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4. ECONOMICS AND NATURAL GAS
INTRODUCTION

In general, natural gas is found in an environment similar to that in which crude oil originates, and on occasion it has been called gaseous petroleum. (There are also occasions when lecturers refer to petroleum as oil + natural gas.) Surprisingly, natural gas was initially produced from coal, and its primary use was lighting. Although many people believe that gas and oil are found in reservoirs, or huge underground caverns, they actually originate in water coated pore spaces in rocks – for the most part sedimentary rock classified as organic shale. This shale originated as the remains of prehistoric plants and animals, and was ‘cooked into oil and gas’ by heat, the pressure of the earth acting over millions of year, and various chemical reactions.

Some hydrocarbon deposits contain oil but no natural gas, while others – where the cooking referred to above continued until the hydrocarbons were reduced from liquid oil to molecules of natural gas – contain natural gas but no oil. This latter category is called non-associated gas. A very common arrangement is the presence of gas and oil in the same deposit, and in this situation the gas is referred to as associated gas. Associated gas is non-discretionary, because it becomes available whenever the associated crude oil is produced, and thus if it is not piped away to be sold it might be reinjected in order to maintain the pressure of the reservoir, or flared (i.e. burned up in the air). There was a time when a ‘light show’ took place almost every night over the Middle East oil fields, due to enormous flaring.

I once thought that flaring was a thing of the past, but I was definitely mistaken. When I was sitting in the library at the Australian National University (in Canberra), someone told me that ‘gas gathering systems’ were being constructed in his country, but even so more than 100 billion cubic meters (100 Bcm 100 Gcm) of gas was being flared annually, most of it in the Middle East and Africa. About the same time 8 percent of gross production was being reinjected, and I eventually found out that – in theory – a large fraction of reinjected gas can be recovered after oil production has ceased. This might also be the right place to inform readers that a natural gas (or oil) well is roughly a hole in the ground, out of which comes gas or oil, while a deposit is a ‘property’ that often contains considerable gas or oil, and usually featuring many wells! A deposit with a collection of wells and accoutrements is often labelled a ‘field’.)

I perhaps should also mention that while some mathematics might be useful in this chapter, many readers and potential readers have made it clear that they do not want to be served any, and I don’t blame them. The highly mathematical approach to academic economic theory is sometimes fascinating and useful, but often an unproductive and tiresome waste of time. In case you are interested in this topic, I happen to believe that the intermediate courses in economics are the most important, and in a university in which I was in a position to give the orders, students majoring in economics would not be allowed to attend higher courses unless they proved beyond the shadow of a doubt that they understood several of the intermediate courses perfectly!

To continue, if there is no math in this chapter, then what is there? There are words and several diagrams, one of which everyone should be aware of in case the next president of the U.S. also tries to convince his countrymen and countrywomen that the U.S. is the proud possessor of 100 years of natural gas at the present consumption rate. As it happens, the important thing with gas (and oil) is not the ‘life’ of the well or deposit, but the time to when it peaks. Discussing this issue is probably best done with an analysis based on ‘The Logistic Distribution’ (Figure 2 below), for which there are some beautiful mathematics and statistics that were used by Marion King Hubbert to predict that oil in the U.S. would peak in l970, To the great disgust of his peers he was correct, and jealous colleagues and observers did everything possible to misinterpret the peak.

About the peaking of oil and natural gas output. The unexpected technological improvements for obtaining oil and gas via ‘fracking’ have probably – but not certainly – made forecasting the amount of oil and gas in the crust of the earth considerably more complicated. This is an issue that I do not feel qualified to confront, but I don’t hesitate to say that something is definitely wrong in the presentations about shale gas. Something doesn’t fit, and I suspect that caution should be the byword for students and researchers. We need less guesswork where this and other energy topics are concerned, and that includes guesswork by so-called experts who answer to our decision makers.

