Re-evaluating the 30 Tcf Economy

Abstract: Once upon a time, forecasts projected the U.S. would evolve into an economy that consumed 30 Tcf of natural gas annually. It looks as though that theory is running out of gas.

Analysis: There are some great concepts that make life exciting. Santa Claus and the Easter Bunny are two that come to mind. For the oil and gas industry, it is the prospect of a 30 Tcf economy.

"Thirty Tcf." The phrase has a nice round sound to it. Tcf, of course, is Trillion cubic feet. It applies to natural gas consumption. The U.S. is a 22 Tcf economy at the moment and has been since the late 1990s. And therein lies the problem.

In the mid-1990s, the U.S. Department of Energy (DOE)released a long-term outlook on U.S. natural gas consumption that suggested natural gas consumption would grow to 30 Tcf by 2020. It looked like a sure bet. Annual gas consumption was rising steadily. Extrapolating the lines forward showed gas use would increase by a third or more over two decades.

The 30 Tcf economy was based on a model that looked great on paper. The model traced the correlation between U.S. Gross Domestic Product (GDP) growth and electrical demand. Those lines had risen in tandem since 1950 regardless of whether the economy was up or down.

Then a wild card entered the mix. Natural gas had been considered a finite resource and only partially reliable as a fuel source before 1990. The knock on natural gas concerned deliverability, which is a polite way of suggesting that maybe there just wasn't enough gas out there to meet sustained high demand. The wild card was growing concern over the global warming issue. Coal began losing favor among policy makers who began to promote cleaner burning fuels. Natural gas was reborn as an environmentally friendly hydrocarbon.

That idea found its way into forecast models. While electrical demand and GDP were projected to continue rising through 2020, the components of power generation were estimated to change. Coal, which is the main fuel for electrical generation, was anticipated to decline in use over time, ostensibly because of environmental issues. Oil use for power generation was predicted to stay flat. Nuclear fuel was also projected to decline. The only line that was estimated to head up was natural gas, which was anticipated to take greater volumes of market share away from all other fuels the further those lines moved into the future. The concept electrified the oil and gas industry. It implied demand growth of 35 percent, or roughly 8.5 Tcf over and above existing levels. To place the numbers in perspective, it meant adding 26 Bcf/d in gas production to a system that by 2001 was struggling to achieve 60 Bcf/d in capacity.

By the late 1990s, the 30 Tcf economy was the primary component in all industry forecasts whether the products came from think tanks, originated with the DOE, or were part of National Petroleum Council projections. The 30 Tcf economy was a core assumption in the 2001 effort to create a national energy policy.

Remember those frenetic statements just two years ago that the nation had to build a power plant a week for the next 20 years? The 30 Tcf economy became a factor in the evolution of the hydrocarbon industry in the U.S. from an oil and gas industry to a gas and oil industry. There were early false starts such as the 1992 drilling boomlet inspired by the pending expiration of Section 29 gas credits. That just added to the gas bubble. Still, it was clear by the mid-1990s that oil was a thing of the past for the U.S. as far as targets go, particularly with the specter of Iraqi production returning to the market at some point and excess productive capacity a perennial issue with OPEC.

The majors responded by dumping U.S. assets and sprinting overseas. Independent E&P firms responded by focusing on natural gas as a target, particularly with pipeline deregulation unfolding. The result was the drilling mini-boom in 1997 and the creation of super-sized independent E&P firms based on large natural gas production and reserves.

The oil-directed portion of the rig count never recovered after 1997, and gas typically accounts for 70 percent or more of drilling activity today.

By the late 1990s, excessive optimism began creeping into the natural gas story. Instead of 30 Tcf by 2020, investor relations presentations began projecting a 30 Tcf economy by 2015, and eventually 2010.

But a funny thing happened on the way to a 30 Tcf economy. For one, U.S. natural gas production began falling. Even in 2001 when nearly 1,000 rigs were drilling for natural gas, the best that occurred was a flattening in the trend line for one year. Since then, the trend line has reverted to its steady downward progression. Ultimately, the math doesn't work. To achieve a 30 Tcf economy, the oil and gas industry must expand the existing reserve base to more than 500 Tcf. Estimates vary, but combining U.S. lower 48 reserves with Canadian reserves creates a North American natural gas reserve of roughly 225 Tcf. At current rates of consumption, the U.S. will drain that supply in 10 years unless the industry rapidly expands exploration to identify additional supplies. Right now, more than 95 percent of all drilling activity is involved in developmental work. In essence, the natural gas industry is harvesting existing reserves for monetization rather than expanding reserves th! rough the drillbit.

That's on the supply side. The demand side is also intriguing within the context of a 30 Tcf economy. Here, a combination of rising gas prices and slowing economic activity has reduced daily industrial gas consumption by 40 percent in just four years, particularly for gas-consuming sectors like paper, primary metals, chemicals, and the petrochemical complex. If current trends continue, the U.S. could represent a 19 or 20 Tcf economy in the next few years. A lot has foundered on the shoals of the 30 Tcf theory--just ask Duke, Dynegy, Mirant, and others who collectively borrowed up to half a trillion dollars to underwrite capacity expansion for co-generation or combined fuel power plants.

Nor was it just the bigger companies that placed their bets on a future that fizzled. In Lubbock, Texas, the municipality's electric company decided to purchase a gas turbine to generate power to sell to surrounding rural communities. Lubbock Power & Light had been a cash cow for the city of Lubbock for more than 70 years. It kept property taxes low and underwrote municipal electrical consumption for such necessities as street lights. Unfortunately, an equipment failure eventually prevented the city from delivering electricity generated from the turbine. Then gas prices soared, making it unprofitable. The project has now turned into an $18 million liability that has resulted in layoffs, resignations both for elected officials and power company managers, and the usual fingerpointing that makes local politics so endlessly entertaining. While there may not be a Santa Claus or Easter Bunny, there is no need to panic. The U.S. will not run out of gas soon. Higher base natural! gas prices will support enough field activity in Canada and the U.S. to sustain U.S. consumption in the 19 to 22 Tcf level through 2008 or so, at which point the first gas is projected to arrive from the Canadian Arctic. This could be followed in 2012 with gas from the Alaskan North Slope. And there is the possibility of expanding LNG use. But that is another story for another time.