Natural Gas Economics

King (Low-Cost) Natural Gas

From a Review by David Rotman, MIT Technology Review, October 2012

Last summer, a simple graph from the U.S. Energy Information Administration shocked even the most astute energy wonks. It showed that for the first time since the federal agency began keeping track, coal was no longer the dominant fuel used to generate electricity in the United States. Over the previous few months, the use of natural gas in power plants had risen so quickly that it accounted for as much electricity as coal, a far dirtier fossil fuel. (As usual, renewables such as wind and solar power flatlined near the bottom of the chart.)

The milestone was just one more sign of a transformation in the energy prospects of the country—and probably the world. The sudden abundance of cheap natural gas has dramatically changed the way the United States produces and consumes energy, dwarfing the changes wrought by decades of subsidies and other incentives for the development of nonfossil fuels.

The so-called gas revolution is largely the result of advanced drilling techniques—horizontal drilling and hydrofracking—that have become more widespread over the last several years. These methods make it practical to extract huge amounts of natural gas that have long been known to exist in shale deposits around the country, most notably in the Marcellus shale that spreads for tens of millions of acres underneath much of Pennsylvania and parts of New York, Ohio, West Virginia, Maryland, and Kentucky (see “Natural Gas Changes the Energy Map”).

Experts disagree on how much recoverable gas these deposits actually hold, but by most guesses it is more than enough to supply the United States for many decades. What’s more, large deposits of shale gas have been identified in China and in spots throughout the rest of the world.

Though it’s been increasingly evident since the late 2000s how important this resource is, it’s startling how quickly and thoroughly it has altered our energy habits. The reason has to do mainly with another statistic that the EIA carefully tracks: for much of the first half of this year, the price of natural gas hovered around $2 to $2.50 per million BTUs, far below the $13 it reached in 2008 (before the rapid expansion of drilling in the Marcellus shale). At $2.50 per million BTUs, the price of natural gas is the equivalent of around $15 per barrel for oil.

Put another way, modern natural-gas-fired power plants can now produce electricity at around four cents per kilowatt-­hour. That’s cheaper than energy from new coal plants, and far less than the price of even the most efficient wind or solar power when the cost of backup systems for those intermittent sources is taken into account (see chart on facing page). [But, prices are likely to change of the coming years.]

The United States is saving about 400 ­million metric tons of ­carbon ­emissions annually in the recent switch to natural gas from coal. That’s roughly twice as much progress as the European Union has made in complying with the Kyoto Protocols for carbon dioxide reductions through policy efforts.

Indeed, economists say it is hard to overstate how significant the sudden availability of cheap natural gas is. “It is the largest change in our energy system since nuclear became part of the electricity grid 50 years ago. And I don’t think we fully understand the implications,” says Michael Greenstone, an economist at MIT and director of the Hamilton Project, an economic policy initiative at the Brookings Institution in Washington, D.C.  He cautions that it’s “an open question” how it will affect climate. “There are two views,” he says. “It’s a ‘blue bridge’ to a green future, or it’s the death of nuclear and renewables. I don’t think we know the answer yet.”

Blue Elephant

Burning natural gas, which is mainly methane, produces far less carbon dioxide than burning coal. UCSD’s David ­Victor, for one, estimates that a modern gas-fired power plant emits roughly two-fifths as much carbon as even a new coal plant. According to his calculations, the United States is saving about 400 million metric tons of carbon emissions annually in the recent switch to natural gas from coal. That’s roughly twice as much progress as the European Union has made in complying with the Kyoto Protocol through policy efforts. “There is no single event that has had as large and sustained an impact on carbon emissions as the gas revolution,” he says.

But optimism about the environmental benefits should be tempered. For one thing, utilities might return to using more coal as increased demand makes natural gas more expensive. Another concern is that extracting and transporting natural gas itself generates greenhouse gases. Dueling studies have published varied and sometimes contradictory estimates of the total emissions associated with natural-­gas production, but the contributing factors include the energy used in the extraction process and the fact that methane—an extremely potent greenhouse gas—is released during drilling and leaks from pipelines during transport. In fact, there are no reliable measurements of how much energy drilling for shale gas consumes or how much methane actually escapes.

In any case, it’s clear that switching from coal to natural gas will not come close to delivering the huge reductions in greenhouse-gas emissions that most scientists contend are needed by midcentury to ward off the worst effects of climate change. According to estimates by economist Henry Jacoby and his colleagues at MIT, the increased use of shale gas might lower carbon emissions somewhat in the next five to 10 years, but at best it will keep them flat through 2050. In other words, there is a short window of opportunity to begin inventing and deploying cleaner technologies. Jacoby predicts that natural-gas prices will stay relatively low over the next decade, climbing slowly to around $5 to $6 per million BTUs—still making it hard for renewables to compete.

The “real elephant sitting in the room,” Jacoby says, is that we don’t have a climate policy aimed at penalizing carbon emissions, which would provide an incentive to invest in cleaner technologies. “The benefit of renewables is simply that they don’t emit carbon dioxide,” he says.

To many economists, the obvious textbook remedy is to establish a price on carbon emissions, through either a tax or a so-called cap-and-trade system. Various schemes for establishing such a carbon price have been proposed, but none has gained any political momentum in the United States. What’s more, a growing number of economists believe that carbon pricing alone is unlikely to spur a boom in clean energy technologies.

“The renewables are not yet ready for prime time,” says Greenstone, who has done extensive cost analysis of various electricity sources. Not only are gas-fired plants the cheapest source of electricity, but renewables are still far more expensive even if the costs to society of pollution and greenhouse-gas emissions are factored in. “If we accept that as a fact, what are we going to do for electricity for the next decade or two?” he asks. Replacing coal with natural gas can act as a “bridge” that significantly reduces carbon emissions, he adds. “Now the question is, what is at the end of the bridge? Does it really lead to the day when renewables are able to compete with fossil fuels? In the absence of pricing carbon and a substantial investment in basic research and development, that’s not very likely.”

Those who are developing alternatives need to accept the reality of abundant and cheap natural gas for the foreseeable future, and they must recognize the need for clean energy technologies that are far less expensive than those existing today. The good news is that many such technologies are in the works. The importance of inventing renewables that are truly competitive with fossil fuels remains unchanged. Cheap natural gas has simply emphasized, once again, how challenging finding the breakthroughs will be.

Updates on Natural Gas Prices: Natural gas spot prices (Henry Hub)