The Natural Gas Revolution II: The economic consequences

22 Jun

Gas is more abundant and cheaper than oil, and possibly even than coal. It will spread in heating and electricity production. Whether the same happens in transportation is more questionable – electricity may push out oil first. But if not, we may have a “methane economy” in a few decades. Whatever the outcome, the important lesson is that you will never have to face “Peak Energy” if you can face expensive energy for a while. High market prices are a powerful tool to incentivize the search for alternatives. 

The consequences of cheap gas are going to be huge and wide-ranging. We cannot cover everything, in this piece we look at some key economic and technology aspects and in the next one politics.

First thing to point out is that gas is cheap relative to oil, and at the moment even compared to coal in the US, as we wrote in our previous piece

Oil and coal got a lot more expensive over the past 10 years, their prices rising to about 4 and 3 times, respectively. Over the past 10 years, we had an energy shock, supply could not keep up with demand – emerging countries really started emerging, and entered an energy-intensive growth phase. Energy prices went up, initially including gas as well. Then it turned out that at those high prices there is plenty of gas available (the same is not true for oil), and gas prices dropped back in the US to levels seen ten years ago (but elsewhere it is still more expensive). Partly in response to high prices, gas production technologies went through their revolution as we described in our previous piece. 

A safety valve – but only for those who can manage capital 

So natural gas provides a safety valve to the global economy – when it seemed to hit a wall of energy constraints, cheap gas is an escape route. But it needs more capital investment for dedicated transport infrastructure than oil or coal does. Gas needs to be cooled down, shipped in highly specialized ships, re-heated, and/or transported through dedicated pipelines. Oil transportation cost is typically a few percent of its value. In the case of gas, transportation costs can be more than the stuff costs at its origin. 

So here is the first consequence: gas will be cheap only for those countries that can manage large capital investments well, either into domestic production and inland transportation, or into gas transport infrastructure (re-gasification terminals or pipelines). Countries do not have to have the capital themselves, but need to provide an environment where investors are willing to commit large amounts of capital for many years. So let’s say Argentina may not have cheap gas for a while, despite domestic reserves. Rich countries, which typically have at least some of the physical and market infrastructure in place, have a head start. Many poor African countries will still be using expensive oil for long years while the rich US already is enjoying the benefits of cheap gas. Well functioning capital and other markets, a legal system investors can trust, good contract enforcement, good and transparent regulation – these things are necessary for getting rich in general, but especially for capital intensive projects. 

Natural gas will substitute for other forms of energy 

Since natural gas is (going to be) so much cheaper than oil, it is going to be increasingly used instead of oil. In electricity production, oil is hardly used even now in rich countries – except for emergencies like in Japan after Fukushima. Gas will gradually push out oil in electricity production and household/industry energy use even in poorer countries. Whether it can do the same to coal is a more difficult question. Currently this is happening in the US: there is no transport infrastructure to ship gas out of the US, and it is cheaper than coal there. It is pushing coal out of electricity generation, and some of the coal gets exported. In a quirky way, cheap gas in the US means cheap coal elsewhere. 

But it is not clear if gas can win over coal in the long run without proper pricing for externalities like CO2 and local pollution (externalities will merit a separate post). Certainly it would be better for everyone if gas won – less CO2 emission and less local pollution like soot, mercury and sulphur. But coal is plentiful as well, and its price in the long run may well be below gas prices in energy terms. 

In any case gas demand for electricity will increase fast, even if it turns out to be more expensive than coal, exactly because of the other benefits. As China is getting richer and leadership more representative, it will tolerate foul air less than it does now. 

Can gas replace oil in transport? Yes in theory, harder in practice 

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The 10 trillion dollar question is whether gas can eventually replace oil not just in stationary energy uses (where the answer is yes), but in transportation. In theory there is no serious technological barrier. Natural gas (mostly methane) can in theory be used for any application for which currently oil is used. But there is always a “but”. Gas can be directly burnt in cars or trucks, but that requires large tanks for compressed natural gas or very low temperatures if it is used in liquefied form (LNG), so is a bit unwieldy. But despite of these drawbacks, this is already happening – you guessed it – in the US. Trucks, especially those that go back and forth between set destinations are switching to CNG or LNG in serious numbers (thousands of trucks). And a US road-natural gas supply network is building up. But even in the US, the spread of natural gas in trucking is likely to be a slow process, you have to replace the existing truck fleet, and build up a distribution network. 

Outside of the US this will take even longer – first, cheap gas has to come, and then the infrastructure will have to be built to utilize it. In case of personal cars, there is no serious progress even in the US – the practical barrier of too large tanks are preventing the spread of CNG. Meanwhile, the car industry at the moment thinks that electric cars are the future, and does not want to bother with the detour of the natural gas car. It may change its mind, depending on battery and gas prices. 

Methane economy 

In the long run, if natural gas prices remain cheap, it is possible that a “methane economy” or a “methanol economy” will evolve – and here there is the usual Hungarian-Nobel-laureate-living-in-the-US link as well, George A. Olah’s Methanol Economy.  

source: origo.hu

A new distribution network would also be needed in that case. Alternatively, methane can be turned to methyl-alcohol (methanol), which is a high octane gasoline substitute already used in racing cars and model aeroplanes. It would require only small modification to the car and the fuel distribution system, but it is highly toxic. Methanol can also be turned into di-methyl-ether, which is non-toxic and a very good diesel fuel substitute (it is clean burning and has better combustion quality than the current norm). 

Natural gas is already turned into normal diesel fuel in the so called “gas to liquids” plants. Shell recently opened one in Qatar. These GTL plants are expensive at the moment (Shell’s cost about $20bn), but can pay back very quickly if the gas feedstock is cheap and oil is expensive. The Shell plant will pay capital costs back in two years, although it gets the feedstock for free. 

It is likely that these technologies will evolve and new ones come into play to utilize cheap methane more efficiently. Methane is the smallest possible hydrocarbon building block. Just add energy, capital and technology, and you can manufacture many more complicated hydrocarbons out of it even with currently existing technologies. Its big advantage is that there are typically no unwanted pollutants like sulphur in the resulting product, and there are no unwanted side-products like the heavy and dirty residue that remain after distilling out lighter products from crude oil. You manufacture more or less what you want. That will be an advantage in a world where regulation and a preference for less pollution will increasingly punish unwanted bad side products. And did we mention that gas is also cheap? But here again the transition to a methane economy, if happens, will take decades as a new infrastructure needs to be built up. But if gas remains as cheap compared to oil as we think it will, then eventually gas can replace oil – if something else, like electricity in transportation does not get there first. 

Don’t be afraid of Peak Energy 

To finish this piece we would like to draw two very broad policy lessons. The first is that scarcity will be overcome in a market economy, even energy scarcity. There are unimaginable amounts of energy lying around. If not oil, then gas, if not fossil fuels then solar or geothermal or whatever – the only constraint is the technology and capital to exploit energy sources. The second lesson is that to achieve this miracle, you have to let prices and markets work. You have to endure large relative price changes. Economies and societies are getting less able to deal with that, even in market economies. It would be a good thing to get better at that, for other reasons too. 

The immediate political instinct is to dampen relative price changes with regulation, taxes, release of strategic reserves and so on. That will feel more comfortable in the short run, but you take away the incentive for supply (and also demand) to respond, and will result in problems in the longer run. With price regulation comes rationing – only in that context does it make sense to talk about “Peak Anything” – oil or other resources “running out”. You will never have to face “Peak Energy” if you can face expensive energy for a while. Let prices do their magic, let them adjust, and let innovation and markets work. If that is in place, all else will be detail.

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