By Karl Smith
Will our carbon footprint continue to shrink? The Energy Department forecasts that CO2 emissions will tick up nearly 2 percent this year and 0.7 percent in 2014, as the economy recovers. Coal use in power plants is also expected to rebound as gas prices rise from their 2012 trough.
Historical precedent is not promising. The drive for energy efficiency that started in the 1970s did not continue once oil prices fell in the 1980s; among other things, American drivers fell in love with S.U.V.’s and trucks. In 1981, the Ford F-series pickup truck became the nation’s best-selling light vehicle. In 1986, Ronald Reagan had the White House solar panels taken down.
Whether or not natural gas continues to displace coal is a complex question, but for the most part it hinges on to two questions:
- How cheaply can drillers create a horizontally fractured gas well?
- How robust is the demand for ethane and other natural gas liquids from petrochemical manufacturers?
Traditional oil and gas wells are long-term capital investments similar to an office building. It costs a lot to drill the well, but you continue to get a slow stream of profits or rents for years to come. Hence, the key issues are the interest cost of financing the well and the certainty of the stream of profits. From that perspective, the swings in both energy prices and interest rates during the 1970s and early 1980s was heart-stopping for drillers.
Horizontial fracking is a bit different. The enormous pressure of the shale formation sends oil and gas gushing out the well when it is first fracked. Fracked wells have been known to gush at 100 times the initial rate of an average vertical well. However, the inherit low porosity of the shale also implies that once the initial gush dies down, the flow will become a trickle. To some old-school analysts, this makes fracking seem like a flash in the pan. From an big-picture economic standpoint, however, it makes fracking less like a capital investment and more like a service. You pay X for a fracked well and you get Y in oil and gas -- today.
Not 20 or 30 years from now, but right now. Or as soon as you can build the infrastructure to take the fracked products to market. In recent years that has been the bottleneck. This means that well drilling and finishing costs -- not financing or the future of energy prices -- becomes the major determinate. Wells either pay for themselves in terms of today's prices or they do not.
George Mitchell, the father of fracking, got well costs down to about $4 per million BTU of natural gas for fracking the Barnett Shale. That made fracking economic and started the revolution. This also implies that unless new wells are much harder to drill, natural gas prices will have a hard time staying above $4 for long. As they do, fracking becomes profitable once again and drillers will move in.
Can costs stay below $4 for any extended period of time? That depends on the future of fracking technology. Some drillers have suggested they have well costs down to $2.50 per million BTU. Such estimates tend to be overly optimistic, but technology looks to be on their side.
With drilling being the determinate cost, new techs like multi-pad drilling and ultra-mobile drill rigs attract a lot of attention. Moreover, building better machines is something that we have had ton of luck with over the past several hundred years, and is a more reliable source of growth than finding new easy-to-get deposits of oil and gas or decreasing the long-run volatility in energy prices.
The energy revolution has led some pundits to suppose that a manufacturing renaissance is coming to the U.S. However, while cheap energy helps, it's not really the driver. If anything, cheap energy is likely to hurt U.S. manufacturing via the Dutch Disease.
What matters is cheap feed stocks. In the 1967 classic "The Graduate," Mr. McGuire famously wanted to say only one word: plastics. Plastics, in North America, are made primarily from one thing: ethylene. Ethylene in turn comes from ethane, which in turn comes from natural gas wells. Natural gas is mostly methane, a hydrocarbon with only one carbon atom. However, when natural gas wells are drilled, a fair fraction of what comes out of the ground is ethane, a hydrocarbon with two carbon atoms.
As an energy source goes, ethane is like a messier version of methane. Like methane, it takes enormous pressure to turn ethane from a gas into a liquid. Propane, with three carbon atoms, can be liquefied at room temperature and with reasonable pressures.
Unlike methane, however, ethane can liquefy at normal earth temperatures (methane will not liquefy above -117 F). Consequently, it is possible for ethane to liquefy inside a high-pressure pipeline. Liquid in a high-pressure pipeline creates the possibility of a boiling liquid expanding vapor explosion (BLEVE) fire. This particularly nasty event is akin to what you get when you pour water on a grease fire -- not the kind of possibility you want to see out of the gas lines going into the average American home.
As a result, ethane is typically processed into ethylene, which becomes, among other things, polyethylene -- the most common plastic in the world. Currently, the gas coming out of hydraulically fracked wells in the Eastern U.S. is chocked full of ethane. Since it almost has to be made into ethylene, this has led to record-low ethylene prices for chemical companies.
The price today is so low that ethane and the ethylene it produces is something of a headache for gas extractors. However, if demand from the petrochemical industry ramps up then the ethane will become valuable again and add to the profitability of drilling a well. That, in turn, implies that lower natural gas prices could still pay enough to support fracking, as ethylene and hence ethane demand make up the difference.
Will It Be Enough?
If drillers can keep costs down to the $2.50 per million BTU range and ethylene demand ramps up, then U.S. natural gas prices should stay well below the $3 per million BTU level that encourages switching for coal fire to gas generation.