“by early next century, natural gas will have become more of an energy problem than an energy solution”.

Subsequent events have provided ample support for Riva’s grim assessment: (1) domestic NG production only reached 19.7 tcf in 2004 despite an additional 461 rigs in the field—an 82 % increase over 1997; (2) NG well head prices have steadily escalated from $2.10 mcf in 1998 to $ 6.31 mcf in the first four months of 2005 – an increase of $ 4.21 ( 200 %); and (3) chief U.S. policy makers (e.g., Alan Greenspan) now readily admit the nation cannot meet its NG supply needs and will be increasingly reliant on imports from politically unstable areas – darkly paralleling our current dependence on foreign areas and the entailing socioeconomic costs.

In essence, Riva’s foretelling is coming to pass. The present paper takes his concerns as a point of departure to delineate a range of reasons as to how unless the United States begins to take the NG supply / demand situation more seriously, NG is likely to move from the role of energy boon to national liability.

THE SPECTER OF DEMAND SHOCK

Given the status of NG as the cleanest of the fossil fuels, a confluence of environmental regulations, efficiency of combustion and simple convenience has led to an unprecedented build-out of the NG demand infrastructure – particularly through massive construction programs for power plants and new single family homes. Yet, despite this increased dependence on NG to supply electricity and heat our buildings, the casual observer of business news would be hard pressed to find a systematic discussion of the commodity. The price of oil has its own ticker on television business networks but NG may or may not be mentioned in a given day. As a result of this benign neglect there is only dawning recognition that a shortfall of NG may soon reverberate throughout the socioeconomic system – harkening back to the 1970’s with the closing of schools and businesses in the dead of winter, reducing manufacturing production and leaving millions of homeowners wondering how they are going to pay their heating bill.

The stunning realization of the NG problem, however, is only a sustained heat wave, hurricane, frigid January, coal strike or nuclear shut-down away. And when that day comes the U.S. will come face to face with a series of NG demand issues looming ever larger on the horizon:

(1) Construction of NG heated homes – throughout the 1970’s and 80’s electricity was the preferred space heating source for newly constructed single family homes. In 1979, for example, 51% of new homes were heated with electricity as opposed to only 39% with NG. Over the past decade, however, NG has clearly become the fuel of choice in 70% of new homes with electricity dropping to 27%. In fact, over the period 2001-2004 over 3.3 million new homes heating with NG have come on line – over 70,000 per month. Further, the construction of new homes is hardly slowing as the most recent housing data indicate that single family homes heating with NG are growing at an annualized rate of over 1.1 million. Finally, these homes are being constructed in regions with harsher winters .The latest American Gas Association data indicate 92% of new homes in the Midwest heat with NG as opposed to only 48% in the South.

(2) Construction of NG fired power plants. The NG shortages of the 1970’s prompted the passage of the 1978 Fuel Use Act (FUA) effectively banning NG fired electric power plants as well as the use of NG in large industrial boilers. These restrictions on NG consumption led to a substantial decline in demand and the eventual formation of a supply “bubble” – which in turn resulted in chronically low NG prices (See EIA, 2005). In 1987 much of the FUA was repealed setting off a surge in the construction of NG power plants. Indeed, NG consumption for electric generation rose from 2,636 bcf in 1988 to 5,352 bcf in 2004 (a 103 % increase). In fact, since the 1990s virtually all new power plants have been NG units in an historic departure from the traditional fuel diversification strategy of electric utilities:

In essence, in just five years we have added over 200,000 MW of NG facilities to the electric power system in the United States – the functional equivalent of 245 Calvert Cliffs Nuclear Units (825 MWe). And the NG beat goes on – in April, Florida Power and Light announced the addition of a new 1,100 MW combined cycle plant at Manatee; in May, Calpine placed a 500 MW unit in operation at Pastoria in California and this summer, utilities in Wisconsin will add almost 1,300 NG fired MW to the grid. Finally, and somewhat amazingly, the EIA projects that over the period 2005 – 2007 we will build an additional 83,000 MW of power stations – of which 73,000 (88%) will be NG fueled.

(3) Organic Demand Growth

The population of the United States increases by one person every 12 seconds – or 2.6 million per year. In April of 2005 there were about 650 thousand homes under construction which will heat with NG. Thousands of MWs of new NG fired turbines are being constructed or are in the planning stage. The OMB projects the economy of the United States will grow by over three percent each of the next five years. Each year thousands of cars, trucks and busses join the NG fleet. Stores, swimming pools, apartments, agricultural buildings and many other NG dependent facilities are constructed throughout the Country every single day.

