The energy outlook for the next two years is surprisingly diverse. Oil and its liquid derivatives will remain fairly high priced, but natural gas will continue to cheapen, increasing the spread between the two fuels to unprecedented levels.
Global oil supply has increased modestly. Gains have been driven by new technology (fracking and horizontal drilling) and high prices. These positives have outweighed by the negatives of mature oil fields and political control of much of the world’s oil-bearing territories.
Energy Prices, Source: Forbes, 2012
The increased global oil production is spread across the entire world, as the oil market is global. Prices have remained high because the increase in production is still fairly modest, roughly in line with demand gains.
Natural gas prices, in contrast, have plummeted in North America. Oceanic transportation of natural gas is quite limited, so the market is essential continental. Supply has increased tremendously, much faster than demand. Many energy consumers are switching fuels as rapidly as possible. Already some electric plants have switched from coal to natural gas, and truckers are beginning to use natural gas.
In the near future, 2013 and 2014, the divergence in prices between oil and natural gas will continue. Oil prices will remain high because of the limited increases in supply, though more gains will come. Increasing oil production takes quite a few years, involving time spent on seismic studies, exploratory drilling, production drilling, as well as construction of infrastructure for transportation and refining. More supply will be forthcoming, but demand will increase as more of the world’s poor people move into the middle class. As their economic positions improve, they buy motorbikes and cars, ballooning their gasoline demand.
Natural gas will continue to be cheap in the North American market. Although new drilling is declining, a well that has been drilled will continue to be productive long after prices have fallen. Operating costs are tiny in most cases, so natural gas will continue to move to market. We have set in place continued supply increases, as in-fill drilling in proven fields is fairly cheap. Even with lower natural gas prices, new production will come to market.
These economic changes will drive business changes. First, companies that currently consume gasoline or diesel fuel must consider all avenues for fuel conversion. It’s not exactly simple, but neither is it so complex as to be beyond an ordinary management team’s ability to master. Piped in natural gas will be used for stationary applications, such as some generators. Compressed natural gas will be used for short-haul deliveries. Liquified natural gas will increasingly be used for long-haul truck, train and ship propulsion. The infrastructure to support natural gas is being developed rapidly, so lack of re-fueling stations will be much less of a problem in a year’s time. Companies need to start thinking of the change now.
(Oil companies are working on gas-to-liquid conversion. There are full size plants up and running, but right now it’s a niche suited mostly to gas that would otherwise be vented to the atmosphere at the site of an oil field. The conversion is only about 60-75 percent efficient, but at current gas/liquid price differentials that might not be too bad. The big challenges are the high cost of a conversion plant and their technical complexity. If price disparities continue, look for gas-to-liquid conversion to have a major impact ten years from now.)
Cheap natural gas will boost two industries that are large users of the fuel: chemicals and the sector of “stone, clay and glass.” In many subsectors of these two industries, natural gas is one of the largest costs, and thus the change in North American prices constitutes great competitive advantage for our producers. The other significant industrial user is iron and steel production, though iron ore and various other metals used to make alloys are also significant costs. Look for our steel industry to get a shot in its arm from cheap natural gas.
Companies that sell to these industries should expect increased orders. Even if you’re just the business selling sand to the glass industry, you should expect to sell much more sand in the coming years.
Businesses that use any of these products in their operations should expect competitive advantage from cheaper input prices. Start sketching plans to win international contracts over companies located on continents with more expensive natural gas.
The connections may be complex. Modern tools of economics, such as input-output analysis, can help identify impacts and opportunities. In fact, this would be a good time to call your favorite economist familiar with business, or business analyst familiar with economics.
Source: Forbes, 2012
Author: Bill Conerly, Contributor