What Price, Natural Gas? Long-term Question Will be Cost

Testimony of EIA at Senate hearings on natural gas, 10/28/09

by Frank Clemente, Ph.D., Penn State University

Natural gas price in the next decade is one of the most important U.S. energy questions. Steadily increasing U.S. dependence on gas poses risk to higher energy prices and electric reliability and national energy security, especially because the Energy Information Administration (EIA) projects natural gas supply to decline 4 percent through 2020.

 

Our dash to gas during the past decade has led to higher electric rates, has increased home heating prices and has raised manufacturing costs. Why should the next decade be different?

  • More than 90 percent of new power plants built since 2000 depend on natural gas. As a result, natural gas-based generation nameplate capacity exceeds 450,000 MW. (Coal-based is about 335,000 MW.) Further, and amazingly, given the projected supply declines, the utility industry continues down the same path. Almost 50,000 additional MW of natural gas capacity will be added by 2012.
  • In 2008 alone, about 10,000 MW of new wind power capacity were constructed. Because wind power has a capacity factor of only about 25 percent, the burden of backup will fall to natural gas generation. “Once you start building more (wind plants) ” you would have to start building natural gas plants,” said Rick Webb, professor of environmental sciences at the University of Virginia, in 1992.
  • Eight million natural gas-heated homes have been built since 2000, and now more than 60 percent of the homes in the United States depend upon natural gas for heating, as do millions of businesses and institutions. A significant majority of new buildings also are heated by natural gas, adding further to latent demand. A sustained cold spell in the Midwest would reverberate throughout the nation. Natural gas consumption doubles during winter in at least 24 states.

The consequences of this mad rush to build out the natural gas infrastructure have been expensive. Natural gas consumption for power generation has increased significantly, and this new demand has created a conflict with families and businesses for fuel—elevating and destabilizing prices for all consumer groups. In 2003, for example, the residential price of natural gas was $7.76 per thousand cubic feet (Mcf). By 2008, it had increased more than 75 percent to $13.68. Just as important, as Figure 2 demonstrates, increased natural gas generation has led to higher electric rates across the nation.

But increased natural gas-based generation does not merely raise the cost of electricity; it also raises the price of natural gas for other consumers. Moreover, during the past decade, natural gas prices have not only averaged four times higher than coal prices but were far more volatile. In 2008 alone, the price of gas to businesses ranged from $7.13 to $13.05 per Mcf. This continuing price volatility puts some manufacturers out of business and forces others to move abroad. Planning a family budget becomes nearly impossible at low-income levels, and the Low Income Home Energy Assistance Program (LIHEAP) regularly is overwhelmed with requests for utility bill support.

Despite these negative experiences and the projected supply decrease, we continue to build out an ever-more extensive natural gas infrastructure, verifying George Santayana’s “Life of Reason” warning: “Those who cannot remember the past are condemned to repeat it.”

The Next Chapter is Even More Frightening

Numerous emerging issues will exacerbate the situation, but two can be clearly identified:

Coal plant cancellations. These are steadily reducing future access to our most viable and affordable source of baseload capacity: coal. It is well-known that upwards of 100 coal-fired power plants have been canceled during the past few years, but most people do not seem to remember that many had been approved by their respective public service commissions and were deemed necessary to meet future load.

Despite the recession, these needs will not disappear as the demand for electricity steadily will increase. Every time a utility announces a coal plant cancellation, it almost simultaneously announces the construction of a natural gas facility.

A price comes with this knee-jerk switch over. The Department of Energy’s (DOE’s) National Energy Technology Laboratory (NETL) estimates that the absence of 18 GW of planned new coal plants could increase natural gas demand by 1.4-2.3 trillion cubic feet (Tcf) per year.

Jay Apt, a Carnegie Mellon University professor, said that with the cancellation of new coal generation, “The amount of time that natural gas generators set the market price of electricity would increase substantially, and other industries that use natural gas may be priced out of the market.”

Finally, in July 2009, the National Academy of Sciences stated in “America’s Energy Future” that “The committee along with most observers concluded that over the 30-year lifespan of an NGCC (natural gas combined-cycle) plant the price of natural gas would be likely to rise, the year-to-year variations could also be large.”

Climate change legislation. This will increase the consumption and price of natural gas. The EIA’s analysis of the American Clean Energy and Security Act of 2009—the Waxman-Markey climate bill—concluded, “Our results suggest that this legislation would likely increase the use of natural gas for generations over the next decade in all of the scenarios we analyzed.”

The California Energy Commission recently came to similar conclusions, indicating that “greenhouse gas polices” are likely to render “future natural gas price forecasts even less accurate and more uncertain.”

Where Will We Get the Gas?

Despite our starkly negative experiences with higher natural gas prices and the debilitating volatility of those prices, optimism for the fuel appears to be a contagion.

Several groups have suggested that natural gas can be substituted for coal as the primary fuel for generating electricity. Others have proposed that natural gas can provide fuel for vehicles, and yet even others have argued that we can continue to build wind turbines at a frenetic rate because natural gas will be there to back up this highly intermittent supply.

When one objectively examines the data, however, these questions are moot. The real question is: Can natural gas production even meet existing demand, let alone incremental demand? As Figure 3 shows, the EIA has projected that by 2020 conventional onshore natural gas production in the U.S. will decrease more than 34 percent, and supplies from Canada will drop 60 percent.

These declines will be only partially offset by two highly questionable new sources: shale gas and liquefied natural gas (LNG) imports. It is important to consider the limitations and unknowns of each in turn.

