The Natural Gas Revolution and Its Consequences
Good news about energy is rare. Energy use and its cost are rising worldwide, most countries remain dependent on oil imports, and little progress has been made toward curbing climate change. So the world should take notice of the recent dramatic increase in estimates of unconventional sources of natural gas in
This development is an unmitigated boon for consumers interested in affordable energy, environmentalists looking for energy sources that emit less carbon dioxide than either oil or coal, and governments that hope to reduce the political and market power of today's major oil- and gas-producing countries. The prospects for a greatly increased global supply of natural gas have dramatic implications for both international energy markets and the energy policies of individual nations. Over time, natural gas use will expand into the power sector and may then displace oil in the transportation and chemical sectors. As more natural gas becomes available and more of it is traded, the regional gas markets that exist today may well merge into a more integrated and open international gas market with a single price.
Countries that import natural gas should anticipate more competing sources of it, which will lower prices and reduce concerns about the security of the gas supply. No longer, it seems, will the world be dependent on a few nations --
THE SHALE GAS BOOM
Most natural gas is extracted from so-called conventional deposits, usually from gas fields or oil reservoirs, and is typically found in highly porous rocks, such as sandstone. Producers need only to tap into the natural pressure of the reservoirs to release this trapped gas. "Unconventional deposits," in contrast, traditionally refers to either tight gas, which is found in relatively impermeable rock formations that release gas slowly; coal-bed methane, which has been absorbed into coal seams; or shale gas, which exists in fine-grained sedimentary rock. (Methane hydrate, a crystalline solid found on the ocean floor and in
Just a few years ago, the U.S. oil and gas industry was concerned about the depletion of conventional natural gas reserves in
To nearly everyone's surprise, unconventional gas turned out to be much more promising than expected. Beginning in 2008, experience in the field made the gas industry realize that shale gas was a large and economically feasible source of domestic supply. Today, all three types of unconventional gas are significant sources of supply in
Two technological advances made shale gas economically feasible to produce: horizontal drilling and hydraulic fracturing (or "fracking"). To extract the gas, workers must drill down until they hit a thin layer of shale, 1,000 to 12,000 feet underground, and then steer the drilling horizontally for several thousand more feet. Fracking fluid -- water, sand, and chemical additives -- is injected into the layer at high pressure, perforating the formation and opening tiny cracks in the shale, thus allowing the trapped gas to escape.
The new technologies that made this procedure possible drove down dramatically the cost of producing shale gas. Today, although the average cost of production depends on many factors and varies from region to region, it tends to range from
With such low production costs for shale gas,
It is not yet clear exactly how large
Companies have been quick to take note of shale gas' potential. In just one year, shale gas production in
Current U.S. shale gas production, at about ten billion cubic feet per day, makes up 20 percent of total U.S. natural gas production. Major oil companies in
But the rate at which shale gas production will increase depends on several factors, including how successfully the industry meets the environmental challenges of production. In
Still, the conclusion is clear:
Many other countries could benefit from this bounty, too. There are no reliable estimates about the size of the economically recoverable shale resource base worldwide, but shale deposits are found all over the globe. And they are not geologically or geographically correlated with conventional oil and gas deposits. Already, companies are developing shale gas operations in
A MORE UNIFIED MARKET
This natural gas boom will have important consequences for the international natural gas trade. Today, the world is essentially divided into three natural gas markets:
In the North American market, demand is essentially satisfied by domestic production, and the price of natural gas is set by its value as a fuel in the power sector, where it competes with coal. In the Asian market, where most natural gas is imported, it competes against oil for electricity generation or for industrial use. Suppliers sell their natural gas there at prices set by the value of the gas relative to the so-called Japanese crude cocktail, a weighted average of oil imports to
Two developments are likely to disrupt this global disequilibrium in gas prices. First, the LNG trade should expand substantially as countries with huge conventional gas reserves, such as
The second change is the recent and rapid development of cheap unconventional gas resources. Unconventional gas production, coupled with increased interregional natural gas pipeline capacity and expanded LNG liquefaction facilities, will make it progressively more difficult to continue linking gas prices to oil prices. Since natural gas is cheaper than oil on an equivalent energy basis (meaning the price per BTU is lower), over time, natural gas will begin to replace oil, first in the power sector and then in the industrial and transportation sectors.
