Building Gas Demand

Dave Pursell, head of macro-research for Tudor, Pickering, Holt & Co. Securities Inc., says, “We are headed for full (gas) storage in 2009 without something dramatic happening soon.”

?There’s an elephant in U.S. natural gas producers’ boardrooms—growing daily gas supply, storage and reserve potential. Its trunk, or gas in storage, is 1.9 trillion cubic feet (Tcf), 33% bigger than a year ago; its balance, or producible reserves in the ground, is estimated as another 2,000 Tcf.

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It’s crushing gas producers’ fiscal planning into the basement.

And, it’s growing. Demand is only about 60 billion cubic feet (Bcf) a day and the foundering economy is providing no traditional, significant relief on the demand side.

Meanwhile, even more supply is under way from U.S. shale plays where producers are racing to hold their expensive, expiring acreage by drilling it into production; from western Canada where Horn River shales are showing promise, and oil-sands operations that use gas in prodding oil from bitumen are being undermined by low crude-oil prices; and from tankers of liquefied natural gas (LNG) from abroad that have no bidders elsewhere or gas-storage facilities to unload it into.

Natural gas is mostly used today in power generation, by industrial plants and in residential/commercial applications— but demand in all three categories has been reduced by a foundering economy.

Gazprom and Royal Dutch Shell signed a deal in early April to send 1 million metric tonnes (some 46 Bcf) of LNG per year from the Sakhalin-2 project in Russia to the Sempra Energy LNG terminal in Baja California and pipe it into Southern California, beginning this year through 2028.

“That’s not a lot of gas,” says one energy-sector observer. But it’s yet more gas, and all sources of supply are adding up to something huge.

“We are headed for full storage in 2009 without something dramatic happening soon,” says Dave Pursell, a managing director and head of macro-research for Houston-based energy investment-banking firm Tudor, Pickering, Holt & Co. Securities Inc.

At press time, the Nymex price for natural gas was $3.60 per million Btu, based on delivery at Henry Hub in South Louisiana. The spot prices for gas delivered at other hubs across the country were even lower in most cases, and higher in a few.

Power-generation demand—one of a triumvirate of rival natural gas consumers at 30% of supply in 2007; industrial demand, 34%; and residential/commercial, 34%—has fallen from 18.7 Bcf a day in 2007 to 17.8 this year, and for this core gas demand “the bias is lower, not higher,” Pursell says.

A Clean Energy Fuels Corp. fueling-station technician in Carson, California, gives a truck a liquefied natural gas (LNG) fill-up.

Meanwhile, U.S. producers have been successful in finding vast new reserves of abundant, producible, indigenous gas supply. They put into sales some 8% more gas in 2008 than in 2007, which itself posted a more than 3% increase from a fairly flat 2006. The increase in production in 2008 was the greatest growth in at least the past 30 years.

Yet, without an improving economy, where is all this backlog of supply to go and when will demand increase to consume this growing supply?

Aubrey McClendon, chairman and chief executive of Chesapeake Energy Corp., the second-largest U.S. gas producer and most active driller, booking yet more reserves and production through its presence in virtually every U.S. shale play, looks to energy policy.

Greater demand will come from weaning more power generation off coal and onto gas, switching more vehicles to compressed natural gas (CNG) and LNG, and convincing consumers to demand natural gas-powered vehicles from U.S. auto dealers.

“Getting behind natural gas vehicles and making it harder to burn coal for power generation are the keys,” McClendon says.

Wind, solar, gas, coal, nuclear

An LNG fueling technician fills up a Port of Los Angeles and Long Beach service truck at a Clean Energy Fuels station.

In U.S. power generation, most electricity is derived from burning coal (51% of the fuel spend in 2007, according to the U.S. Department of Energy); second-most, natural gas (17%). Renewables, such as hydro-, wind- and solar-generated electricity, represent 9% of power supply, with the latter two contributing 1% to 1.5%; nuclear, 21%; and oil, 2%.

Increased use of wind and solar for power generation helps the U.S. natural gas story, according to some observers. Meanwhile, its increased use hurts the U.S. gas story, say others.

Here’s why it helps: Reducing gas demand for power generation helps prove to Washington and Americans that there is that much more domestic gas available for transportation—a thirsty, existing, fuel consumer.

Here’s why it hurts: Until Washington and Americans come around to incentivizing a U.S. transformation of transportation-fuel supply to natural gas, relying less on imported crude oil, growing amounts of wind and solar for power generation result in that much less demand for natural gas.

Questar Corp. chairman and chief executive Keith Rattie say wind- and solar-generated power cannot be relied on 24/7, so natural gas must be at the ready. Across, LNG is cooled to -259 degrees Fahrenheit.