Shale gas production. This is the only bright spot in the domestic supply picture, and substantial reserves exist. There are questions, however, along four key lines:

  • Deliverability at scale. Although the shale gas resource is extensive, even the relatively optimistic EIA projections indicate increases in shale gas will offset only about half of supply declines in other key sources (e.g., Canada). Decline rates in shale gas wells can approach 70 percent the first year, creating a constant treadmill to find additional resources and drill new wells.
  • Environmental and water impact. The impact of the fracturing process is a matter of growing concern, particularly in New York and Pennsylvania regarding the Marcellus shale play. The Congressional Research Service, for example, recently reported, “The hydraulic fracturing treatments used to stimulate gas production from shale have stirred environmental concerns over excessive water consumption, drinking water well contamination, and surface water contamination from both drilling activities and fracturing fluid disposal.” In the Marcellus shale region, for example, the Delaware River Basin Commission, responsible for a watershed that serves more than 10 million people, has identified three major areas of concern: reduction of stream flow, pollution of ground and surface water and proper disposal of “frac water.”
  • New regulations. These regulations emerging from environmental concerns could significantly impact production and price. IHS Global Insight estimates that simply subjecting hydraulic fracturing to the federal underground injections control requirements in the Safe Drinking Water Act would result in a 20 percent reduction in the number of new wells drilled and a 10 percent loss of natural gas production.
  • Cost and sustainability. The eventual cost and sustainability of shale gas production are open to question. Geologist Arthur Berman has argued that the high decline rates will make shale gas wells far more costly than projected, and the current rush to shale gas is a “speculative bubble.” Dow Chemical Co. echoed these concerns in 2009 testimony before the U.S. Senate on the role of natural gas. “Although increased supply from shale gas appears to have changed the production profile, we have seen similar scenarios occur,” Dow testified. “In each case, the initial hopes were too high and production increases were not as large as initially expected.”

LNG imports. Given the increasing demand for natural gas and that shale gas will not be able to offset declines in other areas, it can be assumed that the price will rise and LNG imports will increase. “If domestic supplies could not be increased, liquefied natural gas imports would be needed, thereby exposing the U.S. market to increased import dependence and to international prices (with) important energy-security implications,” the National Academy of Sciences warned. The danger that LNG imports may well become the default fuel for our electric supply system is a dark specter that cannot be cavalierly dismissed.

  • Energy security. We will be increasingly dependent on risky suppliers. Like oil, global natural gas reserves are highly concentrated: More than 60 percent of the world’s natural gas reserves are in Russia, Iran, Venezuela, Qatar, United Arab Emirates and Algeria. “The need for more LNG will create closer links to the world oil price, setting the stage for the marginal price of electricity to be set by the whims of foreign oil/LNG suppliers, for the first time in U.S. history,” NETL stated in 2008.
  • Global competition for supply will be fierce. Europe and other parts of the world will depend even more upon LNG than the U.S. and have already demonstrated a willingness to outbid the U.S. Several years ago, for instance, there were cases of LNG cargoes turning around in the Gulf of Mexico because Spain offered a better price.
  • Cost, infrastructure and transportation are out of our control. There is no guarantee that the countries with extensive natural gas reserves are prepared to develop them for international trade. James Jennings, arguably the world’s leading LNG expert, concluded in a recent speech at Columbia University that Qatar “has adopted a wait-and-see policy on further expansion ” (and) Iran is currently preoccupied with developing gas for domestic markets and reinjection in its oilfields.” There is a significant amount of stranded gas, but that does not mean that the gas will ever be developed. Much of the gas is in small pockets scattered across the world. The very size of these pockets will prohibit development for LNG. Operators do not build $10 billion liquefaction plants to exploit limited gas reservoirs. As Jennings pointed out, the natural gas resource needed to make the development of a $10 billion LNG delivery system economical “requires about 12 Tcf of reserves to support a 20-year contract.”
  • Projections of LNG imports have a sorry history of excessive optimism. In 2005, the industry-sponsored American Gas Foundation presented a report arguing that 6 Tcf a year of liquefied gas is pointed toward U.S. markets. Since then, we have never imported more than 13 percent of that amount. In 2008, Michael Stoppard, director of gas at Cambridge Energy Research Associates (CERA), said, “The LNG armada has already set sail.” But only 352 Bcf of LNG made it to the United States in 2008—the lowest amount in the past six years.

A Risky Bet

The U.S. has one of the most reliable electric power supply systems in the world.

Reasonable electricity prices coupled with moderate and stable natural prices helped propel U.S. industry to center stage around the world.

We are now losing that competitive edge. The size of the bet we are placing on two untested sources of new supply is staggering.

We are assuming that shale gas, whose cost, sustainability, deliverability, reliability and environmental impact are not known, will be a silver bullet offsetting declining conventional production and drastically reduced Canadian imports.

Unfortunately, we have been down the natural gas silver bullet road before, and each turned out to be a dud.

And we are assuming that LNG supplies will be readily available at reasonable cost to the U.S.

Yet, we are the last resort for LNG suppliers, given our distance from liquefaction facilities.

For a nation ostensibly worried about the security of our energy supplies, we are placing a strange faith in obtaining the 45 percent of the world’s natural gas owned by Russia, Iran and Venezuela.

If the past decade of natural gas is prologue, we are in for a rocky road.

Author

Frank Clemente is a social science professor at Penn State University, where his research specialization is the socioeconomic impact of energy policy. He is the former director of the university’s Environmental Policy Center. Reach him at fac226@psu.edu.

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