Before we move on, I want to provide some aspects of shale production to remember and think about. Ivan Sandrea, a senior partner in oil and gas at the consultancy Ernst & Young, declared that although initial production rates from shale investments seem to have improved, the natural depreciation (= the partially autonomous ‘wearing out’ and/or ‘decline in productivity’) of shale deposits makes it more expensive to produce a given output from shale oil and shale gas deposits than from conventional deposits, and this might be one of the reasons for shale deposits’ recovery factors remaining low. Moreover, the high variability of the (per ‘unit’) cost of extraction makes it difficult to plan operations and predict profits.
THE PRESENT NATURAL GAS SCENE
The president of the United States, Barack Obama, recently notified his countrymen that the U.S. is now in possession of 100 years of natural gas, and every effort should be made to turn this bounty into the energy basis of a new American industrial renaissance. As an American citizen, I am definitely impressed by the concept of an American industrial renaissance, but as far as I can interpret the existing evidence on all natural gas reserves, the estimated amount of natural gas located within or near the boundaries of the U.S. will not provide 100 years of gas production at or greater than the present annual output of natural gas. (U.S. coal reserves may meet this criteria, but few observers want to talk about that.) The assertion about natural gas is primarily based on the characteristics of the logistic distribution function, which will be referred to later.

There are certainly people in the United States Department of Energy (USDOE) who are as familiar with this issue as I am, or more familiar, but they have also probably discovered that – for career reasons – it makes sense to keep any non-conformist knowledge of and beliefs about this topic to themselves and their closest associates. That, incidentally, is why I was cashiered from a site called ‘Oil Price Com’: I presented the wrong judgement on a preposterous article in which it was claimed that the U.S. possessed more energy resources than the entire remainder of the world.

Where conventional gas is concerned, the 2011 British Petroleum Statistical Review of World Energy lists 6,608 trillion cubic feet of conventional gas, with the top three being Russia with 1,580 Tcf, Iran 1,045 Tcf and Qatar 894 Tcf. Saudi Arabia and Turkmenistan are next with about 283 Tcf each. I will not challenge those numbers, however I have grave doubts concerning some of the information being disseminated about shale gas, since that resource is not economically identical to conventional gas in so far as the mechanics of production are concerned. I therefore did not bother to attempt to bring those numbers up to date, and I very seldom refer to the size of natural gas reserves. In addition, because of a more rapid ‘natural decline’ (= natural depreciation), environmental issues, and perhaps other production quirks, shale gas (like shale oil) belongs in a different category, although this might be a case in which – if shale gas statistics are correct or nearly correct – it might be time for partial sceptics like myself to accept that a fortuitous technological breakthrough has taken place.

Moving from 2011 to the middle of 2014, what we find is that U.S. and Russia are often referred to as the largest owners of natural gas reserves, with Iran in third place (although, according to BP, that country is also a net importer of gas, despite recent large increases in production). This riddle is ostensibly due to various ‘sanctions’. In any event – and this is important – the proven gas reserves of that country are/were 33.8 trillion cubic meters, or 18.2 percent of the world’s total proven reserves.

An interesting paradox is that according to the BP’s latest “Statistical Review of World Energy”, Iran only accounted for 0.5 percent of global natural gas production, at 166.6 billion cubic meters in 2013. I can remember lectures that I gave 20 years ago when I suggested that the future should see Iranian natural gas being imported by many countries in Europe. Apparently we will have to wait at least another 20 years for that to happen.

The latest surmise about Iranian natural gas has to do with the South Pars/North Dome gas field—the world’s largest, alone accounting for 8 percent of global reserves—which it shares with Qatar. A deal has ostensibly been struck to supply three power plants in Iraq with the equivalent of 7 million cubic meters of natural gas per day, to be increased to 40 million by 2020, and there has also been talk about supplying natural gas to Jordan, Syria and Lebanon. More than talk however is a deal worth 60 billion dollars that was signed with Oman to supply 10 billion cubic meters of natural gas per year over a period of 25 years via a 1-billion-dollar, 162-mile (260-kilometer) pipeline.

Despite the boisterous talk about shale gas revolutions and ‘game changers’, there are many observers who are cautious about that resource. Some very smart people claim that it is not a ‘cure-all’ or silver bullet, and one of them, Murray Duffin, in the forum Energy Pulse (www.energypulse.net), has claimed that the average “sweet spot” in shale gas properties – the area in which the concentration of the resource is relatively large – amounts to no more than a modest 30% of the total area. Put another way, within a given property containing shale gas, a more intensive drilling may have to take place in order to obtain (and maintain) the same flow of the resource that would be possible if that or an equivalent ‘tract’ contained conventional gas – i.e. natural gas that was extracted in the conventional manner. Bill Payne, on the same site, notes that higher depletion rates mean more drilling to obtain previous outputs. Ceteris paribus, more drilling means higher costs.

