by Geoffrey Styles, Managing Director  of GSW Strategy Group

The sudden abundance of natural gas in the US triggered a startling divergence of crude oil and natural gas prices that, in turn, has energized the advocates of using more gas in transportation.  Yet despite the availability of wholesale natural gas at less than $0.60 per gasoline gallon equivalent (GGE), and with retail compressed natural gas (CNG) prices under $2.00/GGE in many locations, natural gas accounted for less than 3% of US transportation energy consumption in 2011--most of it attributable to pipeline compressors.  The picture is very different in countries like Italy and Pakistan, where CNG has a significant market share in motor fuels.  As the US looks ahead to greater reliance on secure domestic gas for road transport, it's worth considering why other countries have such a big head start.

The obstacles to greater market penetration by natural gas in transportation are well known.  CNG and LNG (liquefied natural gas) require new infrastructure.  Many more retail gas facilities would be needed to assure motorists of convenient access  at service stations. CNG takes a separate dispenser and compressor, while LNG requires both a new pump and insulated storage.  Where pipeline gas is unavailable, such as in parts of the northeast, additional investments in the local "gas grid" may also be necessary.  

Vehicle conversion costs represent another significant barrier. Engine modifications and crash-resistant fuel tanks add significant costs for both new vehicles and retrofits.  Even with gas priced well below gasoline or diesel fuel, the payback for these costs can be lengthy.  That's one reason that gas has made greater strides in bus, truck and delivery fleets in the US than for personal cars, since the more intensive use of such vehicles substantially shortens the resulting payout periods.  Countries with high gas-vehicle penetration typically have government policies and incentives in place to promote the use of gas by mitigating these obstacles.

Italy leads the EU in CNG vehicle adoption, with more than 11% of new passenger cars equipped for natural gas last year.  That compares to 0.01% for the US in 2012, where only one CNG model, a Honda, was sold.  The Italian government promotes natural gas use in vehicles both directly and indirectly.  The country provides a subsidy of €700 ($945) to purchasers of CNG automobiles, while manufacturers like Fiat offer discounts to expand their market for CNG cars.  Incentives were even larger a few years ago. The government also makes retail petroleum products extraordinarily expensive with high taxes. So even though Italy is a large net importer of natural gas, CNG is much cheaper than gasoline or diesel at the pump.

Fuel availability may also have something to do with the disparity in adoption rates. Despite having an 83% smaller overall vehicle population , Italy has over 40% more CNG or "Autogas" refueling stations than the entire US, at around 900.  This is due in part to state-level incentives, with 50-70% of the cost of a new CNG filling station reimbursed by regions such as Liguria, Lombardy, and Piemonte.

In terms of market penetration, Pakistan, which is self-sufficient in gas, leads the world in natural gas vehicles, at 80%.  That translates into over 2 million CNG vehicles, the result of a determined effort on the part of the government to reduce imports of petroleum by shifting to domestic fuels, with gas as its best option.  This is a common theme in the non-oil-exporting developing world, where oil imports impose a large drag on national trade balances.  CNG use in Iran is even higher than in Pakistan, as an unintended consequence of protracted international sanctions. 

For the US, where oil production is increasing and oil imports declining, a shift to natural gas for transportation is likely to remain an opportunity, rather than a matter of necessity.  The "NATGAS Act", a bill proposing incentives for CNG and LNG along the lines of the Italian model has languished in the US Congress for several years.  It remains to be seen whether this will become a higher priority in the newly elected Congress, which has shown early signs of interest in breaking the recent logjam on energy legislation. 

