A previous post about comparative gasoline prices inspired me to write a post on where oil comes from and how difficult it really is to get oil out of the ground and to the consumer. It’s quite an involved process that I don’t believe a lot of people really appreciate. After I better understood the entire process, I had a new appreciation for the thesis of energy prices being too low just because of the sheer difficulty to get this stuff out of the ground. Now, this is just a broad overview of the process; please understand that there are a lot of specifics that I am leaving out.
I also want all readers to note that I am writing about countries where all of the country’s oil is not nationalized (for example Saudi Arabia, Iran, Venezuela, Mexico). For an independent oil company to exploit oil in these countries, very special agreements between the independent company and the national oil company must be reached.
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.
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.
Natural Gas Trade
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.
After hitting a peak of over $4.10/gallon last summer, US gasoline prices have fallen to about $2.50/gallon in July. That’s still really expensive, right? Well maybe it isn’t. Maybe even at $4/gallon gas is actually really cheap. Sounds like an unimaginable thesis, but it’s the truth.
I like to follow the stuff that peak oil guru Matt Simmons publishes on his website and one of his main thesis is that energy (particularly oil) is way too cheap. He has a slide in one of his presentations where he supplies the following pricing statistics.
I also did a few other calculations, which are quite astonishing:
An average bottle of wine at a nice restaurant, $202/gallon
A beer at a ball game, $68/gallon
An average Starbucks drink, $28/gallon
Now obviously you aren’t buying a gallon of Vicks NyQuil at any given time, but there are a lot of people who drink a gallon of beer on a Friday night (that’s about 10 bottles), or consume a gallon of Starbucks coffee over a week (that’s about one grande drink a day). The question then is, how much utility do you get from that Starbucks drink every morning or a few beers at the ball game versus driving in your car?
Well, let’s look at what a gallon can do for you in your car. A gallon of gas in an average subcompact, assuming a mix of city and highway driving, can take you about 30 miles (18 km), or about on a 45 minute drive (driving at an average of 40mi/h (64km/h)). By any standards, that’s a long ways to go for only $2.50. For comparison sake, go through the list below and decide what’s giving you more utility, 45 minutes in the car or approximately:
1/3 of a gallon of water (three bottles)
1/3 of a gallon of Coke (three cans)
1/5 of a gallon of Budweiser (two bottles)
1/10 of a gallon of a Starbucks drink (a tall beverage)
1/20 of a gallon of beer at a ball game (half a cup)
1/100 of a gallon of wine at a nice restaurant (a drop)
Maybe $4 a gallon isn’t that expensive when you look at it from a comparative perspective. Maybe energy really is way too cheap.
If this post intrigued you, I would suggest you read some of Matt Simmons’s presentations on his website or watch one of the interviews on YouTube.
A few weeks ago, The New York Timesreported about a plant to harvest electricity through a solar thermal application in the African desert and then transmit it back to Europe for use. Upon initial consideration, this sounds like a really great idea: Africa is blessed with heat and lots of sun (the two resources needed for a successful solar thermal project), and Europe needs lots of electricity. Since the technology to do this scheme is there, why not use it?
Plus, there are many technical reasons to go forward with this plan:
It is estimated that 15% of the EU’s electricity demands could be satisfied by such a project.
DESERTEC (a foundation with the mandate to provide Europe with electricity through solar thermal applications in deserts) has announced a preliminary financing plan for their solar thermal project.
Green, renewable technologies are the latest hype right now.
Solar thermal, in the right application, is arguably an economically viable electricity generation alternative.
There is a lot going for this project. But there is also a lot going against it, particularly on the social side. The sentiment of European Imperialism is still in Africa. And coming in and exploiting yet another resource is not going to go over well. Look at how Shell has been treated in Nigeria over the past couple of weeks. They have been forced to shut-in oil production (i.e. stop producing wells) because of massive destruction of their facilities there. Additionally, and more importantly, is exploiting a resource from a historically poor continent for use in a historically wealthy continent something that a socially responsible company does?
But socially it’s not all bad. This project could have a lot of positive effects on an economy. The typical increase in jobs that comes with any new development would be excellent for the economy as well as quality of life of the citizens. Furthermore, this kind of solar thermal allocation would require skilled labor, which requires additional education of citizens, another great benefit to any country.
It’s is a great concept from a technical perspective, and if the cards are played right, it could be a great development from the social side too. The question is, how are the cards going to be played?