Let me start by admitting that the future of natural gas is especially difficult to predict. Commodity forecasting is always a pseudo-science at best. At times it seems that its primary function is to make astrology look respectable.
But America has enormous natural gas resources, roughly a 100 year supply. That supply could be the low cost/low pollution energy source that provides a bridge to a better economic and environmental future. Or it may just sit in the ground for some time.
After 25 years in the oil and gas business I spent ten years working in public policy and politics. In many ways that made geophysics seem pretty straightforward. But I did learn at least one valuable lesson: In spite of all the flowery words, there is no more powerful force for change than the market.
But the market doesn’t care about political correctness. The market only cares about supply and demand. And right now natural gas is on the wrong side of that equation.
The warmest winter since 2000 plus abundant shale gas has forced US natural gas wellhead prices below $2 per thousand cubic feet (Mcf), their lowest level in 13 years. By comparison Europeans currently pay almost $12 for imported natural gas. We have almost two and a half trillion cubic feet in storage, a glut of almost a trillion cubic feet above our seasonal average. That’s the largest glut in almost 30 years.
For the last two decades, the ratio of oil to natural gas prices has averaged around 10. Today it is over 50.
The market is unlikely to allow that distortion to endure. Adversity often creates opportunity. As Winston Churchill said, “When you’re going through hell, keep going.”
North America is cursed and blessed with huge shale gas resources, depending on your perspective. Shale gas may be predictable but it’s not free. At prices much below $4 these resources won’t be developed. No one in their right mind will spend two billion dollars to develop a field with a billion dollars’ worth of natural gas. And that’s the problem that a lot of gas producers currently face. Natural gas reserves are and always have been a function of price. At the European price of $12/Mcf, we’d all be shocked and amazed at how much gas America has.
Before we look at current US natural gas consumption we should consider LNG exports. While crude oil is traded globally via tankers and pipelines, natural gas trading remains primarily isolated within the US and Canada and lacks the infrastructure to be a true global commodity. However, federal regulators just approved America’s first large-scale natural gas export facility, Cheniere Energy’s Sabine Pass LNG terminal. It should come online in 2015 or 2016, and should be able to export close to 900 Bcf per year. Several other US and Canadian companies are proposing similar facilities. This is the greatest potential game changer for natural gas. The market is a powerful force, and eventually finds a way to correct distortions of any commodity price. But it takes a while for new LNG facilities to be approved and built. For now let’s consider current US natural gas markets.
History teaches us that our natural gas resource won’t get consistently developed. We will continue to see boom and bust cycles. Gas producers will pour money into drilling wells when prices spike, and those very actions will create the next bust. And those same price spikes will discourage long-term commitments to gas by large-volume utility and industrial consumers.
Maybe, just maybe, we can learn something from history that will benefit both producers and consumers. But first we need to better understand the natural gas market: what’s just ahead, and what may be down the road. To do that, we need a data-driven analysis of the market potential for this abundant resource.
So let’s start by looking at the opportunities for growth of natural gas in electricity generation. Why electricity? Here is a picture of today’s gas market:
Electricity is the biggest slice, but also the slice with the greatest upside. When Willie Sutton was asked why he robbed banks, he reportedly said: “Because that’s where the money is.” And that’s the same reason we need to understand the electricity market. For gas, electricity is where the money is.
But first, let’s take a quick look at the other market segments. Residential and commercial use is mostly for heating and air conditioning. The market has helped drive retrofits and construction of more energy- efficient buildings. It seems likely that even with economic growth residential and commercial gas use will likely be flat, as it has been for the last 40 years. Use by gas producers has also been flat for decades, though higher prices could drive greater efficiencies and lower consumption. Natural gas vehicles have great potential, but even if consumption doubled that total market would be less than 1% of the gas used for electricity. However, Westport Power estimates that if every heavy-duty US and Canada vehicle was converted to LNG, annual gas consumption would increase by 5 Bcf, increasing gas demand by 23%.
