Is The Inclusion Of Natural Gas Liquids In The Definition Of Oil Plausible?

by: Juan Carlos Zuleta

A new debate has emerged in recent days around the new definition of oil. In a commentary published on July 16, 2012 on Peak Oil Review, Kurt Cobb argues that the idea that global oil production has been spinning around 88 and 89 million barrels per day (mbpd) this year is wrong. This is because these figures include, following the new definition of oil, not only crude oil but also natural gas plant liquids (NGPL) (mainly, ethane, propane, butane and pentane) and biofuels.

According to him, excluding these products from the analysis, global oil production would be reduced to only about 75 mbpd. Moreover, since 2005 the volume of crude oil would have stalled between 71 and 75 mbpd, while liquids extracted from natural gas would have grown "rather rapidly" and biofuels to a lesser extent.

The previous figures are slightly lower than those presented by Leonardo Maugeri, who in another controversial study on the supply of oil in the world speaks of a total of 93 mbpd including liquids and 77-78 mbpd, without them. Apparently, these volumes would have been the result of the recent boom in "shale" oil and natural gas, particularly in the United States, not contemplated in Cobb's analysis.

This finding, however, does not explain why oil prices went up so much in the last 7 years or so, leaving Cobb's counter argument to the abundance of world oil hypothesis intact not to include NGPL and biofuels in the definition of oil. I describe below the various points of view put forward by Cobb.

Let me start with ethane. Ethane is used primarily to produce ethylene, one of the most widely used chemicals today, which serves mainly for the production of polyethylene, a well-known plastic, or an automotive antifreeze, and polystyrene, which is used in isolation or packaging systems. In this sense, it indeed turns out to be rather difficult to see how ethanol, the most abundant liquid natural gas, is a good substitute for petroleum-based liquid fuels.

Cobb fails to mention ethanol, a chemical used mainly as a fuel or fuel additive for vehicles, which could also be derived from ethylene or even obtained directly from natural gas by using a new technology. Needless to say, this method of ethanol production would be particularly ideal for those countries with higher relative contents of methane (ethane) in its natural gas and crude oil and gasoline shortages.

As for propane, Cobb concedes that it is used as fuel for grills and camping stoves and that there are about 270,000 propane-based vehicles in the United States. He also says that there would be about 17.5 million such vehicles in the world. But this represents only 1.7% of the global fleet, which shows its limits in terms of production as a substitute for different liquid fuels derived from petroleum. These production limits - which also apply for use of propane as a substitute for oil used in heating systems - would be linked in principle with the fact that only about 4 or 5% of natural gas on earth is composed of propane.

The ease with which heating systems that use propane can be installed in places where there is no natural gas networks have now made the former an interesting alternative to those based on oil, particularly in the United States, something also emphasized by Cobb though without mentioning that these days it is possible to get more and more propane from "shale" natural gas deposits, which could contribute to its increased use.

In connection with butane, its most popular use is as fuel for lighters, but when mixed with propane it can be into converted into liquefied petroleum gas (NYSE:LPG) having a variety of energy applications, particularly in developing countries. In addition, Cobb notes that liquid butane is not suitable for transport, which seeks to strengthen his approach. However, evidence does exist that LPG can be used as vehicle fuel.

Here, it should be noted that the physical properties of propane and butane are similar and that when the correct pressure is regulated, its performance would be nearly identical. Nevertheless, there are some differences between the two gases. In principle, butane would possess the most advantages because it: (i) is less toxic and can legally be used and stored within any infrastructure, (ii) has 12% more energy than propane, but as it is heavier, results in a similar energy density, and (NASDAQ:III) is cleaner than propane. However, propane would have only one major advantage, albeit a big one: That the liquid in a bottle can be boiled into gas at much lower temperatures, making it much more effective as a useful source of gas. This difference explains why it is so convenient to mix the two liquids to form LPG.

