The Myth of Natural Gas as a Bridging Fuel


The Myth Of Natural Gas As A Bridging Fuel

I often disagree with the consulting group Bloomberg New Energy Finance, but they may be spot on in questioning whether natural gas can serve as a bridge to the future.  Of course, they would say no, renewables will take over quickly, while I would say it will continue to be an important fuel, not a bridge, and that forecasters, including the oil industry, are greatly understating its potential. It all reminds me of the many times in the early 1980s when oil company executives would say, “natural gas is the fuel of the future,” and some smart aleck would respond, “and always will be.” I finally jumped in and said, you’re producing twenty trillion cubic feet a year, it seems like natural gas is a fuel of the present. Contrast this with the late Matthew Simmons’ view that world gas production had peaked, based on short-term declines in four major producers. Indeed, peak oilers like Jean Laherrerre regularly produced pessimistic views of future gas production and resources, while oil industry mavens like Robert Hefner III, and maverick academics like Peter Odell, countered that it was somewhere between abundant and superabundant. Now, some climate activists and renewable energy advocates are arguing that gas should be left in the ground and/or that it will be because of declining costs of wind and solar.  Most oil company forecasts see only minor changes in demand, specifically moderate growth (see figure). Amazingly, nearly all of these either ignore prices or treat them as high and rising, due to bad economic theory and a simplistic or incorrect view of the market. Typical comments focus on the “quality” or cleanliness of natural gas, without considering prices. This is enough deja vu to make Yogi Berra’s head spin. For my entire career, beginning with the Carter Administration’s review of the proposed Alaska Natural Gas Transportation System (yes, ANGTS), long-term natural gas prices have almost always been predicted to rise by almost everyone (except my colleagues at MIT and myself).  And apparently based on nothing more than a belief that a) gas is better than oil, and b) depletion will drive us from cheaper to more expensive sources. The first is not relevant (it’s supply and demand, not just demand) and the latter suffers from an omitted variable problem. The next figure shows the current state of natural gas price forecasts around the world. Most groups no longer present detailed forecasts, perhaps due to budget cuts but possibly also in response to past embarrassing failures.  Natural gas prices in international trade have been linked to oil prices for decades, and long-term oil price forecasts have been atrocious (the reasons are explained in my book.)  The problem is that too many believe that oil and gas prices should be linked or tend to converge, which means that gas prices are forecast to be high.  (The Figure below shows some Asian gas price forecasts, with actual Japanese LNG prices.)
North America is the only truly competitive market in natural gas, as close to a free market as it is possible to come.  And while some think they perceive convergence on energy prices, natural gas prices are set by supply and demand, and only marginally influenced by developments overseas since the high cost of transportation precludes easy long-distance shipping. This is why U.S. gas prices have often been well below those in Europe and Asia (see figure). Basic facts: Natural gas is superabundant as a resource, although the bulk of it is methane hydrates which are not currently economically feasible. The remaining resource is still superabundant, with supergiant discoveries still occurring and production rates generally exceeding those of conventional wells. Two things have kept the global market for natural gas from achieving its true potential: the cost of transportation and the price. The latter is something that can and hopefully will change. Natural gas prices in many countries are controlled, with the industry treated as a monopoly if not outright state-owned. Often gas prices are kept low to provide cheap fuel for the electricity monopoly and thus supposedly improving the welfare of the poor. But this also retards the development of gas resources (and usually benefits the wealthy more). In gas-importing countries in Asia and Europe, gas is often priced similar to oil on the basis of their respective heat content. This makes as much sense as pricing tea according to its caffeine content relative to coffee. It is a historical artifact of the industry which has survived because of oligopolistic behavior by producers, who are happy to reap oligopolistic profits. But it means that natural gas imports often don’t compete with oil, let along coal. Countries like Korea and Taiwan still burn some oil for power generation. Natural gas is cheap, at least cheap to produce. Witness North America, one of the world’s most mature petroleum provinces yet one where the natural gas wellhead price is approximately one-half to one-third the equivalent petroleum price. Gas from Iran to India and Russia to China could displace enormous amounts of coal being burned and reduce greenhouse gas emissions by a tremendous degree. These countries account for over 60% of the world’s coal consumption, and coal accounts for about half of the global CO2 emissions. This is the lowest hanging fruit on the planet, but the desire of exporters to achieve extremely high price has been an obstacle.
In the U.S., natural gas from shale has meant a boost to the economy while reducing GHG emissions, all at no cost to the taxpayer (indeed, strong benefits). Market share for gas has risen sharply (Figure below) even though the U.S. was already a mature market, rising at 0.8% per year from 2006 to 2016, while global gas market share was increasing at 0.1% per year. Most forecasts anticipate a slightly faster rise, about 0.2% per year, despite the many benefits of natural gas, primarily because they assume that international natural gas prices will remain uncompetitive. The U.S. petroleum industry is poised to change that, not just because of the volume of exports but the willingness of exporters like Cheniere to provide attractive price clauses. The contracts typically specify that the gas will be at U.S. Henry Hub prices plus a fixed amount to cover liquefaction and transportation. In other words, if oil prices return to $100/barrel, U.S. LNG exports could be half the price of competing countries (and/or make huge profits). The preferred solution (for the planet) would be for a flood of U.S. LNG exports breaking the informal exporter cartel which has kept prices high and demand low for many years. That would obviously hurt the Russian, Algerian, Norwegian, and Australian economies in particular, but it would do far more to reduce GHG emissions than any international agreement.