The Energy Futurist

The Siren song of LNG exports

The Siren song of LNG exports

Posting in Energy

Natural gas fever has overtaken America, pumped up by a vigorous industry propaganda campaign, columnist Chris Nelder writes.

Natural gas fever has overtaken America, pumped up by a vigorous industry propaganda campaign. We're going to convert everything to run on gas, become energy self-sufficient, and correct our trade deficit by exporting massive volumes of gas. So the story goes.

I say we need to check ourselves before we wreck ourselves.

To begin with, let's review what we know.

The industry asserts that we have a 100-year supply of natural gas. This estimate comes from a proprietary, $495 report published last year by an opaque industry group known as the Potential Gas Committee, whose web site consists of a single press release. The numbers in that press release do not add up as shown, nor are any details about how they arrived at those numbers publicly available. But leaving those issues aside, if we take their 2,170 trillion cubic feet (tcf) estimate of proved, probable, possible, and speculative gas resources at face value, and divide by the 2009 rate of American consumption—about 22.8 tcf per year—that would give us a 95-year supply of gas. At the 2010 consumption rate of 24.1 tcf/yr, it would be a 90-year supply. (Therefore, we can say that one year’s increase in US gas consumption shaved five years off the claimed supply.)

However, only 273 tcf are currently recognized by the EIA as proved reserves, a technical classification meaning that they are believed to exist and to be commercially producible at a profit (a 10 percent discount rate). At the 2010 rate of consumption, only an 11-year supply of gas is currently proved. The rest is speculative. (If you want to explore the details, I attempted to update and rationalize the data here.)

We also know, as I detailed last month, that "dry" gas production is a currently a money-losing enterprise for all but the most productive, least expensive operations. Operators need $8-9 per thousand cubic feet (mcf) to break even, but their own drilling frenzy has caused prices to sink well below that threshold. Henry Hub spot now stands at just $2.40/mcf as of this writing, a 23 percent decline in five weeks. Last week futures fell to $2.32, their lowest level since 2002, although they have since rebounded to $2.57. This is death for producers, particularly the ones that took on a great deal of debt to continue drilling. Top shale gas producer Chesapeake, heavily laden with debt, finally said uncle on Monday when it announced that it would slash its production by 500 million cubic feet, or about 8 percent, effective immediately. If nearly everyone is producing gas at a loss, then Chesapeake's move should be a harbinger of what's to come: declining gas production as producers move to plays rich in higher-value natural gas liquids, and cut back on pure dry gas production.

At the same time, resource estimates are falling as we acquire more actual experience producing these relatively new shale gas plays. The EIA made news on Monday with an early release of its Annual Energy Outlook 2012, in which they cut their headline estimate for the Marcellus Shale by two-thirds, from 410 tcf to 141 tcf, and gave a "mean" estimate of 84 tcf for the technically (not economically) recoverable resource. Alert readers will recognize that this wasn't really news; the EIA merely adopted the reassessment released in August 2011 by the US Geological Survey, which I referenced last month.

For the entire United States, the EIA cut its "unproved technically recoverable resource" shale gas estimate from 827 tcf to 482 tcf, a 42 percent reduction. Against our 2010 consumption rate, that gives us just a 20-year unproved supply which may or may not be economically recoverable.

Such large reductions in estimates are normal for a new, unproved resource. Estimates generally start out low, when very little is known about the resource, then are revised much higher, as euphoria develops over initial results, then are cut back as the resource is slowly proved out. But you won't see that pattern if you just read the headlines, because the press gives top billing to upward revisions, then tends to ignore the later downward revisions. Everybody loves a happy story.

New domestic demand

Abundance euphoria hasn't diminished in the industries that want to use it, however. The Siren song of almost-free gas has called a fleet of new ships to its rocky shores.

The first industry to switch to gas should be power generation, as I detailed two weeks ago. It would mean lower electricity prices for consumers, and reduced emissions. In AEO2012, the EIA estimates that demand for gas in electricity generation should grow by 1.5 tcf through 2035, in part due to the retirement of 33 gigawatts of coal-fired capacity. That estimate seems very conservative, though, considering that the utility sector expects to begin retiring from 30 to 60 gigawatts of coal capacity in the next three years, most of which will be replaced with gas capacity. If so, then new gas demand for power generation might add as much as 3 tcf over the next 23 years.

