A Q2 '09 view of a possible future

7/1/09 – Second quarter 2009

Today I want to revisit the concept of long-term coupling of all energy prices and what may constitute the “Master BTU Contract.”

In Step-4 of my report, Confessions of an Energy Price Forecaster: A 12-Step Program to Enlightenment, I suggested that over the long run all energy is priced in BTUs with oil acting as the “Master BTU contract”. All other forms of energy are priced to oil adjusted by:

  • A basis differential reflecting the desirability of that form of energy
  •  A basis differential reflecting the quality of that energy, which for oil is API gravity or the “sweetness” of the particular BTU
  • A basis differential reflecting the location or the transportation costs

After all, energy, or BTUs and in the refined form KWhrs, is fungible and the user of energy doesn’t really care what form its in the long run because eventually he can change his infrastructure to accept any form of energy that makes economic sense to him.

Natural Gas

As has been noted way too many times, natural gas has been mislabeled the “fuel of choice.” However, it maybe the hydrocarbon of choice from a carbon footprint perspective. Now its attractiveness may add the component of price. Liam Denning in a WSJ 6/19/09 opinion made the analogy of junk food being cheap calories and natural gas being cheap BTU’s. Calories, BTU’s: it’s all energy. (See 3.1.2 in the Confessions report.)

I had suggested that oil has been that master BTU contract based on its global use, its transportability, abundance (in spite of its pending “peak”) and variability of supply source (in spite of OPEC). Now we are seeing truly break through technology in recovering natural gas from shale. In the US, such a technological break through could add substantial reserves to our base. However, without belaboring the point, the regulatory environment must still allow those resources to become reserves and be produced.

The global energy markets are also seeing a continued expansion in LNG in spite of current low natural gas prices. Much of this expansion reflects the long lead-time needed to construct liquefaction and regasification facilities and the added value realized from being able to monetize natural gas liquids that might otherwise be stranded. LNG can be a low cost supplier, and with this new transportability it has the flexibility to seek the best markets just as oil has over the years.

While domestic gas has an advantage over LNG of not having to cover the “refining” cost, the whole natural gas market is evolving on a comparative basis with oil that must be refined into usable products in its cost structure. Even the Alaskan arctic gas line seems to have new life.

Nevertheless, natural gas is a hydrocarbon, a clean hydrocarbon, but an energy source that is in itself (methane) a green house gas and when burned adds CO2 to the environment.

Point to Ponder

With this abundance of natural gas, its relative environmental desirability and its improved transportability, could natural gas become the new long-term master BTU contract?

  • Currently oil is still dominant in the mind of the players in the market as they continue to seek protection in established commodities. In addition old habits are hard to break and oil is looked at as a leading indicator of economic recovery.
  • However, it will be very difficult for the current speculation in oil to pull up the rest of the energy complex in light of the realities of continued financial weakness.
  • A more likely scenario is for natural gas to pull oil back down to its BTU parity as natural gas plays a bigger role in whatever economy we are dealt. Could such a pull establish natural gas as this master BTU contract?
  • And what does this do for energy policy? The more likely low natural gas price regime from its new abundance could have a heavy negative impact on new emerging fuels and make them even less economic than they already are. Indeed, natural gas at the $4/mmBTU level even brings a lot of coal into question.

Click here for more information about Confessions of an Energy Price Forecaster: A 12 Step Program to Enlightenment

Click here for John Tobin's full bio


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