Emissions, Gas, O&M

Economist sees erosion of price spread between natural gas, crude oil

In a development that could have implications for an increasingly gas-dependent power industry, an economist with CME Group says the traditional price spread between natural gas and crude oil could be narrowing in the United States.

Both oil and natural gas have experienced a production boom in recent years. But while 71% of oil is used for transportation, natural gas use “is currently split amongst the power generation, industrial, and residential/commercial end-use sectors at approximately 30% each,” CME Economist Samantha Azzarello said in a recent analysis.

Azzarello advises to keep an eye on the transportation sector, where natural gas usage is only a modest 3%, but growing quickly.

“From the vantage point of units of energy, the price spread between natural gas and crude oil is significant, with natural gas giving a lot more energy bang per buck compared to oil,” according to the analysis posted on the CME website.

“In BTU terms, $1 of natural gas can obtain 200,000 units of energy (at a spot rate of $5/million BTU) compared to $1 of WTI [West Texas Intermediate] oil which garners 60,000 units of energy (at a spot rate of $97/barrel). This is a whopping 330% energy content price gap – even after the polar vortex and deep freeze have raised natural gas prices,” Azzarello said.

The massive energy price gap could be eroding, however, and quicker than many observers might think, Azzarello said. The market consensus is that the gap will narrow over decades, “while our own base case scenario is that it could happen in just three to five years,” she adds.

Azzarello said new technologies (fracking and horizontal drilling) have allowed shale-related natural gas production to increase by a tremendous 417% between 2007 and 2012. This surge made up a large portion of the overall increase in natural gas production, which expanded by over 20% in that same period, the economist adds.

This natural gas production boom has enabled natural gas prices to fall more than 50% between 2006 and into 2013. The recent harsh winter in much of the United States has pushed Henry Hub spot prices above $5/mmBtu “at least temporarily, although still lower than the average price in 2002-2006 before the production boom,” Azzarello said.

Crude oil supply has also increased within the United States, by 23% since 2007. Yet, WTI crude oil prices have risen from approximately $72/barrel in 2007 to $98/barrel in December of 2013, she says.

“With both crude oil and natural gas production rising in the US, and despite some temporary price spikes, average natural gas prices are lower and crude oil prices higher than before the production revolution began,” Azzarello said.

Natural gas primed to be bigger player in transportation

“The sector where a natural gas versus crude battle can really be fought is transportation,” Azzarello said. The transportation sector can be broken into passenger travel – light duty and high duty vehicles and freight travel.

“Once entirely commanded by crude, natural gas in the form of liquefied natural gas (LNG) has moved into the heavy duty trucks and the long haul industry, while compressed natural gas (CNG) has moved into corporate fleets and, to a much smaller degree, passenger vehicles,” Azzarello said.

The Energy Information Administration (EIA) estimates that between 2011 and 2040, natural gas usage in transportation will grow at an annual rate of 12% per year. “We think this may represent a large underestimate of the growth rate and potential for natural gas to cause a major shake-up within the transportation sector,” Azzarello said.

She points to the quickening pace of commercial deployment of natural gas transport technology. Even train companies like General Electric (NYSE: GE) and Caterpillar (NYSE:CAT) are testing hybrid retrofitted engines capable of running off diesel and LNG, Azzarello said.

“Even if natural gas just increases its share of energy use for transportation from 3% to the 7% to 10% range over the next five years, that could translate into a dramatically faster closing of the energy price gap than the consensus now suggests,” Azzarello said.

“Of course, whether the energy gap shrinking results from crude oil prices falling or natural gas prices rising is another story, determined by a plethora of factors and involving much more impact from global factors,” Azzarello said.

This article was republished with permission from GenerationHub.

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