The Role Of Natural Gas Grows Despite Economics

At a recent breakfast conference focused on unconventional resources, the observation was made that unconventional gas will soon no longer be unconventional.  As several speakers pointed out, in 2001 less than 1% of the nation’s gas supply came from unconventional gas resources, while today it is slightly under 20%.  If projections prove correct, natural gas from shales and tight rocks will account for more than 50% of our supply by 2020, assuming the economics for gas improve.  This, unfortunately, is the critical ingredient for expanding the role of natural gas and its potential to become the “silver bullet” of U. S. energy policy.

Unconventional gas will soon no longer be unconventional

Since the early 1990s, as shale formations began to emerge as a possible source of future gas supply, the struggle has been between the technical challenges of extracting hydrocarbons and the economics of the effort.  We have recently been engaged in an email chain exploring the question of what was the catalyst that started the current shale boom, which will be the subject of a future Musings article, but suffice it to say that there was no single catalyst in contrast to the conventional belief that it was a eureka moment as E&P professionals discovered that marrying horizontal drilling and multi-stage fracturing would miraculously allow us to extract huge supplies of natural gas.  The success really came through trial and error and hard work.  Those characteristics, inherent in the genes of E&P professionals, were helped by rising natural gas prices that provided the incentive to seek solutions and, importantly, the cash to do so. 

The struggle has been between the technical challenges of extracting hydrocarbons and the economics of the effort

As pointed out by several of the forum’s speakers, and in conversations we have had with other experts, for all the thousands of tight gas sands, coal bed methane and gas shale wells drilled in this country, there is likely more about shales that we don’t know than what we do.  As a result, the industry will continue to drill and fracture wells and inch the technology forward and improve the recovery of this potentially huge global hydrocarbon resource.  Boosting gas demand, as opposed to further improving technology has become more important for improving shale extraction economics.  The alternative of slowing drilling and production could become a disruptive force in furthering the development of technology.  As one speaker put it, we are no longer looking at gas shales costing $10-$12 per thousand cubic foot (Mcf), but rather it is now in the $6-$8/Mcf range thanks to technology.  Can we bring it down to $4/Mcf?  That is the challenge.

In the meantime we need a stronger economic recovery, both in the U.S. and Europe as they are the principle drivers for increased natural gas consumption, either as dry gas or in the form of liquefied natural gas (LNG) shipped from far off locations around the world.  A natural gas recovery requires a stronger economy and in turn an improvement in domestic auto sales, which have shown surprising strength in recent months, and a solution to our housing industry problems.  The latter has proved a more difficult problem to solve. 

Boosting gas demand, as opposed to further improving technology has become more important for improving shale extraction economics

The best chance for increasing natural gas demand is to expand its role in generating electricity.  Increased gas consumption by the nation’s industrial sector depends on accelerating the economic recovery.  Some gas industry executives point to the residential sector’s contribution to greater gas use, but that will come slowly as it depends upon new home construction.  These executives point out the impact of the public’s fascination with electronic gadgets and how that is boosting electricity consumption, but the reality is that demand growth is largely offset by continued improvement in the electricity efficiency of large consuming appliances such as air conditioners, televisions, clothes dryers, ovens and stoves. 

Other gas industry executives tout the potential for expanding the use of natural gas in our auto and truck fleets.  There are clearly opportunities in this area but the impact will take a very long time to have much impact on the nation’s overall gas market.  We have had some success, and likely can continue that success, with fleets of buses, garbage trucks, postal vehicles and the like.  These are vehicles that travel limited distances and return to a central facility helping to justify the cost of installing natural gas refueling facilities. 

The gas industry, however, continues to promote the concept of replacing our over-the-road trucking fleet with natural gas powered units.  They tout the environmental advantages of natural gas versus petroleum fuels, but they seem to ignore the practical and economic issues this switch entails.  The American Trucking Associations (ATA) has studied the issue and reported on the economics this switch imposes on their business.  It recently updated the 2009 study with more recent data and experiences of operators.  Without going through all the technical challenges encountered, depending upon the gas-powered engine utilized, the economic challenges are daunting.  Both compressed natural gas (CNG) and LNG have a lower energy density than diesel.  The ATA states “Because of its lower energy density, CNG is not practical for long-distance, heavy-duty truck applications.”  It further says, “LNG…has higher energy content per volume than CNG (although still significantly lower than diesel).” 

