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Gas price uncertainty a key factor Economist says companies reluctant to decide on North Slope gas line because of huge uncertainty in future gas supply curve Alan Bailey Petroleum News
Reflecting on a 40-year Alaska tradition to always claim that a North Slope gas line is just 10 years from fruition, on Dec. 2 Paul Carpenter, chairman and principal of the Battle Group, told Law Seminars International’s Energy in Alaska conference that market uncertainty, especially on the supply side, is the critical roadblock to gas line development.
Although there are scenarios in which a North Slope gas line to the Lower 48 could prove viable, there is huge uncertainty over that viability, Carpenter said. And at the same time, given the finite volumes of gas that could be shipped from the North Slope, alternative options for monetizing the gas are probably mutually exclusive.
Option value For commercial organizations evaluating this problem, the high uncertainty leads to what economists term “option value,” in which the organizations see more value in waiting for the uncertainties to resolve rather than risk taking what turns out to be a bad decision.
“And that’s essentially what’s been happening with this project for 30 to 40 years,” he said.
The State of Alaska, however, has a very different perspective on the problem. Delaying the gas line project to wait for the uncertainties to resolve could close the door to some gas sale options and perhaps concede markets to other gas supply sources.
“The tension … between the state’s interest in early monetization of the gas and the commercial ‘option value’ in waiting, I think is what we’re faced with at the moment,” Carpenter said. “The higher the uncertainty, the greater the tension becomes.”
And if the uncertainties are never resolved, the situation could end up in a market failure requiring state intervention, he said, commenting that Gov. Parnell has been making statements about putting state resources behind an option to export North Slope gas as liquefied natural gas, or LNG.
Price volatility While the breakeven gas price for the viability of a gas line to the Lower 48 is somewhere around $6 to $7 per million British thermal units, North American prices have swung wildly above and below that price range, Carpenter said.
For example, Henry Hub futures in the Lower 48 have been incredibly volatile over the past 10 years, he said. In the early part of the decade prices climbed steadily, eventually spiking in 2005-06 following hurricane disasters. With prices then hovering in the range of $7 to $9 per million British thermal units between 2006 and 2008, the prospects for the gas line started to look good. But then came the economic crisis of 2008: natural gas prices fell and have remained fairly stable in a range of $4 to $6 since then, Carpenter said.
Shale gas Since the economic crisis and downturn depressed the price, the emergence of shale gas production has proved a major factor in keeping gas prices low. At the moment drilling in shale plays in the Lower 48 is entirely focused on developing gas liquids and oil, rather than gas, thus reducing the value of produced gas to zero in some projects, Carpenter said.
With the price of oil recovering in the aftermath of the economic crisis, gas price and oil price trends have diverged in North America, breaking a long-held assumption that the prices of the two commodities are linked.
“That has tremendous implications for what is going on in the market, both in the Lower 48 and in Asia,” Carpenter said.
And there is huge uncertainty about the long term impact of shale gas on Lower 48 gas supplies.
“Has it really fundamentally changed the shape of the longer supply curve, or is it another temporary boom in a boom/bust market?” Carpenter questioned.
But given the long lead time for the development of a North Slope gas line, and the long timeframe for financing the project, stakeholders in the line need gas price assurance out beyond 2020.
Supply curve At the end of 2010 the Massachusetts Institute of Technology published a report which included a U.S. natural gas supply curve constructed by aggregating supply curves from gas plays across the Lower 48 — that aggregated supply curve shows how the presumed breakeven cost of gas production increases with increasing volumes of total, ultimate U.S. gas production. The graph reflects major uncertainties in the total size of the U.S. gas resource that might be developed and presents three different future cases corresponding to high, medium and low estimated volumes for the U.S. natural gas resource base.
Assuming that after 2020 the total U.S. ultimate gas supply would be in the range of 500 trillion to 1,000 trillion cubic feet, the high supply curve, for plentiful gas resources, indicates a breakeven gas price of $4 to $7 in 2007 dollars, Carpenter said. That price range does not bode well for a pipeline from Alaska into the Lower 48, he said. The supply curve for a medium-sized total resource gives a price range of $4 to $9, a range that could move the Alaska line into viability. And a price range of $4 to $15 for a low total resource makes the economics of the Alaska line look pretty good, he said.
These very large uncertainties in the gas supply curve pose the main obstacle to a decision over a gas line to the Lower 48, Carpenter said.
Gas demand The U.S. demand for natural gas, the other side of the supply/demand equation for the gas market, is also uncertain. Although gas demand has only grown quite slowly in the past 20 years, the availability of low-cost gas for potential electrical power generation has caused the Energy Information Agency to revise upwards its gas demand forecasts, Carpenter said. A major unknown for future gas demand is the question of whether the Environmental Protection Agency will mandate new clean air technology for existing coal-fired power plants, he said. Battle Group analysts have estimated that the closure of coal plants and their replacement by gas-fired plants, if EPA implements that mandate, could boost U.S. gas demand by 5 billion to 6 billion cubic feet per day, a demand increase roughly equivalent to the throughput of a North Slope gas line, he said.
The conversion of heavy-duty commercial vehicles to the use of natural gas as a fuel could add another 1.5 billion to 3 billion cubic feet to daily gas demand. On the other hand, improved energy efficiency and a major increase in wind generation capacity push gas demand down somewhat. However, tax credits for new wind farm development are about to come to an end, a factor that could bring new wind development to a halt, Carpenter said.
Although increases in gas demand would push gas prices up, the implementation of a North Slope gas line would in itself impact the market. Moreover, the relatively modest price increases that might ensue from increased demand would be completely swamped by the huge uncertainties in that U.S. gas supply curve — resolving the uncertainties in the supply curve remains the key to determining whether a North Slope gas line to the Lower 48 will progress, Carpenter said.
Global market But what about the global natural gas market, including the supply of LNG to Asian and European countries? Currently there is a wide divergence between the price of LNG sold in these markets and the price of gas in North America.
Contract prices for the import of LNG to both Europe and Asia are currently linked to the price of oil, Carpenter said. Asian dependence on oil as the next best alternative to natural gas enables LNG producers to maintain that oil price linkage, he said. On the other hand, there have been disputes in Europe over the desirability of the price linkage, he said.
There has been much discussion recently about whether global gas prices will converge, Carpenter said. A collapse in the price of oil would bring Asian and European LNG prices down towards North American gas prices. But the upwards convergence of North American prices towards the LNG prices would require the building of North American LNG export facilities, something that is unlikely to happen on the scale necessary to drive Lower 48 prices to parity with global prices, Carpenter said.
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