The EIA has projected NG consumption growth along these lines:

This relentless pressure from natural increase provides a chronic dynamic of demand growth complementing the potential acute demand from weather or alternative fuel problems.

(4) Supply constraints on other fuels for electricity

The United States is the most electric intensive nation in the world. Demand for electricity has steadily increased over the past half century and that growth has accelerated over the last 15 years. In 1991, for example, the U.S consumed about 2,762 billion kilowatt hours (kwh) of electricity. By 2004 demand reached 3,550 billion or an increase of 29%. Coal provided half of this electricity, nuclear 20% and NG 17 %.

Further, the demand for electricity is projected to increase steadily for the foreseeable future. The EIA has projected that 2005-2006 will see a demand increase of 189 billion kwh. To put the magnitude of this bi-annual increase in perspective, an 825 MWe nuclear power plant such as Calvert Cliffs 1 generates about 7.5 billion kwh in a year – or about 4 % of what must be added in 2005/2006 alone – thus, necessitating the construction of the equivalent of over 25 such nuclear power plants (compared to an existing nuclear fleet of 103).

Virtually all of the recent growth in electricity demand , as well as forecasted growth , has been, and must be, met by NG. The construction of NG power plants dominates the electric power situation in the United States.

In essence then, for the entire decade, new capacity for coal, nuclear, hydro and all other fuels combined will have provided only seven percent of all new power plants – dramatically highlighting the Nation’s increasing dependence upon NG. Further, each of these alternative fuels has sufficient problems to question whether they can meet even that meager expectation.

Coal provides about half of our electricity but is faced with (a) stringent environmental regulations, (b) transportation constraints and (c) questions about expanded production. The EIA, for example, has projected that coal production would expand 53 million short tons in 2005 versus 2004 – an increase of 4.7%. Year to date output, however, reveals that production in 2005 has actually decreased sequentially by 489,000 short tons or 0.1%.

In terms of nuclear power, the 103 existing stations are already operating near maximum capacity (94%) despite their aging status (most over 25 years). The lead time to build a nuclear plant would take us well into the next decade. And in regard to hydroelectric, drought conditions in the western U.S. make each year a touch and go situation. This year, for example, the snowpack melt peaked in late May and rivers in Washington are currently running below normal. Further, not only is there environmental opposition to new hydro facilities but even the relicensing of existing units faces intense scrutiny. Finally, as of this writing, oil is over $60 per barrel. Clearly, the degrees of freedom for fuel switching away from NG to meet incremental , indeed, even existing , electricity demand are quite limited.

THE EMERGING SHORTFALL OF NG SUPPLY

In 2004 the United States consumed 22,424 bcf of NG – virtually all of which came from one of three sources – (1) domestic production [82%], (2) imports from Canada [15%], and (3) imported LNG [3%]. Further, the EIA has projected steady demand increase with consumption rising to 25,433 bcf in 2010 and 29,952 in 2020. Given the increasing demand for NG, continued – and expanded – supply from the three primary sources delineated above is essential to meet growing demand.

Unfortunately, significant and alarming problems with each of these sources threaten to substantially curtail supply and thereby contribute an emerging shortfall of NG. Consider, for instance, in 2004 only three regions accounted for 58% of the U.S. NG supplies – the Federal Gulf of Mexico (18%), Texas (24%), and Canada (16%).

(1) Declining Production in the Gulf of Mexico

In 2000 the Federal Gulf of Mexico (GOM) accounted for 24 % of NG production in the United States. Depletion and the exodus of major oil companies, however, have taken a toll:

As these data indicate, production in the GOM declined steadily over 2001-2004 by 889 bcf or 18 % and by 2004 the GOM accounted for only 20% of U.S. production. Further, data from January, 2005 indicate this decline is continuing as a further 17 bcf (5%) Ivan adjusted drop occurred relative to January, 2004. And, given the recent drilling patterns in the GOM, it is likely this decline will continue. In 2001 there were 153 rigs drilling in the GOM, by 2003 that number had decreased to 108 – and last week it had slipped to 95.