They tout the environmental advantages of natural gas versus petroleum fuels, but they seem to ignore the practical and economic issues this switch entails

A major inhibitor for switching the nation’s heavy-duty truck fleet is the cost.  Natural gas trucks sell at a premium ranging from $45,000 to $75,000 compared to diesel-powered heavy duty Class 8 trucks.  There are federal and state tax incentives available for gas-powered truck buyers, but the ATA says these incentives are generally not sufficient to offset the price differential.  They also point out that natural gas prices fluctuate just as diesel prices do, and they vary by geographic region.  Generally, gas prices are cheaper than diesel, ranging during 2009 between $0.75 and $1.50 per gallon.  We don’t believe that natural gas fuel for vehicles is taxed to support the highway trust fund, something that would be addressed by the federal government as it begins to lose tax revenues with declining gasoline and diesel fuel sales.

Refueling gas-powered vehicles is a major headache for the over-the-road trucking industry.  LNG trucks must be refueled at specialized stations configured for specific truck models.  Because the fuel is dispensed at between -255 and -270 degrees Fahrenheit, employee training and personal protective equipment is needed.  CNG trucks also require specialized refueling.  Depending upon the temperature, it may take two or more refueling to make sure the tank is full.  Since mobile natural gas refueling is not an option, running out of fuel on the side of the road is a significant challenge and the truck would have to be towed to a refueling location.  The cost of natural gas refueling stations ranges between $750,000 and $1.2 million.

The cost of natural gas refueling stations ranges between $750,000 and $1.2 million

The last major challenge for natural gas-powered trucks is their range and weight, both of which impact the economics of trucking company operations as fuel is the second largest expense of a trucking operation.  Spark-ignited natural gas engines have a reduced fuel economy of 7% to 10%.  Compression-ignition natural gas engines have about a 1% fuel economy penalty, but they burn a blend of natural gas and diesel fuel.  Reduced fuel economy hurts the economic benefits of lower natural gas prices.

Weight is the biggest problem.  Each 119-gallon LNG tank adds approximately 500 pounds to the truck’s weight.  Two of these tanks are needed for the truck to have an operating range of 775 miles.  A 72-gallon tank adds about 270 pounds to the weight of the truck.  A CNG truck equipped with five 15-gallon tanks (300-350 mile operating range) would weigh 1,200 pounds more than its diesel counterpart.  This incremental fuel system weight reduces the revenue-carrying capacity of the truck worsening its economics and largely, if not totally, offsetting the fuel economy savings.

While waiting and pushing for gas demand to increase, gas producers compound their weak economic position by continuing to drill wells and bring highly productive ones on stream.  What we have witnessed this year, however, has been a shift in drilling focus from dry natural gas and toward wet gas and crude oil.  This shift has been manifested within a steadily increasing share of active rigs drilling horizontally. 


The impact of horizontal drilling and gas shale well productivity has been clearly demonstrated by the long-term trend in the number of drilling rigs seeking natural gas.  Most analysts were mystified by the quick recovery in the gas rig count following the financial crisis in the


face of a growing natural gas supply glut and low gas prices.  Rational behavior argues that low gas prices should slow or stop gas drilling, but what wasn’t fully appreciated was the impact of the gas shale land grab with associated drilling requirements considered critical to become a successful gas shale producer. 

In recent weeks, analysts were encouraged by the drop in the number of drilling rigs seeking natural gas.  The belief was that low gas prices were finally beginning to alter producer attitudes that they should drill to hold acreage regardless of gas prices.  Last week’s Baker Hughes (BHI-NYSE) drilling rig count data disproved that view as gas rigs have returned to an uptrend. 


We expect horizontal drilling to continue to grow as a share of all drilling activity as the technology has proven successful and, in many regions, is the environmentally-preferred approach for extracting hydrocarbon resources.  As long as we keep drilling highly productive gas shale wells, we probably won’t see a meaningful increase in the total number of active rigs drilling for gas.  Likewise, until the economics of low gas prices overwhelm the need to drill to hold leases, a significant decline in rigs drilling for natural gas will not occur soon.