It’s been almost 5 years since I first began speaking out publicly on “The Emerging Natural Gas Crisis.” It may be an appropriate time, therefore, to step back and reassess the likely long-term prospects for price and supply in the U.S. market.
After 5 years of soaring prices, where do we stand? Are the most severe price shocks already behind us? Or a few years from now will the price increases of the past few years look tame – just as 3 years ago the notion that oil might soon reach $75 per barrel might have been considered absurd?
If the latter is true – if we’re still at a relatively early stage in the emerging crisis – what steps, if any, can be taken, to avoid the potential for serious further harm to the U.S. economy from rising energy costs?
And perhaps most critically, how can we instill the sense of urgency needed to put in place a comprehensive national energy strategy? Over the past 5 years, higher-than-expected natural gas and electricity costs have drained more than $ 400 billion dollars from the U.S. economy (roughly comparable to the cost of the Iraq war) and seriously impaired the ability of U.S. companies to compete in global markets. If largely avoidable costs of this magnitude haven’t been sufficient to stimulate a more effective response, what will?
Fully answering these questions would require a book length report. I won’t attempt, therefore, to provide definitive answers here. Instead, my goal is to stimulate further discussion and deeper inquiry into matters of urgent concern.
Fundamentally, however, four major conclusions stand out:
1. The severity of the crisis is much greater than I assumed might occur when I first began speaking out on the potential for sharply escalating natural gas prices almost five years ago. Even before Hurricane Katrina struck the Gulf of Mexico last year, natural gas prices had quadrupled in just 3 ½ years:
These price increases are likely to be just the “tip of the iceberg,” however, unless action is taken immediately to develop new sources of energy supply to meet the needs of the U.S. economy. As explained in detail in Parts II and III, during the next decade, an unprecedented gap is likely to develop between the amount of natural gas required to meet the needs of the U.S. economy and the supplies likely to be available to the U.S. market.
By the mid to later part of the next decade, this gap could reach 7.5 to 10.0 Tcf per year – an amount roughly equivalent, in BTU terms, to 1.5 X the amount of oil the U.S. currently imports from the Middle East.
Further, under very plausible scenarios, this gap could easily be twice as large (i.e., the equivalent of almost 3 X current U.S. oil imports from the Middle East) – especially if new environmental restrictions are enacted at either the federal or state level that have the effect of encouraging the increased use of natural gas (as appears increasingly likely to occur).
2. An energy supply gap of this magnitude could result in hundreds of billions of dollars per year in needless energy costs and seriously impede the growth of the U.S. economy. This massive shortfall in supplies will not necessarily result in physical curtailments of supply – although the possibility of periodic physical curtailments of supply cannot be ruled out, especially in the power sector.
Instead in a de-regulated market, price is the mechanism used to ration available supply. Given the magnitude of the potential natural gas supply gap, however, unprecedented price increases are likely to be required in order to reduce demand to the level of available supplies. This is especially true since, over the past 5 years: (i) due to tighter environmental restrictions, opportunities for fuel switching (which has acted as a safety valve to mitigate price increases in the past) have been greatly reduced; and (ii) repeated price spikes already have driven many of the most price sensitive natural gas users out of the U.S. market.
As a result, in the future, as the supply/demand balance continues to tighten, steep price increases may be required in order to drive even small amounts of additional demand from the market. To balance supply and demand by the end of the next decade, however, demand may have to be reduced by an amount that significantly exceeds total current U.S. industrial demand – a truly formidable task.
If we fail to begin implementing an alternative energy strategy soon, therefore, by 2020 the price increases required to reduce demand to the point that it matches available supply could prove to be brutal – slowing the growth of the U.S. economy, and potentially resulting in the permanent shutdown of a significant portion of the manufacturing sector in the U.S.
Further, there is a serious risk that in some regions of the country, the huge investments that have been made to maintain the reliability and cost-effectiveness of our electricity supply infrastructure will prove to have been for naught, since power companies may be unable to obtain the fuel required to operate all of the gas-fired generating units currently interconnected to the grid.
