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The New York Times Says Shale Gas is a Giant Ponzi Scheme. Erm, No.

By: Steve Maley (Diary)  |  June 28th, 2011 at 11:59 PM  | 

RESIZE: AAA

The New York Times really hates natural gas. Just in the last year, the Times has run scaremongering articles on the dangers of hydrofracking and Gasland-inspired tales of groundwater contamination in the “shale plays”, the unconventional sources of natural gas that have redefined domestic gas supply withing the last decade. On Sunday, the paper drifted into unfamiliar and inhospitable territory: petroleum economics.

The Times published a pile of Assange-style emails from unnamed “industry insiders”, most expressing skepticism about the economic viability of natural gas from shale.

Natural gas companies have been placing enormous bets on the wells they are drilling, saying they will deliver big profits and provide a vast new source of energy for the United States.

But the gas may not be as easy and cheap to extract from shale formations deep underground as the companies are saying, according to hundreds of industry e-mails and internal documents and an analysis of data from thousands of wells.

The articles features quotes which characterize the shale plays as “inherently unprofitable” and “giant Ponzi schemes”. (My personal favorite email, however, belongs in the “scare quote” Hall of Fame — see p.5.)

This, from The New York Times Company (NYT), which has managed to turn each $1,000 of investor value into $160 over the last 10 years. Ahhh, sweet irony.

One can imagine that the effort to pooh-pooh gas is intended to boost “green” alternatives like ethanol and wind energy. But both rely on gas (for processing and fertilizing corn ethanol, and as a conventional backup for unreliable wind) and on constant infusions of tax credits. Those, my friends, are “inherently unprofitable” technologies.

Now, having said that, it may come as a surprise to you that I am something of a shale gas skeptic. I am not the least surprised by some of the opinions expressed in the Times’ emails, and I have probably said some of the same things myself in private correspondence. From my Redstate diary dated 5/18/11:

Left to its own devices, the oil industry is its own worst enemy. Relatively low barriers to entry have made the industry freely competitive. The reward goes to the quickest and the most efficient companies…

The best current example of this free market dynamic in action is in the active shale gas plays across the country. Success of new technologies has led to a glut of natural gas on the market; for the consumer, this means plentiful supplies of [natural] gas, and stable [wellhead] prices in the range of $4.00 to $4.50 per million BTU, about a quarter of the current cost of an oil BTU. Many observers consider the current market prices of gas lower than the average cost of finding and developing that gas, suggesting a long-term unsustainable business model for the “average” company. Ultimately, the survivors will be the companies who can be significantly better than the average, through better efficiency, better technology or better business savvy.

The consumer gets gas at the lowest possible price because capital, presuming higher future prices, oversupplied the market. Supply goes up, prices come down. Econ 101. [Emphasis in original.]

Evidence for that assertion is provided by the following graph, which depicts eleven years of oil and gas price history. Oil and gas traded roughly in proportion with their respective energy content in 2004 (1 barrel ~ 6 million (MM) btu). For a brief time in 2006, gas was even more expensive than oil on an energy basis. With the advent of shale gas, the curves began to diverge, to the point that a historically wide gap has developed between the two fuels. One MMbtu of gas fetches $4.00 and change at the wellhead, roughly the equivalent of a $25 barrel of oil.

Monthly History of U.S. Oil and Gas Prices, 2000 - 2011. Modified from, and used by permission of the Ryder Scott Company, Petroleum Consultants.

My company is not a shale gas player. Part of the reason is that it is known to be a high cost play. Reserves are uncertain, and an economic return is highly dependent of future gas prices.

Paradoxically, the large volumes of gas being produced in the shale plays is depressing gas prices, which in turn depresses financial returns.

The market will regulate prices and financial returns. If and when natural gas prices rise, the owners of reserves in the ground will profit handsomely; there’s lots of gas down there. The only way to share in that prospective upside is to be a participant.

Just last year, ExxonMobil spent $42 billion to buy a large independent gas producer, primarily for their shale gas expertise and acreage. Many analysts are skeptical of the wisdom of the purchase, but a lot of money has been lost over the years betting against Exxon. They didn’t get to be the world’s largest commercial enterprise by being a bunch of dummies.

Thomas Edison favored DC over AC for electrical power. Albert Einstein refused to embrace quantum mechanics. Plenty of smart people thought the internet was a fad.

New technologies come along all the time. Early adopters take substantial risk of failure, and many lose their money. They have loads of detractors along the way. The detractors may be right. But if the technology works, the reward goes to the participants who are luckier, smarter or better managers than the rest. And that’s as it should be.

By the way — 25% of the nation’s natural gas supply comes from shales, up from just a couple of percent ten years ago. Some fad.

Cross-posted at stevemaley.com.


