The Potentials and Problems of Expanding Use of Shale Gas in the Continental U. S



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Factors Influencing Demand


The short-term demand in the US is generally cyclical and seasonal. During the winter times, there is an increased need for residential and commercial heating. Thus, natural gas prices spike in January/February and dip in July/August.

Long-term demand determinants are crucial to the future role of natural gas. These include prospective climate change legislation in the US and also changing demographics. According to the Work Progress Administration, people have moved towards warmer Southern and Western states, which could increase demand for cooling in the long-term. Other factors include technological advancements.


Supply in the US Market


The US has the largest gas market in the world, with 4% of the world’s gas reserves in 2002. Since then, gas reserves have only continued to rise, because new drilling technologies such as fracking are unlocking substantial amounts of natural gas from shale. Indeed, unconventional production is the single largest source of natural gas, which is predicted to account for 30% of US production by 2030 [1].



Figure . US Natural Gas production by sources, 1990-2025

This huge increase in available supply exceeds the market demand, which has created a “glut” and resulted in stable and low natural gas prices, especially compared to that of petroleum [1]. Experts believe it is directly the result of increasing production from North American shale rock formations.


II. Benefits of Shale Gas

1. Environmental Benefits


Compared to coal and oil, natural gas is a relatively cleaner energy source. Natural gas is combusted to generate electricity. In the electricity-generating process of using natural gas, no substantial amount of solid waste is produced, and the combustion of natural gas requires very little water, except for cooling purposes of natural gas-fired boiler and combined cycle systems [4].

Burning of natural gas produces carbon dioxide, nitrogen oxides, sulfur dioxide, and mercury compounds. Emissions of carbon dioxide and nitrogen oxides from burning natural gas are of lower quantities than from burning coal or oil; and emissions of sulfur oxide and mercury compounds from natural gas combustion are negligible. Specifically, natural gas’ average emissions rates in the US for carbon dioxide, nitrogen oxides, and sulfur dioxide are 1135 lbs/MWh, 1.7 lbs/MWh, and 0.1 lbs/MWh, respectively [5]. When comparing coal-fired electricity generation with natural gas-fired electricity generation, coal produced twice as much carbon dioxide, more than three times as much nitrogen oxide, and one hundred times as much sulfur oxides.

The relative “cleanliness” of the energy sources can also be demonstrated by comparing the amount of one major pollutant—carbon dioxide—emitted per unit of energy output. Pounds of carbon dioxide emitted per million Btu of energy for various fuels are [6]:

Table

Coal (anthracite)

228.6

Coal (bituminous)

205.7

Coal (lignite)

215.4

Coal (subbituminous)

214.3

Diesel fuel & heating oil

161.3

Gasoline

157.2

Propane

139.0

Natural gas

117.0

When burned for generating energy, natural gas emits the least amount of carbon dioxide comparing to coal or oil.

However, one large concern of using natural gas is that methane—a greenhouse gas and a primary component of natural gas—is emitted into the air when natural gas is not burned completely. Methane leaks can also happen during natural gas production, transmission and distribution.

2. Economic Benefits

Need for Infrastructure Development


Expanding natural gas would increase the potential in the market for developing infrastructure. Apart from drilling and extraction needs, the expansion of natural gas use also increases demand in pipeline and storage capacity across the nation. Particularly with the recent shale boom, it is crucial to build new and enhance existing infrastructures to ease the difficulties in transporting natural gas to other regions. This includes pipeline networks or liquefaction infrastructure and equipment, as well as regasification facilities at the destination. Investments on natural gas infrastructures deserve significant attention. It is estimated that more than $30 billion per year will be required in total capital expenditure on infrastructure for natural gas and liquids [7]. Despite infrastructure investments involve large amounts of capital and long period of time to see return on investments, investments are needed to ensure the integrity and security of existing transmission and distribution infrastructure, which bring positive externalities to the economy. A comprehensive supply chain can enable a monitor system that can detect leaks and any potential safety and environmental concerns. The expansion of natural gas transmission, storage, and distribution can also alleviate any bottlenecks in the pipeline system, so that nationwide end-users can benefit directly from increased domestic gas supply as well as less volatile prices.

This section argues that with the shale boom, shifting production profiles require pipeline constructions, as well as maintenance with the existing pipeline network. Then, a strengthened pipeline network will lead to a higher demand for storage capacity. Next, it will also highlight current government support that aims to incentivize infrastructure development.


