February 5, 2010

The Quiet Energy Revolution


By Max Schulz

How ironic that during the ‘drill, baby, drill’ demonstrations as gasoline prices spiked in 2007 and 2008, a silent revolution with natural gas was already underway that will make those concerns largely irrelevant

The 20th century was the century of oil. Wars were fought over it, and the outcomes of the century’s biggest conflicts hinged on the stuff. In World War I, for instance, Churchill’s conversion of the British Navy to oil gave the crown’s ships supremacy over German vessels. In World War II, when the Nazis and Japanese each failed to secure supplies of oil, they were doomed. Later, President Ronald Reagan, CIA Director William Casey, and America’s Middle Eastern partners manipulated global oil production to bankrupt the Soviet Union and win the Cold War. In the first half of the century, oil policy served as the catalyst for military victory. In the second half, oil helped propel the greatest economic expansion in the history of the world, and liberated mankind from the tyranny of immobility.

All hail oil! But not too much, because the 21st century won’t be defined by oil. It is more likely to be defined by a different fossil fuel: natural gas.

Two monumental shifts in the world of energy are underway right now: one technological, the other financial. They will change the way we power our lives (especially our cars), provide a real measure of energy security, and help curb greenhouse gas emissions. Neither shift has anything to do with the turn to a green renewable energy economy promised by President Obama. Physics ensures that will never happen, no matter how much wishful thinking (and government subsidy) is applied. Sorry, greens, carbon-based energy will continue to dominate our energy future, not windmills or solar panels.

The first profound shift was made possible by a little-noticed technological breakthrough in the last three years that has changed the way we extract natural gas. Engineers now make use of two important innovations. One is horizontal, or directional, drilling, which permits wells to move laterally beneath the surface instead of going straight down. This technology minimizes the number of holes that have to be drilled, leaving a smaller surface footprint and accessing a larger area. The other technology is hydraulic fracturing, used to extract gas trapped in porous shale rock. In this process, also known as fracking, water and chemicals are pumped at tremendous pressure into shale rock formations to push gas into pockets for easier recovery.

By marrying and perfecting the two processes into a technology called horizontal fracking, engineering has virtually created, from nothing, new natural gas resources, previously regarded as inaccessibly locked in useless shale deposits. Suddenly, the mammoth shale formations in Texas, Pennsylvania, Ohio, New York, North Dakota, and elsewhere have the potential to produce abundant amounts of gas for decades to come.

How significant are these developments? Exxon Mobil announced in December that it will pay $41 billion—that’s right, billion—to acquire XTO Energy and its expertise at extracting unconventional natural gas resources. The French energy company Total SA, meanwhile, is paying $2.2 billion to acquire a 25 percent stake in Chesapeake Energy’s Barnett Shale operations in Texas.

Human ingenuity has turned theoretical gas reserves—too costly ever to be exploited—into practical resources. And just in time. Less than a decade ago, experts were noting that conventional natural gas production had begun to plateau, despite annual increases in the number of wells drilled. The National Petroleum Council warned in 2003 that “North America is moving to a period in its history in which it will no longer be self-reliant in meeting its growing natural gas needs.” In the spring of 2004, Federal Reserve Chairman Alan Greenspan warned that, driven by these looming shortages, wellhead natural gas prices might top $6 per thousand cubic feet by summer, roughly double 2002 prices; and indeed, until the recession brought down demand, natural gas did sell in the $5–$9 per thousand cubic feet range.

Horizontal fracking has helped eliminate many of those grave worries. As Pulitzer-prize winning author and energy analyst Daniel Yergin and his colleague Robert Ineson wrote recently in the Wall Street Journal, production in the lower 48 states “surged an astonishing 15 percent from the beginning of 2007 to mid-2008.” And this is just the tip of the iceberg, as production ramps up in the nation’s shale formations, such as in Marcellus, Bakken, and Haynesville. What was once a shortage has given way to a glut, or, as Yergin and Ineson put it, a “shale gale.”

Proven reserves of natural gas in the United States have been revised upward by 50 percent in the last decade, and those numbers are sure to climb higher as more shale gas is discovered. Perhaps not surprisingly, other nations are sending geologists to the United States to study techniques for extracting gas from unconventional sources. China, India, and Australia all have enormous shale fields. In the coming decades, the shale gale won’t be just an American phenomenon; it will blow all over the globe.