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COMMENTS

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  • Adjoran

    if you are unsure what to think on an issue, check the NYT position, and take the opposite side. It’s an extremely accurate system.

  • zooboy

    Mr. Maley,
    Thank you for sharing an insider’s knowledge to cut through the hype and baloney. Since shale gas is likely to keep the gas-price-per-BTU at a low level compared to oil, why aren’t the car makers making vehicles that run on natural gas, instead of wasting effort on Volts, Leafs, and oil-electric hybrids?

    • http://stevemaley.com Steve Maley

      The large independent gas companies are building fueling stations at least in TX, OK and LA. Eventually the infrastructure will be built out.

      • gmscan

        But the distribution system already exists in most of the country in the form of natural gas lines. It should not be a big deal for a filling station to add a natural gas pump — IF the cars existed. There is a huge small business opportunity in converting existing vehicles.

    • whatconstitution

      Just think of all the govt tax incentives that you are paying for in taxes, that is why they are producing Leafs and Volts. It is also a bit of a chicken and egg thing. Chesapeake Energy has partnered with OnCueExpress gas stations to install CNG refueling stations across the state of Oklahoma so that they can convert their fleet of field vehicles over to CNG.

      • dennism

        CNG station is about a mile from my house (Oklahoma). $1.39 a gallon. A gallon of CNG may not be equivalent to a gallon of gasoline… I just don’t know.

        • juumanistra

          This is because how much natural gas you can fit into a given container varies by its compression: Native, uncompressed natural gas has an energy density of <1MJ/L while at rates of greater than 10,000 PSI one starts to get energy densities that are not scoffed at by gasoline. Assuming that OnCue is using a compression rate that's sane, you're looking at CNG still having an energy density of somewhere in the neighborhood of a third of that of gasoline.

          Which means, for our purposes, you need three times as much CNG to travel the same distance as you would in a regular, gasoline-powered vehicle. So that $1.39/gallon for CNG works out to $4.17/gallon of gasoline-equivalent.

    • juumanistra

      Energy density, of course, being the amount of energy that is contained per given unit of volume or mass. To consult a handy graphic:
      http://upload.wikimedia.org/wikipedia/commons/c/c6/Energy_density.svg

      Of concern is volumetric energy density, measured in megajoules per liter on the X-axis, where gasoline tips the scales at ~34MJ/L. Natural gas in its native form has a sufficiently paltry energy density that it is effectively a rounding error as far as the table is concerned, while CNG at 250 bars is a mere ~9.5MJ/L. This markedly inferior energy density mandates that, in order for a vehicle to have comparable range to a gasoline-powered system, the size of the fuel tank must be 3-3.5x larger, all other things being equal. (Which they are most probably not, as the fuel tank will have to built far more rigorously than in a normal, gasoline-powered vehicles, as containing something under ~3,600 PSI is no mean feat.) Given all of the design constraints modern vehicles are under, this increased fuel storage usually comes out truck space and rear seating.

      In light of such, it’s not exactly surprising that CNG’s not caught fire with car drivers. And which is why it probably never will, because barring the invention of some manner of phlebtonium that allows for compression at rates sufficient to bring the energy density up to gasoline without also massively increasing the weight of the fuel tank, the energy density problem cannot be solved.

      • blownawayin5

        I have it on good authority that as of next week, Ohio will lead the nation in having the most high pressure CNG refueling stations. It’s clean, abundant, and American. What’s not to like???

        • juumanistra

          CNG is still, at base, a combusting fuel that releases various byproducts of its burning into the atmosphere: True, it is cleaner burning than gasoline, but it’s by no means truly clean. (The only truly clean end-use power sources for automobiles are electricity and hydrogen fuel cells, both of which have more than their fair shares of technical and economic problems to overcome.)

          And, as said above, CNG’s inferior energy density imposes very real quality-of-life downgrades upon drivers: Compare, for instance, the Honda Civic GX, which is the fleet’s natural gas-burner, with its stock model and note the halving of truck space in the former. Now then, that may or may not be an issue for you, or for the bulk of the car buying public. (Though I believe it will certainly be such for the latter.) My point remains that CNG as a motor fuel has rather substantive flaws, and no matter how much economic nationalism you invest into it, such will not change any time soon.

          • romeg

            is via LNG. That can be done with a residential liquifaction unit that is very similar in design to your home’s HVAC compressor/condenser system. It would require that you have a NatGas service at your house.

            Perhaps Steve can enlighten his readers on the technology

          • juumanistra

            The problems with liquid methane as a motor fuel are myriad, starting first and foremost with the task of rendering the fuel tank safe in the event of an accident: Major engineering work will be required in order to produce a fuel tank that will retain its structural integrity in the event of an accident. (As the phase change, in the event that the fuel tank is ruptured, is liable to be violent enough to be explosive. And that’s before things start catching on fire from the plume of rising methane.)

