High Prices Coming Down the Pipeline

(Valuable science perspective on a timely issue! – promoted by Sue Prent)

(Cross posted at minorheresies.com)

“Eventually, the politics of energy has to surrender to the physics of energy.” Randy Udall

Two pieces of news have come together in my mind recently. One is the Vermont Public Service Board approval of a new natural gas pipeline through Addison County. The other is a Wall Street Journal article about investments in shale gas production.

The PSB approval and pipeline story is straightforward. Vermont Gas, a subsidiary of Canadian Gaz Metro, is extending its pipeline from Chittenden County and the population center around Burlington southward through Addison County. Phase 2 of the project will have the pipeline cross the narrows of Lake Champlain and serve the Ticonderoga paper mill in New York. In theory, Phase 3 will bring natural gas to the city of Rutland around 2020.  

There are objections to the pipeline by many residents of Addison County, generally on two grounds: First, that this will encourage the use of hydrofractured (“fracked”) gas, which is controversial due to its threat to ground water and the general environment near drilling sites. Second, that it will detour us from the pursuit of renewable energy and energy efficiency. A number of people simply don’t want a natural gas pipeline on or near their land.

The proponents of the pipeline argue that it will bring cheap energy to western Vermont, with the resulting economic benefits. Phase 2, they say, will bring far cleaner, cheaper energy to the Ticonderoga plant, with resulting environmental and economic benefits.

A sidebar on shale gas production:

So-called conventional oil and gas generally reside in underground sandstone formations, like sponges made of rock. The oil and gas are in the holes in the sponge (porosity) and the holes are connected to some extent (permeability) so that the oil and/or gas can flow through the sponge, much the same way that water can soak through from one end of a sponge to the other. These conventional deposits can be miles across and hundreds of feet thick.

Shale oil and shale gas deposits can be described the same way, but with different measurements. A shale deposit might have one one-thousandth the porosity and permeability of a sandstone deposit. A shale formation like the Bakken in the northern Midwest covers thousands of square miles but is only ten to maybe 150 feet thick. To imagine the scale, picture a layer of plastic wrap over a couple of football fields. This distribution means two things. One is that there is a lot less energy per horizontal acre in a shale field. The other is that the oil and gas won’t travel from one part of the field to another without a lot of help.

Horizontal drilling is the process of controlling the drill bit so that after going straight down it curves sideways and follows the thin shale formation. Drillers make a number of these horizontal boreholes out from a central drilling point in order to get access to a large area of shale.

Hydrofracturing is the process of injecting a mixture of water, chemicals, and then sand at extremely high pressures to blast open the cracks and pores in the shale. The sand is a “proppant”, keeping the blasted shale from collapsing back on itself. These two operations are an expensive proposition.

A horizontally drilled, hydrofractured well has a relatively short productive life. After a massive initial rush of production, output could drop by 40-50% in the first year. It might drop another 30-40% in the second year, and 20% or more in the third. The key to maintaining production levels is drilling intensity – quickly drilling more wells to replace declining ones. This is also an expensive proposition.

Investor Flight

The Wall Street Journal Article (paywalled), as quoted in the ASPO-USA Peak Oil Review (http://us6.campaign-archive2.com/?u=e230969c7ec1dec75cc347eaf&id=d61ea0ac6b&e=7b1d4340e6), casts doubt on the cheap energy claim by Vermont Gas. There has been a huge rush into shale gas drilling over the past decade. With that rush came a huge rush of natural gas, driving the price down to the historic lows of the past few years. Those low prices, bottoming out below $2 per thousand cubic feet (Mcf), were below the cost of production. Shale gas exploration companies lost tens of billions annually. As far as I can tell each company’s strategy was to hold on to the mineral leases and produce at a loss until their competitors went out of business. Then the remaining companies could clean up as supply declined and gas prices rose. The industry has been running on continued injections of investor cash.

Recently the investors have been getting cold feet. Here’s the key quotation from the WSJ article:

  “Since 2008, deep-pocketed foreign investors have subsidized the U.S. energy boom, as oil and gas companies spent far more money on leasing and drilling than they made selling crude and natural gas. But the rivers of foreign cash are running dry for U.S. drillers. In 2013, international companies spent $3.4 billion for stakes in U.S. shale-rock formations, less than half of what they invested in 2012 and a tenth of their spending in 2011, according to data from IHS Herold, a research and consulting firm. It is a sign of leaner times for the cash-hungry companies that have revived American energy output. The value of deals involving U.S. energy producers plunged 48% this year from 2012, to $47 billion, the first annual decline since 2008. So U.S. oil and gas producers have started to slash spending.”

                             — (The Wall Street Journal, Jan 2)

Remember that the key to low prices is continued high production and the key to continued high production is drilling intensity. The key to drilling intensity is investment, and that is going away, dropping by a factor of ten in just two years. Investment will only come back when the price of natural gas rises enough to make shale production profitable. Industry analysts argue endlessly about what the breakeven price of shale gas is for various fields, but my general takeaway is that it could mean a doubling of wholesale prices.

Back in Vermont, the residents and businesses of Chittenden, Addison, and Rutland Counties are being promised a bounty of cheap natural gas. The geology of shale gas dictates the economics, and the economics, via investor flight, indicates that this is a false promise. Just about the time that consumers find themselves hooked up to the pipeline and paying for their new appliances the price will start heading for a profitable range. The politics of energy will surrender to the physics of energy before Rutland ever sees a cubic foot of natural gas.

4 thoughts on “High Prices Coming Down the Pipeline

  1. I’m curious about the extent to which the Public Service Board considered future prices and what VT Gas said about the issue.

  2. This post makes a very important point: there are laws of physics that govern energy production and that then strongly influence the economics of energy. When the politics of energy gets detached from those fundamentals, the resulting policies are unlikely to work.

    What I see in Montpelier is that politics dominates all policy-making, and the resulting policies often do not work well since they are not based on the fundamental realities of the issue.

    Geology and economics always bite back.

    Rep. Cynthia Browning, Arlington

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