3. This impending crisis can be prevented by adopting a comprehensive national energy strategy to reduce U.S. dependence upon natural gas as a fuel to generate electricity. The crisis potentially created by this massive looming energy supply gap can be largely avoided – but only if we begin to recognize the magnitude of the energy supply shortfall we currently face and begin within the next 12 months to develop and implement a comprehensive program to bridge this gap.
There is no single, “silver bullet” solution to this problem. To bridge a gap of the magnitude that is likely to arise over the next decade, a multi-pronged strategy must be put in place. This strategy should include aggressive development of renewable energy (as already mandated by an increasing number of states), drilling for natural gas in areas that are currently restricted but can be developed in an environmentally responsible manner and a revival of nuclear power.
Realistically, however, to adequately address the massive energy supply gap that is likely to develop by the middle of the next decade (when we currently face a crisis of major proportions), during the next 5 to 10 years, most of the required solution must come from two areas:
i. Energy efficiency. We need to set far more aggressive goals than we have done in the past for improvements in energy efficiency and develop a realistic strategy for achieving these goals. Improved energy efficiency, particularly in the commercial sector, is the quickest and most cost effective way to begin closing the energy supply gap in a meaningful way in a short period of time.
ii. Accelerated deployment of coal gasification and coal-to-liquids projects on a major scale. Energy efficiency alone, however, is not enough. Given the magnitude of the supply deficit we face, it is also essential that we begin immediately to develop programs to more fully utilize our most abundant domestic energy resource: coal.
As a growing number of major environmental groups now recognize, substitution of the use of coal for natural gas and liquid fuels can be done in a way that is a way that is fully consistent with all major environmental goals, and can achieve hundreds of billions of dollars of savings for the U.S. economy during the next decade.
All that’s missing is the will to act.
4. Action must begin now. To avoid serious harm, however, action must begin immediately. The characteristic of energy infrastructure is that it takes a long lead time to modify. Further, while actions that begin soon could begin achieving significant results within 4 to 5 years (and even sooner in the case of energy efficiency), scale is also a major issue. Realistically, even with major improvements in energy efficiency, a decade or more will be required to close the energy supply gap described in these articles.
Quite literally, therefore, there is no time to delay in moving forward with these programs.
Warning Signs Clear
How could the U.S. be facing an energy crisis this severe without the potential risks being better understood?
In a sense, of course, the failure to anticipate the next phase of the natural gas crisis shouldn’t be surprising. Earlier in the decade, the U.S. Energy Information Administration (EIA) and most major private forecasting firms failed to anticipate the massive price dislocations of the past 5 years – one of the more stunning failures of market analysis in industry history. For the most part, however, these forecasters still are using the same basic price forecasting techniques, often with the same personnel. Over the past 3 to 4 years, the track record of many of these forecasters is only marginally better. It is not immediately apparent, therefore, why they should be expected to do a better job of anticipating major price dislocations in the future.
The warning signs, indicating the potential for major future price dislocations, couldn’t be clearer. Specifically:
1. Over the past several years, the E&P industry has experienced far more difficulty avoiding further declines in U.S. production than was expected just three years ago, at the time of the National Petroleum Council’s 2003 Study.
Over the past several years, in response to higher prices, the E&P industry in North America has “pulled out all of the stops” to increase production – ramping up development far more aggressively than most observers expected.
Expenditures on development have reached an all-time high. Further, drilling of new wells has increased at a ferocious rate. Since 2002, the number of natural gas wells drilled in the U.S. each year has nearly doubled, increasing by more than 15,000 wells per year to an estimated nearly 32,000 wells drilled in 2006 (an increase of 90% over 2002). The story is much the same in Canada, with the number of new wells increasing by more than 8,600 wells per year (95%) to any estimated 17,700 new wells in 2006.
