Why worry about high oil prices, when a boom in natural gas may be on the way?
Appeared in The Economist, August 26, 2004
EVEN as headlines scream about $50 a barrel oil, energy firms and their investors are becoming increasingly excited about its likeliest replacement: not wind nor wave nor solar power, but gas - or, to be precise, gas that is frozen and transported as liquefied natural gas (LNG). This is expected to become as ubiquitous and crucial to the global economy as petroleum is today. Scenario planners at Royal Dutch/Shell think that gas may surpass oil as the world's most important energy source by 2025.
While oil became increasingly important during the past century, for much of that period natural gas was seen as its ugly stepsister: burnt off or "stranded" when discovered by accident, and rarely sought after. Demand for gas has taken off in recent years, thanks chiefly to its greenness - it burns far cleaner than oil or coal, making it ideal for new power plants from California to China. And burning gas is much less carbon-intensive than burning coal - making it helpfully less easy to blame for global warming.
Until recently, the development of a global gas market has been hindered by one inconvenient fact. Gas is, by definition, gaseous at room temperature; oil is a liquid that can easily be transported. Gas traditionally needed elaborate systems of pipelines to get it from the wellhead to the customer. That meant it was typically used fairly close to where it was produced, shipped at great expense via pipeline - or, more often, simply wasted.
The rise of LNG promises to change that. Put simply, gas can be frozen into liquid form near its source, shipped to market in refrigerated tankers, warmed back into gaseous form on foreign shores and injected into the local pipeline system. Thanks to this technological advance, gas has the potential to be a fungible, global commodity like oil.
True, energy-poor countries such as Japan and South Korea have long relied on a rather clunky form of LNG. But soaring demand for gas has unleashed rapid innovation and investment that is driving down the capital cost of LNG. Tanker ships are getting bigger and more affordable. One-off project planning is giving way to economies of scale. Even so, shipping gas remains much more capital intensive than shipping oil. Building typical 5m tonne "trains" of LNG - which include liquefaction plants, tankers and regasification terminals - can cost $5 billion. Thus, as one senior gas executive puts it, "only a few firms can play in this game." Still, leading executives now expect the energy industry to invest a massive $100 billion in expanding LNG over the next decade.
This expansion of LNG is being driven by America, the world's largest energy market. As demand for gas has taken off in recent years, North American supply has not kept pace, causing a spike in prices (see chart) that, last year, alarmed even Alan Greenspan, chairman of the Federal Reserve, America's central bank.
America's market is clearly ripe for imported gas. On one estimate, North America's now puny gas imports could soar over the next decade or so to be as large as today's entire global LNG market.
Yet already energy pundits in America are ringing alarm bells about rising gas imports. In particular, they point to three long-standing worries about oil that they now think may be true of gas, too: scarcity, ever-rising prices and oligopoly power.
It has become fashionable to claim that the world is running out of oil and gas. Several alarmist books have just been released, ranging from "The End of Oil" to "Out of Gas", claiming that the hydrocarbon age is drawing to a close. To the doomsday crowd, the spike in natural gas prices is permanent, the result of scarcity.
From OPEC to OGEC?
This is not the first natural gas "crisis." In the 1970s, fears of global gas scarcity led many governments to ban the use of gas in electricity generation. Price controls at the wellhead in America held back the development of new supplies. Yet, in fact, there was never a genuine shortage of gas, merely a disincentive for firms to find it. When America deregulated its gas markets in the 1980s, unleashing the incentive to discover and market gas, prices collapsed - and stayed low for more than a decade.
This time prices have soared because - with the exception of Alaska, which is distant from most consumers - North America is indeed running out of gas. Yet the rest of the world is awash in gas. The reason that this was not recognised sooner, says Joseph Naylor, who runs Chevron Texaco's gas efforts, is because "firms simply never looked for gas before." As energy liberalisation gathers pace, from Spain to South Korea, argues BP's Anne Quinn, "fungible markets will attract supply."
If scarcity is not a serious worry, what of ever-rising prices? Certainly, there are plenty of experts who expect prices to remain high for many years, even if rising supply pricks today's gas bubble eventually. That is because, with LNG capacity taking years to build, supply will rise slowly. Sara Banaszak of PFC Energy, a consultancy, says that "LNG cannot prick the price bubble in the next 6-8 years."
Still, it will be surprising if LNG imports do not ultimately lower American gas prices below $5 per mBtu from today's over $6. LNG is usually profitable at $3.50 (BG, a British firm, says it is profitable at $2.50), so there is plenty of incentive to invest in capacity at today's prices - as long as local planning rules and safety fears do not stop LNG terminals being built.
What of the third comparison with oil: the threat that a new cartel will be established, a gas version of OPEC? Around three-quarters of the world's proven gas reserves are in the former Soviet Union and the Middle East. Amy Jaffe of Rice University worries that rising LNG imports may give Russia, the kingpin of gas reserves, huge market power from around 2020. Maybe. But there are several reasons not to expect an OGEC gas cartel.
What gives Saudi Arabia power over the oil markets is its massive investment in spare capacity, says David Victor of Stanford University. Indeed, the main reason oil prices are now surging beyond OPEC's control is that the Saudi buffer is precariously low. The capital expenditure needed to build spare LNG capacity is so much larger than that for oil that nobody with any sense will do this. Firms with control over local pipelines may well exercise some market power, argues Mr Victor, but a global gas cartel seems unlikely.
Moreover, gas reserves are in fact more widely dispersed and more abundant than oil reserves. That means that the potential troublemakers, from Iran to Russia, are not guaranteed to attract investment. Rather, Mr Victor and Ms Jaffe agree, western capital will probably flow to those countries with the most investor-friendly policies. That is why Trinidad is being developed as an LNG producer before its turbulent neighbour, Venezuela, and why Qatar is emerging as the Middle-Eastern Goliath of LNG even as massive gas reserves in investor-unfriendly Iran and Saudi Arabia remain largely untapped.
Despite the current optimism, the huge political and financial risks inherent in the LNG business mean that the boom is not yet certain to happen. The capital required is huge, the number of firms with deep enough pockets very small, and the memory of the earlier gas-price collapse induced by America's deregulation is fresh. As Malcolm Brinded of Shell puts it, "our hopes have been dashed before."
Yet, at today's prices, the potential rewards are fabulous for those firms with the courage, capital and competence needed to complete LNG projects. As Mr Brinded himself concludes, "gas will be the fuel of choice for at least the first half of this century (and) flexible, long-distance supplies of LNG are the key." Get ready for a $100 billion investment boom, the prelude to the "century of natural gas".
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