In the meantime, adoption of natural gas vehicles in the US will proceed based on market forces, supported by a small advantage in the way CNG cars are counted in manufacturers' fleets under the stringent federal fuel economy regulations issued last summer.  That could lead to natural gas fueling 3% of US vehicles --mostly trucks--by 2020, based on the analysis of a partner at McKinsey & Co.  Much like the case for energy efficiency investments, the available savings indicate a much larger potential, but funds for CNG/LNG transport must compete with other priorities.

by Geoffrey Styles, Managing Director  of GSW Strategy Group

2012 was a remarkable year for energy in the US, with domestic output of oil, gas, wind and solar energy all advancing strongly.  This was the result of an unfolding revolution in unconventional oil and gas, along with federal, state and local incentives and regulations promoting renewable energy.  Yet despite extensive media coverage and vocal constituencies for each of these energy sources, I haven't seen any recent efforts to compare their respective contributions to US energy supplies. 

That may be due in part to the confusing array of energy units involved. It's daunting to match up oil in 42-gallon barrels (bbl), gas in cubic feet or British Thermal Units (BTUs), and wind and solar in kilowatts (kW) or Megawatts (MW) of capacity, or kilowatt-hours (kWh) or Megawatt-hours (MWh) of actual generation.  Conversion factors among these various units are easy to find on the internet.  However,  meaningful comparisons are complicated by important distinctions between liquid or gaseous fuels and grid electricity, and the fact that these energy sources compete with each other only in specific situations. 

For purposes of comparison, since wind and solar routinely compete with gas-fired generation, let's assume that the output of wind turbines and solar panels can be equated to the power from a natural gas turbine with an effective heat rate of 7,000 BTU/kWh.  That recognizes the efficiency losses in fossil generation and the premium value of electricity to end users.  Gas and gas-equivalent renewables can be further equated to oil using the standard conversion factor of 5.8 million BTU/bbl.  So even though wind and solar rarely compete with oil in the real world, because less than 0.6% of US electricity is now generated from petroleum products or byproducts, we can still assess their relative contributions to America's energy economy in familiar terms.  Please note that Energy Information Agency (EIA) data on production and generation for the full year won't be available for a few months, so the figures below are based on published data for the most recent 12-month periods.

Natural gas posted the biggest gain last year, with "marketed gas production", including gas liquids like ethane, propane and butane, growing by 1.57 trillion cubic feet for the 12 months ending in October 2012, compared to the same period a year earlier.  That's equivalent to adding at least 750,000 bbl/day of oil.  US gas production appears to have set an all-time record last October.

Oil production also grew rapidly in 2012, as noted several times in the presidential campaign and debates. Thanks to surging tight oil (shale oil) production in North Dakota, Texas, and elsewhere, US crude oil output increased by 710,000 bbl/day on a November-October basis.  In fact, October's production of 6.82 million bbl/day was the highest for any month since December 1993.  Recent production looks even higher.

Although final installation data aren't in yet, wind power also had a banner year, with developers on track to install between 11,000 and 12,000 MW of new capacity in the US.   Much of this growth was attributable to companies accelerating projects in anticipation of the scheduled December 31, 2012 expiration of the federal Production Tax Credit, or PTC, the main US tax incentive for wind energy. As it turned out, the Congress extended the PTC for another year as part of the recent "fiscal cliff" deal. On the basis of the most recent 12-month comparisons from the EIA, US wind farms generated 21.6 million MWh more last year than the previous year.  That equates to 150 billion cubic feet (BCF) of natural gas, or around 71,000 bbl/day of oil.

That brings us to solar, which was on pace to set a record of around 3,200 MW of new installations in the US in 2012.  On a November-October basis new solar panels added roughly 2.3 million MWh of reported generation last year, equivalent to 16 BCF of gas or 7,600 bbl/day of oil. This probably doesn't capture the contribution of all grid-independent installations, but it's unlikely to be off by more than a factor of 2.

Although the above chart shows that wind and solar power have a long way to go, both have earned credibility by advancing to the point of being measurable on the same scale as oil and gas.  Both contribute to reducing emissions. At the same time, the significance of developments in US unconventional hydrocarbons leaps off the page.  In just the last year, for the second year in a row, shale gas has added domestic energy production equivalent to the entire current output of all US non-hydro renewable electricity generation: wind, solar, geothermal, biomass and waste power. Tight oil added a like amount in 2012.  We're clearly in the midst of an energy transformation, but it doesn't much resemble the one that was anticipated just a few years ago.   

