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If there is any remaining doubt regarding this issue, it should be thoroughly dispelled by the National Petroleum Council’s recent Report to Secretary of Energy Spencer Abraham.
The Council’s Report, entitled “Balancing Natural Gas Policy – Fueling the Demands of a Growing Economy,” presents the results of the most comprehensive assessment of supply and demand of natural gas in the North American market undertaken in many years. To date, it has received surprisingly little attention – despite Alan Greenspan’s warning last May regarding the potential threat to the U.S. economy posed by tighter-than-expected natural gas supplies. Anyone who reads the Council’s Report carefully, however – and I would urge everyone who reads this article to do just that -- can’t help but come away from the experience shaken. (The Report is available on the Council’s web site at www.npc.org.)
The Council’s last assessment of the U.S. market, completed in December of 1999, was one of the few government or privately-sponsored studies that offered any substantial basis for believing that it would be possible to significantly expand North American supplies of natural gas above 1999 levels. It also provided the basis for many of the assumptions used by the Energy Information Agency (EIA) in its subsequent annual forecasts of supply and demand in the U.S. market. As such, it played an important role in justifying decisions by power plant developers to build more than $ 100 billion in new gas-fired generating units over the past four years – foregoing the opportunity to construct a more diversified portfolio that relied more heavily on coal-fired generation and renewable energy.
As a result, in March of last year, Secretary of Energy Spencer Abraham asked the Council (an advisory group the sole purpose of which is to advise the Secretary on issues pertaining to supply and demand of petroleum and natural gas) to undertake a comprehensive new assessment of the North American market. To help improve the accuracy of this assessment, the Secretary and other participants provided substantially greater funding and stronger technical support than had been made available in 1999. The Council’s new Study, which reflects the results of 18 months of intensive effort, includes a comprehensive, region-by-region assessment of likely future production for every major basin in the U.S. and Canada. This assessment, in turn, is based upon intensive interaction with the producers in each basin, to attempt to develop realistic estimates of future production for each field.
The results of this reassessment are stunning and warrant urgent attention at the national level. They give notice of a potentially severe crisis during the next 10 years that will not be eliminated even if Congress immediately enacts the federal energy legislation about to be sent to the floor of both Houses. In its new Study, the Council begins by noting that, by 2002 (i.e., less than 36 months after the 1999 Study was issued), North American production already had fallen 6 BCf/day below the Council’s forecast for 2002.
The Council concludes, however, that this inability to achieve the production levels previously forecast by the Council will not be a one time event.
Instead, it reflects the inevitable result of the maturation and increasingly rapid aging of most major fields in the U.S. and Canada. This rapid aging has resulted in flat or declining production in many of the most important basins in both the U.S. and Canada and, as a practical matter, can not be reversed.
As a result, the Council concludes that, with each passing year, North American production is likely to fall increasingly further behind the Council’s earlier projections. The Council’s new Report estimates that, by 2015, North American production from “traditional U.S. and Canadian sources of supply” (defined by the Council to include every basin south of the Arctic Circle) will fall an almost unfathomable 21 BCf/day short of the levels the Council had concluded would be necessary to meet the needs of the U.S. market when it issued its earlier Study less than four years ago.
This equates to a drop in expected production, compared to the Council’s earlier estimate of expected production by 2015, of more than 7.5 Trillion Cubic Feet per year – i.e., a downward revision of more than 22% in less than 48 months.
In BTU equivalent terms, the effect of this steep reduction is to create a hole in expected U.S. energy supply equivalent to more than 1.5X the amount oil the U.S. currently imports from Saudi Arabia (which is currently averaging a little over 1.8 million barrels/day).
The Council bases this unprecedented downward revision in its earlier forecast on a combination of:
- A significant reduction in its estimate of reserves in the U.S. and Canada that are technically capable of being developed;
- A far more rapid than-expected drop-off in production from existing fields in both the U.S. and Canada; and
- A dramatic decline in the size of new wells in both the U.S. and Canada.