            To say nothing of the fact that liquid methane is [i]dangerous[/i] to handle. At -260 degrees F, it’s the sort of thing that really is best left to professionals, given that even minor accidents handling the fuel risk serious injury and the real potential of an explosion. These problems are magnified even more so if you want the fueling station to be located in someone’s garage, as it moves all of the risks of an industrial accident into the home of John Q. Citizen.

            Even assuming you can overcome the obstacles above, you’ve still got the issue of having to keep the liquid methane at -260 degrees. Barring some manner of lightweight phlebtonium that allows it to remain liquified for prolonged periods of time without any energy inputs without greatly increasing vehicle mass, you’re looking at having to build out some kind of new infrastructure in parking lots to support plugging in and keeping your liquid methane from boiling off. (And it wouldn’t be as simple as simply “plugging in”, either. Because this wasn’t already complicated enough!)

            And for all of those problems, you get a fuel that has a volumetric energy density which is inferior to straight ethanol, to say nothing of gasoline. LNG is just too much risk for too little reward in the grand scheme of things.

      • http://stevemaley.com Steve Maley

        Natural gas is priced for retail sale, if I understand correctly, in “gallons of gasoline equivalent” (GGE). It is intended to be an apples to apples comparison, and at current rates is about half the price of gasoline (about $1.63/GGE).

        It is extremely clean burning. There are virtually no impurities to gunk up an engine. And the CO2 emissions of gasoline are 24% more than NG, if that sort of thing matters to you.

        The main technical drawback is the tradeoff between the size of the tank & range. That, and the current lack of a distribution system that compares with gasoline. Retail sales are at high pressure and take about as long as refueling with gasoline. There are home refueling stations that can be installed, but refueling is an overnight process.

        • juumanistra

          If I wanted to spread disinformation, I’d fall back on the tried-and-true saw that fracking contaminates groundwater sources with carcinogens and chemicals that make you gay if you ingest them. One can still be factually mistaken without promoting disinformation, can’t they? Or have we become so balkanized in our energy policy preferences that anybody not towing the line is, ipso facto, a tool of the enemy?

          Re: CNG prices at the pump, I stand corrected. Though what I said re: CNG burning remains true: I will add that, by the definition of cleanliness being implied by my previous post, even hydrogen fuel cells are not completely clean, as they have emissions from their tailpipes. (True, the emissions are just H2O, but what’s the point of making a pedantic point and then not going all-in on the pedantry?)

          CNG tank size, and its range trade-offs, are the byproducts of its innate energy density problem: As said, barring some kind of unforeseen materials science innovation that allows you to crank the compression up without increasing the size or weight of the tank, these issues will dog CNG until the cows come home. I do concur that the distribution system will solve itself with due time, and…you know what? Fueling time never even crossed my mind as a potential issue: Given what industrial compressors can do, and do without risking life-and-limb of the fueling party, never occurred that there might be a problem with the length of time required to compress the CNG into the vehicle’s tank. Good to see that the developing fueling infrastructure has already taken care of it, though.

  • vitalis

    I always remember Rush’s saying “Gee, that’s amazing, I wonder if it’s true?”
    Not knowing anything about the economics of fracking, I was almost taken in by the article. Then I came to the part where they admitted that fracked gas had gone from 2% to 25% of total gas in the last ten years. Yeah, fracking is a flash in the pan alright. Just like the NYT to stake out their own version of reality in the first few paragraphs, then bury the truth that puts a lie to their whole thesis at the end of the story.

    • http://stevemaley.com Steve Maley

      …the average investor will suffer poor financial returns, although some may do quite well. Still a better deal than NYT stock, IMHO.

      The landowners have 12.5% to 25% of revenue cost-free: many are already millionaires. You don’t hear that story much.

      Tax coffers benefit from royalties, severance & ad valorem taxes, income taxes, sales taxes, etc.

      Then there’s hundreds of thousands of jobs.

      It’s a 100% domestic fuel source. All the risk is on the greedy capitalist investor. What’s not to like?

      • The_Gadfly

        before it became apparent how effective the technology is will make money, and all the johnny-come-latelys who got in on the tail end when prices had moved beyond realistic limits will lose. Which is pretty much always the case for anybody looking to make a quick and easy buck.

  • SoFiMil

    Social Security? Now *there’s* a ponzi scheme.

    And since when is the NYT so concerned about the economic vitality of ‘lil shale or any non-government subsidized company? I’d think if anything the Times would be thrilled that bad-shale is investing in such a “risky scheme” that they will undoubtably lose everything.