This massive increase, however, hasn’t been nearly enough. Instead, as a result of the continued aging of most major fields, production per well has declined by 16.6% since 1996, with a particularly steep decline over the past 4 years:
In the U.S. and Canada combined, since January 1, 2000, a total of 247,000 new wells have been drilled. This approximately equals the number of new wells that had been drilled in the previous 17 years, and has significantly reduced the number of attractive new prospects that remain to be developed on both sides of the border.
Despite this massive increase in drilling, however, U.S. production, after peaking at 19.6 Tcf/year in 2001, has declined by 1.3 Tcf per year – a decline of 6.7%. Canadian production has largely drifted sideways for the past 7 years.
By now, of course, this decline is widely recognized within the industry. Even after expectations have been lowered, however, natural gas production has continued to disappoint.
In September of 2003, for example, after completing a major multi-year study, the National Petroleum Council (NPC) dramatically reduced estimates of future U.S. production – reducing expected U.S. production in 2010 by 6.0 Tcf/year (a reduction of > 23 % from its previous estimate, issued less than 4 years earlier). See National Petroleum Council, Meeting the Challenges of the Nation's Growing Natural Gas Demand (1999) and Balancing Natural Gas Policy – Fueling the Demands of a Growing Economy (2003)
In the 3 years since this revised estimate was issued, however, despite far higher prices and far higher drilling rates than the NPC assumed in its Study, production has continued to fall far short of expected levels:
This rapid fall-off in North American production since 2001 does not bode well for future U.S. supplies. Over the past 5 years, major new development efforts have been initiated in some regions – including the Barnett Shale region in Texas, southwest Louisiana and several areas in the Rockies.
It is possible that, for the next 2 to 3 years, continued expansion of these fields, coupled with a continued aggressive ramp-up in drilling (if drilling continues to be aggressively expanded), will be sufficient to hold U.S. production at constant levels or even expand production modestly.
Few in the industry, however, expect that these increases can be sustained for any extended period.
Record prices have given producers strong incentives to increase the intensity of drilling in existing fields and prompted developers to reach far down into their inventory of remaining prospects in these fields.
At least for now, this has been sufficient to avoid even steeper declines in U.S. production – keeping the price of natural gas in single digits in most months.
The intensity of In-field development can’t be increased indefinitely, however. Instead, some of the best and brightest developers in the industry believe that the effect of the intensive development of the past few years inevitably will be to hasten the day when production in many fields will begin to precipitously decline – as began to occur almost a decade ago in the Near Shelf Region in the Gulf.
Notably, since, 1997, production in the Near Shelf Region in the Gulf – until recently the most important producing Basin in the U.S. -- has declined by 5.25 Bcf/day (a decline of nearly 42 %):
If production in other major basins also begins to decline rapidly sometime soon (as some developers believe is likely), we could see a sudden further fall-off in total U.S. production and simultaneous rapid increase in prices.
2. At the same time, the amount of natural gas needed to meet the requirements of the U.S. economy has grown dramatically. This increase is due primarily to rapid growth in the amount of natural gas required to generate electricity -- which has increased by over 900 Bcf in the past 2 years alone, reaching an expected 6.22 Tcf this year (equivalent to > 428% of total U.S. demand). Increases have been particularly steep in the May through September period:
This growth in power sector demand closely tracks estimates we issued several years ago. It far exceeds, however, estimates developed by both EIA and the National Petroleum Council.
As recently as February of this year, for example, EIA estimated that, during the 5-year period between 2004 and 2009, power sector consumption of natural gas would increase by a total of only 40 Bcf, from 5.32 to 5.36 Tcf/year (an estimate that the Agency should have recognized was absurd):
The actual increase in consumption between 2004 and 2006 is more than 40 X as large – less than 1/3rd of which can reasonably be attributed to hotter-than-normal weather this past summer. EIA’s long-term forecast assumed that power sector consumption of natural gas would not reach this level until 2013 – i.e., for another 7 years.
