We’ve been reading a lot lately about the potential for cheap natural gas to replace oil-derived transport fuels in the US — and perhaps globally.
Much of this excitement overlooks some fundamentals of energy and commodities in general and the US natural gas sector in particular. The short version is that energy markets are incredibly difficult to predict, and adding interactions between energy sources only adds to the uncertainty.
We’ll get to the longer version in a moment. But first, to be absolutely clear: this post series will not be arguing that oil demand won’t peak sooner than expected. Nor are we arguing that there’s been nothing significant about the last few years of US natural gas production.
The death of oil demand is not in itself a spurious suggestion — peaking oil demand is a compelling idea and I’ve written about it myself several times in 2009 and 2010. To quote a bunch of people, “the stone age didn’t end because we ran out of stones”. On the other hand, it’s not that simple — but we digress. Peak oil demand is an interesting idea, a very big subject in itself, and not one that we’re knocking. Nick Butler, who blogs for the FT about energy, has a more recent take on the reasons why oil demand could well peak before the end of this decade.
Our point here is that it’s not natural gas that will be key to bringing about a peak in oil demand, if it happens this decade.
Now for the longer version of our case… To start with, here’s a list of those factors that might interfere with the natural gas-displacing-oil trajectory:
1. The great promise of shale gas is mostly limited to the US. It’s just not taking off outside of that country. China’s shale could be big in the future, but not in the near future.
2. If the transfer from liquids-based transport fuels to natgas-based fuels happens on any kind of scale significant enough to show up in the wider US economy, then we can assume natgas demand will, in aggregate, be a lot higher than it is now. Therefore, natgas prices will rise, at least in relation to crude-based fuels.
3. The current prices are unsustainable for large chunks of the industry anyway, as Chesapeake and others who bought up vast shale assets at high prices can attest.
4. There are several sources of potential surge in demand for natgas which could push prices high enough to destroy some of its appeal as a transport fuel. One is LNG export terminals. So far only one facility, planned to liquefy 2.2bn cubic feet per day has been approved, but applications worth almost 32bn more are outstanding. Some members of the US manufacturing industry are rather worried that this will push up electricity prices sharply and are lobbying hard against the new approvals.
5. So just tap that eighty squillion years’ worth of US shale gas reserves, right? Not so fast. Despite the prospect of higher prices, no-one is very keen to start drilling for lots more gas. Again, prices at recent low levels are not sustainable, especially considering expensive debt-funded asset purchases and short shale gas well production peaks.
Points 1 and 2 are straightforward, so let’s look at no. 3 in more details. The recent, very low natural gas prices are not sustainable for big swathes of the gas producing industry.
But look! Prices have been rising of late, and Chesapeake is already rather excited:
Steve Dixon, Chesapeake’s acting chief executive, told analysts on Monday that the company had “taken advantage of the recent surge in natural gas prices” to lock in prices for more of its planned sales in 2013. It had also begun hedging for 2014 at prices “well above $4” per million British thermal units, “a level the market has not seen for quite some time”, he said.
More drilling all round, right? Err, maybe not:
However, he said Chesapeake would not be taking advantage of the higher prices to step up its gas production, and would instead continue to focus on developing its more profitable oil reserves.
Chesapeake has its own problems, chiefly a massive debt burden, that’s contributing to its reluctance to drill more (and enthusiasm for selling off assets). There were also masses of shale gas assets writedowns in the past year. And the rest of the industry does not appear likely to counter by raising their production, either. Barclays’ energy analysts recently suggested that this year’s production would likely be lower than 2012′s (click to expand & see which companies are included):
There are some big footnotes around those numbers: in addition to being limited to the universe Barclays have chosen (mostly their covered companies), forecasts can be affected if planned asset divestments fail to go ahead (production may then exceed forecasts) and “ethane rejection“. But in the past they’ve been a fairly good predictor of actual output. Barclays’ analyst Biliana Pehlivanova wrote a couple of weeks ago that total natural gas output from the Eagle Ford shale play may actually fall into decline this year. The amount produced from gas-focused wells has been in steep decline since late 2011 but until recently, was offset by gas produced from wells drilled to produce oil. But output from the latter appears to have levelled off since August.
It’s absolutely true, however, that natural gas output has increased dramatically in the past few years in the US, and prices have been dramatically lower, in general, since 2009.
Natural gas has also been a big contributor to a very dramatic change in the US energy environment:: it’s been the key source of displacement for coal-fired power generation. More than 150 plans for new coal plants have been cancelled since the mid 2000s and only one new plant began operation last year. Well over 100 plants have been retired since 2009 and about 120 are slated to close between this year and 2015, according to the EIA.
This didn’t just happen because a cheaper power plant feedstock (gas) replaced a more expensive one (coal). Capital costs and environmental regulations also played a big part. It’s now much cheaper to build a combined cycle gas turbine plant than any type of coal plant in the US. There’s also evidence that it is sometimes cheaper to build a new gas plant than to upgrade an old coal power plant to meet recent and future air pollution rules.
Furthermore, much of the coal displaced from US electricity generation is simply being burned elsewhere, quite often in Europe. This shouldn’t be a big surprise. As Gregor Macdonald has been pointing out for years, coal is the key to understanding modern energy — even more so than oil — and for years now coal’s use has been growing faster than any other energy source.
US shale gas does add a new element to the world energy mix, but there’s scant evidence it will bring global oil (or coal) demand growth to a juddering halt.
Related links:
China’s shale frenzy and the technology hurdle – FT Alphaville
Oil demand could peak within five years - FT blogs / Nick Butler
Chesapeake foresees higher gas prices – FT