(2) Stagnation in Texas

Texas has been a mainstay of NG production in the United States and in 2004 accounted for 27% of output. But there are real indications that the relentless nature of depletion is beginning to take a toll on Texas production. Indeed, Dietert and his associates (2005) have argued that important NG fields in Texas are susceptible to significant decline rates. While EOG has pegged the overall first year decline rate for new wells at 30% , 2005 Dietert et al have argued that decline rates for particular fields --- Barnett Shale, Bossier Trend and South Texas are now in the 65-75% range. Actual production data from Texas starkly indicate the treadmill facing the NG industry:

In other words, it took three times as many wells in 2004 to produce 62% of the NG produced in Texas in 1970. These data give real meaning to the oft repeated maxims “treadmill” and “the lowest fruit has already been picked”. And the downtrend continues, preliminary data from the Texas Railroad Commission indicate that 71,440 wells as of February, 2005 could not stem a production decline of over 12% versus February, 2004.

(3) Canada has its own NG Problems

In a 2003 article I argued that Canada would be unlikely to alleviate NG supply problems in the United States. Specifically, Canada faces many of the same supply issues which plague the U.S. – namely – depletion. In terms of depletion, First Energy (2004) has estimated annual decline rates for western Canadian NG fields :

Actual production data provide strong evidence of these decline dates. In 2002, there were 9,061 NG wells drilled in Canada and production was 17.4 bcf/d. In 2004, there were 16,000 wells drilled and production was still 17.4 bcf/day. In other words, an increase of 6,939 (77%) wells from 2002 to 2004 was only able to keep production flat. The shocking implications of this pattern are obvious.

This situation is especially disturbing since Canada has been the overwhelming source of NG imports to the U.S. In 1993, for example, Canada accounted for 86% of U.S NG imports and by 2003 that figure was 87%. The Canadian safety net has been crucial as our own NG production declined and demand ramped up.

Unfortunately, based on EIA forecasts the days of increasing NG imports from Canada appear to be over:

In essence, the rise in Canadian imports in the 90s appears to have peaked and declining imports are projected with a decline of 898 bcf (26%) from 2000 to 2010.

(4) Drilling and Service at Full Utilization

In 1980, 3970 rigs were drilling for oil and NG in the United States. As the industry fell on hard times in the next two decades the number of active rigs steadily declined to reach a nadir of only 625 in 1999 – a decline of 3,345 ( 84 %) rigs in less than 20 years. Idle rigs were sold at pennies on the dollar, left in the field to rust or cannibalized for parts. The rig construction industry came to a virtual standstill as less than ten rigs were built per year. The rig service industry experienced a corresponding decline as workover and service companies simply went out of business or were merged with larger competitors. And finally, the workforce in the oilpatch steadily aged as few young people were willing to risk a career on what many considered a moribund industry.

This chronic underinvestment in our energy supply infrastructure is coming home to roost. Andrew Gould, CEO of Schlumberger, succinctly summarized the situation in the keynote presentation at the Howard Weil Energy Conference in April:

“the industry is dealing with … the lack of investment over the past 18 years … A lot of the rig fleet, and much of the equipment are old. Very little spare capacity exists … [but] the most disturbing shortage by far is the lack of [energy] professionals … skilled people have either been laid off, or have retired from the industry.”

Recent data place Gould’s concerns in bold relief. The U.S. rig count has surged to over 1,358 out of an estimated 1,470 capable rigs. When rig float (units being moved from one site to another) is considered there are apparently only several dozen capable rigs not working.

In fact, Richard Mason at Land Rig Newsletter has indicated the panic to get a rig has propelled huge increases in dayrates because land drillers are “out of rigs for all practical purposes”. Further, Mason notes that even the most optimistic estimates indicate less than 100 newbuilds or refurbishments would be available before 2007 – compared to 325 added from inventory in 2003-2004 alone.

The situation in the GOM is even more alarming --- the rig market is so tight that dayrates have leaped from $24,000 in 2003 to $62,000 or more. Attrition of older rigs and years of outmigration from the GOM have left the region with only a fraction of once available rigs.

Further, the GOM faces the specter of even further outmigration as national oil companies and operators in the Middle East, Far East and North Sea are willing to pay as much as $140,000 per day for a premium rig. And, to add insult to injury, although there are over 30 news builds on order, it appears that none will be available for the GOM. Given a world-wide bidding war, Daniel McNeese at Rowan summed up the risk to GOM production:  “rigs are going to get pulled out of here if rates don’t go up … I mean people are bidding all over the world”.

