An interesting and important debate is set to take place in Washington shortly—in fact, it’s already talking place, but few people are paying attention yet. Joe Nocera over at The New York Times wrote an instructive column a couple of weeks ago on the very topic that is starting to exercise any number of people—energy exports, particularly exports of Liquified Natural Gas (LNG). Not that it’s a very good column. In fact, it’s a terrible column, marred most of all by sheer laziness. Nocera often has interesting things to say, but not this time. It’s instructive in that it reads more like talking points provided by the energy industry, when in fact the issue requires a bit more diligence than Nocera seems inclined to bring. It’s a complex issue that Nocera doesn’t give the depth it deserves, sadly. Instead, he uses the column to take some cheap shots at Dow Chemical’s opposition to unfettered energy exports. Frankly, Dow may deserve cheap shots from time to time—it’s one of the world’s largest chemical companies, after all—but not this time.
Here’s something of the background. The United States is allegedly in the midst of an industrial renaissance. That, at least, is what we are constantly being told in the media. Whether this is true or not, and it may not be (as our friends over at FT‘s Alphaville have suggested), it certainly makes a good story. And it basically all comes down to the lower energy prices currently prevailing in the US relative to Europe and Asia. And this all comes down to the production of natural gas by fracking—hydraulic fracturing, coupled with horizontal drilling technologies, all of which has been “perfected,” if that’s the word, during the past decade. It’s been 18 months since our last comment on shale gas and fracking. A lot can happen in 18 months.
Let’s start with the obvious. Over the past several years, the price of natural gas in the US has dropped, and has more or less disconnected from the price of oil. The one undisputed fact relating to shale gas and fracking, irrespective of whatever other benefits or controversies it may generate, is that it has resulted in significantly lower natural gas prices in the US. During 2012, after the end point of this table, natural gas prices declined even further, although the have been rising the past nine months or so. Still, the story holds:
These aren’t real prices—they’re normalized to that you can see how they move relative to each other. And you can see pretty clearly the disengagement of natural gas from oil prices around 2009. Not only that. These developments also have lowered Natural Gas prices in the US relative to other markets:
And, among other things, lower natural gas prices have significantly lowered the costs of feedstocks to the US chemical industry, to say nothing of the costs of energy. An industry that was closing plants a decade ago is now re-opening plants, or planning on building new ones, on the back of these lower feedstock (usually ethane) costs—and in scale. Ethane derived from natural gas is now a whole lot cheaper than naphtha, an oil derivative, which is what Europe uses, for example, in much of its chemical production:
This table isn’t quite current—naphtha prices have been dropping recently—but it still holds.
The US now has a competitive advantage in a whole range of chemical products, and a number of observers expect the US to retain this advantage. And the chemical industry’s response? Well, invest, invest, and then invest more. Depending on who you believe, the US chemical industry (including international companies with plant in the US) is planning on spending anywhere from $70 billion to $120 billion over the next 15-25 years. Given all the hand-wringing about America’s loss of manufacturing jobs—which is completely justified, by the way—you would think this was a blessing (depending on how you feel about the chemical industry, of course). But it’s not just chemicals. Any number of industries are re-opening plants, or opening new ones, based on America’s lower energy costs.
So what’s the rub? The current narrative of permanent lower energy costs in the US for the foreseeable future involves three assumptions relating to shale gas and fracking. First, it assumes that current resource estimates regarding shale gas are reasonably correct, and not significantly overstated. Second is the assumption that recovery rates from shale gas drilling will be straightforward. Third, it assumes that the costs associated with shale gas production by fracking will remain low relative to conventional gas drilling. However, over the past 18 months some uncertainties have arisen on all three assumptions.
First, it is now clear that the US Energy Information Administration’s 2011 estimates were high—in fact, quite high. In 2012, in response to some analysis by the United States Geological Survey (USGS), the EIA reduced its overall estimates for the US for “unproved technically recoverable resource” from 827 trillion cubic feet (tcf) to 482 tcf—a pretty substantial reduction. Massive, in fact. This reduction largely resulted from a significant downgrade for the Marcellus shale region, which runs from West Virginia and Ohio up through Pennsylvania to Western New York and New Jersey. (Refer to our earlier post for a handy little map of shale areas in the US.) Estimates from other sources show an increasing range in assessments as well. For example, the Potential Gas Committee’s most recent estimates, released in April 2013, represent a 20% increase in technically recoverable US gas resources from their previous (2010) estimates. The increases stem from higher estimates primarily in several shale gas basins. And a recent assessment from the Texas Bureau of Economic Geology, associated with the University of Texas, has concluded that the Barnett Shale may contain significantly higher estimated resources than foreseen by either the EIA or the USGS (although also noting that production has likely peaked at Barnett). Conversely, recent reports from the Post-Carbon Institute and independent geologists have raised a number of questions regarding these estimates and their durability.
