The future of natural gas

The future of natural gas is a hard thing to predict. Commodity forecasting is a pseudo-science at best. At times it seems that its primary function is to make astrology look respectable.

The US has enormous natural gas resources, arguably a 100-year supply. Will that resource be the low-cost, low-pollution energy source that provides America with a better economic and environmental future, or will it remain in the ground? What will decide this question?

There is no more powerful force for change than the market. But commodity markets do not care about political correctness. These markets only care about supply and demand. And right now natural gas is on the wrong side of that equation.

In March 2012 increased production drove Lower 48 gas storage to 2.4 Tcf, almost 0.9 Tcf above the five-year seasonal average. That was the largest seasonal glut since the Energy Information Agency (EIA) started keeping records in 1994. The warmest winter since 2000 plus abundant shale gas soon forced US natural gas wellhead prices below US $2/Mcf, the lowest level in 13 years. By comparison, Europeans currently pay almost $12/Mcf for imported natural gas. The US has been blessed with huge shale gas resources. Shale gas may be predictable, but it is not cheap. At prices much below $4, these resources will not be aggressively developed. Commodity reserves are and always will be a function of price. At the European price of $12/Mcf, we would all be shocked and amazed at how much gas the US has. Perhaps exports will drive development and price, but we will have to wait and see how the politics play out.

History indicates that natural gas resources will not get consistently developed. Boom-and-bust cycles will likely continue. Gas producers will pour money into drilling wells when prices spike, which too often will create the next bust. Unfortunately, those same price spikes discourage long-term commitments to gas by large-volume utility and industrial consumers.

Maybe these lessons can benefit both producers and consumers. But first some data-driven analysis is needed to better understand the natural gas market: what is currently happening as well as what may happen down the road.

Electricity

Electricity is the biggest slice of the demand side and also the slice with the greatest upside for increased gas consumption. In January 2011 coal was the fuel of choice for 48% of electricity generation, while natural gas accounted for about 20%. But as prices plummeted by April 2012, gas was generating as much electricity as coal.

Operators can show simplistic images of their fracing operations, but the public also is being bombarded with images such as the burning faucet in Gasland.

Unfortunately for coal, the EPA recently set tough limits on COemissions for new electricity plants. Without carbon capture and storage (CCS), coal is no longer an option for new plants. Clean coal cannot happen without CCS, and no coal CCS facility has ever been built in the US. However, the greatest challenge for CCS is not technical; it is economic. The numbers just do not make sense.

A 2008 McKinsey report, “Carbon Capture and Storage: Assessing the Economics,” estimated that if about 100 CCS projects were built by 2030, the cost of removing 90% of the COproduced from new coal plants might fall to somewhere between $37/ton to $55/ton of CO. Early plants would cost at least twice that much. And combining oxygen atoms with coal produces about two tons of COper ton of coal burned.

For reference, US utilities paid about $45/ton for coal in 2012. Burning clean coal would roughly triple that fuel cost. But the story gets even worse. Due to carbon capture energy demands, utilities would have to burn 25% more coal just to produce the same number of kilowatts. And only a handful of America’s most modern coal-fired plants could potentially be retrofitted with CCS.

Coal’s greatest asset as a fuel is the number of older, paid-off coal plants. But those plants also produce the most pollution and are likely to continue to be shut down to meet increasingly strict pollution standards.

The real issue is not what the plant costs but what the electricity costs. The short version is that electricity from new natural gas plants costs about half as much per kilowatt as new coal plants, and those EIA estimates are at gas prices of $4.78/Mcf. The other big electricity source is nuclear. The only two new US nuclear plants to be built since 1979 (remember Three Mile Island?) were both initiated when gas prices were approaching $11/Mcf. Both are well over budget and far behind schedule, and there is about $1 billion in utility vs. construction vendor lawsuits pending.

Economics is what drives utilities to decide what kind of fuel to burn and what kind of plants to build. More and more, natural gas has been winning that competition. For new plants not only does gas produce cheaper electricity, but the capital costs are lower, construction is faster, and new capacity can be built closer to where it is needed. There are far fewer “not in my backyard” objections, so smaller modular gas-fired plants can be located nearer consumers and power grids. Plus, pollutants are a small fraction of those from coal plants, and gas plant COemissions are about 37% of coal per kilowatt, already meeting new EPA standards.

