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A barrel of oil contains 5.8 million BTU and can be purchased today for $77.00. But in natural gas, using today’s price of $4.80 per million BTU, you can obtain the same quantity of energy for $27.85. This price discount started developing as far back as 2005, but did not reach its current levels until after the deflationary crash of 2008. Natural gas, it should be mentioned, had always carried a small discount to oil owing to the latter’s versatility as a liquid and its greater penetration into industrial society. The present day discount is historic however. Especially with respect to its duration.

There are a number of factors at play here. First, North American natural gas supply is trapped, as no export facility exists to ship LNG to the rest of the world. (This will change when the Kitimat LNG project comes on line circa 2013). Accordingly, North American natural gas sells at a persistent discount to global volumes of LNG. Second, North America is a heavy user of oil-based transport but as a continent we are really defined by our remaining coal and natural gas resources–not our depleted crude oil resources. Finally, the 6 straight years in which global oil production has remained flat to declining reflects sturdy, structural changes that are now embedded in the price of oil. Accordingly, because the price spread is so enormous, a number of analysts think that the price of natural gas will eventually catch up again, to oil. And possibly soon. Not only do I think otherwise, but I think it could take a decade or more for the BTU in natural gas to price once again near the BTU in oil. If ever.

That the energy in natural gas costs only 35% of that in oil will understandably lead many to conclude a transition to natural gas from oil is imminent. The hurdles to any fast switch to natural gas are formidable, however. There is the problem that natural gas has to compete with coal, for instance, which also prices itself way, way below oil for an equivalent amount of BTU. The larger barrier is of course the built environment (nicely illustrated by the above photo of Los Angeles). North America is very much built out for oil. Not natural gas.

As we saw in the 2009 BP Statistical Review, natural gas was the big loser in 2009. Cheaper than oil, but not cheaper than coal, natural gas currently has no edge as either an easy replacement for oil in infrastructure terms, or, as a competitor to coal in price terms for power generation. It’s also a bit of problem, to say the least, that there is punk demand growth for electrical power in North America owing to our weak economy. Demand for power in the US was hit very hard in 2009. This brings us to an irony of energy transitions that may have been a part of the painfully long transition from Wood to Coal, and also Coal to Oil: cheaper is not the holy grail of transition. The path dependency of your built environment can trump the price attractiveness of an alternate source of energy for a long time. I expect that for years to come, people will be asking in bewilderment, “Why aren’t we transitioning to cheap, domestic, plentiful, natural gas?”

Photo: from the series, Lighter than air: A view of downtown L.A. from the Goodyear blimp, by John W Adkisson, LA Times.
Source: Natural Gas: Cheap Is Nice, But It's Not Everything