Industrial gas use (which is nearly as much as electricity) is mostly for heat, power and chemical feedstock. Increased use of industrial heat and power will mostly be tied to the ups and downs of US manufacturing and improved energy efficiency. However, low gas prices have resulted in several companies announcing expansions of feedstock consumption.
Ethylene is a byproduct of so-called “wet gas” production. Ethylene production helps subsidize the cost of natural gas wells. Dow Chemical is investing $1.7B in a Texas ethylene plastics plant that will create 35,000 new jobs in the region, as part of $4B in shale gas-driven investments. Chevron is moving ahead on a similar sized ethylene-to-plastics plant near Houston. Shell is also planning a $2B ethylene plant near Pittsburgh and is considering investing $10B in a new Louisiana plant to convert natural gas into diesel fuel. Other companies are looking at similar investments. The American Chemistry Council’s CEO noted, “Thanks to abundant, affordable natural gas, the nation’s chemical companies have entered an era of renewed global competitiveness which can help generate new domestic investment, jobs and manufacturing exports.”
But none of these market segments come close to the impact of electricity. Coal is the fuel of choice for 44% of electricity generation, while natural gas accounts for a quarter. However, under court order the EPA just set tough limits on CO2 emissions. Without carbon capture and storage, or CCS, coal is no longer an option for new plants. ‘Clean Coal’ can’t happen without CCS, and no coal CCS facility has ever been built in America. The first one may be ready in 2015, but it’s only a small generator. All the pretty TV ads about Clean Coal have little to do with reality. But the greatest challenge for carbon capture and storage is not technical. It is economic. The numbers just do not make sense.
A 2008 McKinsey report estimated that if about 100 carbon capture and storage projects were built by 2030, the cost of removing 90% of the CO2 produced from new coal plants might fall to $37-55 per ton of CO2. Early plants would cost at least twice that much. And coal produces about two tons of CO2 per ton of coal burned.
For reference, utilities paid about $44 a ton for coal in 2011. Burning ‘clean coal’ would approximately triple that cost. The ‘clean coal’ TV ads are pretty and patriotic, but for some reason they left out the part about the fuel cost tripling. What do you suppose would happen if the oil industry proposed ‘clean gasoline’ that cost three times as much at the pump? I guess they wouldn’t mention price in the ads, either.
To make matters worse, due to carbon capture energy demands you have to burn 25% more coal just to produce the same number of kilowatts. Worse still, only a few of America’s newest coal fired plants could be retrofitted with CCS. And very few modern US coal plants have been built in the past 20 years.
Coal’s greatest asset as a fuel is the number of older, paid-off coal plants. Those plants also produce the most pollution. But utilities would have to build new ‘clean coal’ plants using CCS to meet the mandated CO2 limits. And they would have to be 25% bigger just to produce the same amount of electricity.
So how is carbon capture and storage doing in the US? In 2003 President Bush announced FutureGen, America’s project to build a coal-fueled power plant using CCS. It took industry sponsors 5 years just to select a plant site and estimate costs. But the Department of Energy immediately cancelled funding due to cost overruns. In August 2010 DOE announced FutureGen 2.0, with the goal of retrofitting and resurrecting an old 208 MW oil-fired plant. We all know that 2.0 releases are better than the initial product, right? Well, maybe not in this case. Shortly after the announcement the last two remaining utilities dropped out of the project citing cost overruns. Of the current sponsors all are either coal mining or mining equipment companies plus one recently recruited utility from Kentucky, America’s third largest coal producer. More detailed design work and new cost estimates are underway, with hopes of a startup in 2015.
When you take an honest look at the economics of carbon capture and storage it is remarkable that anybody can discuss clean coal with a straight face. When has so much ever been said about so little, and so much paid for TV ads to say it?