On the negative side, if gas prices spike, utilities are stuck burning gas. And that market risk is the greatest impediment to long-term natural gas demand.

Recent low gas prices have kept the more efficient gas plants running nearly flat out. Stricter pollution regulation has also benefited gas, and the increased use of gas has been a major factor in a 14% drop in US COemissions since 2007. Gas has been a favorite alongside intermittent wind and solar since plants can start up and shut down in about 30 minutes and also can run at variable power levels. It is impossible to do a quick startup or shutdown of a coal or nuclear plant. Since 2001 and especially in the past year there has been a dramatic decrease in the use of coal and a dramatic increase in the use of gas. Once again, the market is a powerful force. Here is what the US electricity market looks like right now, and here is where it appears to be headed:

• Coal will continue to shrink due to cost and pollution issues (but export markets are strong);
• Gas has major market and environmental advantages and should continue to grow if we can mitigate price spikes and better address public concerns about fracing;
• Delays and cost overruns for the two new US nuclear plants will hurt prospects for growth;
• Hydropower lacks good sites for new dams and has little growth potential;
• Wind and solar are heavily dependent on unpredictable subsidies to consistently grow; and
• Everything else is too small to matter unless enhanced geothermal can greatly reduce costs.

Pitfalls in the road ahead

There is a lot of opportunity for natural gas to continue to expand its market in electricity generation and potentially in exports. Shale gas has been a game-changer for the supply side, but we need growth on the demand side. What are the pitfalls in the road ahead?

No matter how unfair it may seem, fracing has a bad reputation with far too many Americans. There is a rule of thumb in the media that “if it bleeds, it leads.” The David-and-Goliath battle of local landowners and environmentalists vs. big oil and gas comes close enough.

Both sides are approaching the fight in very different ways. The industry feels that it has logic and reason on its side, but the storyline may be a bit technical for most folks: “Fracing takes place deep in the earth, with thousands of feet of solid rock between the fracing and your water supply. The fractures only affect a small part of the deepest rocks, and steel casing and cement in the well protect the aquifers.”

That does not exactly tug at folks’ hearts like a family whose water has gone bad. Unfortunately, one anecdote can have more influence than a thousand statistics. While it is true that the fracing of the rocks has never caused a problem, in a few cases the cement job around the casing that protects aquifers has failed. Such examples are rare, and companies have almost always been quick to respond. But so has the media. A few accidents translate into a lot of newsprint and 30-second TV spots.

Progressive gas developers have worked with states to tighten well completion standards, which were typically established long before shale gas fracing was common. Many companies voluntarily disclose fracing fluids on public websites. Several states already require disclosure, and more will follow. But as long as a few companies are unwilling to disclose, the issue will remain in people’s minds. Every time the industry argues that 99% of frac fluids are sand and water, the public immediately thinks about that other 1%. Who will the public believe?

Opponents to fracing have often taken a visual approach. In the movie Gasland, millions of Americans saw flames shooting out of a faucet. That “anecdotal evidence” leaves a powerful impression, especially compared to our more technical arguments, even if it is false and misleading.

Due to public concerns, the Colorado Oil and Gas Conservation Commission tested the methane from this burning faucet. Scientific analysis proved that the flaming gas was biogenic in origin as opposed to the thermogenic gas that comes from deep shale gas deposits. Unfortunately, the average homeowner does not understand or much care about the difference between shallow biogenic and deep thermogenic gas. They just remember the flaming faucet.

Wars seldom determine who is right, just who is left. We have a lot at stake. But if both sides are willing to sit down and truly listen to each other, it is sometimes possible to find a compromise that works reasonably well for everyone. Sometimes you can find a 60:60 deal, where both sides working together get more out of the compromise than they would if they treat their differences as a win-lose battle. This is true for gas producers and utilities as well as gas producers and fracing opponents. The compromises may not be perfect for both sides, but can we afford to let the perfect be the assassin of the good?

I know many people in our industry who care deeply about the benefits that natural gas can bring to America and to the world. Environment and economic prosperity can coexist. But if you want to catch a trout, you have to be willing to sacrifice a fly. Unless both sides can find reasonable compromises to our differences, we will waste far too much of our lives and far too much of our treasure waging war. Worse still, we may all lose out on this potentially transformational opportunity in American history.