“A megawatt hour of electricity generated by wind or solar is a megawatt hour less generated by natural gas,” says Chuck Stanley, executive vice president and chief operating officer of Salt Lake City-based integrated gas company Questar Corp.

Yet, here’s where increasing reliance on wind and solar power helps gas again: Outside of steady, existing nuclear plants, U.S. power generation is primarily fueled by coal or natural gas.

Sometimes the wind doesn’t blow, or it will blow too hard and wind turbines have to be shut down; the sun doesn’t shine on a solar panel at least half the day, and sometimes it’s cloudy.

Meanwhile, power isn’t stored. It’s used as it’s made or it simply dissipates.

Keith Rattie, Questar chairman, president and CEO, says, “Unless there’s a major breakthrough in high-density electricity storage—a problem that has confounded scientists for more than 100 years—wind and solar can never be relied upon to provide base-load power.”

So, when the wind- and solar-power sources don’t show up for the grid, something’s gotta kick in. And, the party-starter is natural gas.

Stanley says, “Wind and solar are both intermittent power providers. You have to have ‘spinning reserves,’ or back-up, base-load plants ready, running, idling to take up the load when the wind dies down.

“The only kind of power plants that can respond to rapid fluctuations in power-generation demand are natural gas plants. Coal takes a long time to start up, and nuclear plants generally run 24/7 unless shut down for maintenance. Coal plants can’t respond to quick changes in electricity loads.”

Gas-fired power plants are abundant. “Some 40% of America’s power-generation capacity today—400,000 megawatts, half of it built in the past decade—is built to run on natural gas, compared with 315,000 megawatts of generation capacity that runs on coal.

But America’s gas-fired plants operate on average only about 20% of the time. By comparison, this country’s coal plants operate nearly 75% of the time.”

The infrastructure is there. “It already exists,” Stanley says. “It’s already hooked up to the grid. There is a huge amount of installed, under-utilized gas-fired generation capacity.”

Rattie adds that it takes a lot of wind, sunshine and infrastructure for wind and solar to make a significant contribution to American power resources.

“Turning biomass or the photons in sunlight or the kinetic energy in wind, requires massive investment to concentrate that energy into a form that’s usable on any meaningful scale,” he says. “To be clear, we need all the wind and solar power the markets can deliver at prices we can afford.

“But please, let’s get real: Wind and solar are not ‘alternatives’ to fossil fuels.”

Is there enough supply?

Should America switch to natural gas and reduce its use of coal for power generation and so much oil for transportation, is there enough domestic gas supply to last for a while? Stanley says, “The key conclusion from each study is we have a growing certainty and confidence in supply. We’ve undergone a technical renaissance, and industry consensus is that we have the resources to meet current natural gas demand for at least 100 years—maybe even longer.”

LNG-fueled trucks that work for the Ports of Los Angeles and Long Beach fill up at a Clean Energy Fuels station in Carson, California.

“This is almost divine intervention,” Andrew Littlefair, president and CEO of Clean Energy Fuels Corp., says of the abundance of gas that U.S. producers have proven to be able to produce economically.

The divinity is cited by T. Boone Pickens as well. The company, based in Seal Beach in southern California, is the largest provider of natural gas as transportation fuel—CNG and LNG—in North America. It was founded in 1997 as Pickens Fuel Corp. by the long-time oil and gas investor and author of “The Pickens Plan,” which encourages Washington to use more indigenous natural gas as a transportation fuel—and quit importing economically and politically repressive oil—and to introduce wind and solar into the power-generation mix.

LNG consumes 1/600 of the tank space as compressed natural gas, thus it packs more Btu power for long-haul vehicles.

Pickens is proving the feasibility of natural gas as a transportation fuel at Clean Energy, which sold 75 million gallons of CNG and LNG in 2008 and had $129 million in revenue. It has more than 320 fleet customers currently, fueling more than 15,000 natural-gas-powered vehicles at more than 175 Clean Energy stations.

CNG users are primarily short-haul cars and vans—taxis, airport shuttles and individual-use vehicles. These can use LNG too, but LNG is currently used primarily in longer-haul vehicles’ tanks, as it is denser and packs more power into an equivalent space than CNG.

For example, garbage-collection trucks may use CNG but the tractor-trailer rigs that take the super-compressed, heavier load made from many door-to-door trucks’ contents would use LNG, as they travel hundreds of miles to and from landfills.

Andrew Littlefair, president and CEO of Clean Energy Fuels Corp., says natural gas is 130 octane out of the ground, and, compressed, its octane tests even higher. One thousand cubic feet of natural gas has the energy content of eight gallons of gasoline.

