Pieces of eight

Michael J Economides
Thursday, July 7, 2011

Earlier this year the refrain was ‘$5 natural gas forever', based on the US Energy Information Administration's (EIA) annual outlook, which argued that natural gas prices will remain below $5 per million btu until 2022. The underlying rationale was growth in the ‘vast' US shale gas resource base. Many bloggers, bankers and bureaucrats accepted the verdict. Not to be outdone, the Paris-based International Energy Agency (IEA) issued a press release on January 20th claiming that ‘booming' shale gas production in the US would prompt a ‘global rush' to explore for the ‘new' resource, against a backdrop of natural gas prices in Europe and Asia ranging $8-11/mmbtu.

The extremeness of the EIA and IEA claims attracted immediate rebuttal from some of the industry's more reasoned voices1. And one salutary effect of such extreme claims is the prompting of more balanced analyses, such as one we performed in March 2011. We were able to characterize the debate as one between $5/mmbtu camps and $8/mmbtu camps (in 2020, based on 2011 dollars).

Now, just two months later, the $5 vs $8 debate is still ongoing – but with a significant twist: not whether we will have $5 or $8/ mmbtu natural gas, but whether $8 gas will occur not in 2020, but rather in the next two years.

Our prediction: look for $6 natural gas in the US by the end of 2011 or early 2012, and $8 natural gas by 2015, possibly much sooner. On the world stage, natural gas demand and continued price pressures between now and 2020 will present major socioeconomic and political trade-offs, from Japan and China, to Russia and Europe, to the eastern Mediterranean and, ultimately, the US.

$5 vs $8 natural gas The various public and private analyses of US natural gas prices in 2011 can be characterized as two polarizing camps: the $5/ mmbtu ‘And' camp and the $8/mmbtu ‘Or' camp2. There are several factors that may affect US natural gas prices in the nearto mid-term, and the impact of these factors on the emerging price environment.

To be a member of the $5 camp, one must hold that several assumptions are all true: (1) natural gas output can continue to grow in the face of dismal profitability in the natural gas E&P sector; (2) externality costs such as new taxes or compliance costs or curtailments related to water and air pollution will not put a negative crimp on E&P activities or natural gas profits; (3) various identifiable ‘catalysts' for new US natural gas demand will not materialize; and (4) US shale gas production can increase threefold by 2020. We contend the $5 scenario requires that all four of these assumptions be true, so we refer to this as our ‘And' scenario. The ‘And' scenario is roughly equivalent to gas consumers correctly calling a coin flip four times in a row. Las Vegas offers much better odds.

To be a member of the $8 MMBtu camp, one need only hold that either: (1) continued growth in natural gas output requires a return to at least normal profitability in the natural gas E&P sector; or (2) externality costs will negatively impact the natural gas sector; or (3) demand catalysts will lead to increased US natural gas consumption; or (4) US shale gas production will not be able to achieve a threefold increase between 2011 and 2020.

There are several areas in which strong US natural gas demand can be anticipated as consumers and regulators re-orient to take advantage of this environmentally premium fuel and the perceived long term bargain shale gas pricing and availability: electric power, industrial/chemical , transportation and LNG export. We estimate that together, these upside demands (which are mostly excluded from current EIA natural gas forecasts) total an enormous 31.4bcf/d, almost half of US current daily production.

Power demand. We anticipate that natural gas demand related to the US power sector will grow by 12.8bcf/d between 2011 and 2020 as US power generation grows from 11,433GWh/d to 13,154GWh/d. This assumes that 100% of new US power demand is met by natural gas. There are currently four coal-fired plants under construction, but we anticipate that new coal generation will only offset coal plant retirements. Renewables and nuclear energy can make only marginal contributions to power generation from 2011 to 2020.

Industrial natural gas demand. US industrial natural gas demand fell 22% between 1997 and 2010, from 23.3bcf/d to 18.1bcf/d as industrial gas consumers moved offshore to source cheaper, stranded natural gas. However, recent announcements by the US chemical sector, which represents the largest industrial demand (35%), indicate a major reversal of trend. We anticipate that industrial demand will regain the lost 5.2bcf/d of natural gas demand from 2013 through 2020.

Transportation Fuel. Natural gas demand in transportation has so far been fueled by on-road diesel conversions, mostly in local bus fleets and limited long-haul trucking operations. For the sake of estimating, we assume this trend continues and that 50% of diesel demand is ultimately met by natural gas in 2020. We assume that diesel demand grows 3% annually (the 20 year trend is 3.7%/yr). At current delivered retail prices, diesel fuel is four or five times more expensive than natural gas on an energy content basis, so there is ample incentive for natural gas to invade this market. Whether or not natural gas replaces diesel demand, it is clear that natural gas will play a large role in the transportation sector, either as an alcohol feedstock or source of power generation for electric vehicles.

LNG exports. Major US and Canadian LNG export projects have been announced over the last year, representing some 12.6bcf/d of new export capacity by 2015. Notably, Cheniere Energy received a formal okay from the US Department of Energy late last month to export 2.2bcf/d of natural gas from its Gulf Coast LNG terminal3. Assuming that current LNG imports (1.2bcf/d in 2010) ramp down to zero by 2020, and exports from the US and Canada reach 50% of the announced capacity, also by 2020, then net LNG exports (effectively new US natural gas demand) will reach 4.3bcf/d.

The combined impact of these upside demand catalysts is summarized in Table 1. We are inexorably moving towards $8/mmbtu for natural gas in the US, a price that will dominate for a very long period of time.

Michael J Economides is a professor at the Cullen College of Engineering, University of Houston, and editor-in-chief of the Energy Tribune. The views expressed in this column do not necessarily reflect OE's position.
This is a summary of an extensive report on the subject by the author along with Ronald E Oligney and Phil Lewis. Copies are available upon demand at mje@economidesconsultants.com OE


Categories: Energy Production Shale LNG North America

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