August 2009 Vol. 236 No. 8

From the Burner Tip

Natural Gas Outlook Uncertain As Supply/Demand Balances Vary

Natural gas might be clear and odorless gas but its future is as cloudy as a London fog!

At the turn of the century, natural gas was hailed as the “bridge fuel” of the future. With crude oil the No. 1 source of U.S. energy and gas sometimes No.2 or 3 – depending on how coal was doing – natural gas use was estimated in the 1999 National Petroleum Council (NPC) Report to jump from around 22 Tcf to 29 Tcf per year by 2010. Estimated consumption by the Energy Information Administration (EIA) for 2009 will be 22.7 Tcf, a far cry from the 2010 forecast!

There are sufficient reasons in the energy business environment to speculate why natural gas has failed to meet expectations. But, more important for this critical U.S. fuel, is what the future may hold. Many of the qualities natural gas had at the turn of the century remain but a changing world with varying demands and a new political correctness is having an effect. Natural gas is still the bridge fuel to the future but the future is hazy and is undergoing a metamorphosis!

Natural gas has superior qualities as a fuel for many applications. It is one of the cleanest burning fuels; in commercial quantities it is essentially only carbon and hydrogen giving off relatively pure combustion products. It is the easiest fuel to make commercially available as the production from the ground, the preparation to make it a commercial product, and transportation are relatively clean and simple. Coming from wells in various producing regions of the country, there are more than 530 processing plants to make the gas commercially useful if cleanup is needed. There are 300,000 miles of intra and interstate pipelines to deliver the gas to consuming regions.

With a few exceptions, natural gas is a relatively inexpensive fuel. Not as cheap per energy unit as coal but when transportation, storage, and combustion product clean-up are considered, its overall costs make it one of the cheapest fuels for electric generation, its second-largest market.

Supply is abundant – even in 2000 gas was sufficient to meet demand. With new sources from shale deposits such as the Barnett and others in various parts of the country, supply is even more secure. Adding even more confidence to sufficient supply is the number of foreign liquefied natural gas (LNG) sources available.

So what killed the goose that laid the golden egg? Why no 30 Tcf by 2010? And what do these reasons offer as prognosticators of the future? There are many reasons for the missed target but two stand out: the major market for expansion – electric generation – did not materialize for gas as much as expected and the volatility of gas prices along with the economic crisis cut into demand.

The biggest use for natural gas is in the industrial sector – either for feedstock or fuel. Next is gas for electric generation and then residential and commercial follow with a small amount for transportation. Industrial consumption peaked in 1997 at 9.7 Tcf while electric use in 2000 was 5.2 Tcf. Other than a potential of normal growth in the other sectors, these two were going to carry natural gas to 30 Tcf by 2010 with electric generation offering the most potential growth.

In 2008, fed by the economic slowdown and price volatility, industrial consumption of natural gas fell 14.5% from 2000 to 7.9 Tcf. Natural gas spot prices at Henry Hub were close to $14/MMBtu in mid-2008! At the same time, electric generation demand for gas from 2000 to 2008 rose only 27.9%, just 3% per year compared to much higher expected annual growth. The big factor here was that coal demand for electric generation remained strong in light of gas price volatility and some concern for supply.

Now, with history behind us, what is the outlook for natural gas in the short and long term? Remember, these are turbulent times in the energy business – “cap and trade” laws are under discussion, U.S. energy independence is the big promise, everyone wants “green” energy, and the economy is still wobbly. Bad time for forecasting, but what are the big points to ponder?

Major considerations are legislative or political which includes environmental and regulatory, along with the economy and how well it responds – which plays a vital role in demand – and while not critical at the moment, supply. Pricing is not listed since it is not an independent variable but is a product of the other three factors.

Pricing is in the $3-4/MMBtu range because of the large supply of gas including what is accumulating in storage and the relatively lower demand. Though producers have taken steps to cut back on future production – as evidenced by the severe decline in the drilling rig count – gas continues to be available. Cash-flow requirements and potential damage to wells are forcing producers to continue to produce and that has helped keep the price in the current range. The likelihood is that it will stay in this range and perhaps move up a little in the early winter months and, if all goes well, to the $5-plus range next year.

Taking the major factors in reverse order – supply, economy, and legislation – makes the discussion easier. Supply is rather straightforward – between increased U.S. production, high storage levels and increased LNG imports, there is no shortage of gas. The development of gas production from shale reservoirs, starting in the Barnett and many more including the Marcellus in Pennsylvania, adds greatly to the supply. While production from these reservoirs requires at least $5/MMBtu prices, there are enough wells that need to be produced for cash flow, production reasons, etc. even at these low prices.

The underground storage-fill season most likely will end near full capacity at about 3.8 Tcf. LNG imports, which dropped considerably last year because of extremely high prices in European and Asian markets. Also, a decline in foreign markets has made more LNG available and no country has the storage the U.S. can offer.

As far as the economy, it is “black and white”. An improved economy means more demand – that could help lift prices which mean more supply. Enough said!

The legislative, political, environmental, and regulatory questions are the biggest unknowns as no crystal ball can tell what is on the minds of politicians and the like! Much passion and pressure is coming from environmentalists to stop all carbon dioxide-producing fuels except for those produced from current agriculture or biofuels. The argument, while not very sound really, is that the biofuels took up carbon dioxide from the atmosphere to be produced and burning them is a net zero release of dioxide back into the environment.

Regardless of whether it’s right or wrong, much of this thinking is behind the desire to stop further offshore oil and gas production. Even though natural gas is a relatively clean fuel and holds promise as the bridge fuel until new carbon-free fuels can be developed, the “green” people are against natural gas not only because of the carbon dioxide released but also, they claim, the potential environmental hazards from gas production! This comes into play especially with tight formations where hydraulic-fracturing wells have come under scrutiny as well as some other production actions.

The House of Representatives passed a 1,500-page cap-and-trade bill that would change the energy picture totally – by 2050 carbon dioxide production would be reduced 80% from 1990 levels. Whether cap-and-trade makes it through the legislative process or whether there is a straight carbon tax or something else to reduce carbon emissions, energy prices will rise, some more than others.

Natural gas could see benefits since the levy on coal will be much higher than on gas and gas could replace part of the use of coal that now provides more than 50% of the fuel for electric generation. Nuclear has a potential but the current era of political correctness does not even mention it as a replacement; even if it gains in popularity, the time to build new units is excessive. There are too many parameters and variables to make an accurate assessment of what will come out of the legislation. It is a political football and the best politicians will win regardless of the technical, social, or economic conditions.

The outlook for gas is good, especially if the economy improves with time. Farther out, gas still has a bright future since it will be needed to replace coal, and even if biofuels, wind and solar do progress to be major fuels – now less than 2% – natural gas will have a place in the energy market.