So, let’s ignore the CO2 issue and compare natural gas to conventional coal. How much do modern power plants cost to build? According to the latest government figures, here is a comparison:
In fact, not only are natural gas plants much cheaper to build, but they’re ready in about half the time of coal. There are far fewer ‘not in my back yard’ objections, so smaller modular gas-fired plants can be located nearer consumers and power grids.
But these prices are ‘overnight’ capital costs. They assume the plant gets built overnight… no financing costs, no construction delays, no environmental challenges, no inflation… no kidding! Anyone who has ever developed a major industrial project wishes they lived in that world.
But the real question is, “What does the electricity cost?”
The short version is that electricity from new natural gas plants costs about half as much as coal, and that’s at gas prices approaching five dollars… two-and-a-half times the current price! Wind needs gas prices of seven to eight dollars to be cost competitive. Solar needs a serious technology breakthrough. Nuclear is expensive to build but the fuel is cheap. However, as you may have heard nuclear has some other issues.
You may wonder whether there is already enough generating capacity without building new plants to replace coal with natural gas.
Except for inefficient ‘peaking plants’, ‘24/7 baseload’ gas plants use modern combined-cycle natural gas generators. While it might appear that there is plenty of gas capacity to replace average electricity demand, the reality is that there are a lot of peaks and valleys in that demand. Unfortunately, it’s pretty easy to drown crossing a river that’s an average of two feet deep. Plus, there is a lot of difference in the economics of peaking plants and modern combined cycle generators.
And 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, the capital costs are lower, construction is faster and you can build new capacity closer to where it’s needed. Plus, pollutants are a small fraction of coal plants and CO2 emissions are about a third. On the negative side, if gas prices spike you’re stuck burning gas. And that market risk is the greatest impediment to growing natural gas demand.
If a utility is deciding what to burn in an existing plant, recent low gas prices have kept the more efficient gas plants running nearly flat out. Stricter pollution regulation has also benefited gas. And gas has been a favorite alongside intermittent wind and solar since plants can start up and shut down in about thirty minutes, and can also run at variable power levels. It’s impossible to do a quick startup or shutdown of a coal or nuclear plant.
Given the recent drop in gas prices, it’s interesting to look at how the mix of electricity fuels has changed:
Since 2000 there has been a dramatic decrease in the use of coal and a dramatic increase in the use of gas. The market is a powerful force. Renewables have grown, but less than you might expect.
It is also important to understand what utilities are planning to add in the way of new capacity:
Natural gas is the overwhelming favorite. However, you might notice that in 2011 and 2012 there is a significant amount of coal capacity being built. But these plant decisions were made around 2008, when gas had spiked to an all-time high near $11/Mcf. There is also a fair amount of wind and solar planned. However, that’s only half the story. The above chart is based on theoretical ‘nameplate’ generator capacity, not the actual amount of electricity they are expected to contribute. When you adjust for ‘capacity factors’, which is the percent of time the generator is expected to be operating, the story changes:
Unfortunately the wind doesn’t always blow and the sun doesn’t always shine. Nameplate generator capacity for wind and solar looks great. But while my Jeep may be rated at 120mph, I often need to slow down for traffic and red lights. Based on expected use, gas market share is even more dominant.
But for coal, the story has recently gotten even worse. Due to air quality issues, in 2012 twenty-three states will face stricter standards for sulfur dioxide and nitrous oxide emissions. These new standards are expected to save $280 billion in annual health care costs and prevent tens of thousands of premature deaths. And starting in 2015, the EPA will begin enforcement of court-ordered limits on mercury emissions. While the EPA has provided for emissions trading programs, there will be a lot of closures of older coal plants. So, how will these new EPA rules impact natural gas plants?
Not at all. Fortunately, natural gas has far lower emissions than coal plants. Have a look at the small nitrous oxide, sulfur dioxide and mercury emissions versus coal. That makes natural gas a natural choice for most replacement 24/7 baseload generating capacity.
