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What If We’re Wrong About Natural Gas?

by Michael Levi
February 7, 2012

Most analysts are incredibly bullish about the prospects of shale gas production in the United States. An early preview of the annual U.S. government energy projections, released last month, sees U.S. gas production rising steadily for decades. Petrochemicals producers are building new plants, and other industrialists are conjuring schemes for exporting the fuel. Security hawks dream of compressing the gas and putting it into cars and trucks so that the United States can use less oil. Some environmentalists are relieved that gas will back out coal and thus cut carbon emissions.

But what if we’re wrong? I’m not saying that I buy the various arguments out there that claim to show that shale gas reserves are grossly overstated or that shale gas economics is a crock. But energy is an uncertain space that regularly hands out surprises (like, um, shale gas). Relatively immature areas like unconventional gas deserve special care. Moreover, even if the economics of shale gas hold up, public opposition to drilling could curtail supplies.

There’s one natural response to this possibility: So what? Private investors are risking their money on shale gas production. Private landowners are leasing their properties. Private chemicals firms are building facilities that depend on abundant supplies of cheap gas. Yes, if the natural gas glut turns out to be less than advertised, they’ll lose money. But investors lose money all the time. There doesn’t seem to be much reason that policymakers should care.

That’s true up to a point. But there are several areas where wrong projections could, in principle, have troubling public consequences:

Power Plant Regulation. Policymakers are currently considering a range of regulations aimed at reducing pollution from coal fired power plants. These rules, aimed in particular at curbing greenhouse gas emissions, are typically crafted with the aim of ensuring that their benefits exceed their costs. But their estimated costs depend on the alternatives available. In particular, abundant gas makes stringent regulations look less expensive, and hence makes them more likely to be adopted.

What happens, though, if that gas turns out to be a mirage? Aggressive regulations based on an expectation of cheap gas could drive coal fired power plants to shut down early; gas plants would take their place; if gas supplies then fell, people would be stuck with expensive gas, since they’d have gotten rid of the immediate alternatives.

Some may think that this is still a good outcome – after all, aren’t coal plants dirty? – but, at a minimum, it’s one that should be reached deliberately, not by mistake. Moreover, depending on the details, there’s probably a case for arguing that it’s an outcome we want to avoid.

Natural Gas Exports. Several firms have recently applied for permits to export natural gas. Some people worry that the combination of exports and domestic production shortfalls could be economically devastating. My instinct says that this danger is overstated.

If U.S. gas production doesn’t meet expectations, domestic prices will rise, and exports will become less economically attractive. To be certain, preexisting export facilities involve sunk costs and thus will have their own momentum, but scary economics are still hard to line up. The capital costs of a liquefaction facility work out to be a bit less than a dollar as much as $1.50 per thousand cubic feet of natural gas. So long as export contracts are closely linked to U.S. gas prices – the U.S. government should probably insist on this – economics should prevail.  As a result, except in a narrow set of circumstances (i.e. that one sunk dollar or so tips the balance between keeping gas at home and exporting it), the fact that export facilities already exist won’t have much impact on whether gas is used at home or sent abroad. After all, the fact that import facilities already exist hasn’t made anyone ship gas to the United States against their economic interests.

Large Capital Investments. One might worry, in a similar vein, that people will overbuild gas-using equipment (such as chemicals plants) only to later find gas supplies scarce. If that equipment is expensive, and gas remains a relatively small part of its owners’ costs, then those owners will presumably continue demanding gas despite rising prices. This will leave less fuel for others – and hence those others will face higher prices.

This all makes sense, but with a big caveat. We’re talking about enterprises in which gas would remain a relatively small part of costs even given rising prices. (That’s why they won’t shut down.) These are generally not the sorts of enterprises that will get created in response to low gas prices in the first place. As with export terminals, there might be a sweet spot in which sunk costs create their own momentum, but that sweet spot is probably small.

Renewable Energy Development. Low natural gas prices are apparently deterring deployment of renewable and nuclear energy, and hence learning and innovation in those sectors. This is a problem regardless of whether gas is scarce or abundant, since reasonably ambitious climate policies will require sequestration of carbon dioxide (including from gas use) or a strong shift to renewable and nuclear power within a couple decades or so. But it is an even bigger problem if natural gas supplies turn out to underwhelm, since in that case, the need to shift to zero-carbon sources would become even more pressing and sudden. This simply reinforces the case for ensuring that prudent deployment of and innovation in zero carbon energy receives solid public support even if the market currently prefers natural gas.