Abundant North American reserves mean natural gas as a fuel is not a short-term proposition, Littlefair says. “What can 7 Tcf per year of natural gas displace?” Demand by 1 million U.S. heavy-duty trucks—about 40% of those at work right now or 16 billion gallons of diesel—plus 30- to 50 million light-duty vehicles—or about 28% of those on the road or 38 billion gallons of gasoline.

He believes natural gas can displace some 70% of annual U.S. oil imports, or 135 billion gallons of gasoline and 40 billion gallons of diesel. “Natural gas is the only fuel that can achieve significant foreign-oil displacement.”

What about pump price? Natural gas is 130 octane out of the ground, he says. Compressed, its octane tests even higher. One Mcf of natural gas has the energy equivalent of 8 gallons of gasoline. Natural gas prices would have to rise to more than $24 an Mcf to be bested by a $3 gasoline pump price, not factoring fuel taxes.

While Pickens’ plan tells a compelling story for natural gas, some in the industry are disappointed by it.

“Pickens’ plan has perhaps added to the perception that there is not enough natural gas for use in both transportation and power generation,” Stanley says. “We certainly think natural gas as a transportation fuel reduces dependence on foreign oil and cleans the air, but recent discoveries of new shale-gas plays around the U.S. mean there’s still plenty of natural gas for power generation.”

Unlikely friends

For all the controversy over Al Gore’s global-warming story and whether mankind is truly causing it or if it is largely a natural Earth cycle, comes a friend to U.S. gas producers. Natural gas, while it does have a carbon footprint, is more important as a carbon-particulate- and CO2 mitigator, in that its footprint is vastly smaller than that of crude oil and coal.

In the past, natural gas as a transportation fuel has been rejected by Washington due to its belief that there was too little economically producible domestic supply, and would merely result in conversion from U.S. reliance on imported crude oil to imported natural gas.

Melanie Kenderdine, associate director of MIT Energy Initiative and a former vice president of the Gas Technology Institute, says gas explorationists have proven abundant resources in the Lower 48, where infrastructure is at the ready to take it to markets; in Alaska from which only a pipeline is needed; and in Canada.

There are 2,000 Tcf of known unconventional gas resources in North America, she says, and the number is likely to be revised upward. Current demand is some 22 Tcf per year, she adds, thus some 100 years of indigenous gas supply is available at the current rate of consumption.

Santa Monica, California, runs its bus fleet on LNG. Here, a “Big Blue Bus,” as they are called in Santa Monica, is traveling along its Wilshire Boulevard route.

Even the Sierra Club has embraced substitution of U.S. natural gas for coal. So too have Speaker of the House Nancy Pelosi and Senate Majority Leader Harry Reid, who recently led the effort to force the Capitol Power Plant to stop burning coal and switch to natural gas.

Carl Pope, Sierra Club executive director, told Oil and Gas Investor’s readers in early 2008, “Use renewables as much as we can. Natural gas is the next-cleanest fuel, then we have oil and then we have coal…We’re trying to make sure that we innovatively and creatively use whatever fuel we burn (and) that we rely primarily on the fuels that are the cleanest.

“And, among the fossil fuels, natural gas is at the top.”

That natural gas could be imported, thus reducing or holding the line on domestic drilling. But, Pope says, “taking a bunch of natural gas from Indonesia and moving it to the United States is intrinsically not terribly efficient, so we would rather see what we can do with domestic production here in the United States before we start substituting imported natural gas for imported oil.”

And, wind and solar proponents are allying with natural gas. McClendon says, “Natural gas is the foundation of the alternative-energy triangle. Solar and wind cannot exist without natural gas. Gas-fired power plants have to be ready to fire up at a moment’s notice.”

And, about its carbon footprint, he says, “I’d like to see a riot of people outside a car dealership saying, ‘Let me get this right. Cars are made around the world that run on a fuel that we also make here in America and produces 90% fewer particulates and half as much CO2, and it costs me half as much to fill up with it—and you won’t make these same cars here and sell them to me?’ I don’t get that. I want to drive a car made in America and powered by a clean, job-creating all-American fuel.”

GM and Ford make 18 models of CNG-fueled vehicles abroad. None is sold in the U.S.

An unlikely skeptic

Meanwhile, Matt Simmons has been a help to the U.S. gas story. The founder of energy investment-banking firm Simmons & Co. International Inc. is a “peakist,” a believer in that peak oil supply was reached decades ago.

His “the end of cheap oil is near” story the past few years upset oil producers whose investors began to wonder if they were placing retirement funds in a sustainable business. Yes, the investment would become more valuable as oil prices grew due to constricted supply, yet eventually worthless as the world mostly quit crude oil and most oil companies just produced themselves out of business.

For gas producers, a conviction in Washington of the “end of oil” story could prod policy-makers to look at other resources. And, in plain view is natural gas.

