The Realities of Natural Gas
Ferdinand Banks, April 18th, 2008
The Realities of Natural Gas
By Professor Ferdinand E. Banks
ferdinand.banks@telia.com
Since the publication of my natural gas book (1987), many changes have taken place in this market. Globally, the growth in the demand for gas may still exceed that of all energy media, except renewables, and until recently gas was often highly recommended as an input for electric power generation. (In both the U.S. and UK, a gigantic infusion of gas-based equipment was planned before the authentic supply-demand situation for gas was identified.)
A main reason for the popularity of gas was the advent of combined cycle gas burning equipment with a very high efficiency. What happens here is that in addition to the gas turbine, there is a secondary turbine producing steam from the waste gases/heat of the gas turbine. The kinetic energy in this steam is transformed to mechanical energy that turns a generator. When compared with earlier equipment, additional electricity could be produced for a given input of gas.
However, as often happens, there are many misconceptions in circulation about natural gas, the most pernicious of which - at least in Europe - have to do with the restructuring (i.e. deregulation/liberalization) of gas markets. Some questions need to be asked as to why and how these misconceptions came into existence, and it appears that the answer has to do with the inability of consumers, and to a certain extent producers, to judge the future availability of gas. For instance, one of the arguments for deregulation turned on the crank belief that more ‘competition' - to include a greater resort to spot markets and derivatives (i.e. futures and options) - could compensate for the unavoidable depletion of physical resources.
In addition, in some parts of the world, gas producers expressed themselves in such a way as to give the impression that there was virtually an infinite amount of natural gas reserves (in one form or another) that would eventually be available for exploitation, if their transactions were not disturbed by ‘regulators'. Similarly, many gas buyers were almost totally unaware of how supply and demand could develop in the long-run, and instead continued to make plans for a future in which they would have access to all the gas that they would need, at prices that resembled those of the recent past. This might be a good place to note that in Brazil, some starry-eyed deregulators counted on gas-based electric power being cheaper than hydroelectricity and nuclear. As they now admit, this incredibly gauche supposition was completely wrong.
In much of North America, despite propaganda to the contrary, exploration and production have been yielding disappointing results for a long time, and expectations about e.g. the Gulf of Mexico and imports into the U.S. by pipeline from Canada often have an air of unreality about them. In Europe a more rational tale can be deduced on the basis of what happened in Finland. With copious potential gas supplies adjacent to Finland in Russia and Norway, the decision-makers in that country chose nuclear as the best option for additional power. They understood that given the likely future demand for gas in Europe, Asia and North America, in the long-run they might have found themselves relying on imports from very distant sources - e.g, Qatar and Iran.
According to the International Energy Agency [IEA] of the OECD, fossil fuels will account for 90% of the world primary energy mix by 2020. Global gas demand is expected to rise by 2.5-2.7%/y (although in the U.S. this figure will be 2%/y), even though the price has started moving up rapidly. The big consuming area will likely be Asia, where it has been suggested that demand will increase by an average of 3.5%/y between 2001 and 2025. The share of gas in world energy demand could move in that period from 21% to at least 24%. An earlier estimate had the average global gas production increasing by 2.75%/y until at least 2025, and gas quickly overtaking coal in the global energy picture. This no longer sounds right, nor does an absurd forecast the IEA which envisaged the global consumption of oil in 2030 reaching 120mb/d.
World gas prices might already be on an unambiguous upward trend. In picturing world gas prices remaining flat until 2005, the IEA was clearly mistaken, but they are correct in noting that a tightening of U.S. and Canadian gas supplies is unavoidable, and this process could turn out to be very unpleasant for buyers. A wellhead price of $2.5/mBtu (in 1997 prices) for purely conventional U.S. gas in 2020 seemed offbeat to me when it was predicted at the beginning of this century, and unless the global macroeconomy greatly deteriorates, a sustainable gas price of at least $10/Mcf could be experienced before the end of this year, with occasional ‘spikes' that carried the price well above that figure. Bargain basement oil has gone out of style, and the same is going to happen with gas.
As I explain in my new textbook (2007), if recent changes in the price of gas continue, they will soon restore gas to the position in the electric generation ‘merit order' that it occupied before the introduction of combined-cycle technology. In case readers are a bit vague on this subject, what this means is that gas will be judged as economically unsuitable for carrying the electric base load, and as a result the many investments made earlier on the basis of a low expected price of gas were ‘sub-optimal'.
IN THE MOOD FOR MISUNDERSTANDINGS
That brings us to restructuring. The IEA mostly got it wrong on restructuring in the electricity sector, and as a result I see no reason to expect an improvement in their ability to analyse the economics of world gas. However, since even the experts of the IEA are capable of comprehending that major uncertainties exist about the ability to develop and transport the more distant gas reserves, then it might be appropriate to suggest that considerable effort should be made to prevent the cavalcade of unsound ideas about deregulation/liberalisation from getting in the way of sound engineering and managerial practices. I think it useful to stress that the same exaggerated claims made for electric deregulation have also been made for gas, though not so aggressively as a decade ago. The term "exaggerated" may also apply to the future of liquefied natural gas [LNG]. In the U.S. the only place that LNG has been declared welcome is on the Gulf coast - although a friendly reception is no longer certain in e.g. Louisiana. In the Northeast and on the West Coast, pipeline gas is preferred - although where this pipeline gas will originate is something that nobody seems to know.
A main shortcoming of the gas market debate was, initially, the presence of several academic economists without the slightest feel for either the economics or the engineering aspects of the natural gas sector. This includes economists with a modicum of engineering training in their background. The question was therefore raised as to how we should treat the avalanche of misjudgements about this market in order to help prevent expensive, irreversible investments from taking place.
