Unconventional Gas Riles and Refigures the World Energy Market: The Oil Market (Part III)

By Donald Hertzmark -- February 24, 2011

Author’s note: No, I have not been in a cave for the past two weeks.  The impacts of unconventional gas on energy markets will be measured in months and years, not in days and weeks.  There is essentially nothing that current unconventional gas production can do to moderate crisis-driven escalation of oil prices and oil-linked LNG prices in the next few weeks.

In Part I and Part II of this series, the impacts of unconventional gas discoveries in the U.S., Australia, Canada and elsewhere were explored.  Gas-to-gas competition was seen as a powerful force for price moderation.

U.S. shale gas discoveries and production from coal bed methane (CBM) have already provided great benefits for energy consumers in the Atlantic Basin.  Gas-to-gas competition – shale v. LNG – has led to interesting market outcomes and investments.  Gone are the panic days of encouraging any and all LNG regasification plants in the US in the fear that the US might “lose out” to others on the LNG bonanza.

Now, the U.S. is quickly moving toward overall sufficiency in gas supplies with investments in two-way (regasification and liquefaction) LNG plants now firmly on track in Texas and Louisiana.

Other markers of the sea change in gas markets include proposals for another two-way LNG plant in Canada and investments in gas-to-liquids production in British Columbia.

In the U.S., shale gas production has led to investment in new gas separation facilities and a revival of moribund petrochemical firms.

Australia’s exploitation of its CBM resources has created investments in more than 14 million tonnes/y (mtpa) for export to Asian markets.

In China, India, Poland and elsewhere, drilling is firming up new supplies of shale gas and CBM.

Even the U.S. government has entered the fray, with its Global Shale Gas Initiative.  The program aims to assist countries in identifying shale gas resources and the technology to produce it.

Where will it end?

Will the Gas-to-Gas Party Be So Much Fun That Oil Joins In?

The short answer is no, or at least not yet.  However, detailed investigations of the impacts of unconventional gas on energy markets in the US, Indonesia and elsewhere indicate that eventually the unconventional gas bonanza will “leak” into markets where gas can act as a near substitute for refined oil products.

What is necessary is not promise,[i] but production.  The Atlantic Market was not roiled until the US decreased its imports of LNG.  The oil and gas markets will react to what is or what will almost certainly come soon, not to what might be.

In the U.S., for example, natural gas production in the various shale basins is leading to additional gas pipeline reticulation, displacing #2 oil.  Some transport fleets in the U.S., especially local delivery vehicles, continue to convert to compressed natural gas (CNG) fuels.  In Australia long distance trucks in that country’s West rely increasingly on gas engines using LNG for fuel.[ii]

In Part II we noted that it was premature to declare gas-to-gas victory in the Pacific market.  To do so unconventional gas development production would need to develop so that:

• Production of Asian unconventional gas outside Australia and Canada exceeds the “lost” Indonesian LNG exports (~15 mtpa);
• Unconventional gas output in Indonesia can swing to LNG feed;
• China and India challenge oil-linked LNG prices based on domestic unconventional gas output; and
• Central Asian gas exporters (Turkmenistan, Kazakhstan) accept gas-to-gas pricing basis.

However, recent discoveries of shale gas in India and China, as well as likely near term CBM development in Indonesia may generate gas-to-gas competition in the Pacific by 2014 or 2015.

The first shoe to drop is likely to be LNG oil parity pricing.  This is likely to occur once Australian and Canadian LNG exports to the region start in large volumes.  At that point neither India nor China, each with its own unconventional production, will wish to pay oil-linked prices for their LNG imports.

The next step is likely to be large-scale oil product substitution in Indonesia.  Recent studies of CBM potential and transport indicate that replacement of 500,000 b/d of oil products or more is likely by 2020.  Indonesia’s CBM resources are huge, estimated at more than 400 tcf.

Is Unconventional Gas Doing Any More Than Nibbling Around the Edges of the Oil Market?

If unconventional gas is to truly impact oil markets, as it should (someday) given its abundance, then the market for transportation fuels must be breached by natural gas or gas-derived fuels.

Already, there are some indications, as noted above:  CNG in the US and India, LNG in Australia.  But so far, nothing has challenged the dominance of gasoline for personal vehicles.  LNG is too complex for small vehicles and CNG lacks the fuel density that most drivers want, especially to be able to carry groceries and children instead of fuel.

A second front is synthetic fuels – gas-to-liquids.  In the past GTL technology has been heavily dependent on very low gas prices.  The technology used is still essentially the same as the synthetic fuel technology used by Germany in World War II, South Africa in the 1970s and 1980s and promoted by the US in the 1970s.  For natural gas, of whatever source, this means conversion to synthesis gas, reaction with CO and Hydrogen and catalytic conversion to gasoline and diesel.

In other words, take champagne, covert it to beer and then transform the beer into cognac (or something like that).  Under special circumstances such approaches can work.  SASOL, the South African synthetic fuels company, is looking at just such a special situation on the West Coast of North America.  With fuel quality specifications tightening and additional oil production or refining in California unlikely until the geothermal energy source rock freezes over, that state will be a prime market for synthetic fuels manufactured from shale gas in Canada.

At this point GTL technology cannot compete with conventional oil refining.  However, direct conversion of gas to liquids, the holy grail of synthetic fuel technology, is not yet commercial.  Until such technology becomes less costly gas can only restrain the uglier excesses of the oil market; it cannot yet replace the mass market for transportation fuels, especially in China and Southeast Asia.

As noted in Part I unconventional gas resources are often found in the same or nearby vertical strata relative to one another.  Government’s can assist mostly by getting out of the way – permitting pipeline and network construction – a key element in the US success with unconventional gas; avoiding price guarantees – unconventional gas is perfectly able to stand on its own against oil and LNG; and permitting investment by companies that can do the job.

With fuel quality specifications tightening and additional oil production or refining in California unlikely until the geothermal energy source rock freezes over, that state will be a prime market for synthetic fuels manufactured from shale gas in Canada.[i]

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[i] As in “Nobody ever said Willie Mays had promise.  He had bypassed promise and potential.”

[ii] For long distance trucks the density of CNG is not sufficient for the desired range, hence the use of LNG.

[iii] California has at least two shale gas basins.  I invite MR’s readers to form a pool about whether and when the California authorities will ever permit them to be exploited.