticism I found most interesting was that US refineries would not want the stuff because the release was from the more sour (high sulfur) crude containments.  The argument was that they would need hydrogen for desulfurizing (true) and that rising natural gas prices made the hydrogen (mostly derived from natural gas) prohibitive (not so true).  The US may be the one country not having a natural gas supply issue, provided producers choose to respond to the relatively high prices.  One factor in favor of so doing is that shale gas wells have a short payback period due to high decline rates (rate of drop in production).  Consequently, an investment in shale gas is not a bet on the long term prospects of the commodity.

Also, the LNG business will continue to grow to feed Europe, Japan, China, India, to name a few dependent on it.  The relative lack of it is why the prices are at unprecedented highs in those countries.  In other words, LNG will be an important customer for decades for new natural gas.  Another parenthetical point on what US refineries want: they do not want US shale oil because it is too light and too sweet(!), and they have expensive kit going idle if all they refine is shale oil.  This is one reason that the US imports 4 million barrels a day of heavy crude from Canada (and only 0.4 million from the Saudis).  The SPR release oil will blend in just fine.

The moral of this particular episode is that while long term carbon mitigation goals must be set, if they cause significant privation in the short term, the current public support for carbon mitigation could dwindle, making it harder for those goals to be bolstered with necessary policies.  Take the current explosion in natural gas prices worldwide, but mostly in the net importing nations.  European governments are scrambling to protect the public from crippling heating bills this winter.  In this scenario, investors shunning fossil fuels do not serve the common good.  The argument is made that investors are leery of taking positions in areas that are in decline.  Natural gas may be the one fossil fuel that will see growth in the short to medium term, and eventually take longer to decline than oil.  In part this is because over 90% of essential backup of renewables comes from natural gas.  As noted in a previous blog, this will continue until we solve the storage problem at scale.

An important consideration for investors is the payback period, and to a degree the allowable amortization period.  The latter is a policy matter for governments.  The US has a long-standing policy favorable to producers (essentially a subsidy), which is debatable in its merit because of the broad swath.  But were it to be used in targeted areas, the use of public funds could be supportable.  In any case, some mechanism must be found to incentivize investment in the bridging areas.  This applies also to vehicles.  We are a very long way from electric vehicles being in the majority.  The auto industry ought to continue to invest in innovation in the efficiency of IC engine based vehicles.

The concept of bridging to a greater goal must not only be tolerated, but ought to be considered essential.  Renewables have intermittencies, which will require fossil fuels to fill the gaps, for at least a decade and change. Today we are faced with the inescapable prospect that additional solar or wind places incremental demand on natural gas. This is an uncomfortable truth that must be faced until cost effective sustainable alternatives take a hold.

Vikram Rao

November 28, 2021