Murray Duffin – like many others – also made a quite conventional observation about the extremely large (natural) physical depreciation/decline taking place in shale deposits, and this is an accusation that convinced shale partisans have not bothered to deny. Moreover, it is possible that only the presence of valuable natural gas liquids in shale deposits assures that those deposits can be profitably exploited at natural gas prices in the vicinity of those now prevailing in e.g. the U.S.

On this score – at least until recently – much effort has gone into boosting the selling price for properties containing shale gas to a level that some observers feel is manifestly incorrect, given the (low) price of U.S. natural gas prevailing at the time. But that of course is the point! Some firms and persons who have invested considerable amounts of money in shale deposits expect (or expected) to increase their fortunes as a result of the appreciation of property values rather than the production of natural gas. Students and observers of the natural gas scene should always keep this in mind, and they should also be aware that the reporting of natural gas reserves (in a particular deposit) to potential investors as compared to reporting the amount of reserves in the same deposit to the authorities can show striking differences!

The discussion just above can be summed up with the following comment: shale gas is characterized by rapidly depleting wells that require expensive and complicated inputs. This is not an economic disaster for producers unless natural gas prices collapse, however present U.S. gas prices have often been judged comparatively unhealthy For instance, during the last few months those prices in the U.S. have moved from a healthy six dollars per million cubic feet (= $6/mcf) to something around $4/mcf. Even so, for a number of reasons, shale gas may be a very valuable resource for the countries in which it is found in large quantities. As Lord Browne (formerly of BP) noted, domestic (natural) resources increase (energy) security, tax revenues and jobs, and in the long run might play a major role in reducing power prices.

Environmental doubts (associated e.g. with possible ground water pollution and methane leakage) have caused the French government to ban the exploitation of what may be the largest shale deposits in Europe, with the possible exception of Poland, although it should be kept in mind that attempts to obtain the same scale of results in Poland as in the U.S. have failed, and some firms apparently want nothing more to do with shale gas exploration or promotion in that country.

As for France, it would be very fortunate for the French economy and their president if – ceteris paribus – a large-scale extraction of shale gas were possible in reality as well as theory. An argument commonly heard in the U.S. is that massive investments in shale gas could be instrumental in curing certain macroeconomic ailments with which many countries are plagued, however rather than accepting the risk of being harassed by environmentalists if they lobbied the French government for permission to undertake the production of large quantities of shale gas, the French energy ‘major’ Total has apparently elected to deepen its acquaintance with shale gas in other parts of the world. Things may change though, because the present government in France appears to be breaking down because of its economic failures.

Many students have difficulty understanding why, in a country as large and well supplied with technical expertise as France, and where a large portion of shale gas reserves might be located in districts where they arguably cannot do any environmental harm if exploited, a nation-wide production ban has been imposed. In my opinion it is a political gesture similar to the outlandish nuclear retreat proposed for Germany, whose purpose is to entice voters with a strong environmental focus to support a particular political party. I will admit though that as long as France sticks with its traditional nuclear policy, shale gas is unnecessary. However, as in Germany, the only policy that the present government in France is interested in is one that will make fools of voters.

A similar problem arises in trying to figure out why the Chinese firm Sinopec has apparently invested several billion dollars in foreign shale deposits, since estimates are that Chinese shale resources are the largest in the world. One reason might be the presence of valuable (natural gas) liquids in their foreign acquisitions. (The worth of these liquids is constantly cited!) Another might be that given the extent of various energy investments in China and elsewhere, Chinese managers regard the opportunity cost of additional domestic energy commitments as too high just now, even though China seems to be in the process of becoming the most enthusiastic purchaser/developer of energy resources in the world, and does not lack the billions of dollars needed to finance what it regards as attractive acquisitions. Something that deserves repeating is that despite the presence of millionaires, luxury automobiles and high fashion, the Chinese economy is managed in a very different way from that of the U.S. or Europe.

Somewhat more abstract, the Chinese might regard domestic energy supplies as an energy reserve, and find it preferable to help exhaust foreign resources. After all, China undoubtedly has intentions to challenge the U.S. for the top position in the global economy, although many observers refuse to acknowledge this situation, though not so many as was the case a few years ago. . Or, as once suggested in the (London) Financial Times, the Chinese are not sufficiently competent yet to master the technology required to obtain large amounts of shale gas. If the sponsor (or sponsors) of that bizarre belief were sober, they hardly deserve to be called ignorant.