The next major load to switch to gas should be trucking. The "NAT GAS Act" (New Alternative Transportation to Give Americans Solutions Act of 2011, HR 1380/S 1863) still haunts the halls of Congress singing "I'm Just a Bill" three years after its introduction. But the combined lures of cheap natural gas, and the potential to cut domestic diesel demand meaningfully, should give the final push it needs to make it into law, and the $5 billion price tag seems a small price to pay. If indefatigable champion T. Boone Pickens is correct, and the NAT GAS Act can displace 2 million barrels per day of oil demand, that would cut about $73 billion per year from the nation's current bill of $454 billion per year for imported oil. The increase in gas demand for trucking might be in the range of 1.5 tcf.

The plastics and petrochemical industries, who use natural gas as a feedstock, are also planning to take a big bite out of the new gas supply. Ethane production moved away from the U.S. due to high gas prices, but low prices have been calling it back. Shell is planning the first new ethylene cracker to be built in the U.S. since 2001, which will consume gas from the Marcellus Shale and produce nearly 1 million tons of ethylene per year. Another project will create 3.3 billion pounds of new polyethylene production capacity in Baytown, Texas. The director of ethylene for CMAI (now a subsidiary of IHS CERA) sees 6 million tons of new ethylene expansion through 2017. How much gas these new plastics plants will demand is unclear—data on this subject is hard to find—but it will be substantial.

Another sector that should be expected to increase its demand for gas is residential and commercial heating, as users (primarily in the Northeast) switch from expensive heating oil to cheap gas. This is another hard-to-quantify source of demand, but with households using heating oil now spending over three times as much as gas users, "there’s going to be a continuing incentive to get off heating oil," as former EIA administrator Jay Hakes remarked to the New York Times.

Unintended consequences of exports

In the AEO2012 Reference Case, EIA expects the US to become a net exporter of liquefied natural gas (LNG) in 2016, with export capacity rising to 1.1 billion cubic feet (bcf) per day by 2016, then to 2.2 bcf per day by 2019.

Again, this appears to be a conservative estimate. Cheniere Energy alone has applied to build a $6 billion LNG liquefaction and export terminal at its Sabine Pass, Texas facility with 2.2 bcf per day of export capacity, and has received green lights to move ahead. Another aspiring LNG exporter is Gulf Coast LNG Export LLC, which is planning to build a new liquefaction facility with a 2.8 bcf per day capacity, according to the Pittsburgh Tribune-Review.

Nine gas export applications have been filed with the federal government, for a total of 12.6 bcf per day of LNG export capacity. That's 19 percent, or almost one-fifth of total U.S. gas consumption today. These extremely expensive LNG export terminals typically have at least at 20-year lifespan, so whatever LNG export capacity we build will have an enduring impact on domestic supply. . . at least until the rest of the world unlocks its shale gas resources, and makes LNG from the U.S. uneconomical.

What that might do to gas prices is obviously an important question—obvious enough that the Department of Energy (DOE) asked the EIA to develop some scenarios on how increased exports could affect domestic markets. That request was answered on January 19 with a new report offering four different scenarios of export volumes, factored against four different supply outlooks and assumptions about the growth rate of the U.S. economy.

The multiplicity of results from this analysis found that if gas exports rise rapidly, domestic gas prices do too, and that the more gas we export, the higher prices go. Slower growth in exports causes prices to rise more slowly, but also results in higher average prices. All the scenarios indicate higher prices for gas at some point over the next 23 years, ranging from 14 percent higher in the "low/slow" scenario, to 36 percent higher in the "high/rapid" scenario, to nearly 100 percent higher in the "Low Shale EUR" scenario.

