Friday, April 18, 2008

The Gas Gap

Today's Wall Street Journal features a lengthy and informative article on the growing globalization of the natural gas market, which I've heard described in energy circles as the biggest energy story of the first part of this century, surpassing renewables--for now--in its impact. It's clear that such an article can't cover every nuance of such an important market, particularly without crossing the border into editorializing. With that in mind, I would like to highlight two additional points about the relationship between the US and international gas markets.

Although imports of LNG have become an important balancing mechanism within the last decade, they still account for only 3% of the 23 trillion cubic foot (TCF) per year US natural gas market, dwarfed by the 14% of supply provided by our net imports by pipeline from Canada. As the Journal noted, the use of gas to fuel electricity generation has been growing at a faster rate than any other large segment of demand, at a compound average growth rate of 4%. With US gas production only recently recovering from a multi-year decline, it is fair to say that the increase in power plant gas use has been facilitated by LNG imports and by the destruction of significant quantities of industrial demand, with attendant job losses.

As US gas demand grows, LNG will play a larger role, and so the expansion of the international market for gas is good news. However, whether that also results in higher US prices for natural gas is as much a function of US policies as of the global marketplace. While it's true, as the Journal mentioned, that companies such as Chesapeake have been very successful increasing gas output from non-conventional sources, including shale and coal-bed methane, it remains equally true that federal and state drilling bans are keeping hundreds of TCFs of gas off limits, leaving the US to choose between restraining demand or increasing imports. If that story sounds familiar, it should, because it's precisely how we got into our current dependence on oil imports. Natural gas was one of the pillars for restoring energy security after the energy shocks of the 1970s, but if we're not prudent, in a decade or two we will be lamenting the high degree of US vulnerability to our LNG suppliers, just as we now bemoan our dependence on foreign oil suppliers.

The other point I'd like to leave you with concerns gas's large BTU discount versus crude oil, approaching 50% at yesterday's NYMEX futures prices. The Journal suggests this may be viewed by investors as an attractive speculative opportunity--one bubble inflating another, perhaps? While I agree that this price difference looks too large to persist indefinitely, it is not intuitively obvious that it will correct in only one direction. Although the value of gas relative to coal should continue to trend upward, reflecting its lower emissions of greenhouse gases and local pollutants, gas remains much less fungible than oil. Storage options are fewer, and long-distance pipelines and LNG supply chains are built around long-term commitments, not momentary arbitrage opportunities. Caveat emptor, indeed.

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