Earlier this month, EIA revised its near-term forecast – acknowledging reality, at least to a limited degree. Remarkably, however, EIA continues to take the position that, between 2006 and 2011, power sector consumption of natural gas will increase by a total of only 290 Bcf (i.e., an average of 58 Bcf/year):
This is an absurdly low forecast of growth in power sector consumption in an industry in which 40 % of all generation is now gas-fired, as a result of $ 100-billion + in new gas-fired generation added over the past 6 years:
EIA’s assumption regarding growth in power sector consumption of natural gas, however, is the single most important assumption in its estimate of total U.S. demand – and therefore the cornerstone for its price forecast during this period.
The National Petroleum Council’s 2003 estimate of future power sector demand is slightly more accurate than EIA’s 2006 forecast – but not by much. By the end of this year, (i.e., 2006), total power sector consumption already will have matched the level that in 2003 the National Petroleum Council was projecting would occur sometime between 2010 and 2011 – in effect reaching in 36 months a level previously projected to take more than 7 years:
The inevitable result of this steep increase in power sector demand, at a time when total U.S. production of natural gas has been flat or declining, has been a rapid increase in the price of natural gas, in order to reduce demand to the point that it matched available supplies.
Not surprisingly, therefore over the past 5 years, industrial use of natural gas has declined by almost 1 Tcf/year – a decline of just under 16 %. Without this decline, over the past 5 years, it would not have been possible to satisfy burgeoning power sector demand for natural gas and still simultaneously serve space heating demand in winter months.
In future years, however, this squeeze between available supplies and the amount of gas needed to meet the requirements of the U.S. economy is likely to become even more severe.
During the next 10 years, the underlying rate of power sector use of natural gas to generate electricity is likely to continue to rapidly increase. The only question is by how much. Even if no new environmental restrictions are enacted at either the federal or state level that result in increased use of natural gas at any time in the next decade, for example, (a scenario that currently appears unlikely), we would expect power sector consumption of natural gas to increase by an average of 350 to 500 Bcf/year for much of the next decade, after adjusting for differences in weather.
Cumulatively, therefore, by the middle part of the decade, even in a “no change” scenario, power sector demand for natural gas would be likely to increase to at least 9.5 Tcf/year (vs. EIA’s AEO 2007 estimate of projected consumption of 7.11 Tcf/year in 2015 – reduced slightly from its AEO 2006 estimate, despite EIA’s huge underestimate of near-term consumption in AEO 2006).
A number of major States, however – including California – already have initiated major programs to reduce greenhouse gases, not reflected in any of the most frequently-referenced published forecasts of natural gas demand or likely future prices for natural gas. With control over the State legislatures in a number of key states recently have passed into Democratic hands, the pressure to adopt such measures is likely to increase significantly during the next two years.
It remains to be seen, of course, whether new programs will be enacted and, if they are, how they will be structured and how affected companies will choose to comply. Clearly, however, the time has passed when the potential for major new environmental restrictions that would affect natural gas use can be blithely ignored in predicting future demand for natural gas or likely future price levels.
Instead, depending upon whether such programs are enacted and specifically how they are tailored, major further increases in power sector demand for natural gas, not factored into any current forecast of future demand for natural gas or future prices are clearly possible, with the potential to increase power sector demand for natural gas by several Trillion Cubic Feet per year within the next 10 to 15 years.
Further, this isn’t the only omission in most estimates of future demand for natural gas. Instead, many estimates of long-term demand for natural gas:
These are not minor omissions. Instead, the effect of these omissions in all likelihood is to understate the potential natural gas requirements of the U.S. economy by at least an additional 2 to 4 Tcf in some future years, on top of the errors in estimating power sector consumption of natural gas discussed previously.