Source: EIA, Figure 3: Natural gas wellhead price difference from AEO2011 Reference case with different additional export levels imposed

Rising gas prices would have cascading effects, like domestic demand destruction, increased imports from Canada, and sharply increased consumption of coal and liquid fuels. None of these would be beneficial to the U.S. economy, nor to the cause of combating climate change.

Total U.S. expenditures on natural gas would increase from $6 to $13 billion, depending on the export scenario. Electricity prices would also rise by anywhere from 0.14 cents to 0.85 cents per kilowatt-hour (2 and 9 percent increases, respectively).

Why export gas?

Before we greenlight large new volumes of LNG exports, we should answer two questions: 1) After satisfying new domestic demand, is there enough left over to export it; and 2) Will it benefit the U.S. economy?

I don't see a "yes" answer to either one.

As it stands, we don't really know how much new demand we're anticipating. As a practical matter, the EIA notes, the DOE is primarily interested in ensuring that our LNG trade conforms to free trade agreements, not ensuring that new demand for gas remains well-matched to supply. I have found no evidence that they even attempt the latter.

But if my rough numbers are in the right ballpark, then we're already contemplating adding around 5 tcf per year, or about 20 percent, in domestic demand for power generation, trucking, plastics, petrochemicals, and heating. On top of that, we're contemplating another 19 percent increase for LNG exports, which will ultimately have untoward effects on the U.S. economy, although it would enrich the exporting companies and their Congressional cronies.

We're going to build all this new demand because we're suffering under a hallucination that we have a "100-year supply of gas" at current rates of consumption. In reality, we only have an 11-year proved supply, while our alleged resources are being sharply reduced, operators are drilling at a loss, and consumption is set to increase by nearly 40 percent.

If we follow through with the planned expansion of LNG exports, we can say goodbye to that 100-year supply, and goodbye to cheap heat, cheap and clean(ish) power generation, cheap fertilizer, and cheap feedstocks for plastics and petrochemicals.

We would do well at this point to pause and remember the egregious error of Britain's Thatcher administration in the 1980s. The discoveries of the Forties, Brent, and Argyll fields in the North Sea in the 1970s were called "God's gift" to the British economy, and Thatcher was eager to take advantage of the new tax revenue to balance the budget. Against the advice of wiser heads in the petroleum industry, she ordered an all-out drilling program and the UK produced oil as quickly as possible, even after prices crashed in the final years of her stay in office. The unintended consequences of this were to make the economy extremely dependent on the new revenue and fuel, while selling a great deal of that "gift" at very low prices. As production in the North Sea fell by more than one-half over the last decade, Britain went from being self-sufficient in oil and gas to a substantial importer of both at a time when oil prices are historically high. The UK is now at the mercy of Russia every winter to keep the gas flowing, and struggling to pay its imports bill, just like we are. Had they stewarded their North Sea resources more carefully, like Norway did, instead of blowing their windfall gains immediately, they would be considerably better off today.

It simply makes no sense for America to export our new gas bonanza. It might not even be a bonanza; we'll have to wait a few more years to see how it plays out. Replacing old coal power plants with new, high-efficiency gas plants will be good for the economy and the climate, as would converting transport trucks to CNG, and transferring heating loads from oil to gas. But exporting gas on top of all that could be a short-term benefit and a long-term disaster.

The wise course of action is to make our gas last as long as possible and use it domestically. We should take advantage of it as a cheap bridge fuel to see us over the chasm of terminal oil decline that we'll be hitting around 2014, not burn it as quickly as possible. The DOE should tie LNG exporters to the mast, stuff wax in the ears of Congress, and deny new exports until we have a better idea of just how much gas we really have, and how much we are planning to use.

Photo: Odysseus and the Sirens, mural on the ferry boat Dionysios Solomos, Ionian Sea. (robwallace/Flickr)

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Chris Nelder

Columnist (Energy)

Chris Nelder is an energy analyst and consultant who has written about energy and investing for more than a decade. He is the author of two books on energy and investing, Profit from the Peak and Investing in Renewable Energy, and has appeared on BBC TV, Fox Business, CNN national radio, Australian Broadcasting Corp., CBS radio and France 24. He is based in California. Follow him on Twitter. Disclosure