Economic Impact of the Natural Gas Boom

How to Benefit from the Natural Gas BoomEID 374 - Business EconomicsProfessor Thomas SynnottMurray Choueka & Joseph Stern

BackgroundShale gas is a natural gas trapped within shale formations a fine-grained sedimentary rock made of mud and clay mineralstrapped in geological formations with low permeability

New technologies in drilling has led to a rapid growth in shale production: Horizontal Drillingdrilling vertically to reach the shale layer and then drilling laterally to access a larger proportion of the source rock

Hydraulic Fracturing (Fracking)injecting high pressure mixture of water, sand, and chemicals to create fractures in the source rock to free the trapped gas and allow it to flow

How is Natural Gas used?Natural Gas is used in modern society in four major ways:

Fuel for household heating and cookingFuel for power generationFeedstock for fertilizer and petrochemical industryTransportation fuel

Where is it found?

Production Growth2001: Production of shale gas was 1 Bcf (billion cubic foot) per day2010: Production has increased to 15 Bcf per dayaccounting for 27% of total natural gas production2035: Expected to rise to 60% or 88 Bcf per day

As a result of this boom, the price of natural gas has become extremely cheap relative to the price of crude oil.

ExxonMobil forecasts that 46% of global gas will be used for electricity in 2040, with 37% used by the Industrial sector and 17% by Residential.

Effects?PositivesReduction of greenhouse gases and other pollutants Stimulating economic growth

NegativesNo appropriate regulations - entrepreneurs are driving the sector and not governmentToo competitive against clean-tech energy projects

How will it affect the U.S. Economy?SEMF The Stanford Energy Modeling Forum (which consisted team of 50 experts and modeling teams) concluded the following:Nat Gas Revolution will raise the GDP by $70 billion per year over next few decades (0.46% of the $15 trillion GDP in 2012)Why so modest?Who uses the natural gas? Energy companies and petrochemical companies make up a small slice of the U.S. economyThe end users of natural gas only account for 1.08% of employment Depends on price of gas going forward.$1 drop $55 billion added to GDP.

Energy Sector Accounts for 27 percent of U.S. energy demandProduction is on a long-term growth pathPromising low and stable gas pricesWill allow U.S. to rely on its domestic production of nat gasReducing imports of liquefied natural gas (LNG)Has become the primary choice of gas in the electric power sectorIts a cleaner burning fuel than coal the carbon dioxide emissionsBut is it only replacing coal?

Environmental EffectsNatural gas has helped displace coal power in the U.S. Significantly reduce carbon emissions Produced the carbon emissions that coal does

Cheap natural gas will displace clean energyDiscourage efforts to conserve energy and boost efficiency

What Will Natural Gas Replace?

From Stanford Forum Report.

Quick Tax Revenue EstimateU.S. gas production will average 20 tcf over next decade.Gas price will be $4-$6 per thousand cubic feet (lets call it $5 and let 1 thousand cubic feet be one unit of gas)10 cents/unit tax $2 billion per year50 cents/unit tax $10 billion per year$1/unit tax $20 billion per yearBut this is less than the loss in GDP ($55 billion / $1 price drop)

Perhaps a Carbon Tax?

Effects of a Carbon Tax

Effects of a Carbon TaxA carbon tax solves multiple problems:Reduces CO2 emissions and preserves natural gas by making it economical to continue producing clean energy.Raises revenue for the government (how much???)But how would a carbon tax affect the price of gas? How would it affect GDP?How would it affect the energy companies?

look at how price of oil was correlated with inflation in the 1960s-1970s.

Transportation SectorCurrently, use of Nat Gas in transportation sector is negligible3% of total 27.0 quadrillion Btu of energy consumed for transportation is NG14 Currently, on a Federal level, [compressed natural gas] is taxed at the same rate as gasoline on an energy- equivalent basis ($0.18 per gasoline gallon equivalent, or 0.21 per diesel gallon equivalent), while [liquefied natural gas] is taxed at a higher effective rate than diesel fuel (EIA 2012a, p. 38).

Rapidly rising ratio between oil prices to nat gas prices on a per-energy unit basis is quickening the trend to move over to gas-based fuels in the transportation sector

Current Status of Nat Gas in Sector3 ways: Convert nat gas to liquid fuels- methanol, ethanol, and diesel through a GTL (gas-to-liquids) processCompressed NG can be burned in light and medium duty NGVCooled to LNG and used as a replacement for diesel in heavy-duty trucks

Natural Gas VehiclesCurrently 14.8 million NGV on the road worldwideUS ranks 17th globally with # of NGVs on the roadNGV in US was limited to buses or garbage trucks, FedEx and UPS trucks. 114,000 CNG vehicles [passenger vehicles, publics transit buses (20% of NG consumers), and trucks]3,000 LNG vehicles of heavy-duty trucks

1. Natural Gas Vehicles for America, http://www.ngvc.org/about_ngv/index.html2. Behind Iran, Pakistan, Argentina, Brazil, India, Italy and China.