While the Council’s focus is principally on long-term supply and demand, the implications of its findings for the adequacy of natural gas supply in the North American market during the next 10 years are deeply disturbing.
Even if the proposed Alaskan natural gas pipeline ultimately goes forward, it will not be completed for at least a decade; further, as much as the additional supplies it brings are needed, if and when it goes into service, it still will offset less than 21.5% of the shortfall in production identified in the Council’s Report.
Further, the Council’s new estimates do not include any contingency factor to allow for the potential that its new estimates will prove to be too optimistic.
This, too, should give cause for significant concern.
As a result of the rapid aging of most U.S. and Canada fields, the Council already has been forced to reduce its estimate of future production levels by more than 22% in less than 48 months. Given the trend line, there obviously can be no guarantee that this year’s downward revision will be its last.
Instead, if anything, given the continued declines in production that have been occurring during the past year (despite higher than expected prices and a high rate of drilling of new wells) further downward revisions in expected North American production may be likely to occur – with the potential that the decline rate could accelerate rapidly over the next several years.
The Council did find that, under some scenarios, assuming much higher prices than the Council previously had thought would be necessary, it might be possible after an extended period to achieve a modest increase production from the lower 48 states compared to this year’s sharply reduced levels. To do so, however, would: i) require prices well above $ 5.00/MMBTU in $ 2002; (ii) take several years to achieve; and (iii) require a series of policy changes and other heroic measures that are relatively unlikely to occur (e.g., opening up for development areas that currently are restricted for drilling, significant speed-up in deepwater drilling in the Gulf, etc.). Further – and just as significantly -- even if all of these conditions are met, the Council estimates that, at most, these efforts would be unlikely to expand U.S. production to a level more than 1.0 BCf/day higher than the levels of U.S. production achieved three years ago, before production began to rapidly decline. (During this same period, the Council expects production from Canada at best to be flat.)
This miniscule increase in U.S. production, even if achieved, will offset only a small portion (i.e., less than one year) of the growth in power sector demand for natural gas expected to occur over the same period.
The Council also concluded that assuming that: (i) construction of the proposed Alaskan pipeline goes forward on an all-out, fast track basis with no impediments to prompt completion; and (ii) a number of other significant policy changes are adopted (e.g., fast-track permitting for new LNG terminals), by some time during the next decade, the massive supply deficit identified in the Report can be partially offset by bringing natural gas from the Arctic Circle into the lower 48 states and by major increases in the amount of Liquefied Natural Gas (LNG) imported into the U.S.
In addressing these longer-term solutions, however, the Council’s focus was primarily on long-term supply and demand. This focus on long-term solutions is consistent with the Council’s mandate from Secretary Abraham, which was to examine supply and demand of natural gas through the year 2030. In the interim, as the Council emphasizes in its Report, North American demand still is expected to grow at a rapid rate, due primarily to the expected increase in the amount of natural gas used to generate electricity in the U.S.
This expected increase is likely to be particularly steep starting in 2004 and continuing throughout the next 7 to 10 years, since natural gas-fired generating units are currently the only source of supply available to meet the incremental electricity needs of the U.S. economy during this period.
Even if the Alaskan pipeline is started immediately and LNG imports ultimately become one of the primary sources of energy supply for the U.S., therefore (as the Council’s Report envisions), a huge gap still will remain between the maximum supplies that realistically are likely to be available to the U.S. market during the middle and later part of this decade and the projected needs of the U.S. economy over the next 7 to 10 years.
A Decade of Crisis
We believe that this near-term supply deficit is potentially the most serious problem facing the U.S. economy during the remainder of this decade.