I sincerely hope that shale gas will live up to expectations in the energy future of North America and elsewhere, because as I enjoyed pointing out in lectures many years ago, it may be true that economic progress can best be described as an increasing function of technological development and the accessibility of economical energy resources. At the same time I feel it best to ignore (or partially ignore) some of the rosier estimates that one encounters almost daily about the merit of various non-conventional energy resources and alternatives, by which I especially mean wind, solar and perhaps even shale gas.

Something worth noting here is that because turbines burning natural gas can rapidly vary their output, and it may be that the availability of natural gas has drastically increased for some countries, this equipment is ideal for complementing the large number of wind farms and solar panels that someday might be featured in various energy undertakings, but whose output of electricity tends to be irregular because of occasional shortages of wind and sun. Fast-start gas turbines might have a prominent role to play in districts where gusts of wind not only lose their force suddenly, but occasionally become so strong that wind turbines must be shut down for safety, and also the stability of the grid. Of course, when dealing with this subject, attention should be paid to the additional expense associated with installing gas turbines, and providing infrastructure to transport gas.
FURTHER INTRODUCTORY OBSERVATIONS

As already pointed out, when shale gas appeared on the scene in a spectacular manner, it became necessary to emphasize that a natural gas deposit consists of more than methane (or CH4), which (quantitatively) is the major component of a deposit. Methane is colourless, odourless, widely found in nature, and according to some environmentalists and others, more dangerous than carbon dioxide (CO2). But regardless of the advantages or faults of natural gas, it is an excellent fuel, and it plays an important role in the electric generation ‘merit order’. (The merit order is a way of ranking energy sources – especially those generating electricity – so that the source with the lowest marginal cost delivers the next unit of electricity.) Thus if we have nuclear and gas, where gas has low capital costs but perhaps a high variable cost, while the opposite is true for nuclear, for peak loads (or loads lasting only a short time) gas would be preferable, but for base loads nuclear would be preferable, because base loads are on the line for long period, and so a very expensive reactor should not be idle for long periods.

Natural gas from a well consists of methane (on the average 85%), heavier hydrocarbons collectively known as natural gas liquids (and composed of ethane, propane, butane, pentane, and some heavier fractions), water, carbon dioxide (CO₂), nitrogen, and some other hydrocarbons. (And, note here, that gas is not free of carbon dioxide. It merely has less than oil and coal.) Before dry natural gas can be distributed to consumers, some undesirable components must be removed and, by decreasing the share of heavier hydrocarbons, a uniform quality attained.

The last-mentioned operation takes place either at or near the gas well itself, or in special installations farther away. It is at this point that the natural gas liquids (NGL) can be separated out. (NGL should not be confused with liquefied natural gas (LNG), which mostly consists of methane and ethane.) The most important constituents of NGL are butane and propane, which I have heard called ‘wet gases’, and in liquid form these are called liquefied petroleum gas (LPG). In many countries, LPG is sold under the name gasol or bottled gas, and when I taught in Australia I remember hearing that the government wanted a greatly increased use of LPG, although I never heard anyone say how or why this made economic sense in that energy-rich land, with its huge reserves of inexpensive coal. What did not make sense was to export instead of keeping uranium.

Before turning to less provocative aspects of this topic, something should be made clear. According to Robert Bryce, an editor of the Energy Tribune Magazine, coal dominated the energy picture in the 19^th century, oil the 20^th, and – in his opinion – natural gas will be the dominant “fuel” of the 21^st century. Whether he was thinking of the U.S. or the world is unclear. In the U.S., when his article was published, natural gas accounted for 23% of domestic electric power, while coal generated about 40%, wind and solar only about 3%, and nuclear about 20%. With power demand scheduled to increase between 15 and 20 percent over the present decade, and the looney belief expressed by many prominent and highly educated Americans that the U.S. possesses a 100 year supply of natural gas (ostensibly at the present level of consumption), it might be easy to believe that – in the U.S. at least – natural gas is capable of outshining coal and nuclear as, e.g., a source of (base load) electricity throughout the entire 21^st century. I have very strong doubts about this contention however. Actually, it sounds completely wrong, and the persons flaunting this belief should move to other newspapers and television stations.