Light-Duty VehiclesHondaexpanding availability of NG fueled Civic from 5 to 36 statesChryslerdeveloping new tank technology for CNGHong KongPlans on building CNG/gasolin/electric hybrids in the US

Honda Civic

Problem? Absence of Fueling StationsTrucks and buses travel in predictable routes and are stored in common lots. Widespread use of CNG in passenger cars would require a new refueling infrastructure.1,050 CNG stations53% open to the publicConcentrated in areas like California and Utah

Chicken and Egg ProblemVehicle users will not buy NGV until they believe there are enough refueling stations

BUT, motivation to build an NGV refueling infrastructure will be limited until a sufficient number of vehicle owners demand the fuel.

GTL= Gas to LiquidsWith GTL technology, nat gas can be converted into diesel and gasolineConversion rate translates into a cost of $40/barrel of oil-equivalentBUT, costs $10 billion to build a plant!Sasol (a South African company) announced plans to build the first GTL plant in the US in Louisiana for $14 billion (2018)Shell announced plan for GTL plant for 2019

Converting to Ethanol and MethanolNG can be converted to methanol and ethanolNG methanol+ethanol+gasoline (in certain fractions) = alternative fuelE85 (85% ethanol, 15% gasoline) and M85 (85% methanol, 15% gasoline) are usable for flex fuel vehicles. Research shows that wider use of E85 in passenger vehicles makes strong economic sense given current fuel price differentials

This is based on estimates of the cost of producing ethanol (and eventually E85) from natural gas, using Celanese Corporations TCX process. As more details become available about the costs of this process, the use of blended fuels may very well look increasingly promising to consumers.

Federal and State EffortsEnergy Tax Policy Act of 2005-2010income tax credit for buying a new alternative fuel vehicle of up to 50% of the incremental cost of the vehicleplus an additional 30% if car meets tighter emission standardsrange from $2,000-$32,500 depending on size of vehicle

Federal and State EffortsDepartment of Energy funding $300 million for natural gas technologies for state and local governmentsNAT GAS Act in 2011- proposed legislation offering tax credits for new NGVs at the retail and manufacturing ends, commercial and residential refueling infrastructure, and gas itself Rejected by the Senate in March 2012

Federal and State LevelObama announced a new $1 billion challenge to spur deployment of clean, advanced vehicles in communities around the country.Electric, natural gas, and other alternative fuels States offering incentives for converting diesel truck fleets to LNG and CNG alternatives

Private EffortsWithout government subsidies, private governments are promoting natural gas for transportation. Chesapeake Energy, GE, Clean Fuels, and Pilot Flying J collaborated to commit $150 million to develop 150 CNG and LNG refueling stations

Economics of NGV vs. Gasoline or DieselLNG heavy trucking industry is rebuilding infrastructure, so LNG trucks are becoming more prevalentCNG as a fuel for LDVs remain a tough sell, because there are no policies in place that price carbon (favoring NG over oil)

Honda Civic

Light Duty Vehicles- LDVsNGV is more expensive than the Hybrid and gasoline Civics (without subsidy- 32%)Maintenance cost is more expensive (50%) Same fuel economyNot enough fueling stations

Nat Gas LDV is almost $200 more expensive annually + $521 annually for installation of home fueling stations ($4,000 unit)

Assuming a $1.50 gallon of gasoline equivalent advantage for natural gas over gasoline, seven years of annualization, and a 6 percent interest rate, and without counting infrastructure cost or any subsidies, we found that a natural gas LDV is almost $200 more expensive annually than its gasoline-fueled counterpart. Infrastructure costs for the NGVs must be considered, however, under the assumption that individuals will not purchase such vehicles unless they have access to a home fueling unit and already have natural gas in their homes. These units cost $4,000 currently. We assume they last 10 years and amortize their costs at the same 6 percent interest rate.27 Adding this annual amount to the annual cost of an NGV raises its cost premium over a gasoline-fueled counterpart from $200 to $721.

