Oil as 'the' Energy Price Benchmark? Natural Gas Makes More Sense

By Rob Day

Everyone pays attention to oil prices as their first cut on energy prices. I see numerous Wall St. analysts comparing oil price changes to solar stock price changes and showing strong correlations, and I scratch my head. Oil prices shouldn’t really drive the fortunes of solar companies. Very little of our electricity generation mix in the U.S. or in Europe or Japan (or other solar markets) comes from oil-fired generators. And yet investors seem to view solar as a hedge on oil prices, probably because oil prices are highly visible and volatile. We pass by gas stations all the time in our daily lives and see the prices go up and down. Oil prices are reported on in the evening news. VCs are often asked what their oil price “breakeven” is when looking at cleantech opportunities (ie: “what long run oil price do you invest based upon?”). Oil, oil, oil.

But I would argue that the more salient price is natural gas. It’s the peak generation fuel of choice and thus determines the peak electricity prices that most affect energy efficiency and smart grid and PHEV techs. Ditto for solar prices, since solar is largely a peak power play (esp. once peak-shifting energy storage options are implemented). It’s also a minor transportation fuel, so in some scenarios it can affect transportation tech options as well (if natgas prices drop, we’ll see a lot more natgas cars on the road). Coal prices would be another good price to follow, but since it looks harder and harder to build new coal-fired facilities in the developed world, natgas fired generation is just as important for long-run scenario planning.

Funnily enough, right now there are a lot of divergent viewpoints when it comes to future natural gas prices for the U.S. Here’s one analyst who argues that peak U.S. natural gas will occur between 2010 and 2020. Yet I’ve also seen industry participants such as Ziff Energy point to the rapid expansion of “non-traditional” reservoirs in the U.S. such as the Barnett Shale and argue that natural gas prices are going to go on a long-term decline (more good info from FERC in this pdf), although others say that such reservoirs will be costlier to access. Forward price curves, according to FERC and NYMEX (note: link opens pdf) are up, but not significantly. (Coal futures also creep up a bit but stay relatively the same, btw — pdf at this link)

So basically, no one has a sure idea of what natural gas prices are likely to do over the next decade. But with natural gas expected (by the EIA at least — note, link opens yet another pdf) to dominate new generation capacity additions between now and 2030, it’s a critical question for those investing in renewable energy markets. Certainly a question I worry about more than the vagaries of daily oil prices.

Comments

[Paul Killinger:]

Yes, it will be interesting to see what happens when NG returns to its historic price relationship to oil (8,000 cu/ft to the barrel). Will its price go up, or the price of oil go down?

Apr 14 09:17 AM

[Ferdinand E...:]

"Solar is largely a peak power play". Hmm, I can't get rid of the impression that when you say that you need peak power, you mean peak power and not an announcement by the weather man that if you are lucky the sun will appear. Of course if solar energy could be stored in one form or another, that statement might be correct, but even so...l

Apr 14 09:19 AM

[Mad Hedge F...:]

You are absolute right on a BTU basis. Natural gas ($NATGAS), which peaked at $13.50/btu last year, has become the red headed step child of the energy complex, plunging a gut churning 72% to a low of $3.40. To see demand this weak coming out of a cold winter is nothing less than stunning. The credit crisis has forced US companies like Chesapeake Energy (CHK) and Devon Energy (DVN) to scale back exploration, so the US rig count had dropped by half. The price collapse is welcome news for consumers, as NG is an essential raw material for making naphtha, fertilizer, and plastics and accounts for 20% of US electric power generation. It also is a favored fuel of the green crowd, as the only products of its combustion are carbon dioxide and water. The industry was making the leap from a domestic industry to a global one just the global recession punched it right between the eyes. The completion of six liquefaction plans in Qatar, Russia, Indonesia, and Yemen costing $48 billion is expected to boost global production by 25% this year, and more big plants are coming on stream in the near future. If I’m right, and those really are crocuses out there and not some florid hallucination, then it’s time to load the boat with NG.

Apr 14 09:34 AM

[User 353732:]

1. People focus on oil because they see the continually changing price of oil (via gasoline and diesel) each time they pass a filling station and it is the only form of energy which is tactile to them: they "experience" oil when they fill the tank in way they do not experience the acquistion and price of any other form of energy. Oil evokes an emotional response akin to gold. In that regard Oil is a proxy for larger hopes and fears, as is gold. People project on to oil these existential sentiments and emotions that they do not project on other commodities. It is difficult to see this emotional nexus being transferred to natural gas, coal, uranium or solar panels and windmills.
2. The press focuses on oil because oil is "glamorous", so the ordinary person and the non-energy investor focuses on oil. Investors want simple metrics, no matter how irrelevant or flawed, and oil provides this metric.
3. Once smart, interactive , electricity meters become pervasive(say in a decade) and people can see the price of electricity every 15 seconds and watch their use on a screen or (multiple screens) electricity may become more tangible and comprehensible to people . Then and only gradually there may be a shift in attention and reporting to electricity. Of course, electricity is regional in its price movements and cannot provide the simple, global metric that oil does or ,in 15 years, LNG FOB Qatar or LNG FOB US Gulf could. As natural gas globalizes and when , by energy content, worldwide, natural gas production exceeds oil(many years away yet) then I think a critical mass of household, media and investor attention may shift to NG prices as the reference metric.

Apr 14 10:08 AM