Many countries, such as
The consequences that cheaper natural gas will have for renewable energy are more complex. On the one hand, since today it is more expensive to generate electricity from wind, geothermal, or solar power, natural gas will be a competitor to renewable energy. On the other hand, cheap electricity from natural gas will make hybrid power plants -- which generate electricity from intermittent wind or solar electricity as well as from natural gas -- more attractive.
In the longer term, natural gas could substitute for gasoline or diesel in vehicles (most likely in the form of compressed natural gas). Yet in
But for the moment, natural gas has economics on its side. In
WINNERS AND LOSERS
The radical increase in the global supply of natural gas will require governments to make significant adjustments to their policies. But the effects will not be uniform. Countries that export large amounts of natural gas will suffer from lower than expected revenues and a reduced ability to use energy as a tool of foreign policy. Countries that import natural gas will benefit from the worldwide increase in reserves and production because prices will be lower than previously anticipated. And since there will be more sources of supply, these countries' concerns about the security of supply will be dampened.
For years, major natural gas holders -- such as
In the long run, however, investors have an enormous economic incentive to develop technologies that will exploit the price difference between natural gas and oil. For example, the industry is sure to consider new uses for natural gas that were previously uneconomical, including gas-to-liquid conversion processes such as producing methanol from natural gas.
U.S. foreign policy must be adjusted as well. A transparent global gas market would be beneficial to
As the second-largest holder of natural gas,
Gas importers, by contrast, stand to gain from the increased availability of natural gas.
The news for Asian natural gas exporters is not as good. Most of the natural gas traded in
In addition to affecting natural gas markets, the increased supply of natural gas will dramatically change the outlook for oil markets. As natural gas edges out oil in the power, transportation, and chemical sectors, oil prices will fall and the price disparity between oil and gas will close.
The major oil-producing countries, of course, will need to readjust their expectations. Most of them operate through national oil companies that serve their government's political and economic interests. The newfound natural gas reserves, dispersed around the world, will reduce the market power these companies have enjoyed. There will be difficult negotiations between natural gas suppliers and consumers over new contract terms. Accordingly, past concerns that the
Nobody knows how significant this prospective shift from oil to natural gas might become. But two points deserve emphasis. First, although the explosion of shale gas production will lead to gas substituting for oil and erode the market and political power of today's major oil- and gas-exporting countries, this market penetration will not be so large that the security concerns of
None of these changes will occur rapidly. There are significant uncertainties about how much shale gas around the world can be produced economically, the environmental implications of widespread production, and the economics of substituting natural gas for other sources. The large investments required for natural gas exploration, production, and distribution depend on financing supported by long-term contracts. Established industry practices change slowly. There will continue to be fierce competition over pipeline routes, LNG projects, and supply contracts -- which means that there will continue to be difficult commercial, financing, and political negotiations between supplier and consuming nations. The countries and international oil companies that are large producers of conventional natural gas will resist delinking the price of the gas they sell from the price of oil.
But at the end of the day, economic reality should prevail, and a global market for gas will develop just as it did for oil. Eventually, there will be a transparent and integrated global gas market with diverse supplies that is governed by economic considerations and is free of subsidies. And gas consumers everywhere will be better off.
Foreign Affairs, January/February 2011
JOHN DEUTCH is Institute Professor of Chemistry at the Massachusetts Institute of Technology and former U.S. Undersecretary of Energy, Deputy Secretary of Defense, and Director of Central Intelligence. He is a present and past adviser to several energy companies and was a participant in the 2010 MIT study "The Future of Natural Gas." The views expressed here are his own.
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