In its most recent quarterly survey of U.S. natural gas extraction activity, Raymond James & Associates disclosed a disturbing trend: output is declining on a year-over-year basis, and the gap is widening. Company analysts expect 2002 volumes to decline by 4.6% compared with 2001 totals. Based on the survey’s results, Raymond James stated that “with drilling activity yet to increase significantly, natural gas production will likely continue to its rapid deterioration for the foreseeable future.”

Domestic extraction volumes have been lagging behind demand for years, but this was not considered grounds for worry as long as the gas industry could count on increasing shipments from Canada to make up the difference. Canadian exports have risen substantially in the last 10 years, and now account for 18% of U.S. natural gas consumption. But a recent Lehman Brothers report stated that Canadian gas output slipped by 0.5% in 2002 compared with year-earlier results. With Canadians shivering through a colder winter this year, several energy analysts believe that exports from Canada are now tracking 2% to 3% below last year’s volumes.

“Exports are going to be down more than the production declines because we in Canada are going to need that gas,” said Peter Linder, an analyst with DeltaOne Energy Fund in Calgary.

The convergence of falling domestic output with declining exports from Canada threatens to send natural gas prices, now at $5.50/MMBtu, up toward levels not seen since the winter of 2000-2001. That brief but memorable price spike led to record drilling activity in 2001, but extraction volumes went up only slightly in 2002. When spot market prices reached $10/MMBtu that winter, demand from industrial customers began dropping like a stone, cutting short the rally in the futures market.

However, it is unlikely that 2003 will see a surge in new well completions comparable to the boom of two years ago. A combination of higher costs in the field, a credit crunch plaguing the energy industry, and low share prices is deflating expectations that another burst of drilling is in the offing. A Lehman Brothers survey suggests that gas industry will spend fractionally less money on exploration and production this year than in 2002, a year that saw modest drilling activity following the frenzy of 2001.

Absent a concerted effort to step up well completions this year, the volume of natural gas extracted from U.S. sources can head in only one direction: down. As Robert Morris, oil and gas analyst for Salomon Smith Barney, put it, “we would need 1,200 rigs in the field [in 2003] to keep U.S. production level.” As of January 17, there were 712 rigs in operation, down 30% from 2001’s peak of 1,068 rigs.

Little wonder, then, that several energy analysts, including Andrew Weissman of Energy Ventures Group, are calling attention to the structural imbalance that now exists between current demand and industry’s ability to supply it. Weissman warns that “as 2003 unfolds and the magnitude of the emerging near to mid-term mismatch between supply and demand in the North American market becomes clearer, we believe that higher natural gas prices are inevitable over the course of the year.”

We don’t know the price range needed to stabilize output from U.S. and Canadian sources, nor do we know whether it is even possible to maintain supplies at present levels, given the degree of resource exploitation that has occurred to date. As one might expect, the largest and most accessible deposits were the first to yield their contents to the gas industry. The prospects that remain tend to be smaller, tighter and deeper, requiring higher expenditures of capital, energy and man-hours per therm extracted. Thus the growing supply-demand imbalance can be likened to an ever-accelerating treadmill which threatens to overtake the gas industry’s ability to keep pace unless high prices are sustained over time.

Of course, the big energy companies would rather travel halfway around the world to feast on one prospect the size of Lake Superior than nibble on the many puddle-sized deposits that remain in the Lower 48. Lately, they've been contemplating two very ambitious and expensive undertakings. The first involves drilling in the Arctic frontier and building a new pipeline to transport natural gas into the United States. The second undertaking envisions a series of new developments in overseas locations like Saudi Arabia, which have huge deposits but no pipeline capacity, and shipping the gas in liquefied form to the United States. To pull off either scheme would require a massive infusion of capital to build the infrastructure--rigs, pipelines, liquefaction facilities, terminals and tankers. Financing would be very difficult to obtain unless lenders were certain that gas prices would remain at historically high levels.

