Abundant Natural Gas Could Bring Big Changes to U.S. Energy Markets and Policy

The RFF Policy Commentary Series will take a brief break for the holidays and return in the new year. In this commentary, originally published in March 2010, RFF Nonresident Fellow Stephen Brown covers the economic and environmental implications of abundant shale gas in the United States. His insights remain timely given the ongoing public debate about shale gas development. You can keep up with RFF research on this issue by checking out a new project now underway at RFF’s Center for Energy Economics and Policy, which will identify the priority risks associated with the shale gas development process and recommend how government and industry can reduce those risks.

Over the past few years, the outlook for domestic natural gas markets has shifted dramatically. A few years ago, most forecasts showed the United States growing ever more dependent on imports of liquefied natural gas (LNG). Now, it seems likely that North America will grow increasingly self-sufficient in natural gas—even if new climate policy initiatives substantially broaden U.S. natural gas use.

The shifting outlook owes to substantial increases in estimated U.S. shale gas resources. Estimates of conventional natural gas resources remained steady while estimates of shale gas resources more than doubled from 2007 to 2009. Moreover, the cost of producing these shale gas resources has also dropped considerably.

More abundant U.S. natural gas could dramatically affect the composition of U.S. energy consumption, sharply reduce prices on global natural gas markets, and increase carbon dioxide (CO2) emissions, even as it reduces the costs of pursuing climate policy. Nonetheless, experience with shale gas production is limited, and more aggressive environmental controls could limit its production further. The resulting uncertainty suggests that climate policy should be designed in a way that is robust across different projected futures.

Advances in Technology Yield Greater Availability

The oil and gas industry has long been aware of the natural gas resources trapped in shale formations. Ranging 5000 to 10,000 feet below the surface, shale gas formations are characterized by a low permeability that  impedes the flow of natural gas out of the formation through the bore hole to the surface. To increase the flow and make production affordable, the permeability of the formation needs to be artificially increased. Old production techniques simply didn’t do enough in this regard, but new techniques do.

The most important technological advances are horizontal drilling and hydraulic fracturing. Horizontal drilling is accomplished by first drilling downward then turning to create a long horizontal bore through the underground structure holding natural gas. This horizontal bore hole increases exposure of the resource to an outward passage. Hydraulic fracturing—which is most commonly accomplished by forcing a combination of water, sand, and organic chemicals into the bore hole—further opens up the structure to increase flow of natural gas toward the horizontal bore hole.

Despite these advances, projections of future shale gas production remain highly uncertain. The industry has limited experience producing shale gas, and cannot yet well predict how resources in the ground translate into future production. The prospects for additional environmental regulation add to the potential uncertainty.

Environmental Concerns

Concerns about the environmental effects of some aspects of hydraulic fracturing could eventually restrict the production of natural gas from shale formations. Chief among the concerns are the organic chemicals used in hydraulic fracturing. If they are accidentally spilled or leak into ground water as the result of faulty preparation of the drill hole, the harm could be severe. Another concern is the volume of contaminated water returned from the process. In addition to the organic chemicals used in the process, the water picks up salts and other contaminants from its round trip to subterranean depths.

Currently, hydraulic fracturing is mostly regulated by state agencies, but EPA is taking steps toward registering and regulating the organic chemicals used in the process. Industry sources variously say that EPA regulation could have no effect, could slightly increase the cost of producing natural gas from shale formations, or could completely shut it down.

Awash in Natural Gas

Natural gas already plays an important role in U.S. energy use, and it is widely used throughout the economy. Ranking second only to oil, natural gas accounted for nearly 25 percent of total U.S. energy consumption in 2008. In contrast with oil and coal (the use of which are concentrated in transportation and electric power, respectively), natural gas is used across a variety of sectors in the U.S. economy. The industrial sector is the largest user, accounting for nearly 35 percent of total natural gas consumption. The electric power sector accounts for nearly 30 percent. The residential and commercial sectors account for 21 percent and 13 percent, respectively, and a small amount is used in the transportation sector.

Greater natural gas supplies will enhance considerably the fuel’s role in the U.S. energy mix. As might be expected, a larger supply yields lower projected natural gas prices and strong gains in U.S. natural gas consumption. My research with colleagues (see Further Reading) projects consumption to be nearly 11 percent above a baseline scenario in 2030. The biggest gain is in the electric power sector, which shows 22.5 percent greater use of natural gas, primarily as the result of the substitution of natural gas for other energy sources. Some of the gain comes from increased electricity use brought about by lower electricity prices.

We also find that increased natural gas supplies could put the United States in a position of being a net exporter of natural gas by 2030, rather than a net importer.  Between 2010 and 2030, U.S. natural gas imports would be substantially lower than previously projected. Even if the United States does not become a net exporter of natural gas, its reduced imports are already having profound effects on the global natural gas market.

Suppliers around the world had been gearing up to supply LNG to the United States—by developing new liquefaction facilities, export terminals, tankers, import terminals, and regasification facilities. But abundant supplies and depressed prices in the U.S. natural gas market have kept out and will keep out nearly all of that LNG from the United States. The world is now awash in LNG and projected to be so for some time. Natural gas producers worldwide are facing substantial pressure to reduce prices below those set in existing contracts indexed to crude oil prices.

Pursuing Climate Policy

At first glance, we might expect that more abundant natural gas would make it easier to reduce overall U.S. CO2 emissions because the emissions from natural gas are about 45 percent lower per Btu than coal and 30 percent lower than oil. Natural gas can displace coal fairly easily in electric power generation. It also might displace oil in industry and transportation if advancing technology were to further increase the substitution possibilities between natural gas and petroleum products.

But markets don’t always conform to our expectations. In the absence of federal regulation to reduce emissions, abundant natural gas supplies seem likely have little effect on such U.S. CO2 emissions. Lower natural gas prices push coal out of the way but also displace some zero-carbon (nuclear and renewable) electric power sources. In addition, complex market interactions reduce projected prices for other energy resources. The combined effect is to boost the projected energy consumption for 2030 by slightly more than 1 percent and the projected CO2 emissions by slightly less than 1 percent. With a federal policy in place to reduce CO2 emissions, however, abundant natural gas supplies moderately lower the cost of reducing CO2 emissions in the electric power sector.

Uncertainty and Climate Policy

Despite the increased estimates of shale gas resources, their likely production remains highly uncertain. The prospect of tighter environmental regulation adds further uncertainty.

Such uncertainty has important implications for climate policy. Climate policies that mandate the use of specific fuels or technologies require accurate predictions about future resource availability and technology change to be cost-effective. Policies that provide carbon pricing, such as cap-and-trade systems or carbon taxes, do not require such accurate predictions.

With pricing, market participants have an incentive to seek out the most cost-effective means for reducing CO2 emissions, which makes such policies robust across different projected scenarios. If natural gas is as abundant as recent estimates of shale gas resources suggest, the reliance on market-based climate polices will favor its use. If it proves less abundant, market-based policies will favor other means for reducing CO2 emissions.

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