Equipment and tubular manufactures such as National Oilwell Varco (NOV) and Maverick Tube (MVK) are hard pressed to meet demand and face record backlogs. Thomas Richards at Grey Wolf Drilling recently complained that even simple rig components were taking six months on order and another drilling firm stated that NOV should “double the size of their company”. Clearly, the age of the fleet (most rigs are over 25 years old) means that continual refurbishment is exacerbating the already intense pressure on rig suppliers.

And finally, the shortage of experienced personnel haunts the industry at every turn. Guardis Banister, Technical Director at Shell Energy has anecdotally commented that “while the U.S. produces 43,000 lawyers per year we graduate only 430 petroleum engineers.” Further, there are simply not enough oil field hands to meet demand, setting off intense competition for skilled workers. In a recent article, Richard Mason offered the following anecdote:

“Contractors are now beginning to cannibalize the existing labor force. A help wanted advertisement in our local Sunday newspaper was run by an Oklahoma City contractor who is moving refurbished rigs to West Texas. The Company was looking for toolpushers … a bonus, was available if toolpushers could bring crews along.”

Finally, the lack of new blood in the industry is becoming extremely apparent. Panelists at an Offshore Technology Conference session in May warned that the average age of personnel in the upstream sector is 49.

Restricted Access to Major NG Fields

Environmental and political opposition to drilling new areas greatly constrains potential NG production. Despite our haste to build a huge NG demand infrastructure we do not have the commitment to increase supply. There is a hypocrisy in place here. Recently, Representative Lois Capps (D-CA) expressed her:  “strong support for the long standing bipartisan legislative moratorium on new leasing activity … despite efforts by … the natural gas industry to open up the Outer Continental Shelf to drilling”.

Yet Capps represents a state which consumed 2,383 of NG in 2004 but produced only 320 -- an 87 % shortfall. A similar situation exists in Florida, a state which consumed 726bcf in 2004 but produced only three due to offshore moratoria on drilling. Of course, neither of these states hesitates to burn NG produced off the coast of Louisiana or Texas.

The estimated NG reserves which are off limits due to governmental restrictions and moratoria are somewhat staggering:

Despite the ready availability of these reserves, however, the Nation refuses to initiate the development of this much needed supply. As recently as May 19, the U.S. House defeated by voice vote a proposal to open sections of the OCS to NG exploration and development.

CAVEAT: DEUS EX MACHINA?

At this point most readers will be contemplating how (a) LNG imports and (b) non-conventional NG production, e.g. coalbed methane and deepwater drilling will alleviate this situation. There is no question both of these sources have great promise – but at this point the argument that they can both offset NG production declines and meet incremental demand is more hypothesis than proposition. Specifically, we are betting much of our energy future on untested assumptions. Recent comments from the energy industry highlight the problems with U.S. production : (1) Lee Raymond , CEO of Exxon, recently told reporters “Gas production has peaked in North America’’ and (2) Energy Security Analysis, Inc. noted the “ steep decline rates of aging fields in Texas, Louisiana and Oklahoma” and the fact that “domestic production will make up a significantly diminished share of U.S. supply”.

In terms of LNG, for example, Andrew Weismann (2005a, 2005b), has raised serious questions regarding LNG (a) availability, (b) price and (c) impact upon both our national and fiscal security. In regard to non-conventional sources, one should recognize that depletion, lack of equipment and environmental regulations impact these sources as well. Overall, the expectation that relatively untested (on a massive scale) sources of NG will offset the issues mentioned here is a high stake gamble. Like the Greek tragedies of old, salvation may arrive from out of the blue but submitting our energy future to a complex and fragile series of unverified assumptions is risky indeed.

MAJOR REFERENCES

Dietert, Jeff; Kessler, R and Morris, M. “Outlook for Natural Gas”, Simmons and Company International, 2005.
 

Energy Information Agency – various reports, forecasts and analyses at www.eia.doe.gov
 

Land Rig Newsletter, various issues, 2005.
 

Riva, Joseph, U.S. Conventional Wisdom and Natural Gas, Colorado School of Mines, July, 1997.
 

Weissman, Andrew, “The Critical Need to Examine More Carefully the role of Liquefied Natural Gas…” Energy Pulse, (2005a).
 

Weissman, Andrew, “The LNG Challenge”, Testimony presented before California Public Utility Commission, (2005b).

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