So what will the impact likely be? A coal industry-financed study estimates a total of 42 gigawatts of coal capacity will be shut down, with a corresponding annual increase in natural gas demand of 1.6 trillion cubic feet. Others estimate as much as 90 gigawatts will be shuttered, with twice the gas demand. Given that current gas consumption for electricity is 7.6 trillion cubic feet, gas consumption for electricity generation should grow somewhere between twenty and forty percent.
Then three weeks ago coal’s prospects went from bad to worse. The Obama administration announced strict new court-ordered limits on CO2 emissions for new electricity plants other than those already permitted for construction. The practical effect of these standards is that no coal plant will be built without expensive and risky carbon capture and storage. Given that elected or appointed Public Utility Commissions approve most new plants and must by law control consumer electricity costs, it seems likely that the market will choose natural gas.
Meanwhile, the coal industry is fighting back… with patriotic ads:
Their big claim, in spite of overwhelming evidence to the contrary, is that coal can produce electricity three times cheaper than natural gas. Maybe that’s true if you take gas at its all-time high 2008 price, run it through an inefficient ‘peaking plant’ and compare that to an older, totally depreciated coal plant with no pollution controls. In political advertising this is a popular strategic device known as “The Big Lie.”
But in spite of coal lobbyists’ dire predictions of massive mine closings and loss of jobs, it is premature to report the demise of America’s coal industry. Those same claims were made in Colorado when 3 coal plants were closed due to air quality issues. But in reality, Colorado coal production jumped 10% in 2011 as the industry found strong export markets. Employment in the mines rose 12% and there are plans for opening four new mines. While not always good for the environment, the market is certainly a powerful force. And there is a lot of demand for coal in China, India and elsewhere.
Let’s briefly review the advantages of natural gas over coal for electricity generation:
• Cost: Even at $5/Mcf, gas costs half as much per KW-hour as coal
• Pollution and CO2: Gas already meets new EPA standards
• CO2: The latest gas generators produce 1/3 the CO2 of the best coal plants
• Capital cost: Gas power plants are 2.8 times cheaper than coal plants per KW
• Lead time: Gas plants can be permitted and built in half the time
Suppose someone offered you an electricity fuel that would cause tens of thousands of premature deaths every year and add hundreds of billions of dollars in extra health care costs? Or you could choose a fuel that had none of those problems and produced electricity at half the cost? It doesn’t take a genius to spot a goat in a flock of sheep.
Natural gas alone won’t get us to near-zero carbon emissions. But it is an effective bridge strategy to significantly reduce CO2 while other low-and-no CO2 technologies mature. The biggest risk to increased use of gas for electricity generation is price. But unconventional gas has reduced that risk.
Of course, the cheapest ‘energy source’ by far is conservation. It usually pays for itself many times over. Companies and individuals have reaped the economic and environmental benefits of more energy efficient operations, and hopefully will continue to do so. That’s the market at work.
Here are the current sources of America’s electricity. Coal is in the top spot, with natural gas #2 and growing. So for now, let’s briefly look at the two other big electricity sources: nuclear and hydroelectric.
So… what about nuclear? Well, in 1979 the core of Pennsylvania’s Three Mile Island nuclear power plant melted down. The concrete containment structure did just what it was designed to do. No radiation escaped, and no one died. But Americans have never had much tolerance for nuclear disasters. In spite of an extraordinary safety record for US nuclear energy, no nuclear power plant has been ordered up since.
That is, until 2010 when the Department of Energy provided an $8.3B loan guarantee for two modern nuclear power plants. A year later came the Fukushima melt down. But construction on the two new US reactors is moving ahead, though most other utilities are waiting to see if these projects can come in on time and on budget. And that wait is probably four years.
Americans just aren’t comfortable with nuclear power. In politics, perception is everything. And therein lies a valuable lesson for the fracing controversy, as we’ll discuss later.