Lately, I have been receiving a large number of articles denying that peak oil will ever occur. The two topics that are almost always cited are the prevalence of shale oil and that oil is abiogenically sourced. These topics are actually diametrically opposed to each other which make for an interesting discussion topic. The first theory allows for human ingenuity to overcome a decade’s long problem of decreasing US oil production. The second theory claims that the world will never run out of oil due to oil not being produced through biological means and that the Earth will naturally recharge all the oil we use.

 The New York Times recently reported that the US will become the top oil producer in the world by 2017 and will even be a net energy exporter in 2030. There is no doubt that US shale oil production has been a game changer. Note in the chart below provided by the EIA how dramatic US oil production has increased over the last two years, reversing a decline present over the last 20 years.  The question is will shale oil solve all of our world petroleum problems for years to come? The first issue is to understand the differences in how shale oil vs. abiogenic oil works.

The theory of shale oil production is that petroleum is derived from ancient organic materials, such as algae, that were preserved in anoxic conditions where bacteria couldn’t destroy them. These organic materials were then buried deep into the Earth over tens of millions of years along with sedimentary rock debris. As a result of increased pressure and temperature, the organic material was converted into oil, gas, and coal. These organic rich sedimentary rock beds became the “source rock” for almost all of the migrated oil and gas into conventional oil and gas fields discovered over the last 100 years. Shale oil production came into play when someone made the decision that it would be an intelligent idea to drill the source beds which sourced all of the conventional fields and put massive hydraulic fractures on them, realizing that a lot of the oil in them had never escaped. Clearly, this idea has functioned pretty well. The chief reason why the chart above looks like it does is because of this theory of petroleum production. It has also been shown that you can generate oil from algae to make bio diesel. This is one of the most exciting newest forms of alternative energy.

Abiogenic oil proposes that oil and gas is produced from natural non biological processes from the center of the Earth and its mantle. This theory was developed chiefly by scientists in the Soviet Union. The articles I have recently read that have led to a resurgence of this theory are related to the discovery of lakes of liquid methane and methane rain on Titan (a moon of Saturn where the temperature is -180 degrees Celsius). Most of the hydrocarbons found seem to be simple ones such as ethane and methane and not complex hydrocarbons such as the ones found in oil. Although this does lead some credence to the theory that oil can be produced abiogenically, it does not account for the bulk of oil and gas deposits on Earth. Additionally, there have yet to be any significant discoveries of fields drilled based on this theory nor have there been examples of significant recharging of any oil reservoirs in the world. Even if the Earth was generating hydrocarbons, the mechanism would be very slow and wouldn’t have an appreciable effect compared to the rate we withdraw oil from the Earth currently. More importantly, if this was a main mechanism for hydrocarbon generation, we would not have such unbelievable success in drilling shale oil source beds.

Given that oil reservoirs aren’t replenishing anytime soon and we don’t have to deal with “methane rain” here on Earth, will shale oil resolve peak oil? There is no doubt that there are vast reserves throughout the world to tap of this resource. Currently, only the US and Canada have the technology to commercially exploit this resource to the degree needed to change the natural decline profile of the last 20 years.  However, there is no reason why other countries can’t learn from the US and start producing their own source rocks. The question is at what price point will oil become too expensive for oil production to keep growing? The marginal cost of adding additional oil production in the US to replace and increase our current supply is now over $70 a barrel with some sources even saying up to $92 a barrel.  This number is going to continue to increase since drilling horizontal wells is expensive and cheaper sources of oil are going to deplete over time.  As we replace cheaper OPEC oil with more expensive and technologically driven oil production, global commodity prices will have to respond by increasing the base price of oil. So in conclusion, the real issue isn’t peak oil. I think we have plenty of oil for years to come. The question is what is the peak price of oil before some alternative is cheaper?