Cheaper natural gas could fuel policy shift

Posted: July 22, 2011

Since the federal government deregulated natural gas prices in the 1980s, the prices of crude oil and natural gas have moved more or less in tandem.

But in the last three years, the prices have become unhinged. One reason is the dramatic increase in natural gas production from unconventional formations such as Pennsylvania's Marcellus Shale, which has driven down natural gas prices while crude oil prices have soared.

When the two fossil fuels are compared on the basis of energy equivalency, natural gas is a bargain compared with oil. A dollar spent on natural gas buys more than three times the energy that a dollar spent on crude oil buys.

The U.S. Energy Information Administration believes the disparity could last for decades.

"We think we will have relatively reasonable natural gas prices over the long term," said Philip Budzik, an analyst with the EIA. "That looks good to me because I use natural gas at home and I'm happy I don't have to pay oil prices."

The natural gas discount has more implications than a bonus for homeowners considering a switch from heating oil.

The price disparity is fueling a debate over whether the government should encourage electricity generators to accelerate the switch from coal to natural gas. And T. Boone Pickens, the Texas oilman, is lobbying Congress to subsidize converting vehicles to natural gas fuel.

Some believe that new demand for natural gas will invariably drive up prices.

"I suspect volatility will continue, and that the oil-vs.-natural gas price relationship will eventually move back to normal," said Donald B. Marron, director of the Urban-Brookings Tax Policy Center in Washington.

A few skeptics doubt the shale-gas supply is as robust as advertised - whether it could be an Enron-like Ponzi scheme, as a New York Times article implied recently.

But shale-gas production continues to go up, defying the skeptics.

Shale gas will account for 25 percent of the nation's natural gas supply by the end of this year, up from 2 percent a decade ago, according to the EIA. And a Pennsylvania State University study released this week reported that Marcellus production, which is still in its infancy, is outpacing last year's estimates by 30 percent.

"The idea that shale gas is a flash in the pan is simply incorrect," Kenneth Medlock III, a Rice University researcher, said this week after the release of a Rice study that called shale gas "perhaps the most intriguing development in global energy markets in recent memory."

There is more to the pricing dynamic than shale gas.

Two decades ago, when oil and gas traded more synchronously, electricity producers were able to arbitrage the price difference by switching to the cheaper fuel. Fuel switching kept the prices relatively close.

But oil no longer is used to generate electricity - mostly it's a transportation fuel. If natural gas is used in vehicles, it could drive up its price.

Natural gas prices are also based upon mostly a domestic market, while crude oil is governed by worldwide demand, including emerging economies.

Crude oil markets are influenced by traders who regard the commodity almost like a currency, said Ananthan Thangavel, managing director of Lakshmi Capital Management in Beverly Hills and author of a commodity newsletter.

"Natural gas, when you look at trading activity, is much more based on supply-and-demand characteristics than crude oil," he said.

Not everyone is enamored of proposals to increase demand for natural gas by encouraging its use as a motor fuel.

George Biltz, a vice president of Dow Chemical Co., told the U.S. Senate Energy and Natural Resources Committee on Tuesday the abundance of natural gas could be a "game changer" for American petrochemical manufacturers that use natural gas as a raw material. But only if the price stays low.

He encouraged Congress to "exercise extreme caution" about jumping on the Pickens bandwagon. Using natural gas to make chemicals creates more economic value.

"U.S. manufacturers provide the highest value-add of any sector," he said. "Using natural gas to make petrochemicals results in eight times the value over simply combusting it."


Contact staff writer Andrew Maykuth at 215-854-2947 or amaykuth@phillynews.com.

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