Energy economist Phil Verleger, in a recent weekly report, talked about his neighbor's approach to this arbitrage. He said a homeowner near him in the hills of Colorado recently switched to natural gas heating from propane, the latter of which has a price more tied to crude than to natural gas. The neighbor told Phil that the cost of the connection could be recovered in two to three months, given the spread between natural gas and propane, and by extension, the natural gas-crude spread. (Phil doesn't mention it, but presumably the line already is in place, unlike at my house).

 

But the homeowner and Verleger noted that the big gap isn't just in place for today; it's in the five-year spread as well. "When one looks at the data, one finds that five-year forward natural gas sells at a discount to crude of around 60 percent on a rough Btu equivalent basis," according to Verleger's report. "One wonders how long it will take consumers like my neighbor to begin making the physical arbitrage."

 

That is the $16,000 question...the price that I face as a homeowner, since that's the starting point it would cost me to switch to natural gas from heating oil. Of course, that's because I'm not on the grid. But if I was, the costs of conversion could be repaid much faster. I'm amazed that I don't hear more ads from the local gas utility touting this long-term benefit. A friend who is a field workers for that gas utility had not even heard of shale gas when I mentioned it to him a few months ago; that still astounds me.

 

So while I may face the $16,000 question, for others, that "barrier to entry" will be sharply lower. But there are other issues that could hinder a switch that otherwise seems to make perfect sense. For example, the fuel tank in a natural gas vehicle is going to need to be filled a lot more frequently than a gasoline tank, because of the lower BTU content of natural gas. What's the economic value of convenience? (That's usually not an issue with fleets, however, where you would expect more significant conversion rates). What do incidents like the San Bruno gas explosion in California do to natural gas' safety reputation in areas like the northeast US, where heating oil explosions are unheard-of?

 

But ultimately, these are not going to be the issues that determine the substitution of cheap natural gas for oil applications. As Verleger's report notes, far more important are consumers like the US petrochemical industry, presumably salivating at the prospect of being fed by a long-term stable supply of natural gas while Asian competitors are buying gas tied to a crude formula. But that won't last, Verleger notes; he says to expect that Chinese petrochemical producers will want cheap, domestic gas too, and the Chinese government will seek to develop its own shale gas industry in response.

 

Phil's report is called "The Shale Gas Dagger," and he writes that the dagger is aimed right at the world's oil industry. "It is hard to see how oil can remain at a price three times that of a competing energy source if that source is as abundant as many claim," Verleger writes in his report. "The threat to petroleum is increased by the fact that these natural gas supplies are not subject to the tremendous economies of scale observed in petroleum. This means smaller companies can and have easily entered the business in the United States and can likely do the same in other countries."

 

Of course, I've got another problem: my wife is pretty much terrified of the idea of natural gas. So the $16,000 initial price tag is keeping me out of a nasty argument...for now.