Most long-term estimates of future U.S. demand for natural gas, therefore, drastically understate the potential future needs of the U.S. economy. By 2020, for example, the gap between EIA’s most recent forecast of future U.S. demand and the amount of natural gas actually needed by the U.S. economy could easily be in the range of 3 to 4 Tcf per year (looking only at the demand ½ of the supply/demand equation):
3. Our ability to meet future U.S energy needs is currently dependent upon highly speculative assumptions regarding potential future sources of supply. Finally, and in many respects of even greater concern, U.S. energy supply is becoming increasingly dependent upon highly speculative assumptions regarding future sources of supply. In EIA’s 2006 annual energy forecast, natural gas is expected to play a critical role in meeting the long-term energy needs of the U.S. economy, both as for direct use by major energy users and to meet incremental demand for electricity. In EIA’s forecast, however, more than 97 % of expected long-term growth in U.S. supply is expected to come from just two sources – the Alaskan natural gas pipeline and a massive increase in imports of LNG:
The U.S. has an urgent need for additional natural gas from both of these sources. As a practical matter, however, there is virtually no chance that the U.S. can obtained the increased supplies of natural gas from Alaska or from LNG imports EIA assumes in its recent forecasts in the time frames and quantifies EIA assumes in its forecast. Instead, even in a “best case” scenario, completion of the Alaskan pipeline (assuming it goes forward) would be likely to slip by several years, compared to the unrealistic completion dates assumed in EIA’s recent forecasts, and LNG imports are likely to consistently fall well below EIA’s forecast levels (certainly at least for the next 10 to 12 years).
On its face, therefore – the severe errors in EIA’s estimate of future demand aside – anyone who studies EIA’s recent forecasts carefully should quickly realize that they are patently unrealistic, and do not provide a defensible basis for estimating future natural gas prices in the U.S. market.
EIA’s forecasts, for example, assumes that: (i) the Alaskan natural gas pipeline project will go forward in the near future; and (ii) the entire project – from early phase engineering, through permitting, through completion of construction and testing – can be completed in about the same time frame that is required to design, permit and construct a new coal-fired plant at a single site.
The Alaskan pipeline, however, is one of the more ambitious construction projects ever proposed – intended to span a distance of 3,000 miles and expected to take 54 million man-hours to construct. Contrary to the assumption made at the time EIA release AEO 2006, the project has remained at an impasse over the past year, as a result of unresolved issues involving the State of Alaska. Further, even if these issues can be successfully resolved, there is a massive amount of engineering work must be completed, along with a series of lengthy and potentially complex permitting procedures, involving two different countries, with numerous potential opportunities for opponents of the project to assert objections and potentially attempt to block the project from moving forward.
Almost any prudent planner, therefore, presumably would assume the potential for several years delay in completing a project of this magnitude and complexity (assuming it moves forward at all) – which thus far EIA has failed to do.
If anything, however, EIA’s assumptions regarding potential future LNG imports into the U.S. are even more problematic. Notably, even before the final version of AEO 2006 was issued, in its Short-term Energy Outlooks, began cutting dramatically its estimates of expected LNG import levels in both 2006 and 2007 (the two years covered by both its short and long-term forecasts).
EIA’s most recent short-term forecast predicts that 2006 LNG imports will fall 40 % below the level forecast in AEO 2006. The gap in 2007 is expected to remain at essentially the same level – viz., a shortfall of 41 %:
This startling gap between actual and expected imports of LNG (i.e., for 2007, an expected gap of 1.6 Bcf/day, equal to 2.6 % of expected U.S. supplies for the year) provides a foretaste of what is likely to be a recurring pattern throughout the next decade, as major new LNG liquefaction projects frequently come on line well after their original target dates, and U.S. bidders frequently are outbid for the available supply by purchasers in other markets.
These, too, are not minor flaws in EIA’s long-term forecasts of supply and demand in the U.S. market. Instead, EIA has massively underestimated the potential future needs of the U.S. economy and indulged in unrealistic, “best case” or “better-than-best-case” assumptions regarding future supplies.
The end result is a long-term forecast that provides a grossly distorted picture of the likely future supply/demand balance and likely future price levels in the U.S. market – particularly in the mid to later part of the next decade, when the natural gas crisis is likely to become most acute.
The adverse consequences from this distorted picture could be severe.
Why There Isn’t a Greater Sense of Urgency
If the potential stakes for the U.S. economy are so high, and the warning signs of a potential crisis are reasonably clear-cut, why isn’t there a greater sense of urgency, regarding the need to take action to meet our future energy needs?