So how about hydro? Hydropower is a wonderful resource, providing 8% of America’s electricity. Fortunate states like Washington and Idaho with the right terrain and powerful rivers get over 70% of their total electricity from hydropower. But dams have already been built on most of the best sites. The sites that remain are often already occupied… by people.
If you think permitting gas wells is tough just imagine what it’s like to permit a new hydroelectric dam. Here’s how that conversation might go:
“Mr. Smith, I’ve got some great news for you, and some not-so-good news.” So Mr. Smith says, “OK… what’s the great news?” You reply, “The great news is that the people of this valley are about to get electricity that produces no CO2 and costs even less than they are currently paying!” Mr. Smith: “That sounds wonderful. What’s the not-so-good news?” And then you say, “Uh… Mr. Smith, your house will need to be under forty feet of water.”
So if you’ve ever done any permitting, you know that this is when Mr. Smith goes for the shotgun.
Utilities look for ‘small hydro’ opportunities in existing water storage dams and river and canal water flow. Ocean waves and tides are also possible for the future, but realistically the near-term growth potential of hydroelectricity seems fairly limited.
So let’s take a look at renewables, the last component of America’s electricity market:
About 95% of America’s electricity comes from coal, natural gas, nuclear and hydropower. Of what’s left, about 4% is renewables. A third of that is wood, waste products and geothermal. Almost 3% is wind energy.
For the past several years there has been a lot of passion for wind and solar. Expansion of electricity generation from these sources has grown at a remarkable pace. Concern for global warming and its risks to our grandchildren stirred passions in even the most conservative consumers. As investment capital poured into wind projects, majestic turbines whooshed their way onto our open plains. Wind energy skyrocketed from 12 GW in 2006 to 47 GW in 2011. Projects representing roughly 300 GW were in the queue for potential development, enough to raise wind’s share of electricity to 20%.
But then a strange thing happened. According to the American Wind Energy Association, in 2010 wind installations dropped by almost half compared to 2009. Wind projects in the US were installed at half the rate of Europe and a third the rate of China.
The US wind and solar industry blamed this crash on the lack of adoption of a nationwide renewable energy mandate and uncertainty in future subsidies. They noted that national mandates are already in place in China and Europe, resulting in more than $35 billion of expected investment in 2010. The industry called on a reluctant Congress, one faced with recession and record budget deficits, for action. But as November’s 2010 Election Day came and went, it became clear that the renewables industry faced a far more reluctant Congress.
NextEra, America’s largest wind provider has zero new wind projects planned after 2012 when subsidies expire. The CEO of Vestas, the world’s largest wind turbine manufacturer, recently said “US wind power may fall off a cliff” in 2013. In fact, the last three times US subsidies were not renewed, new wind investment fell an average of 81%. The American Wind Energy Association has predicted a 75% drop in 2013. The US Energy Information Agency apparently agrees, and predicts very little growth in wind energy from 2013 through 2019. Unfortunately, this clean source of electricity may be stuck at 3% for some time.
There also isn’t any real growth expected anytime soon for electricity generation from wood or municipal waste. While solar energy efficiency has dramatically increased in the past few years, the previously available 30% cash grants just got converted to 30% tax credits, which have a lot less value for new startup projects with few tax bills. The Solar Energy Industry Association has predicted that “solar investment will fall by half”. Solar is already much more expensive than its other competitors. But given that solar only contributes five-hundredths of a percent of America’s electricity, even if it quadrupled in the next 10 years it still wouldn’t be a material market factor.
So, how about geothermal? Conventional geothermal requires naturally occurring but relatively rare pockets of steam or hot water that are close to the earth’s surface. But a new ‘enhanced geothermal’ approach works by drilling parallel wells deep into hot rocks which are then fractured using high pressure cold water. Producing wells bring hot water to the surface, which then vaporizes a more volatile secondary fluid such as butane, instead of water, to drive special binary turbines. The produced water is then re- injected, heated and reused in a closed loop.