A Study recently completed by our firm, to be released in December, attempts to quantify the size of this supply deficit and identifies steps that can be taken to respond to this deficit. The Study concludes that, absent prompt implementation of the specific steps proposed in our study, for the U.S. economy to continue growing, it will be necessary to increase supplies of natural gas available to generate electricity by at least 3.39 TCf/year by 2010 and by at least 5.19 TCf/year by 2014:
Increased Power Sector Consumption of Natural Gas
* This estimate assumes normal summer temperatures in both 2003 and 2004 and normal growth in the economy. Given the mild weather that occurred this past summer (discussed in the text below) and the recent high growth rate of the economy, a much larger year-over-year increase in power sector consumption of natural gas is nearly certain to be required over the next 12 months compared to this year.
Taking into account potential growth in residential and commercial demand for natural gas, the total increase in the amount of natural gas per year needed to meet the needs of the U.S. economy could be even greater – viz., as high as 5.3 TCf/year by 2010 and 6.4 TCf/year by 2014.
The National Petroleum Council Study demonstrates beyond a shadow of a doubt that the supplies required to meet these projected needs won’t be available. Instead, absent aggressive steps to reduce the amounts of natural gas needed to meet the needs of the U.S. economy during this period, a massive shortfall is inevitable.
Indeed, in the very near term (i.e., between now and 2006 or 2007), it has become increasingly clear that there is not likely to be any net increase in the supplies of natural gas available to the U.S. market (i.e., zero growth in net supplies, after taking into account the net impact of flat or declining U.S. production, modest near-term increases in imports of LNG, declining imports from Canada and expanding exports to Mexico). This is a startling prospect, since the increased supplies of natural gas needed to sustain the growth of the U.S. economy over the period between now and 2007, including likely increases in residential and commercial demand, could easily reach 1.5 to 2.0 TCf/year.
This is an unprecedented shortfall in supplies. And it is likely to last not just for one or two years. Instead, as the amount of natural gas needed to generate electricity continues to grow every, the deficits will continue to mount, since we are unlikely to be able to ramp up imports of LNG rapidly enough to keep pace with growing power sector and residential demand for natural gas until, at the earliest, the mid to later part of the next decade.
The basic contours of the crisis we’re facing, therefore, are unmistakably clear.
Why then is there still no sense of urgency regarding the potential threat to the U.S. economy posed by this huge shortfall in expected supplies of natural gas over the next 7 to 10 years?
Flaws in the Convention Wisdom
Part of the reason there isn’t a greater sense of urgency regarding the crisis we face clearly is that, even though severe price spikes have occurred in two out of the past three winters, the period in which the supply crunch is likely to be most severe – with the most extreme prices – has yet to occur (although it could begin as early as next year).
As a society, we’re seldom very good about addressing serious problems in advance – even when the dimensions of the problem are crystal clear and go straight to the core of our economy.
A second reason is that the most powerful segments of the oil and gas industry, in their public advocacy efforts, have tended to focus primarily on supply options addressed to our long-term needs (e.g., the proposed Alaskan pipeline, expanded offshore drilling and steps to increase imports of LNG).
This, too, is understandable, since at this point in the maturation of the industry opportunities for development in the lower 48 States are limited. The most attractive opportunities for new development, therefore, typically involve more distant sources of supply that often require government approvals to go forward and will take many years to develop. A third, equally important factor, however, is that (at least in my judgment) many of the best private forecasters and Wall Street equity analysts specializing in the oil and gas industry – bright people whose work often can be very helpful – aren’t yet interpreting properly the sweeping changes that have occurred in the natural gas market and instead continue to publish every week analyzes of what is happening in the U.S. natural gas market that are far off the mark.
The result of the continued dissemination of these mistaken analyzes (however well intentioned) has been to perpetuate – and, over the past few months, perhaps even intensify – three pervasive myths regarding the natural gas market:
Myth # 1: The near universal belief that the larger-than-expected injections into underground storage that occurred this summer were due to large-scale reductions in industrial demand that occurred this spring and early this summer.
Myth # 2: The closely-linked belief that last summer’s experience demonstrates that natural gas prices above $ 6.00/MMBTU are not sustainable and instead will quickly result in large reductions in industrial use – which in turn will rapidly bring prices back to more “normal” levels.