A technological advance created the first shift, driven by free markets not by government edict. The second shift complements the first, and has taken place again because of the way free markets work. That is the formation of a global market for natural gas, much the same as the global petroleum market.

We are accustomed to think of crude oil as a global commodity, its price the same roughly all over the world. Partly that is because oil is so easily transported. Turn on the taps, and a tanker ship can be filled with liquid crude before heading for any seaport on the planet. On land, oil can travel by pipeline, by truck, or even by the barrel or the one-gallon container. The portability of oil helped an international market begin to blossom more than a century ago.

Natural gas and natural gas markets, however, are different. Ethereal and highly flammable, natural gas poses significant transportation problems. A tanker ship can’t simply fill up and shove off. For this reason, there has been no single global market for gas, but a number of balkanized, regional markets all over the planet. The price of natural gas in one region has little connection to the price in another, and for many years regions facing shortages could not be relieved by gas from regions with excess capacity.

That is changing, not as rapidly as the shale gale has transformed America’s gas picture, but still rapidly compared with other business transformations. The reason is liquefied natural gas (LNG). Innovations in liquefaction and re-gasification technologies allow gas to be condensed to 1/600th its size, which then can be shipped by sea. Major infrastructure investments by energy companies and governments, along with the development of specially designed double-hulled tankers to transport LNG, are creating a robust, integrated market for natural gas.

The implications are profound and largely positive. The new mobility of LNG will bring a sorely needed measure of market stability after the past five years of unpredictability in price and supply.

On the other hand, some observers fear that creating a global marketplace will spur the establishment of a nefarious natural gas cartel similar to oil’s OPEC. Such worries, however, overstate a potential cartel’s capacity to manipulate a diversified, global market, particularly one in which nations like Australia, Canada, and the United States will be heavyweights. Indeed, one truly positive benefit is that the emergence of a market for LNG will severely limit Russia’s ability to use its significant gas resources as a political and economic weapon, as Moscow has done in recent years with its European neighbors.

LNG, along with the shale gale, should help keep natural gas prices low for a long time. The average wellhead price for natural gas in the United States had crept to $8 per thousand cubic feet in 2008. There is little doubt that high energy prices were among the contributing factors to the economic downturn that began in the latter half of 2008. An ocean of cheap gas augurs well for America’s and the global economy’s future.

Natural gas may also change how we drive, and enable ordinary consumers to break oil’s monopoly on transportation. As my colleague, Peter Huber, notes in a recent Manhattan Institute report, “Gas-handling technologies [have] improved quite enough to make natural gas a practical alternative” to oil. After all, gas is cheaper than gasoline and diesel per unit of energy. That’s why large stationary power plants that used to run on oil switched to natural gas long ago.

The chief obstacle to developing a natural gas infrastructure capable of supplying service stations and highway rest stops is regulatory. If that is removed—and here we do need government action—we could expect to see trucks, buses, and cars running on natural gas in a relatively short period of time. The reduction in greenhouse gas emissions would be considerable.

We may also see continued inroads of gas into the electricity-generating sector (which can also affect transportation as we move to hybrid and electric vehicles). Gas emits about half as much carbon per unit of energy as coal. With worries about long-term gas supplies allayed, expect regulators and utilities to favor construction of new gas-fired power plants over controversial coal plants, which are more expensive to build anyway. This same thing happened during the 1990s, and gas shot to a 20 percent share of America’s electricity economy as a result.

The Energy Information Administration estimates that U.S. demand for electricity will rise 26 percent by 2030. Gas-fired power is slightly more expensive than coal-fired electricity today and much more expensive when the wellhead price of gas soars. But stable, lower long-term gas prices brought on by the shale gale and the emerging LNG market will ensure that coal’s pricing advantage is not so pronounced. Gas is well positioned to help meet that increase.

The age of oil took off with a boom when the Spindletop gusher blew in 1901. A century later, as the price of oil hit new records, our politics were inflamed by an acrimonious debate over offshore oil drilling and breaching the Arctic National Wildlife Reserve. How ironic that during the “drill, baby, drill” demonstrations as gasoline prices spiked in 2007 and 2008, a silent revolution with natural gas was already underway that could make those concerns largely irrelevant.

Max Schulz is a senior fellow at the Manhattan Institute


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