Enhanced geothermal electricity currently costs around 19? per KW-hour. That’s almost as high as solar and three times as high as gas. A 2006 MIT report predicted costs might fall to as low as 4?/KW-hour. If they’re right, enhanced geothermal systems could tap an inexhaustible energy supply of carbon-free, 24/7 ‘base load’ electricity. Three international projects are already operational, and three are in development in the US.
So here is what the US electricity market looks like right now, and here’s where it appears to be headed:
• Coal will shrink considerably due to cost and pollution issues
• Gas has strong market and environmental advantages, and should grow substantially
• Nuclear might grow if the two new reactors come in on time and on budget
• Hydropower lacks good sites for new dams
• Wind and solar are losing subsidies, and without subsidies will struggle to grow
• Everything else is too small to matter, unless enhanced geothermal can greatly reduce costs
There appears to be a lot of opportunity for natural gas to expand its market share in electricity generation. Shale gas has been a game-changer for the supply side. What we need is growth on the demand side. So what might hold gas demand back?
Fracing has a bad reputation with many Americans. Gas producers have a good story to tell, but so do fracing opponents. Here’s an example:
This is typically how the gas developers tell their side. It is a logical argument, but it tends to 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 people’s water supply. If you study this diagram it is fairly clear that the fractures only affect a small part of the deepest rocks, and steel casing and cement in the well protects the aquifers.”
It is true that the fracing of the rocks themselves has never caused a problem. But in several cases the cement job around the casing that protects aquifers has failed. High pressure frac fluid and gasses invaded sources of drinking water. In fact, such examples are rare, and companies have mostly been quick to respond. But so has the media. A few accidents translate into a lot of newsprint and a lot of 30 second TV spots.
Progressive gas developers have worked with states to tighten well completion standards, which were usually established long before shale gas fracing was common. And many companies have signed up to disclose fracing fluids on public websites. Some executives have even drunk fracing fluids at press conferences. But as long as a few companies are unwilling to disclose, public fear will win out. Every time the industry argues that 99% of frac fluids are sand and water, the public immediately thinks about that other one percent. And with all the recent media coverage, they just don’t trust oil and gas companies.
Opponents to fracing have taken a different approach:
Millions of Americans saw flames shooting out of this Coloradan’s sink in the Gasland ‘documentary’. That ‘anecdotal evidence’ leaves a powerful impression, especially compared to more technical industry arguments. And I learned from politics the power of the anecdote. If you’re trying to move a legislative committee or millions of voters, one victim beats statistics and graphs every time. Oddly enough, Joseph Stalin said it best. “One death is a tragedy. A million deaths is a statistic.”
Due to public concerns and in response to Gasland, the Colorado Oil and Gas Conservation Commission tested the methane from this burning faucet. Their scientific analysis proved that this flaming gas was biogenic (near surface) in origin as opposed to the thermogenic gas that comes from deep shale gas deposits. But have you ever tried to explain the difference between biogenic and thermogenic gas to a homeowner? The Commission had tried to speak with Gasland’s producer during the filming, but no self- respecting documentary producer wants to lose a great shot like this flaming faucet.
In fact, many of our problems don’t come from wells. They come from frac water use and disposal, excessive noise and heavy road traffic. Due to the separation of surface and mineral rights, many landowners don’t benefit from gas development. To them, the discovery of gas beneath their land is a disaster. As a gambler would say, they have no ‘skin in the game’. But as long as some local landowners don’t benefit, there will be vocal opponents. The gas producers may win in the courts of law, but lose in the court of public opinion.
Again, here is a common industry argument:
“With a single small pad, we can develop the resources below hundreds of acres using a new technology called ‘horizontal drilling’. When the wells are completed, we only leave a tiny footprint on the restored lands.”
But opponents make a different argument:
This argument, once again, is visual. “Fracing turns our forests into wastelands”. We appeal to reason, they appeal to emotion. And emotion is a more powerful force. Again, in politics, perception is everything.
