A Free-Market Energy Blog

America’s Gift: High Technology and Lower Prices (peak gas not!)

By Donald Hertzmark -- June 22, 2010

In a raft of articles on this blog and elsewhere, the surge in U.S. gas production–due mostly to rapidly increasing output from shale formations–has been touted as a key savior of domestic drillers and consumers.

At the same time shale gas has been more than a headache for LNG exporters and pipeline monopolists, for some it threatens to become a nightmare – softening prices, competing with pipeline supplies, driving LNG demand to spot markets – generally making a pain of itself, from the viewpoint of the gas industry’s would-be GOPEC.

By providing a plentiful alternative source of supply for the world’s largest gas market, the U.S., shale gas has reduced wellhead netbacks throughout the Atlantic Basin.  International reverberations have been dramatic. Even the Russian Bear, feeling the hot breath of the market, is softening its pricing terms for international gas sales.

“A Republic, if You Can Keep It”

At the close of the U.S. Constitutional Convention in 1787 a woman asked Benjamin Franklin, as he was leaving what we know as Constitutional Hall: “Well, Doctor, what have we got—a Republic or a Monarchy?”  Franklin replied:   “A Republic, if you can keep it.”  For natural gas, we can paraphrase Mr. Franklin – a market, if you can live with it.

In the U.S. and throughout the world the bounty of shale gas has created significant opportunities for consumers to save money on energy, and clean energy at that.  Most of these benefits are available only to countries where the market determines gas prices.

Consumers of gas in the U.S., where prices are set by a market, pay about half what consumers in Spain, Belgium and elsewhere pay for that same gas, with prices set by regulators and politicians.  Similarly, consumers of natural gas in the UK pay about half as much for gas from Algeria as do consumers in Spain.[i]

But it is not always this way.  Sometimes Mr. Market delivers a less friendly message –  Produce more!  Consume less!  Build a bigger house! – and punctuates the message with unpleasant price signals – spikes and crashes.  Twice during the 2000s, in 2005 and again in 2008, natural gas prices at the Henry Hub rose above $13/mmbtu, but only for a while.  Conversely, prices have cratered several times in the past decade or so – falling below $3.50/mmbtu four times since 1998.  The thing about Mr. Market is that he makes his point with real zing.  Prices did not stay at such levels for more than a few weeks.  Like the cry of the 101st Airborne, Mr. Market delivers a focused message, one intended to motivate action, not talk.

In contrast, regulated prices[ii] provide the illusion of fairness – fair to the producer, fair to the consumer – all the while gouging the consumer and lulling the producer into laziness and greed.  Netback prices at the wellhead in Algeria or Nigeria, the GMT equivalent of the Henry Hub, have remained north of $7.50/mmbtu for years.  In contrast, the average gas prices in the US have remained well below that level for all but two years of the past ten.  Consumers in most European countries pay more than $15/mmbtu for the commodity gas by the time it is delivered to their houses.[iii]

No Free Lunch

Most of the time markets will deliver the goods in a reasonable manner and at a price that closely tracks the cost of providing the gas.  But this means that we, as consumers, have to listen to the news that the market delivers.  Usually we do, except for those times that we run to the leviathan for some help.

America is now in a unique position to benefit from a geological oddity – the shale gas deposits.  Moreover, consumers throughout the world can also so benefit.  But in order for all of this to work countries around the world will need to connect prices consumers pay with the prices that producers receive for investment, development and production.

And just when the energy world needs a market champion we have panic in the US Executive Branch.  The ill thought-out drilling moratorium in the US Gulf sets an uncomfortable precedent for opponents of shale gas drilling.  So far it is only the deep recession that has kept oil prices under control in the face of a poorly-thought-through policy on drilling.

With shale gas there would be no such luxury.  If fields are not subject to continuous drilling operations production may fall off rather rapidly.  So the response to a shale gas accident, no doubt the object of many Sunday prayers in the US renewable energy community, could cripple that supply, now more than 10% of US gas supply, and lead in short order to far higher natural gas prices.[iv] For Mexico, now a major LNG importer, the increase in prices due to a failure of the US shale program and its umbrella effect on gas prices throughout this hemisphere, could amount to more than 1% of that country’s GDP, an astonishing and unwelcome total given the current state of Mexico’s economy and society.  In particular, such a cost increase could cripple industrial production and raise the cost of power generation by 25% or more.

Even without an accident, shale gas opponents have already had some success in limiting production activities.  America’s gift could be withdrawn, and with it prosperity and comfort for millions all over the world.

[i] Gas prices in most regulated markets in Europe and Asia are based on long term contracts with producers using a market basket of refined products and crudes.  Russia has historically priced its gas sales to Europe the same way.  This method of pricing gas does not account for the less than full substitutability of gas for oil or oil products’ ease of storage and transport.  Rather, it treats all BTUs as equal – a sort of energy theory of value.

[ii] This is the EU version of utility price regulation – prices to consumers are too high and incentives for producers for efficiency are low.  This model contrasts with the developing country regulatory model, where prices for consumers and producers are too low, leading to chronic excess demand and insufficient incentives for new supply.

[iii] This is rather confusingly displayed as the cost of gas per kWh – i.e., gas converted to electricity at 3412 btu/kWh (3600 MJ/kWh).  Prices range from about $10/mmbtu in the Baltics, to more than $25/mmbtu in Sweden and Denmark.  By way of contrast 2010 retail gas prices in the Mid-Atlantic region of the US are about $8/mmbtu for the commodity (including storage) and $3.25/mmbtu for distribution.  The remainder of charges, now totaling about 10% of the consumer’s bill, consist of taxes and renewable energy levies.

[iv] The end of the shale gas effect on US and international gas markets would mean increased prices of at least $75 billion annually in the US, $60 million annually in the Dominican Republic, $11-12 billion/year in the UK and $10-11 billion/year for Mexico.

One Comment for “America’s Gift: High Technology and Lower Prices (peak gas not!)”

  1. rbradley  

    I fear that the U.S. gas industry is ‘overproducing’ in the sense of too many gas folks running to the government for help on the demand side. I am thinking of T. Boone Pickens in particular, whose Plan III is $64k in tax credits to get 18-wheelers to convert from oil to natural gas.

    The gas industry should

    1) fight against nuclear subsidies (such as Obama’s $18 billion loan guarantee plan)

    2) work to block and eliminate renewable quotas on the state and federal level

    3) reject cap-and-trade in the name of promoting a better economy to increase gas demand as the swing fuel in electric generation.


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