How to Incentivize? Must consider subsidizing the $4000 investment cost of the home fueling unitGrant a $2,000 subsidy for home charging stations Reconsider the annual cost of the average 5-year loanAfter adjustments and amortized costs NGV are $100 cheaper than gasoline carsBUT, NGV cars have less trunk space and unreliable for long distances without appropriate fueling stations

HDV- Heavy Duty TrucksLNG is $0.75 per diesel gallon equivalent cheaper than diesel for an independent trucker and $1.00/gallon cheaper for a fleet vehicleDiesel truck costs $100,000Westport trucking company making trucks that are $30,000-$40,000 more expensive

Where are the benefits? Fuel Price DifferentialsNeed fuel price differentials to be around $1.50 per gallon equivalent and rates of interest to be less than 10%

NEED TO LOOK AT THIS AGAIN TO MAKE SENSE OF IT

Considerations Affecting CostNGV cost more, but cheaper fuelSafety concerns- explosive potential of tanksResale market is limitedcommercial trucks are usually resold for personal use (farms and small businesses)LDV have less cabin spacefuel tanks are large and heavyRange of only 218 miles compared to 383 miles

Future ProjectionsMore development and technology will decrease cost differentialsStricter environmental restrictions on diesel is slowly increasing the price of diesel fuelGreat uncertainty for the future prospects of NGVs

In the AEO 2012, EIA runs a side case known as the Heavy-Duty NGV Potential case, in which natural gas refueling infrastructure is expanded (simply by assumption) and a gradual increase is allowed in the share of HDV owners who would consider purchasing an NGV if justified by the fuel economics over a payback distribution with a weighted average of 3 years (EIA 2012a, p. 39). In addition, an HDV Reference case was developed from the AEO 2012 Reference case, assuming that Class 36 vehicles use CNG and Class 7 and 8 vehicles use LNG. Table 11 summarizes the projected sales, market penetrations, and natural gas consumptions in the HDV sector in these two different scenarios in 2035. The wide gap between these two cases reflects a great uncertainty over the future prospect of NGVs. The higher consumption of natural gas in the Heavy-Duty NGV Potential case slightly pushes natural gas prices up, which results in lower gas consumption in other end-use sectors. The overall impact brings about a 5 percent higher total US natural gas consumption compared with the Reference case (EIA 2012a). In the AEO 2013 Early Release, the improved economics of LNG for HDVs, due to a lower natural gas price projection, results in an increase in natural gas use in the HDV sector compared to the projection in AEO 2012. Natural gas use in vehicles is predicted to reach 1.7 Tcf by 2040, including the GTL use, which is about the same level of projected consumption by 2035 in the Heavy-Duty NGV Potential case in AEO 2012 (EIA 2013).

Joseph Stern () - Reference case= EIA assumptions of infrastructure build outWhat to Do? Tons of Potential- Deserves more attention

Where to start?Hondas nat gas fueled LDV needs investment and infrastructure subsidies at the level being discussed in Washington about hybrids

Industrial SectorUS manufacturing has been declining in recent decadesinternational competitionrecessiongradual shift towards the service industry reduction of 20% in nat gas consumption from the industrial sector

Industrial SectorShale Gas Revolution has stimulated a series of expansion announcements in manufacturing in the petrochemical and fertilizer industriesProduction plants are moving back to the US to take advantage of cheap nat gas pricesHuntsman Corp used to spend 90% of discretionary growth capital outside the US now spends 70% within the USAttractive to foreign investmentGerman based BASF is building chemical plant in Louisiana

Industrial Sector BenefitEquipment manufacturers and construction material providers experiencing a boost due to shale gas expansionPetrochemical- cheaper raw materials cheaper plastics and rubberGrowth of income, employment, and tax revenue from this manufacturing renaissance stimulating the US economy by increasing demand in consumption and government spending

American Chemistry Council Study (2012)Direct effects:$121 billion in additional industry output$72 billion in capital investments

Indirect effects (supplier industry): $143.8 billion of additional growth in economic outputwill need to increase demand in other sectors of $76.8 billion economic gain from income and tax growth

American Chemistry Council Study (2012)

New Projects Fueling US Industries

Exporting OpportunitiesCurrently no license for exporting LNG because of US free-trade agreementExporting LNG to Japan and China could: Increase production in USIncrease jobs in production and manufacturing Decrease trade deficitBring US closer to important allies

Exporting Vessels

Possible Negative Effects?Increase domestic gas pricesEnvironmental effects

Petrochemical IndustryNat Gas Ethylene = key component in plasticsChemical companies are building plants as a result of shale gas boomAs nat gas prices fall, so does price of plasticsNat gas prices: $12.5/mmBtu $3/mmBtuEthylene prices: $1,009/tom $323/tonSuch a cost reduction = US manufacturers advantage over international competititors

FertilizersNat gas ammonia =primary ingredient for fertilizersAmmonia= 70-90% of production costs for fertilizer producersBefore the shale boom: US ammonia production shrank by 40% in the 2000sproduction moves overseesShale revolution created US boom in the industryCF industries increased three-fold$784 mill in 2009 $2.6 bill in 2011

Steel IndustryBenefit: increase in product demand = higher demand in drilling equipmentcheaper operating costs due to cheaper gas pricesUS Steel (largest US steelmaker) saw 17% increase in production of gas related productsby switching to NG from coal, steel manufacturers will experience lower electricity prices