We can do better. The answer isn’t better ads; the answer is solving the problems. For example, methane is 25 times more potent as a greenhouse gas than CO2. Environmentalists, myself included, are often more concerned about the amount of raw methane released in gas development than the much-publicized fracing issue, even though their presentations may lead with the fracing controversy. They are smart, passionate people and they know how to do math.
Yet the methane we lose to well completion and leaky pipelines represents a strong economic opportunity for the gas industry. In a report aptly titled Leaking Profits, the Natural Resources Defense Council argues that the industry can cut methane waste by 80% while saving $2B annually. This would cut total US methane emissions by one-third, which is equivalent to the global warming impact of 50 coal plants. Furthermore, all of these upgrades have paybacks of three years or less, and most are under one year. It’s hard to find those kinds of returns these days in the gas patch, much less in the stock market.
Here’s an example from close to home. In 2002 Williams, now WPX Energy, designed and built frac flowback separators to capture Piceance Basin gas that was previously being flared. At the same time WPX recovers frac water for recycling. They received a national Best Management Practices award from BLM and have been honored by the Colorado Oil and Gas Conservation Commission 10 times since 2007. And best of all, the flowback separators are net positive to profitability and capture an extra 15 million cubic feet of gas per well.
WPX/Williams started capturing this ‘waste’ gas ten years ago. Today, about half the gas developers do so. The market is a powerful force. And after 100 days of hearings and more than 150,000 comments from the public, industry, environmental groups and states, EPA just established rules requiring ‘green well completions’, including capture of ‘waste’ gas, by 2015. And they are currently working on national rules for treating wastewater discharged from gas drilling operations, which would address the problem of earthquakes from injection wells. Natural gas, which already produces only about a third the CO2 of coal, is about to get a lot greener.
So how do we work with utilities to grow the gas market? Unfortunately, utilities often operate on a cost plus profit basis. It’s the spikes you see on this curve that keeps utility managers awake at night:
If utilities don’t maintain a lot of diversity in fuel options and gas prices spike, CEO’s find themselves in front of a hostile Public Utility Commission or legislative committee. Unless we can find a way to protect utilities from much of this economic and emotional risk, the shift from coal to gas will be slow in coming.
When you look at the last twelve years of gas prices, the problem is obvious. In 2000 prices went up by almost a factor of three. In 2005 they almost doubled in 8 months. And in 2008, they doubled to almost eleven dollars in 10 months. The sharp spikes you see on this graph are especially painful to utility CEO’s. And their memories are long. You just can’t get people to jump back into the water until they know the shark is dead.
In fact, many utilities already use commodity hedging to manage this pain. But we are in a different environment now than when these spikes occurred. America has vast reserves of predictable shale gas, much of which is only being lightly drilled to hold expensive leases. We need to rethink how we make the most of this valuable asset.
If we’re going to climb out of this economic gas pit, we might consider reallylong term contracts. Gas plants have useful lives of 25 years or more. That’s the sort of time frame that matters to utility managers. Gas executives want to maximize returns, but they care about downside risk as well. Surely we can find workable solutions to this dilemma.
The curve shown in green is a fit to gas prices using a simple third-order polynomial. You may notice that it doesn’t have any spikes, something utility management appreciates. Gas produces will appreciate the fact that the average price of all points on the green curve is the same as the average of the spiky red curve.
Suppose producers offered very long-term contracts based on this concept, with a price floor set modestly above development and production costs. Managers could afford to give up some on the low side, since that isn’t what puts them on the Public Utility Commission’s hot seat. And it hedges risk for gas developers.
Another option would be to enter into joint ventures with utilities for the development of existing ‘on the shelf’ properties. Utilities might pay much of the development cost in return for guaranteed supplies at a modest price, with a significant share of the production going to the gas developer. Given that utilities may have access to capital at attractive rates this could be a win-win deal.
