Andreoli on Oil and Fuel: Movement to CNG/LNG fleets encouraging, but not without risk

Interest in alternative fuel vehicles skyrocketed in 2013, with successful pilot programs for compressed natural gas (CNG) and liquefied natural gas (LNG) trucks being deployed in both private and for-hire truck fleets.

While the success stories are encouraging, investing in CNG/LNG fleets is expensive and not without risks. Decision makers must understand and quantify these risks and balance them against positive developments in the alternative fuel industry.
Regarding the later, the rapid growth of natural gas vehicle fleets and continued strong price differentials between diesel and CNG/LNG (measured on an energy equivalent basis) have inspired a rapid build-out of public, fast-fill CNG fueling stations and promoted growth in the LNG fueling infrastructure as well.

Thus, the long-standing “chicken and egg” question appears to be answering itself—alternative fuel fleets and infrastructure are being built out concurrently.

The growth in demand for CNG-powered trucks has both enabled and driven CNG tank manufacturers to invest in research and development aimed at reducing the weight of CNG tanks. Tank manufacturers have also invested in technologies that help dissipate heat so that a larger volume of CNG can be pumped into the tanks at fast-fill facilities.

These investments have made CNG more competitive against diesel, and as the market grows, it should be expected that scale economies would continue to put downward pressure on the price for CNG tanks. Similar progress has been made in LNG tank design, but the market for LNG trucks remains small.

Similarly, growth in demand for medium and heavy-duty CNG/LNG power plants will continue to inspire innovation and suppress prices. Moreover, as the number of CNG/LNG trucks grows, confidence in the end-of-lease residual value estimates increase, and the inherent investment risk will experience further declines.

While innovations and economies of scale will continue to enhance the viability of CNG/LNG powered fleets, these positive developments must be weighed against the risk that the fuel price differential will contract to a meaningful degree over the life of the fuel-switching investment requirements. In cases where public fueling stations are utilized, the price differential will only have to persist for three to five years—just long enough to cover the lease life of the vehicle and ensure viability of the residual value.

In cases where fleet managers also invest in on-site CNG/LNG fueling infrastructure, the price differential will need to persist for a much longer period of time.

A number of factors could cause the price differential between a gallon of diesel and a diesel gallon equivalent (DGE) of CNG or LNG to either grow or contract. Ultimately, the retail price is driven by the underlying price of oil and natural gas, and it is further influenced by transportation and processing (refining, compression, or liquefaction) costs as well as the retail markup and taxes.

Regarding the underlying commodity price, we see that the average price paid by domestic refiners to acquire a barrel of oil is currently $100.23, and that the highest average price paid over the prior year was $106.20. By comparison, the lowest price paid was $98.67. In relative terms, the difference between the highest and lowest average acquisition cost in 2013 pencils out to approximately seven percent.

While oil prices have remained relatively flat, natural gas prices have fluctuated significantly. The lowest price paid for a unit of natural gas (one thousand cubic feet) at the Henry Hub distribution facility was $3.18 (first week of January 2013), and the highest price paid was just over $4.50 (late December 2013). This equates to a price increase in excess of 41 percent over the year. From a commodity perspective, oil prices remained flat while natural gas prices rose significantly through 2013.

Of course, these values represent national averages, and significant regional price differentials exist. The most recent data indicate that the cheapest diesel was to be found in retail stations in the Gulf Coast region. At just $3.76 per gallon, retail diesel prices were approximately 10 percent less expensive on the Gulf Coast than they were on the West Coast where a gallon of diesel will set the consumer back $4.13. The price differentials between states are even higher.

By contrast, on a diesel gallon equivalent (DGE) basis, retail CNG prices ranged from just $2.10 in the Midwest region to $2.91 in New England—equating to a regional price differential of nearly 40 percent.

Similar price differentials exist for private-fleet refueling facilities. Interestingly, on a regional basis, the retail markup for CNG ranges from insignificant to enormous. On the West Coast, the difference in the average price for a diesel gallon equivalent of CNG acquired at a public retail fueling station was $0.81 (or 43 percent) higher than the final costs per unit at private-fleet stations. By contrast, there was almost no price discount for fleet managers in the Midwest that had installed their own CNG compression and fueling infrastructure.

Looking forward, strategic decisions will hinge on how oil and fuel markets develop and how diesel and CNG/LNG prices evolve over the next few years both regionally and internationally. Key questions include:

• What price is required to return domestic natural gas production, which has been stagnant since January 2012, to growth?

• Will natural gas production return to growth rates that persisted between 2006 and 2012, when dry gas production grew from approximately 1.5 to 2.0 trillion cubic feet per month?

• Alternatively, what price is required to bring the natural gas drilling rig count back up after declining from more than 800 in January 2012 to 430 by December of 2012 to just 370 in December 2013?

• What will be the price impact of the four LNG liquefaction plants that have been permitted for construction and are forecasted to bring LNG exports up to 2.3 trillion cubic feet per year—or approximately 10 percent of the current level of domestic dry gas production?

• On the diesel side, how will the boom in shale oil production impact world oil prices and regional refiner crude oil acquisition costs?

• Moreover, how will the build-out of oil and refined product pipelines impact the crude oil acquisition costs of regional refineries, and will costs/savings be passed to the consumer?

• Finally, how will federal and state regulations and incentives impact the cost of the initial investment?

The coming year promises to be exciting as dynamic market conditions cause the diesel/natural gas price differential to evolve. Market pressures suggest that the price differential will contract over the next 12 months. At the same time, economies of scale will increase and the investment differential between CNG/LNG and diesel power plants should contract.