Myth # 3: The belief that, as long as the amount of working gas injected into underground storage exceeds 3,000 Billion Cubic Feet (BCf) (a benchmark that now has been substantially exceeded for this coming winter) reserves in storage are likely to be sufficient to meet winter needs and severe price spikes are unlikely to occur.
These three beliefs are the cornerstone of the how many observers still look at the natural gas market. As recently as 1999 or even 2000, there still was a substantial basis for holding these views.
As we’ll see momentarily, however, despite the frequency with which these claims are repeated, they clearly and demonstrably are no longer true today, in a market the fundamentals of which have irrevocably changed over the past 36 months.
Instead, all of the larger-than-expected injections into storage that occurred this summer can be explained based upon decreases in the amount of natural gas used to generate electricity compared to the same months last year, not fuel switching by industrial users or other industrial demand destruction as so many analysts contend.
Much of this reduction in the use of natural gas to generate electricity is weather related – and therefore not likely to be repeated.
Further – and just as importantly – over the next 12 months, as the population continues to grow and the economy continues to expand, the amount of natural gas consumed to generate electricity is nearly certain to continue to increase dramatically – and then to continue increasing every year for at least the next 7 to 10 years (i.e., the minimum lead-time necessary to build new coal-fired capacity and/or to ramp-up imports of LNG sufficiently to begin to offset the increased natural gas requirements of the power industry).
Contrary to the assertion that is often made, therefore, there was no structural change in the natural gas market this summer that “eliminated” or even materially reduced the likelihood of a natural gas crisis in future years. Instead, to the contrary, as we’ll discuss below, we dodged the bullet this summer far more narrowly than most of us realized at the time.
If temperatures this summer had been more like the summer of 2002 and/or the resurgence in the economy that began in August had begun just 60 or 90 days earlier, we might well have seen $ 8.00 to 10.00/MMBTU natural gas prices this summer (i.e., during the time of year when natural gas prices historically are at or near their lowest point for the year).
Further, while the sharp drop in the use of natural gas to generate electricity that has occurred over the past six months and the continued mild weather this fall have made it possible to build up larger storage reserves heading into this winter than might have been true under other circumstances, and thus reduced the risk of severe price spikes this winter, depending upon the severity of the weather this winter, before the winter is over, we still could see price spikes this winter that are just as severe as last winter, if not worse.
How could this be? How could the conventional wisdom be this far off? And how could so many well-intentioned analysts have missed almost entirely the huge reduction in power sector consumption of natural gas that occurred over the past several months?
And if the evidence of a long-term crisis is so overwhelming, why have natural gas prices softened significantly since they reached the $ 6.00/MMBTU level this past June? Quite frankly, as we’ll see, the issues involved are not subtle and are not difficult to assess fairly definitively. Instead, to the contrary, the relevant facts are obvious and indisputable.
Why then do the three myths persist?
At least part of the reason may be that all three myths have a certain seductive quality: they suggest that there is no crisis or, alternatively, that if there is it will “solve itself” painlessly, with higher prices quickly driving sufficient industrial demand out of the market to bring prices back down to levels consumers can tolerate.
This seductive quality, however, is as dangerous as it is appealing.
As long as the three myths continue to be treated as credible, we are likely to continue to delay taking the specific actions required to reduce the threat we face during the remainder of this decade as a result of drastically-lower-than-expected supplies of natural gas.
Delay, however, is a luxury we can not afford. The costs ultimately will be far too high: literally tens of billions of dollars of avoidable energy costs over the next 10 years, hundreds of thousands of lost jobs and the potential to seriously retard the growth of the U.S. economy. It may be fairly important, therefore, to understand why each of these myths is false, since until we do we are likely to continue putting off actions that are essential to preserve the health of our economy over the next 10 years. This article is the first of three in a series. Click here to go to Part II