I want to write about the changes that horizontal drilling and hydraulic fracturing have made in the economics of oil and gas by allowing drillers to tap deposits in shale. This is the first of three posts, and contains background.
what they have in common
Oil and natural gas are both hydrocarbon energy sources.
The same exploration and development companies look for both oil and gas. They use the same geologists, the same sub-surface mapping tools, the same drilling equipment and the same oilfield service firms to make the actual holes in the ground.
Oil and natural gas often occur in proximity. Sometimes a single well produces a mixture of the two.
In many areas, including the US, the government provides tax subsidies to encourage exploration.
A barrel of oil is roughly equivalent in heating value to 5,800 cubic feet of natural gas. During much of my Wall Street career (I stared out as an oil analyst), the price of natural gas and the price of oil have been tied relatively closely to one another based on this heating value relationship. In other words, if oil were selling at a price of $36 a barrel meant that natural gas would sell at more or less $6 an Mcf (thousand cubic feet).
That’s no longer true. The current oil price of around $100 per barrel translates, on a heating value basis, into $16.67 per Mcf for natural gas. Gas spent most of 2013 selling at about $3.50 an Mcf. The recent severe cold spell in many of the densely populated parts of the country has caused the spot quote for gas to spike to a bit over $5 an Mcf.. That’s an anomaly that the arrival of warmer weather will correct, but even today’s spot price is still less than a third of the heat equivalent price of crude,
how they’re different
Crude oil reaches the surface as a liquid. In contrast, and as the name implies, natural gas reaches the surface as a gas. This innocuous-sounding difference has enormous economic implications.
oil is easy to transport, natural gas isn’t
The most efficient way to move large amounts of either oil or gas from the wellhead is through a pipeline. Often, when production begins in a new area, there’s no pipeline nearby, though. Building one is expensive and takes time. That’s not a huge problem for crude oil. It can be stored in a tank by the wellhead. Trucks will come by periodically to take the oil away, either directly to a refinery, or to the railroad or a pipeline for further transport.
Natural gas is a different matter. There’s no practical way to store it above ground, and there are no trucks made to transport it In the past, for wells that produce both oil and gas, drillers would “flare” or burn away the natural gas just to get rid of it if no pipeline was available. Today, the driller is most often required to pump the gas back down below the surface rather than simply destroying it. For natural gas-only wells, no pipeline means seal up the well and wait.
One exception: if the amounts of natural gas in a remote location are enormous, the natural gas can be cooled until it becomes a liquid and then transported to market in special refrigerator ships. The cost of the required cryogenic plants + special ships + unfreezing operations at the buyer’s end can run into tens of billions of dollars, however. So this requires lots of time, operational and financial planning, as well as the creation of long-term supply contracts.
lots of buyers for oil, not so many for gas
Early in my career, I studied an offshore oil and gas financing project in New Zealand. The oil from the field was pumped directly into oil tankers that sailed away when full. The natural gas got pumped back underground.
Why not ues the natural gas in New Zealand? …lots of infrastructure needed.
One thing was the cost of the required miles-long pipeline to shore. But that wasn’t the main issue. To get the gas to residential/commercial users, local distribution companies would need to be formed. These firms would then have to tear up all the streets in town to lay pipelines to everyone’s doors. Potential users would have to either replace or modify their existing oil burners so that they could use gas. The expense would be enormous. So, too, the disruption to daily life. And you couldn’t force citizens to use gas, could you? So it would be hard to guess in advance if there would be any payoff to all this.
Another example: in the early 1980s the US tried to promote natural gas as automotive fuel. The effort foundered on the lack of places to refuel. No one wanted to buy natural gas-powered cars if there were no service stations. No company wanted to build a national chain of natural gas service stations if there were no cars. The plans did result in the creation of fleets of natural gas-powered local delivery trucks, but little else.
the big difference
Oil can move to markets all around the world. Natural gas generally can’t.