It’s reasonable to expect further revisions over time—this is what resource geologists do. And it may well be that these resource estimates are reasonably accurate. The US may indeed enjoy the kind of resource advantage currently being claimed. This remains an empirical issue. But it’s one that Nocera seems perfectly happy to accept without question. And further revisions could go either way—up or down.
However, there’s a second issue, that relates to the more rapid rate of production decline of fracked wells relative to conventionally-drilled natural gas wells. While shale gas now provides about 40% of US natural gas production following a very short burst of activity (since 2007, essentially), production has more or less plateaued since late 2011. As a Post Carbon Institute report has pointed out, “80 percent of shalegas production comes from five plays, several of which are in decline.” Production at both the Haynesville and Barnett share areas, the largest and second largest producers of shale gas until recently, have either recently plateaued (Barnett), or are actually in decline (Haynesville) in spite of an increased number of wells being sunk during 2012. Even the relatively optimistic University of Texas report on the Barnett shale play pointed out that production in this area likely peaked in late 2011-early 2012. At present, only two US shale plays are increasing production—Marcellus (now the largest source of fracked natural gas) and Eagle Ford, also in Texas.
While development of more shale gas plays is expected, especially as natural gas prices rise (which they are currently doing), the decline rates of individual well production at Barnett and Haynesville (and other shale plays) relative to conventional drilling after a relatively short history raise some concerns. Keep in mind that the great majority of shale plays in the US have only a three to six year drilling history at present. Nocera seems blissfully unconcerned with these issues.
Third, it’s likely that, irrespective of the above two issues, drilling costs will rise, since it’s likely that there will be some degree of federal regulation introduced in 2013 and 2014. One fundamental reason for the cost advantage the US currently enjoys in natural gas production is the fragmented and uneven set of state, and in some cases federal, regulations governing the drilling industry. Fracking regulations are still evolving, and while a number of states have relatively relaxed drilling standards relating to fracking, other states have, or are in the process of introducing, more rigorous regulations. At present, there are no particular national standards (other than those that apply to conventional gas drilling as well) that govern fracking, although the Environmental Protection Agency is currently developing a set of standards relating to water resources that will be released in 2014, and the Bureau of Land Management has just proposed a set of guidelines for fracking on federal lands. The natural gas industry (as well as a number of other business groups) is on record as preferring a system of state regulations rather than a federal system, so we expect discussions surrounding this issue could be, well, lively. In recent Congressional testimony, representatives of the natural gas industry appeared insistent that the costs of federal regulations would be punitive and would slow US natural gas production. We’ll see.
However, while all of this remains potentially problematic for the issue of whether current US energy costs will remain favorable, this isn’t what Dow Chemical, the object of Nocera’s wrath, is worried about. It’s the issue of energy exports. Dow, and other manufacturers, would prefer that these not be open-ended. The energy industry, with Nocera’s agreement, doesn’t see it this way. What’s going on here?
Let’s start with one of the interesting, and actually positive for the US, consequences of cheaper natural gas. One impact of the increase in natural gas production in the US has been its increased attractiveness relative to coal for electricity generation. But no good deed goes unpunished, right? While the consumption of coal in the US for energy generation declined in 2012, US coal exports to Europe grew strongly—in fact, US coal exports to Europe were up 23% in 2012 over the previous year, in a year when total US coal exports reached a record high. Moreover, in spite of the strong growth in renewable generation capacity in the US and Europe over the past decade, the use of coal has grown even more strongly, according to the International Energy Agency. And while the US EIA expects coal exports to actually decline modestly in 2013, it expects positive long term growth over the next decade. While this is cool for the US in reducing carbon generation, it’s not cool to be exporting carbon, and it certainly doesn’t help Europe meet its greenhouse gas reduction targets.
And, you know, no one really likes coal. Utilities would gladly replace coal with something else, because of the carbon and, yes, the mercury. And the increased consumption of coal in Europe has, among other things, led to increased interest in importing LNG from the US to offset the carbon impact of increased coal use. For example, UK-based Centrica Energy recently announced that it had signed a contract with US-based Cheniere Energy to purchase and import 89bn cubic ft annually as LNG over an initial 20 year period. Centrica is just the most recent company to agree to import LNG to be supplied by Cheniere’s Sabine Pass project in Louisiana, a list that also includes BG Group of the UK, KOGAS of Korea, Gas Natural Fenosa of Spain, Total in France, and Gail in India. Nor is Cheniere the only US company seeking to export LNG—Exxon has just announced construction of an LNG terminal in Texas for which it had received authorization in 2012.
