US Natural Gas Prices and the Election

Every fall my natural gas utility asks if I'd like to lock in my gas price for the next 12 months.  In some respects the timing for this looks ideal.  Commodity natural gas prices haven't been lower than this year's average since 1999.  Gas is also historically cheap relative to other fuels.  Heating oil recently averaged above $4 per gallon, while the fixed price my natural gas provider is offering equates to $1.36 per gallon, including distribution charges.  However, overhanging this relatively simple choice are big uncertainties related to the economy and the potential impact of regulations on shale gas production.  To complicate matters further, both of these uncertainties are entangled with the outcome of the US presidential election, and my gas provider wants my answer by next Monday.

When I last looked at this question in detail, in 2010, I concluded that the utility's offer was attractive, after scrutinizing then-current gas futures prices and the historical relationship between the futures market and "city gate" prices for Virginia, where I live.  Using the same methodology, this year's offer of $0.62/therm ($6.20/MMBTU) looks reasonable.  Much has changed in the interim, though, in ways that undermine the rationale for locking in consumer gas prices.  The biggest benefit of a fixed price is avoiding nasty surprises during winter heating season.  More than four-fifths of my household's gas consumption occurs from November through March, a period when gas prices used to be alarmingly volatile.  

That's less of a concern, now, with US gas inventories high and supply ample. The same shale gas revolution that has increased domestic supply and backed out imports has also reduced volatility and promoted big shifts in demand. Since 2009 residential gas demand has been essentially flat, while demand from commercial and industrial users has grown by 6.5% and consumption in power generation is up by more than 10%, despite a lackluster economy.  (Gas for use in transportation grew even faster but still constitutes less than 0.2% of total gas demand.)  As a result of these shifts, peak monthly average natural gas prices since the winter of 2009-10 have occurred in summer, coinciding with air conditioning demand. With less winter price volatility, the decision to lock in prices now is mainly a bet on gas prices for the next 12 months.  The outcome of that bet hinges on future supply and demand.

On the supply side, will the surge of US shale gas production continue?  New regulations are among the biggest potential constraints on output.  The EPA has set new rules on emissions during well completion and production, with the most expensive aspect phasing in by 2015.  EPA will also issue new rules on wastewater disposal from fracking by 2014. There is growing pressure on the administration to impose federal regulation of most aspects of shale development, superseding management by the states.  Thus far, the White House has avoided a sweeping crackdown that would disrupt gas markets, and the EPA administrator is on record opposing comprehensive federal regulation of all wells.  However, it's not obvious whether such reticence stems from a basic belief in the national importance of this resource or the simple expedient of not killing the golden goose before the election.  Governor Romney has proposed streamlining regulations affecting gas production. Next Tuesday's outcome should resolve this uncertainty.

The other big uncertainty surrounding gas prices concerns demand.  High shale gas output isn't the only reason gas is cheap today.  Anemic GDP growth such as the 2% rate for the third quarter reported last Friday has helped keep gas prices low.  A stronger economy with higher full-time employment would put upward pressure on prices by soaking up much of the surplus production that has depressed them.  However, the consequences of failing to mitigate January's "fiscal cliff"--federal budget "sequestration" and the expiration of many tax cuts--would likely drive natural gas back toward the lows we saw this spring.  With the economy still the number one issue for most voters, its likely future impact on gas demand is linked with our perceptions of the candidates' economic programs and promises. 

My best bet is to convince my supplier to let me wait until after the election to reply.  There's nothing like additional information to improve the value of a decision. Failing that, I'm inclined to pass on this opportunity.  The possibility of cheaper natural gas next year acts as a modest hedge against the risk of another recession, while the benefits of a stronger economy would more than outweigh any natural gas price increases I might experience on the upside.

