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.

Kicking Shale into the Eyes of the Russian Bear

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.


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.

LNG, Shale Gas and Politics in India

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.

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