There are plenty of smart executives among gas producers and utilities. If they work together, I’m confident they can come up with other concepts that are just as good or better. It won’t be easy, though. Where there’s a will, there’s a lawyer.
In 2009, well before the latest EPA regulations, Colorado was struggling to meet environmental air quality standards. Recognizing the advantages of natural gas over coal, Governor Bill Ritter created a coalition of gas producers, environmental groups, Republican and Democratic legislators, and Xcel Energy, Colorado’s dominant electric utility. Dogs and cats, working together…
After analyzing the costs of retrofitting existing coal plants with stricter pollution controls, the coalition proposed replacing several aging coal plants with natural gas generators. In spite of a $2 million campaign by the coal lobby, the bill passed by overwhelming majorities in Colorado’s Senate and House in a remarkably short 17 days. The net impact on consumer bills is estimated to be less than 2%, but that cost is $225 million less than retrofitting existing coal plants. Since then Xcel has expanded the plan from 3 to 5 plants. Similar opportunities exist in other states, if we can just learn to work together.
I also learned from politics that there is a big difference between opponents and enemies. If you treat your opponents like enemies, that is exactly what they become. We all come from different backgrounds and life experiences. From that we develop different values, and often see the world in different ways. If you want to find a solution to problems, you have to understand and appreciate the values of the people on the other side of your perspective instead of going to war.
War seldom determines who’s right, just who’s left. But if you are willing to sit down and truly listen to both sides of a conflict, you can sometimes find a compromise that works well for everyone. It is often possible to find what I call a 60-60 deal, where both sides working together get more out of that 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 environmentalists. The compromises may not be perfect for both sides, but can we afford to let the perfect be the assassin of the good?
Let me leave you with one final thought.
I know many people in the natural gas business, fishermen, hunters and environmentalists as well, who care deeply about the benefits, both economic and environmental, that natural gas can bring to America and to the world. The environment and economic prosperity can coexist. But if you want to catch a trout, you have to be willing to sacrifice a fly. Unless we 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.
Oh, and don’t buy any natural gas options anytime soon. This may take a while.
By. Rutt Bridges
Biosketch: Rutt Bridges is currently Chairman of Transform Software and Services. He is also an alumnus of Georgia Tech, one of the first graduates of what was then the School of Geosciences.
From the Wikipedia: Bridges began his career with Chevron Corporation, then founded Advance Geophysical in 1980. He achieved success with the software products MicroMAX and ProMAX, both used for the processing of seismic data for the petroleum exploration industry. In recognition of his business accomplishments, he was awarded the Enterprise Award in 1991 by the Society of Exploration Geophysicists He is also the chairman of Quest Capital, a private venture capital fund. In 1999, Bridges founded the Bighorn Center, to “give Colorado’s political middle a credible and legitimate voice in the state’s increasingly polarized landscape and more importantly, to get things done.” The Bighorn Center closed in 2006, but the very successful bi-partisan Bighorn Leadership Program is still providing leadership training and development at Colorado State University. In 2004 Bridges ran for the U.S. Senate in Colorado, but stepped aside and supported fellow Democrat and friend Ken Salazar, who went on to win the seat. Looking to the 2006 election, he declared his candidacy for Governor of Colorado. However, he dropped out of the race on August 8, 2005, telling supporters “My passion has always been public policy, not politics.”
the paragraph that includes Dow, Chevron, and Shell building
new ethylene plants. During the 2000-2010 period we shutdown
15 of 40 ammonia fertilizer plants, which use natgas as feedstock.
So, fertilizer import increased to 80 percent from 40; this could go
to zero....by 2020?
And then there's hydrogen...a very large industry. Mostly used in
oil refining, but potentially growing large elsewhere..say automotive
hydrogen. And LNG autos, and CNG autos...
Becides export, which you've started.
A noble task....thanks.