Yet, Simmons has a thing to say about U.S. natural gas too: It is not plentiful enough to be economically produced at current prices. “I think that there’s a realistic chance, within 24 months, our gas supply might be off 20% to 25% because, when you lay down rigs, you expose yourself to these decline rates that are just ferocious.”

One of the firm’s analyses shows that the three-year treadmill of new gas supply is unchanged from 10 years ago, absent new drilling. If new drilling stopped in late 2006, domestic production of nearly 70 Bcf a day would have fallen to less than 55 within a year.

If the end of oil is near and there isn’t enough natural gas to replace it, is nuclear the answer? Former Federal Reserve chairman Alan Greenspan picks it in his autobiography as the most reasonable electricity-generation source. There is one matter, though, he adds: “The major challenge will be to find an acceptable way to store spent fuel and radioactive waste.”

Rattie says nuclear is part of the energy puzzle. “Nuclear is the source of nearly 20% of our electricity. It’s clean, France likes it, but we’re afraid of it.” Yet, there are no near-term alternatives to oil, natural gas and coal, he adds.

“Like it or not, the world runs on fossil fuels, and it will for decades to come. The U.S. government’s own forecast shows that fossil fuels will supply about 85% of world energy demand in 2030—roughly the same as today.

“Yes, some day the world may run on alternatives. But that day is still a long way off. It’s not about will. It’s not about who’s in the White House. It’s about thermodynamics and economics.”

On that measure, natural gas is the obvious answer, Rattie says. “Smart people in this industry have figured out how to produce stunning amounts of natural gas from shale formations right here in the U.S. We now know that America and the world are swimming in natural gas.

“America’s known natural gas resource base now exceeds 100 years of supply at current U.S. consumption—and that number is growing.”

Winning over Americans

“We have to change the culture of how our industry approaches the promotion of its product,” says Aubrey McClendon, chairman and chief executive of Chesapeake Energy Corp., the nation’s No. 2 gas producer and the founder of the American Clean Skies Foundation.

McClendon calls for a rebranding of American natural gas. Got milk? Got natural gas?

“For years, our industry has only been focused on supply—access to land, regulations. No one was very concerned about growing demand for our production. Ours has been a product for which we assumed there would always be enough consumption.

“And, for a long time, there was. And we didn’t really know how to produce more, so there was really no reason to increase the market for it.”

Yet, in the past decade, supply has grown faster than the market. In 2007, Chesapeake formed the American Clean Skies Foundation, a Washington-based think-tank to promote greater use of natural gas. “But one producer can only do so much,” McClendon says.

So, in the past year, most producers have joined McClendon and Chesapeake in delivering the gas message, promoting increased gas demand, with 25 of them forming the American Natural Gas Alliance, representing 40% of U.S. gas supply and producing 9 Tcf per year. The members have pledged $100 million a year toward the organization’s work.

McClendon says, “We have to change the culture of how our industry approaches the promotion of its product.”

First, policy-makers have to be convinced there is abundant natural gas supply, and users need to be convinced of its superior performance on cost, reliability, and particulate- and greenhouse-gas mitigation.

Some industry members are concerned that a carbon tax or another carbon-mitigation scenario will hurt gas demand, as it does have some carbon content.

A consumer fills a personal-use, CNG-equipped Honda Civic GX at a Clean Energy station, while a shuttle bus fills up at the other pump.

McClendon says, “Gas should be dispatched before coal. Something that prices carbon is good for our product. Now, I’m sure there are lots of ways we could come out on the short end of the stick on carbon pricing, if we are not there at the table when the laws are being made. But when you begin to say there is a cost to burning carbon, or producing carbon, then the price of coal should go up.

“When the price of coal goes up, that provides support for natural gas prices.” Higher natural gas prices will result in more production, “and the opportunity to begin thinking about using it in a greater quantity in transportation.”

So, if the end-game is simply to reduce U.S. dependence on foreign oil while, at the same time, switching to a cleaner, domestic transportation fuel, then the card to play is natural gas.

A Clean Energy Fuels station at the Los Angeles international airport fuels rental-car and airport shuttle buses. Airport-related fleets are increasingly using natural gas as fuel as federal policy is requiring emissions reductions when permitting airport growth.

If also wanting to flat-line or reduce coal use for power generation, yet incorporate wind and solar into the game, while adding no new nuclear-power plants, then natural gas is, again, the ace in the hand.

McClendon says, “We have absolutely proven natural gas is no longer scarce and that changes everything for environmental, economic, energy and national-security policy. We have a way to begin to reduce our dependence on foreign oil.

“To paraphrase our friend Boone Pickens, ‘if you’re not for American natural gas, then you’re for foreign oil.’” For proof of abundant U.S. natural gas, there’s, um, er, that elephant that’s in the room.