Cheap Natural Gas, Too? It’s a Technology Thing.

In a previous post, I promised to revisit the topic of natural gas. If you’ve been following the American natural gas market you know that prices have fallen substantially over the past year. Now a lot of this has to do with a lack of demand because of the recession as well as other market factors, but there have been some very interesting technological developments that have also had a profound effect on the price of natural gas.

Source: Bloomberg
Source: Bloomberg

To preface this post, I’d like to say that I am not attempting to fully answer the question of why natural gas prices are lower as of recently, nor am I predicting where they are going, but I’d like to provide some perspective to some of the technical factors that have driven prices down lately.

First, some fundamental information about natural gas. Not surprisingly, natural gas (at typical terrestrial temperatures) is in gas form. Now this is quite trivial given the commodity’s name but has very important implications for natural gas, especially when comparing it to its good friend crude oil (which is a liquid). Since natural gas is in a gaseous state, the way in which it can be transported is much different than oil. With most kinds of sweet light oil (the stuff that’s traded at WTI prices), you can effectively flow in a pipeline directly from a well into a tanker and then to anywhere in the world.

Natural gas, however, is a very different story. Natural gas is in gaseous state; therefore it cannot be transported as easily as crude oil. This is because it takes up a lot more room and more importantly is dangerously volatile. To transport natural gas it must be done through a pipeline or on a liquefied natural gas (“LNG”) tanker (compressed natural gas exists as well, but plays a minor role currently). To utilize LNG, infrastructure has to be in place that will liquefy the natural gas, which means that there needs to be a facility that will cool the gaseous commodity to -162°C. And, as is obvious, to pipeline something the location must be “pipeline-able” (as I like to call it). Essentially that means that you can’t build a pipeline across the Atlantic ocean (well you can, but it’d be pretty silly), but you can from Alberta, Canada to the Chicago or from the Gulf of Mexico to Galveston. The pictures below show you oil and gas movement in the world.

Oil Trade

Source: BP Statistical Review of World Energy 2009
Source: BP Statistical Review of World Energy 2009

Natural Gas Trade

Source: BP Statistical Review of World Energy 2009
Source: BP Statistical Review of World Energy 2009

Since natural gas has historically been a regional commodity, the supply and demand characteristics are also regional. This is one of the main reasons why we see the wide variances in natural gas prices around the world, whereas oil prices are pretty closely tied together (generally, differences in price are due to differences in quality of the oil). Up until just recently, things were looking pretty dismal for the United States on the natural gas front. There were diminishing US supplies but increasing demand—and no real in-country way of adding supply to offset the rising demand.

As of recently, though this problem has been solved by new technologies that can tap into in-country natural gas resources which previously were unrecoverable—which is another way of saying that with current technology and  prices the natural gas was either uneconomic or technologically impossible to recover —are now recoverable. These resources are known as shale natural gas. Previously, shale did not have the permeability to let natural gas flow in a manner that was economic and technologically possible to produce. New technologies, most notably the hydraulic fracturing of a well, can make the previously uneconomic shale economic by increasing the permeability. Essentially what fracturing a well does is create cracks in the rock formation in which the natural gas is present so that the natural gas can flow through the rock and above to the surface. These cracks are created by pumping a fluid with grains of sand or rock (to hold the fracture open) into the well at high pressure forcibly breaking the rock formations and increasing permeability making the natural gas recoverable. This technology has been and continues to be industry-changing.

In June of this year, the Potential Gas Committee reported that estimated natural gas reserves increased by 35% over the past year to 2,074 trillion cubic feet in 2008 (up from 1,532 trillion cubic feet in 2006). This is the biggest increase in 44 years. The massive increase in prospective supply has had a profound impact on the market for natural gas in the United States and has contributed, from a technical perspective, significantly to the drop in the price of natural gas.

This technological advancement once again reminds us that we’re not running out of fossil fuels by any means; we just need to find more clever ways of producing what are now unrecoverable resources.