Crosscutting Lessons. There are two big bottom lines to this whole analysis.

First, the biggest public risks associated with overestimating natural gas potential appear to arise when governments get involved. If private players bet their money on the prospect of cheap gas, they’re the ones who will lose if they turn out to be wrong, but if government creates regulations based on similar assumptions, the public is more likely to end up on the losing end. In the climate space, that’s yet another reason why carbon pricing is so much smarter than rigid regulation – it doesn’t require nearly as much in the way of assumptions.

Second, cheap natural gas probably introduces bigger risks when it leads people and firms to foreclose options than when it leads them to expand choices. Policies that shutter existing power plants, or economic incentives that retard energy innovation, introduce bigger public risks than policies that allow new export facilities, or economic incentives that lead people to build petrochemicals plants.

Policymakers certainly shouldn’t make policy based on an expectation that the shale boom will turn into a bust. But that doesn’t mean that they should ignore real risks. It would be wise to keep the consequences of being wrong in mind as they move forward.

Post a Comment 9 Comments

  • Posted by David K Bellman

    I think the one balancing point to your concern of being wrong with shale gas is the one reason people are focused on gas.

    Relative to all the other technologies in the power space – including coal – natural gas capital risk is relatively small. The risk more lies in the variable fuel price projection – but if you are wrong there you don’t really lose out. Whereas if you go all out on nuclear or other renewable technologies your capital is sunk and now you are at the mercy of wishing and praying for high gas prices – since gas prices set the power price.

    I have discussed about this issue and the need to make sure all viewpoints are examined. I appreciate you bringing this point up. You can see more of my insights on my blog – http://allenergyconsulting.com/blog/category/market-insights/

  • Posted by Home performance energy auditor

    The problem with shale gas (see especially http://www.global-warming-forecasts.com/underestimates.php ) is that it is a very risky proposition.

    First, in order for hydraulic fracturing of shale gas formations to extort the gas out of rock, you need massive amounts of water. Problematic in a water short future (see http://www.global-warming-forecasts.com/water-supply-shortage-water-scarcity-climate.php ). That means that we can expect the same type of mid-air collision that we saw with ethanol (food vs. fuel). There will be a fistfight between those who demand that water supplies be safeguarded for food production and safe drinking-water purposes vs. those who want to draw off large volumes of water for hydraulic fracturing to produce gas. (A problem that is hardly bothersome to clean technologies like wind, PV and energy efficiency).

    Second, when we approach and shoot past the 2015 IPCC greenhouse gas deadline for stabilizing emissions, there will be a rising trajectory of hammer-swinging policies and mandates implemented to flatten GHG emissions levels. That means there will be greater regulation of gas production which is a high stress source of fugitive methane emissions (72 times more potent at trapping heat than CO2). Not to mention the regulatory burst that will occur triggered by accelerating permafrost methane outgassing and Arctic ice melt headlines.

    All these forces combine to push natural gas prices upward and pose greater risks to those investors who invest in shale gas companies and face the prospect of finding themselves taken by surprise when gas company forecasts collide with the realities of water scarcity, heat waves, hurricanes and hardline regulation.

    Surprises? You are right to take a deep breath on this one. Unfortunately, many investors are not doing that.

  • Posted by Evan Schoepke

    I think this is a decent overview of some of the risk associated with natural gas but there are other important concerns not covered. Japan and Germany are both investing heavilly in renewables and there stands to be significant gains in those sectors from emergent technologies such as graphen and other nano tech developments. Relying on extractive industries is not the path forwards into the next century and the US will lose if it doesn’t invest in cleaner, more decentralized, less environmentally destructive means of developing energy. Finally, hydro-fracking not only pollutes essential ground water it causes mini-earthquakes and those are two things that will be come increasingly controversial moving forward.

  • Posted by Rod Adams

    You have ignored the large scale experiment that the US inadvertently conducted during the period from about 1990-2008. Throughout most of the 1990s “everyone” agreed that gas was abundant and would remain cheap, with relatively low cost LNG setting a cap on the ultimate price.

