For most, energy economics means the price of oil. Admittedly, its price is enormously important to producers, refiners and consumers.
Among producers, the world landscape of oil production and pricing has changed forever with the strengthening hand of national oil companies whose governments require growing sums to support social programs, often at the expense of upstream reinvestment.
Alan Greenspan in his just-released biography (The Age of Turbulence – Adventures in a New World, 2007, The Penguin Press) provides a lucid description of this phenomenon and the market forces that attract non-traditional investors (speculators) to acquire inventories to support their positions in futures markets.
Rarely will physical stakeholders (producers, buyers) see the role of speculation portrayed in such a positive light.
Yet the expansion of inventories, Greenspan writes, is vital for flexibility when the underlying supply chain offers virtually no excess capacity.
The resulting wild escalation of oil prices, coupled with the fall of natural gas prices for the second year in a row, must finally put to rest notions of a law of parity between oil and natural gas prices whose schism has grown throughout the year. (Figure 1).
Natural gas spot prices are now less than 50 percent those of oil.
But these comments are not so much about oil as about natural gas, the linchpin energy commodity in today’s energy economy due to its importance to so many kinds of investment decisions.
Why has the price of natural gas become so important?
For producers, prices and unconventional plays have driven drilling activity to new highs – the gas rig count has exceeded 14,000 since August 2006 (a doubling since 2002) and tipped 15,000 four weeks this summer, while the oil count hovers near 300 (up from about 135 since 2002).
Its 120 percent average wellhead price increase since 2002 (from $2.95 to $6.53/mmBtu over the first six months of 2007) has spurred this tremendous activity and other supply-side developments of astounding importance.
Yet high rig utilization and worldwide commodity cost escalation have rapidly driven up marginal E&P costs – by some estimates to $6/mmBtu or higher.
This makes developers wary, but they are not the only ones eyeing prices with awe and dread. The impacts on consumers are where the price effects truly multiply.
Demand growth in the industrial sector has been arrested through “demand destruction,” much of which is permanent. Natural gas impacts in the electric sector also are profound, and far greater than most would expect. Natural gas is used in combustion turbines and combined cycle power plants to provide the last increments of electricity needed to meet fluctuating power loads in many regions – and especially during hours of high demand (e.g., weekdays and summertime), which then translate into the wholesale prices offered for electricity.
In this manner, its price influence is multiplied far beyond its physical role as a generation fuel.
Yet even without this multiplier, it has had a dramatic impact on power costs – accounting for 55 percent of all power sector fuel expenses by 2005, even though only 19 percent of generation was provided by gas-fired technologies.
The price of natural gas also is a key determinant in the economics of new technologies. This is partly because of its role in raising power prices, which improve – along with subsidies and tax breaks – the financial performance of non-traditional technologies (wind, biomass, solar).
Its price is also one of the critical assumptions (and uncertainties) in engineering-economic comparisons of, say, coal plants of various types with natural gas-fired combined cycle power plants.(Figure 2).
When we turn to questions of how the nation can meet carbon reduction goals, natural gas often is considered the default choice where, if anything in the nation’s future toolkit stumbles (e.g. nuclear or renewables or carbon capture and sequestration), natural gas is required to make up the difference. (Figure 3).
Insights into the feasible limits on the role of natural gas are vital to energy-environmental policy, and something for which the AAPG membership has unique qualifications – yet the track record for bringing industry insight into the public sector is not good.
With all eyes on natural gas, it is almost frightful to contemplate the array of paradigm-breaking developments that are soon to transform the market. Practically written in stone is a record surge in world liquefaction additions in 2008. (Figure 4). Very likely are increases in U.S. imports, expanding at roughly two billion cubic feet per day each of the next three years (from an estimated two BCFD this year).
This and other major developments, such as Canada’s changing supply-demand-export balance and the changing economics of the Barnett Shale and other unconventional sources, will be discussed in a forum on economics of natural gas and alternative fuels co-sponsored by the Energy Mineral Division at the next AAPG Annual Convention (set April 20-23 in San Antonio).
Here are some reading recommendations, in addition to Greenspan’s previously mentioned book:
- For an engaging and informative glimpse into oil – Oil on the Brain – Adventures from the Pump to the Pipeline, 2007, Random House.
- For more details on some of the linkages between natural gas and the electric sector, consider “Issues in Energy Economics Led by Emerging Linkages Between the Natural Gas and Power Sectors,” J.B. Platt, Natural Resources Research, Vol. 16, No. 3, September 2007.
Here’s one more reading recommendation – a government study that sheds light on the inscrutable world of energy (natural gas) trading: “Excessive Speculation in the Natural Gas Market, Staff Report,” Permanent Subcommittee on Investigations, Committee on Homeland Security and Governmental Affairs, U.S. Senate).
The trading activities are of Amaranth Advisors, a hedge fund whose incredibly huge position in the futures markets resulted in a loss of about $6 billion as the gas market collapsed in September 2006.
In the aftermath of this event, the subcommittee conducted a unique analysis of its positions on the New York Mercantile Exchange and the Intercontinental Exchange. (Figure 5).
For all who sometimes wonder why the natural gas price, even factoring in fears of hurricanes and other imponderables, does not always move in a direction supported by common sense or fundamentals, this window into normally confidential information gives clues.