Cheap Natural Gas Heralds an Energy Revolution

The Economics of Natural Gas

By S. Fred Singer

All bets are off for the future of energy in the United States and, indeed, the world, as the price of natural gas plummets to ever-lower values—thanks to the development of technology that can access gas and liquids trapped in hitherto inaccessible shale rocks. In 2011, shale gas accounted for a quarter of U.S. natural gas production. But this seemingly bright future may depend on a court decision (expected in June 2012) and, of course, on the outcome of the November elections.

Consider the history of natural gas prices just in the last few years. In mid-2008, the spot price (at Henry Hub) reached a peak of $13 per mcf (1,000 cubic feet, with a heat value of 1 million Btu—denoted as 1 MMBTU)—having doubled since mid-2007. Since then, the price has decreased sharply, dipping to $2 in mid-March, and it now stands at $2.30. If prices decline further, natural gas will be cheaper than the average steam coal, which up until now has been the lowest-cost fuel on a heat basis.

How realistic is such a price path? Operators drilling for gas are also extracting large quantities of natural gas liquids (NGL) as well as crude oil. As pointed out by Richard Trzupek, the profit potential lies in these liquids, as natural gas becomes simply a byproduct. It reminds me of the situation in the early 1970s, 40 years ago, when “associated gas” was so cheap, only pennies per mcf, that it was flared at the well-head. The problem then was the lack of pipelines to convey the gas to consumers in major cities.

Electric Power Generation

With the pipeline problem solved (at least in the Lower 48), consider the consequences of having huge quantities of cheap gas available. It will make new coal-fired power plants uneconomic, but it will also make new nuclear plants uneconomic. (Coal and nuclear do have an important advantage over gas: the fuel can be easily stored—while gas supply depends on the integrity of the pipeline.)

It is ironic that these two longed-for goals of radical environmentalists are being achieved simply through economics, without the need for any regulation. That’s why I’m fairly relaxed about recent EPA demands for the removal of every last bit of mercury emission, which is clearly uneconomic for existing coal-fired power plants—and even for new ones.

By the same token, it makes proposed EPA regulation of CO2 emission for power plants largely academic. On a BTU basis, gas emits about half as much CO2 as coal—not that I regard CO2 as a problem. On the contrary, agriculturalists consider higher CO2 levels a positive benefit for enhancing crop growth. Forget about “problems” with CO2 emission; our concern should be efficient utilization of natural resources. The new catchword is “sustainability,” not “saving the climate.”

The EPA’s proposed regulation sets allowed CO2 emission levels at 1,000 pounds/megawatt-hour, which would stop the building of new coal-fired power plants. In Virginia, Dominion Power is already building a 1,300-megawatt gas-fired plant. Of course, it is quite possible that the EPA will try to extend their regulation to include all coal-fired plants—and then perhaps lower their arbitrary 1,000-lb limit to go after gas-fired plants—part of an ill-advised campaign against all fossil fuels, based on pathological fears of imagined climate catastrophes.

But it is ironic also that cheap gas will completely remove the need for electricity generated by solar or wind—much to the chagrin of environmental zealots. And all those folks hoping that energy prices would continue to rise and that electricity costs would “skyrocket” will be sorely disappointed.

But there are also extra bonus points. “Combined-cycle” gas power plants can reach efficiencies of 60% or more, compared to heat efficiencies of nuclear power plants of 35% or coal plants of 40%.

It gets even better than that. Gas-fired electricity generation is essentially non-polluting and user-friendly, and it can be placed in close proximity to wherever power is needed, making distributed generation economically feasible. For example, a large apartment building of 1,000 units could use its own 10-megawatt power plant. But once installed, it becomes possible to consider co-generation, with the waste heat used for space heating, air-conditioning, hot water, laundry, and other process-heat applications—and even desalination. One can imagine energy efficiencies of as much as 80%, more than double what is achieved today. It would also simplify the problem of waste-heat disposal.

Cheap gas will encourage the petrochemical industry to invest $30 billion in new U.S. plants over the next five years, according to Chevron-Phillips Chemical Co. Plastics producers will get a double-boost—from cheaper feedstock gas, the raw material for their product, and lower electricity costs. When natural gas becomes really cheap—say, less than $2 per mcf—it will become more like nuclear energy, where the main cost is not fuel, but the capital cost of the power plant.

So what needs to be done? The first step is to have a White House that strongly believes in the need for low-cost energy to promote economic growth, increase prosperity, and fight poverty. Electricity costs should “skyrocket” downward, not upward. While new gas-fired combined-cycle plants are being built, existing coal-fired and nuclear plants, representing “sunk costs,” should be kept in operation for as long as possible.

Transportation Future

This leaves only transportation as a major energy consumer that needs to be addressed. On an interim basis, one might use liquefied natural gas (LNG) to fuel trucks, earth-movers, and perhaps even trains and aircraft. Intermediate-sized users, such as fleet vehicles, (SUV-sized) taxi cabs, buses, etc. could benefit economically by using compressed natural gas (CNG)—with fuel costs only a fraction of conventional motor fuels.

But the ultimate solution for the majority of vehicles is still gasoline and diesel oil. And with natural gas prices really low, there is no longer an incentive to aim for highest conversion efficiency. Therefore, there is no need to think about ethanol, methanol, or exotic liquids like hydrogen, all of which would require a new distribution system and major adjustments to car engines. Instead, one can simply adapt existing commercial technologies, like Fischer-Tropsch, to convert natural gas directly into gasoline or diesel.

Even today’s gas price is low enough—about 15% on a BTU-basis—to yield a substantial profit for conversion projects. No wonder that major GTL (gas-to-liquid) projects are planned or already underway in Qatar and other locations. It would seem to be a “no-brainer” investment—with no need for government subsidies or loan guarantees.

What could go wrong?

Of course, there are various kinds of economic feedbacks, which cannot be quantified at this stage. Much depends on timing and on willingness to take investment risks. An increased demand for natural gas would slow or even reverse a price decline. The displacement of coal by natural gas will lower coal prices throughout the world and might encourage increased use.

There are other unknowns. A massive replacement of transportation fuels refined from crude oil with gas-derived liquids would exert strong downward pressure on world oil prices; it would make GTL projects less profitable. How will this, in turn, affect drilling for more shale gas and oil—and their future price? And what about Arctic oil and gas? Will there be a push to explore and develop—or will it go the other way? And when will the truly huge resource of gas hydrates in ocean sediments become technically and economically feasible?

The geopolitical consequences of a coming energy revolution are far-reaching and fascinating. Since the U.S. is a leading energy consumer and producer, much depends on the direction of U.S. energy policy. There would be major impacts on Middle East oil and Russian gas exporters and on trade balances of OECD nations (principally the U.S., Europe, and Japan). For example, Japan now depends on imported LNG (at $15 per MMBTU) for electricity generation; the U.S. is getting ready to export LNG, at much lower cost.

But there are possible “show-stoppers” ahead—for example, environmental regulations against “fracking” that could slow down the natural-gas boom. Or EPA insistence on costly “green” energy—driven by unreasonable fears of climate catastrophes. An important decision point may come in June 2012 if the Court of Appeals for the District of Columbia strikes down the EPA’s “Endangerment Finding” (which attempts to treat CO2 as a “criteria pollutant” subject to the Clean Air Act)—perhaps ending any legal restrictions on the emission of carbon dioxide and the use of fossil fuels.

The next and most important hurdle will be the November elections. They may bring about government leadership essential to assure the right business climate for a bright U.S. energy future, greater prosperity, and more jobs.