On pentane, Cobb indicates that it has industrial and laboratory applications, but is not used as liquid fuel. In this case, the author ignores that natural gasoline, a liquid natural gas which, when mixed with high concentrations of ethanol to increase octane, can be used as fuel for "flex-fuel" vehicles operating on gasoline or ethanol or a mixture of both, is derived from pentane and other heavier liquids.

Next Cobb refers to liquids (gasoline and diesel) derived from coal, whose processing would be extremely messy and expensive and diesel derived from natural gas, through a process known as "gas to liquids" characterized as capital intensive and costly and considered suitable for converting natural gas which could otherwise be burned. These fluids, in addition to biofuels, however, would only amount to about 2 mbpd.

Cobb then mentions three fundamental limitations of biofuels, namely that: (i) most vehicles can only absorb up to 10% blend without beginning to degrade; (ii) in North America, we would require 4 times and a half the arable land available to produce enough corn ethanol to meet total demand for its entire fleet of vehicles, and the production of ethanol (and biodiesel from vegetable oil) needs more energy than it provides, making it more an energy carrier than an energy source.

Cobb closes his analysis by noting that the remaining 2 mbpd of liquids result from the efficiency of refineries, i.e. the increase in the total volume of crude oil due to its separation into different fractions, clarifying that it wouldn't be really a source of oil but rather a result of energy use for refining.

Overall, Cobb's findings regarding the limits of NGPL as oil substitutes seem somewhat overstated. While the above assessment is far from conclusive, it does reveal some elements that reinforce the plausibility of the inclusion of NGPL in the new definition of oil.

Michael Levi, an energy and environmental analyst, arrives at a similar conclusion, wondering in a recent blog whether NGPL are as good as oil for transport vehicles. In this regard, he argues that there are two problems with the arguments that challenge the NGPL as potential replacements for oil.

The first problem is that neither the NGPL nor oil is used directly in cars or trucks. What is used in those is gasoline or diesel produced by refineries. Thus, Levi argues that the key question here is whether the NGPL are useful as inputs for refineries. As it turns out, only propane and butane are inputs that generate high levels of octane for refined products, although in relatively small quantities.

The second problem has to do with the products of the refinery. According to Levi, the third product in order of importance of a refinery (after gasoline and diesel) is naphtha, a petrochemical material used in many industrial processes. Both ethane, and propane (converted to propylene) and butane (transformed into butylene) would be potential substitutes for gasoline. An eventual abundance of NGPL (from shale natural gas deposits, for example) could therefore lead to increasing substitution of naphtha by derivatives of NGPL, which in turn would generate the necessary incentives to oil refineries to install equipment that reduces naphtha production capacity, favoring the production of gasoline and diesel.

Levi then argues that it is reasonable to treat small amounts of liquid natural gas as crude oil equivalent (Chris Nelder finds, for example, that only 19 percent of a barrel of NGPL in the US should really be counted as vehicular fuel), although - for the reason noted above - as we increase production of natural gas compared to crude oil, this parity could be eliminated.

In this sense, Levi concludes that, from the perspective of the necessary inputs for refining oil, propane and butane are in effect the only significant NGPL in the new definition of oil, while looking at the matter in terms of products of the refinery ethane, propane and butane, instead of being potential substitutes for oil, could create incentives for increased production of gasoline and diesel. Therefore, using a different reasoning Levi reaches almost the same conclusion as Cobb.

It should be noted, however, that Levi ignores essentially the same issues identified in the evaluation of Cobb's analysis, which is why his arguments against the substitutability of oil by NGPL would also be overemphasized, albeit for different reasons.

In summary, although based on the above analysis remains the idea that the relative scarcity of crude oil would have been the cause of increased prices in the last 7 years or so, which somehow supports the argument of the so-called "peak oil," Cobb's and Levi's approaches regarding the limits of NGPL as oil substitutes appear to be oversized, which means that the inclusion of NGPL in the new definition of oil does still make some sense.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.