Is natural gas a transportation game changer?
If natural gas continues to be significantly less expensive than diesel, it would make sense that some portion of the transportation sector would convert from diesel to natural gas. But in doing so, demand for diesel would decline relative to demand for natural gas—and this would cause price convergence. How are are we from this reality?
Derik Andreoli, Ph.D.c. is the Senior Analyst at Mercator International, LLC.
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Although the average price for a gallon of diesel has declined $0.22 in the last two months, diesel remains a dollar more expensive than it was a year ago. With little relief in sight, it’s not surprising that an increasing number of fleet managers suffering from “pain at the pump” have become interested in converting all or some of their vehicles to run on natural gas.
Whether or not this is a good idea, however, pivots on whether or not the shale gas revolution, which has driven prices down from more than $13 to just over $4 per thousand cubic feet (Mcf), is sustainable. Unfortunately, a careful study of the process and economics of shale gas production suggests that the current low prices and supply glut are transitory.
While there is no doubt that U.S. shale gas reserves are immense, and shale gas production has come to supply nearly a quarter of U.S. gas demand, the size of the reserve matters much less than the rate of sustainable extraction. While the rate of shale gas production surged from 1.0 trillion cubic feet (Tcf) in 2006 to 4.8 Tcf in 2010, a number of valid arguments cast doubt on the sustainability of this trend.
In a conventional natural gas play, a well is drilled through an impermeable cap rock and into a source rock through which hydrocarbons can easily flow. Because the natural gas in a conventional field is under great pressure, once the drill breaks through the cap rock, the gas flows to the surface under its own accord.
Unlike conventional source rocks, shale is completely impermeable. Consequently, any hydrocarbons that formed in shale are trapped there indefinitely. The only way to release them is by fracturing the rock itself; and even then, only those hydrocarbons at the fracture interface are released.
Importantly, because the gas in the surrounding rock is trapped, the life of a hydraulically fractured well is much shorter than a conventional field. Furthermore, producing the same areal extent of a shale formation requires more costly wells, equipment, and pipelines than would be required on a conventional gas field.
The process of hydraulic fracturing, or “fracing,” requires producers to pump massive quantities of water, proppants, and biocides into the ground under high pressure. The pressure fractures the formation and releases the hydrocarbons found at the fracture interface.
Because the weight of the overburdened formation threatens to greatly reduce the flow of hydrocarbons, proppants are mixed in with the fracing fluid. The proppants act as a mechanical wedge which ‘props’ open the newly created fractures.
The flow through the fractures is also threatened by blooms of hydrocarbon-consuming bacteria. As a consequence, biocides which inhibit bacterial growth are also mixed with the fracing fluid. The necessary inclusion of biocides in fracing fluid is a cause of great concern among activists, and for good reason.
Most, but not all, of the fracing fluid which is pumped into the ground is produced along with the hydrocarbons. This fluid must be transported to a treatment facility, and the cost of treatment is born by the producer. Measures of effluent coming out of water treatment facilities show that some are not capable of effectively processing fracing fluid. More than that, however, it’s unclear where the portion of biocides that remain in the ground will eventually end up.
Currently, there is a growing movement in Pennsylvania, New York, and elsewhere to ban hydraulic fracturing on the grounds that the human health and environmental risks of groundwater and surface water contamination are unacceptably high, and safeguards are unacceptably low. The documentary film Gasland, that famously shows flames shooting out from a man’s water faucet, helped inspire this movement. The logic follows that if the natural gas can migrate into water wells, what’s to prevent the biocides from doing the same?
The anti-fracing movement has been further invigorated by the research of Prof. Dan Voltz who shows a statistical relationship between drinking water quality, cancer clusters, and the sites of shale gas wells. Efforts to ban hydrofracing have inspired the New York legislature to place a moratorium on shale gas production in the watershed that supplies New York City with drinking water. And outside the U.S., hydraulic fracturing has been banned outright in France over rising environmental concerns.
Many fracing proponents argue that the process is safe. Others argue that no process is without risk, and that the detrimental impacts of high energy prices justify taking these risks. But whether or not the process can be done safely is not the point. The point is that there is a large and growing population that does not trust that shale gas extraction can be done safely, and this group has evolved into a very active and effective opponent to the natural gas industry.
It pays to play, but not all shale plays pay: While concerned citizen activists have in some cases been successful in thwarting the efforts of shale gas producers, there are others, like petroleum geologist, consultant, and shale gas proponent, Arthur Berman, who argue that the prospects for shale gas being a “game changer” are inflated—that both reserves and future production rates have been overestimated. Berman makes a convincing and empirically grounded case that the methodology used to estimate shale gas reserves and future production rates is flawed.
In addition to questioning the estimation of critical variables that drive the mathematical models used to estimate reserves and future production, Berman takes aim at a critical underlying assumption—that shale gas formations are homogeneous. If the homogeneity assumption, which is the assumption that the quantity of natural gas per cubic foot is consistent throughout the formation, holds true, the production rate of any particular well can be used to estimate the total reserves and potential production rates across the entire formation.
Berman demonstrates that the shale plays are, in fact, highly heterogeneous. He shows that economical production in two of the most extensively explored and produced shale plays, the Barnett and Haynesville plays, can only be accomplished in core areas. Taken together, these core areas represent no more than 20 percent of the total areal extent of these plays. Hence, reserves are likely overestimated.
The gas glut is the arbiter of arbitrage: For the sake of argument, however, let’s step back and give the industry the benefit of the doubt. Let’s imagine that environmentalists toss in the towel or that their protests have no impact on producers’ bottom lines.
Let’s also imagine that the thoughtful and substantiated criticisms by Mr. Berman and others are proven wrong. In other words, let’s imagine that shale gas production can continue growing at recent rates. Under this scenario, there would be a strong force—call it an invisible hand—impelling producers to transport and sell gas in high priced markets, like eastern Europe, China, and India.
Globally, investment is already flowing into liquid natural gas (LNG) tanker construction, and liquefaction and regasification facilities. These investments could allow a physical arbitrage that would cause prices in the U.S. to rise while prices elsewhere would fall.
Similarly, if natural gas continues to be significantly less expensive than diesel, it would make sense that some portion of the transportation sector would convert from diesel to natural gas. But in doing so, demand for diesel would decline relative to demand for natural gas—and this would cause price convergence.
Does all this mean that fleet managers should not consider natural gas alternatives? Of course not. There is a lot of natural gas trapped in shale, and I have no doubt that it will continue to contribute increasingly to domestic gas production. But as the industry learns more about the process we can expect one of two outcomes. Either the significant proportion of uneconomical wells will decline; thus, the growth in supply will slow, or the prices will rise to make uneconomical wells turn a profit.
Given that shale gas is much more capital, energy, and land intensive to produce, it makes little sense to expect gas prices to remain so low. The problem with shale is not the size of the reserves, it’s that shale gas can’t be inexpensively produced using environmentally benign techniques.
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