One notable dissenter from this pessimistic perspective is the U.S. Energy Information Administration (EIA), which projects that gas consumption will rise 4.7% this year without a run-up in prices. Long term, EIA forecasts domestic gas consumption to increase 2% annually through 2020. Underpinning EIA’s forecast is the assumption that the current slump in the economy will end soon, and that construction of gas-fired power plants will continue apace. But EIA’s seemingly incurable optimism serves another purpose, mainly to prevent concerns over future gas availability from spilling over into the mainstream media.

Can the U.S. economy rebound while the going rate for natural gas escalates in search of a new price floor? Probably not, but that’s only a guess. However that dynamic plays out, we Americans are not in a position to control or even influence the outcome. But we may still be able to reduce to some extent our increasing dependency on natural gas. For that reason, we should examine whether it is a wise idea to keep building more gas-fired power plants.

From a utility perspective natural gas comes close to being the ideal electricity generating source. Unlike coal, it is devoid of sulfur and mercury. Unlike diesel, it is free of particulates. Unlike uranium, it does not, once used, stay radioactive for thousands of years. Unlike wind, it is a dispatchable power source. It is possible to build a power station that can convert up to 85% of the raw Btu value of gas into usable energy: steam, processed heat, and chilled water as well as electricity. Indeed, natural gas generators are uniquely valuable in that they provide firm capacity yet can be ramped up or throttled down at a moment’s notice to match load fluctuations.

Because supplies are limited, natural gas should be priced at a premium to stretch out its availability and penalize wasteful uses of this high quality resource. This would be a significant departure from what we’re used to. Gas has been for many years the cheapest energy source for both bulk generation and home heating uses, and while its prices sagged, its popularity soared. But its attractiveness encouraged a mindset that took its future availability for granted, and now we are beginning to feel the pinch that comes from putting all of our energy eggs in one basket.

So far, market mechanisms haven’t provided the premium pricing that would bring about a more rational and less unthinking use of natural gas. But there is the opportunity, at least in states that haven’t deregulated electric service, to develop broader strategies for meeting future energy needs that don’t rely exclusively on natural gas. Utility commissions ought to insist that new gas-fired projects include specific measures to minimize fuel use. Reducing load growth through such efficiency measures as higher building energy performance standards, and expanding power production from renewable sources would produce more than just environmental benefits. These strategies would also help utilities ease up on their use of natural gas as a generator fuel, and reduce customer exposure to high prices and the potential for electricity shortages.

While new gas-fired plants can provide short-term reliability benefits, the shaky state of future natural gas availability argues for a redoubled effort to keeps loads from growing.

Prudence also dictates accelerating the deployment of wind turbines, ground source heat pumps, manure digesters and solar water heating systems to shoulder a greater share of the energy burden.

A resource strategy that starts and ends with new fossil fuel generation presents a financial and resource availability risk to ratepayers that is likely to outweigh whatever short-term benefits it would otherwise provide.

Sources:

“Analysts: Canadian Natural-Gas Exports to U.S. to Drop,” Dina O’Meara, Yahoo! Finance, January 9, 2003 (no URL).

“Fiscal Caution Slows Hunt for U.S. Natural Gas,” Joseph Silha, Reuters,

December 16, 2002 (no URL).

“Fourth Quarter Production Survey Shows 6th Consecutive Decline In U.S. Gas Production,” Raymond James` Energy "Stat of the Week". January 21, 2003.

http://170.12.99.3/researchpdf/iEne012103b_0738.pdf

“Is There Sufficient Natural Gas in Storage to Meet this Winter’s Needs?” by Andrew Weissman. http://www.energypulse.net/centers/article/article_display.cfm?a_id=132

“Risky Diet: North America’s Growing Appetite for Natural Gas,” Center for Energy Efficiency and Renewable Technologies, July 2002.

http://www.ceert.org/pubs/crrp/natgas/riskydietreport.pdf

“U.S. Gas Output Seen Down,” John Edmiston, Dow Jones, January 17, 2003 (no URL).

Petroleum and Natural Gas Watch is a RENEW Wisconsin initiative tracking the

supply demand equation for these fossil fuels, and analyzing its effects on prices,

consumption levels, and the development of energy conservation strategies and renewable energy alternatives. For more information on the global and national petroleum and natural gas supply picture, visit "The End of Cheap Oil" section in RENEW Wisconsin's web site: www.renewwisconsin.org