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The shift from oil to natural gas

February 24th, 2011 · 2 Comments

Gaining momentum..
Cleaner, more abundant, much of it domestically available and an ever wider price gap…

The Shift From Oil to Natural Gas Seems to Be Gaining Momentum

John Polomny

As the price of oil continues to move higher on news of unrest from the Middle East, the precarious nature of the lack of an US energy policy becomes more apparent. How secure and prudent is our energy situation when we import well over 50% of our crude oil? Not very secure, I would venture. However, several items that I have read in the last few weeks give me some sense that regardless of the lack of leadership from our government on US energy policy, it appears that the free hand of the market is slowly but surely moving to create a solution.

In the past twelve months or so, we have seen the following big transactions in the oil and gas sector; Royal Dutch Shell (RDS.A) announced it would pay $4.7 billion for most of East Resources’ shale gas assets; ExxonMobil (XOM) paid $31 billion for XTO Energy, the largest natural gas producer in the U.S. Chinese oil giant CNOOC (CEO) invested nearly $1 billion in Chesapeake’s (CHK) shale gas assets. Encana (ECA) cut a deal with PetroChina (PTR) in the amount of C$5.4 billion that will allow PetroChina to develop a large portion of Encana’s natural gas assets. BP announced Tuesday that it will invest over $7 billion to acquire a 30% stake in Reliance Industries’ offshore India D6 gas block which supplies 40% of India’s natural gas demand.

Due to the relatively recent technological advancements in horizontal drilling and multistage fracking huge amounts of previously uneconomic shale, properties are being turned into an overabundance of natural gas supply. In fact, because of the lack of liquefaction terminals, the oversupply of natural gas in North America has led to a substantial difference in price between oil and natural gas on a BTU equivalent basis. This “shale gas” revolution is not only limited to North America. Russian gas goliath Gazprom (OGZPY.PK) is taking an intense interest in the developing competition an emerging European shale gas industry might provide to it.

Not only is the news good on the supply front, but we are beginning to see more adoption of natural gas fueled fleets. There are dozens of municipalities around the US that have shifted over to natural gas powered refuse trucks and buses. The ports of Los Angeles and Long Beach are in the process of converting their diesel trucks to natural gas. An article Tuesday reported that UPS is expanding its long haul natural gas powered trucking in the Western US on its Ontario, California to Las Vegas, Nevada and Salt Lake City routes.

In no way am I suggesting that natural gas will completely or rapidly supplant oil as a primary transportation fuel. What I am saying is that if the projections that some people are making about the potential natural gas supply are accurate, then we will see more and more conversion from oil to natural gas where it makes sense. In the past there have been several energy transitions, i.e. biomass to coal; coal to oil and now oil to gas with some nuclear and alternative energy thrown into the mix. This is evidenced by a recent ExxonMobil presentation entitled (.pdf) “The Outlook for Energy a View to 2030.” The one issue I have with the slides in the presentation is that I anticipate that the oil bars will become smaller and the gas bars larger as we near 2030.

It is my view that most of the major oil companies understand oil will become scarcer in the near future though they will deny it publicly. Their continued billion dollar acquisitions of natural gas assets betray their true views. Nevertheless, there are several issues and potential problems with any energy transition from oil to natural gas.

First and foremost, are the future supplies and reserve projections relating to natural gas actually accurate? Can natural gas be produced in the requisite volumes for many decades to be a viable replacement to oil based transportation fuel? There are trillions in sunk costs related to oil production, transportation, and distribution. The consequences of fracking with regard to the environment and seismic events (mild earthquakes in Arkansas) need more study and eventual resolution. There is an obvious bias in government towards oil and against gas which needs to be overcome. The build out of natural gas fueling stations and a larger commitment by OEMs to providing natural gas powered vehicles are needed.

Additionally, there needs to be an overcoming of the general reluctance to change among the consuming public. However, as oil becomes more expensive, scarce options like a natural gas fueled OTR trucking fleet become even more self evident. In conclusion, I am not sure how this transition can be played as an investment theme, however, I think being aware of what first movers like UPS are doing to reduce their cost structure via adoption of a cheaper fuel source may be valuable when considering investments in an oil intensive industry like trucking.

Tags: Natural Gas

2 responses so far ↓

  • 1 lindymc // Feb 24, 2011 at 7:58 pm

    westport innovation looks to be a good play .What car co. is the first mover to nat gas? The italian automaker has talked a good story. Cramer was pushing it but congress was sitting on their hands. With the Gulf of Mexico down maybe Obama will move.

  • 2 n // Feb 25, 2011 at 3:40 pm

    The middle east situation is a wake up call for OBAMA……we need those tax breaks so we can drill domestically…..there is just toooo much risk without the tax incentives to push investors…until we can transition into natural gas…we need to keep the tax breaks for those that produce less than 6,000 BOPD….i dont take marriage advice from a guy thats been divorced twice and i sure wouldnt take my advice from a PRESIDENT thats in favor of re-distribution of wealth…..your rich so share your money with the the poor so we are all equal. Obama and his health care and Energy policy need to go……