Many factors undoubtedly are at work. At least in my judgment, however, one of the most important, however, is that -- notwithstanding the serious harm that already has occurred to the U.S. economy due to higher-than-expected energy costs, the natural gas price forecasts routinely relied upon to formulate energy policy and used as the basis for major energy-related investment decisions (viz., directly or indirectly, the long-term forecasts issued by EIA) do not provide a reliable basis for decision-making.
Given the events of the past 5 years (including the failure of most price forecasters to anticipate one of the most extreme sustained price dislocations that has occurred in the history of U.S. energy markets) it might be reasonable to expect that a vigorous effort would be made to “get it right now” – i.e., to prepare rigorous, well substantiated estimates of likely supply and demand and likely natural gas pricing under a range of different scenarios regarding weather conditions, oil prices, economic growth and other relevant parameters, and to update these forecasts at least annually.
Instead, just the opposite is true. Most forecasts of U.S. natural gas prices (and therefore, indirectly, most forecasts of U.S. electricity prices) are based to a significant degree upon estimates of natural gas supply and demand and natural gas prices developed by the U.S. Energy Information Administration (EIA) – often with only minor adjustments by the entity issuing the forecast.
EIA’s forecasts, however: (i) are based upon unreliable data regarding likely future supply and demand for natural gas; (ii) use poorly-tested assumptions, flawed modeling tools which the Agency itself recognizes are outdated and flawed methodologies; and typically understate severely the risk of higher prices. Yet, critical decisions relating to the U.S. energy supply infrastructure are made every year based upon these profoundly flawed forecasts. These same natural gas price forecasts also provide the starting point for most electricity price forecasts, undercutting the validity of these forecasts as well.
EIA has very limited total funding and does not consider the preparation of its estimates of natural gas supply and demand to be part of its core mission –which it considers to be collecting and reporting historical data on energy use. As a result, only limited resources are allocated to its forecasting effort.
Even though energy plays a pivotal role in our economy, and forecasting is hardly a simple task, in the end EIA’s long-term forecasts are prepared by a very small team (literally a handful of individuals) that lacks the funding necessary to develop reliable estimates and is forced to perform its work using outmoded tools.
While this team does the best that it reasonably can with limited resources, it should not be surprising, given EIA’s budget limitations, that these forecasts often have been far off the mark – particularly in recent years, when the energy markets have been undergoing rapid and far-reaching change.
Remarkably, however, even though EIA’s seriously flawed forecasts already have cost U.S. consumers hundreds of billions of dollars in needless energy costs, and seriously impaired the ability of U.S. companies to compete effectively in global markets, no major effort currently is being made to improve the quality of EIA’s forecasts or to put in place alternative mechanisms to more accurately assess the future natural gas supply and price risks facing the U.S. market.
The inevitable result of continuing to rely on natural gas price and supply forecasts with a proven track record of being inaccurate is to fritter away tens of billion dollars each year on unwise investments, and ultimately saddle the U.S. economy with an energy infrastructure that is likely to fall far short of meeting future U.S. needs -- potentially locking the U.S. into higher energy costs for many years to come.
The next two articles in this series, therefore, will review in detail some of the major flaws in EIA’s estimates of the future demand and future supply, and outline some of the steps required to develop a more accurate set of estimates. Part IV, the concluding article, will then discuss in greater detail the steps required to avoid potential serious damage to the U.S. economy from a shortage in energy supplies.
In my judgment, there is no question that our energy needs can be met – in an environmentally responsible manner - and in ways that contribute significantly to economic growth. The question is only whether we arrive at an accurate understanding of the issues confronting us quickly enough, and have the will to act.
The difference in potential outcomes, however, depending upon whether we take effective action that enables us to successfully overcome near-term challenges, or continue to sit paralyzed, are stark – and may affect the future of our country for generations to come.
Get your event listing in front of more than 100,000 industry professionals by posting on EnergyCentral's Event Center.