The Department of Energy, which must approve such export agreements, is currently reviewing a number of applications (19 as of today) for exports to countries not signatories to Free Trade Agreements with the US (who tend to receive export authorizations as a matter of course), with a total capacity dedicated for exports of nearly 30 bcfd (billion cubic feet per day). This is a lot of gas to be exported. If all pending requests for LNG exports were approved and currently operational, this would represent about 43% of total 2012 US marketed gas production of about 69.2 bcfd. Obviously, existing inventories are much higher, but still. The EIA, for one, sees no problem here, presumably since it still expects production of natural gas to increase over the next several decades. The EIA is calling for a substantial increase in natural gas production, almost entirely from increased shale gas production—in fact, a 44% increase between now and 2040. Admittedly, they hedge their bets a bit, but still, this sense of optimism pervades the entire industry.
A large increase in US LNG export capacity has the potential to be a mixed blessing, then. A number of studies tout the positive economic impact of such exports—Nocera even cites one, of course. (He doesn’t cite any studies that don’t support this view, either.) But there are also a number of significant domestic consumers of natural gas that have expressed opposition to materially increasing US natural gas exports, over concerns that such exports would increase the price of US natural gas. The “domestic consumers” referred to here are an interesting bunch: Alcoa (aluminium requires a lot of energy to be made), Nucor (a steel-maker, also a large energy consumer), a raft of chemical companies in addition to Dow, and the American Public Gas Association, a consortium of local gas distribution companies, basically your local gas utility. This actually has led to competing pieces of proposed legislation in the US Congress, with some legislation currently being proposed that would limit, if not block, natural gas exports, while other proposed legislation would do the reverse—it would allow a significant increase in LNG exports to a wider range of countries. This has created strange alliances, as politics sometimes does—Dow Chemical is aligned with a number of consumer and environmental groups on this issue.
The potential impact of LNG exports on natural gas prices in the US is of more than academic interest for the US chemical industry. The impact of a substantial increase in LNG exports would not be a near-term one—more like 2020 at the earliest. Still, the long term impacts on natural gas pricing are likely of keen interest to an industry set on investing as much as the US-domiciled chemical industry is gearing up to spend. Chemical producers have viewed these proposals with concern—so much so that Dow Chemical resigned its membership in the National Association of Manufacturers in reaction to the latter’s support of increased LNG exports.
Some recent studies by consultants Deloitte have suggested that the cost impact of increased LNG exports would be modest (“quite small”) for US natural gas prices. However, that’s a bit misleading—these studies analyzed only the impact of exports from three existing LNG export facilities (at capacity of 6 bcfd), not the full range of LNG projects that are currently under consideration. These studies, then, probably don’t really address the concerns of the US chemical industry, currently preparing to spend what the American Chemical Council estimates is about $72 billion on committed projects, and what IHS estimates may be as much as $120bn in new or additional plant, mostly to service the ethylene chain, by 2030. Or of other significant (and energy-intensive) US manufacturers. A useful study woul look at the impact of everything that’s currently being proposed, not just a subset.
So how will this play out? Does this come down to a case of who has the stronger lobby—the manufacturing industry or the energy industry? It might, and this probably isn’t comforting, given the power of the energy lobby—which managed to get the fracking industry exempt from the federal clean water regulations in 2005, for example. And keep in mind what proponents of exports are assuming, or even just stating outright—that the US has an ”oversupply” of natural gas. Nocera even says this. Well, not everyone thinks so. Just because we had an oversupply in 2012 from aggressive fracking activity doesn’t mean that we’ll still have one in five or ten years—and it certainly doesn’t follow that exporting 40% of current gas production won’t have some impact on that “oversupply.” The assumption that this “oversupply” can replace 40% of current production may prove unsustainable. The EIA’s significant reduction in its assessment of shale gas resources in the US in 2012 should have given at least some pause to those waxing eloquent about the US natural gas “oversupply.” Apparently not. Does that mean that there isn’t some advantage to lower global energy prices, as proponents of exports argue? No, it doesn’t mean that at all. But given some of the uncertainties that have arisen the past 18 months over potential US shale gas resources, some caution may be warranted here.
So does that mean that LNG shouldn’t be exported? Probably not. Does it mean there should be a real debate about it? Absolutely. Will we get one? Maybe. It would be unfortunate if it were to be conducted entirely by competing gigantic industrial players, without the rest of us chiming in. As it happens, I agree with Dow Chemical in this instance, and it may be one of the few times when that’s the case. But we all have an interest in how this debate turns out, and we should be making sure that our voices are heard.