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Energy Security and Oil Substitution

For the last several years, US energy policy has been operating on the assumption that energy security and climate change were pretty much two sides of the same coin, in terms of motivating changes in our energy production and consumption. The Gulf Coast oil spill and some of the proposals for addressing the vulnerabilities it has exposed reveal the extent to which the connection between these two issues has been oversimplified. I've devoted several recent postings to explaining why renewable energy technologies like wind and solar power will have a minimal effect on our dependence on oil, and why vehicle electrification and biofuels look promising but are likely to be quite limited in their impact on imports for at least the near future. However, that doesn't mean we have no good options today. In fact, some quite prosaic measures could have a significant impact while we're waiting for the slower-cooking ones to ramp up. Something as simple as substituting natural gas for heating oil could be a very useful step, meriting additional support.

The broader concept of energy security, as opposed to simply oil security, gained traction a few years ago, when it appeared that natural gas was about to join the list of commodities for which the US would have to rely on steadily-increasing imports to satisfy domestic consumption. Shale gas is reversing that trend, and we are not at risk of becoming net importers of coal or electricity to any significant extent. From the US energy import and export figures, it's clear that our import dependence problem pretty much starts and ends with oil and its products, particularly when you consider that most of our relatively modest natural gas imports come from Canada. But while we may control our own destiny for electricity and natural gas, oil remains as complicated as ever, in part because most oil, but very little electricity, is used in transportation. If we want to reduce our reliance on oil and oil imports, we must focus on either efficiency and conservation, or on direct substitution. And for now, substitutes for oil in its main uses are still relatively small in scale, entail serious performance penalties, or both. However, if we look beyond the high-profile uses of oil in automobiles or aircraft, there are a few areas for which good, large-scale substitutes are available now.

Consider heating oil, a close cousin of diesel fuel. Although natural gas has been eroding the market share of heating oil in residential and commercial applications for decades, US homes still burn on average around 320,000 bbl/day of heating oil, mainly in the northeast. Commercial and industrial users consume a somewhat smaller quantity. Together, this represents about 10% of total US distillate consumption of around 4 million bbl/day (at least when the economy is healthy), or around 2% of total US petroleum consumption. Every barrel of heating oil displaced by natural gas or other fuels, such as bio-heating oil, could fuel diesel cars and trucks--after being processed into ultra-low-sulfur diesel--or be exported to offset a portion of our other imports. Replacing all of the residential heating oil used in the US would free up enough fuel for around 12 million diesel cars like the Audi A3 TDI that I wrote about a couple of months ago. And with natural gas having gotten much cheaper relative to oil, thanks to the growth of unconventional gas supplies, the economic advantage of switching can be considerable, as illustrated in the graph below, comparing residential gas and heating oil prices in New York.


How practical is this substitution? Well, having lived in a part of the country in which many older homes used oil heat, the biggest obstacle for most homeowners is the cost of replacing the furnace and connecting the house to gas. And there are still regions for which the latter is either cost-prohibitive or simply out of the question, because the gas pipeline network hasn't reached every community and neighborhood. (In such cases, propane, which is increasingly sourced from natural gas, may be a good option.) In the long run, particularly with the discovery of vast natural gas reserves in the Marcellus Shale underlying much of the northeast, the gas will come, and so will the infrastructure. The question is whether that process could be speeded up with a little help, and whether it makes sense to do so.

An article I ran across recently suggested that the American Recovery and Reinvestment Act of 2009 (the stimulus) included standards and funding for converting oil heating systems to gas. When I reviewed the text, most of that support seemed to be channeled through existing state programs. Nor did I see anything promoting the expansion of the natural gas pipeline and reticulation network (i.e., "last mile"), which remains the crucial step in this process for many small towns and rural communities. A quick search of the current draft of the Kerry-Lieberman climate bill didn't reveal anything along these lines, either, despite the emissions advantage of heating with gas instead of oil. That looks like a glaring omission to me.

The oil spill in the Gulf has provided a wake-up call concerning our continued dependence on oil and the ineffectiveness of energy policies focused mainly on climate change to address it. Renewable electricity isn't an oil substitute, and while converting cars and trucks to run on natural gas or electricity looks like a useful long-term strategy, it won't deliver big oil savings soon. In the meantime, we shouldn't ignore less glamorous measures that can have a quicker impact, such as accelerating the ongoing replacement of heating oil by natural gas and other non-oil fuels.

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