    In the mid 1990s, when we were trying to interest potential customers in innovative nuclear energy system designs (search for Adams Atomic Engines, Inc.) our presentations nearly always ended with someone saying that a natural gas plant was so much cheaper and less risky.

    After a decade in which the only new electrical power plants in the US were all fired by natural gas, prices started a long ratcheting climb from $12 per million BTU. The climb transferred hundreds of billions from consumers to producers, and it also helped to push homeowners over the brink to an inability to pay the mortgage on their new, large, inefficient homes in the suburbs. A number of independent power producers who built gas based generation went belly up.

    The inexorable rise as demand exceeded supply lasted a good 8 years. It encourage a number of energy intensive businesses to move to places like Qatar and Australia where gas was still available and cheap.

    It was only near the end of that price increase that people started talking about the revival of the nuclear option.

    The discouragement of new nuclear is not just reducing “innovation” but reducing the necessary investments in the supply chain that is needed to drive costs down. There is a lot of inertia in energy; making a collective large bet is far more risky than you have described.

    Rod Adams
    Publisher, Atomic Insights

  • Posted by VG

    All good points. Regarding the point of costs and benefits of environmental regulations-EPA’s rules in no way dictate that coal plants have to shutter. Low natural gas prices are making uncontrolled coal uneconomic, but if gas prices were higher, we would see more existing plants install pollution controls. Furthermore, EPA’s regs were promulgated under judicial deadlines and were not to take costs under consideration per statute. Even if nat gas prices were $12/mmbtu or higher, we would have ended up with largely the same regulations, but the models would have indicated different control strategies. Your point is well taken, however, as we contemplate mandatory GHG reductions from the power and industrial sectors.

    [ML: Good points. I'm thinking about the future rather than the past. In particular, GHG regulations will presumably be based on cost-benefit comparisons, since there's no threshold to use as an alternative.]

  • Posted by Rod Adams

    A key piece of information disappeared from my original submission, perhaps due to the way that HTML treats the keyboard symbols that mathematically mean “less than” and “more than”.

    In the phrase that currently shows up as the below:

    “prices started a long ratcheting climb from $12 per million BTU”

    Which is totally incorrect and makes little sense, what I really wrote was:

    “prices started a long ratcheting climb from “less than” $2 per million BTU to “greater than” $12 per million BTU”

    Unfortunately, I used the symbols instead of the quoted words so I think HTML thought it was an invalid tag and just ignored the words between the “less than” and “greater than” symbols.

    My bad.

    Rod Adams

  • Posted by amit jha

    World Bioenergy is the number one international event for the bioenergy sector. This is where bioenergy professionals meet to network, find suppliers, buyers and partners for further growth. The tradeshow is held parallel with conference sessions, multiple field excursions and extensive matchmaking. The concept of “taking you from know-how to show-how” attracts professionals within and around the sector of biomass for energy. Welcome to Jönköping, Sweden 29-31 May 2012!
    http://www.exhibitindia.com/tradeshow_files/energy_wind_files/program_ew_files/21016.htm

  • Posted by Sean Zealberg

    Very good article. However, one thing to consider is innovation. Natural gas can actually be produced from wind and solar energy as long as there is water and carbon dioxide on planet Earth. This, in essence, means that natural gas could be forever renewable. With that, innovations in gas-to-liquids (GTL) technologies could enable domestic production of gasoline from natural gas…thereby making gasoline potentially “renewable” too.

    If anyone is interested in how any of this works feel free to visit my Facebook page (www.facebook.com/windfrontiers) or my Youtube channel (www.youtube.com/user/windfrontiers) as both explain these innovations and technologies in-depth.

  • Posted by pjc

    This is a bit like speculating on whether or not the sun will come up tommorrow.

    They’ve barely started shale gas development in Canada. Shale reserves outside the US haven’t been tapped at all.

    There is easily a 100 hundred year ***N. American*** supply of natural gas. There might be a 400 year supply of global gas.

    This is a resource that is going to play out over multiple decades, at a minimum. The US is probably err-ing the other way, in not sufficiently preparing itself for a gas rich global economy.

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