Shifting Production Profiles Require Additional Pipeline Construction


Pipeline construction has been increasing in the US as natural gas production has experienced robust growth over the past decade. The network of U.S. natural gas pipelines is highly complex and can transport natural gas to and from nearly any location in the lower 48 States. At the close of 2008, the U.S. Energy Information Administration (EIA) estimates that there are around 305,954 miles of natural gas pipeline in the lower 48 states (See Figure 4). In addition, according to data available on EIA’s website, from 2009 to present, 8097 miles of pipeline have been built [9]. Currently, there are 123 projects that are either announced, approved or under construction. They sum up to another 8,782 miles of pipeline that will be in service within the next decade [8].

Pipeline projects have many problems that are yet to be resolved. An example is the lack of planning in constructing the pipeline network in the US. Pipelines are often built to service individual ventures or utility needs, they lack the logic of a highway-system-style network [9]. Furthermore, major changes in the US gas market have triggered significant additions to the pipeline network. The direction of pipeline flows in the US, which have historically moved from south to north, have been expanding west-to-east. The country is shifting production from Gulf of Mexico to onshore production including Rocky Mountains.

As a result, not all areas will require significant new pipeline infrastructure, but many areas (even those that have a large amount of existing pipeline capacity) may require investment in new capacity to connect new supplies to markets. However, with the current rate of construction, the distribution network is still insufficient to alleviate geographical unevenness of natural gas distribution. The Interstate Natural Gas Association of America (INGAA), which represents the vast majority of the interstate natural gas transmission pipeline companies in the U.S., estimates that the U.S. and Canada will need approximately 28,900 to 61,900 miles of additional transmission and distribution natural gas pipelines depending on assumptions for gas demand [10]. New infrastructure will be required to move hydrocarbons from regions where production is expected to grow to locations where the hydrocarbons are used [7].



Figure . Estimated natural gas pipeline mileage in the lower 48 states, close of 2008
Building pipeline infrastructure can incentivize production and lower consumer prices. This can be seen with the Rocky Mountain Express pipeline (REX), which was built in 2008. With a capacity of 1.8 Billion cubic feet per day (Bcfd), REX was the largest addition in the U.S. pipeline system, and has allowed Western producer markets to supply gas to eastern consumer markets [10]. Before the construction of the REX pipeline, natural gas transportation out of the Rockies region was very constrained. The relationship of the price differential to infrastructure is observed in the basis differentials at the Cheyenne and Algonquin hubs before and after the opening of the REX pipeline. From Figure 5, we can see that as the REX pipeline moves gas supplies from the region to Eastern markets, the regional price differentials change in a smaller degree, showing how alleviating pipeline infrastructure bottlenecks can incentivize production and lower consumer prices overall [10].



Figure . Impacts of 2008 pipeline capacity expansion on regional prices and average basis [10]

Existing Pipelines Require More Maintenance Attention to Ensure Stable Natural Gas Prices, Which Would Benefit the Macroeconomy

As noted, natural gas markets are not traded as national as oil or coal markets because natural gas is logistically difficult to transport nationwide. Almost half (142,000 miles) of the natural gas pipelines currently in service were constructed in the 1950’s and 1960’s [11]. However, U.S. gas companies are replacing less than 5 percent of their leakiest pipes per year [12]. A recent study by Boston University estimates that leaking pipelines are releasing between 8 and 12 billion cubic feet of methane annually in Massachusetts alone [13]. With existing pipelines in far heavier use than they were during 2000-2011, addressing aging infrastructure is ever more imperative. Despite maintaining aging infrastructure is an immediate issue, there are few federal or state incentives to repair or replace leaky pipes or minimize lost gas nationwide. This is because natural gas suppliers can always transfer the cost of gas leaks onto consumers. As a result, consumers are paying for gas that never reached them [12].

A report by the House Natural Resources Committee Democratic staff suggests that American consumers paid $20 billion from 2000-2011 to cover the cost of natural gas leaks from pipelines operated in 46 states [12]. The limitation of the current infrastructure can be viewed in stark terms through the lens of winter wholesale natural gas prices in New England. In winter of 2013-2014, the wholesale price in Pennsylvania, on top of the Marcellus shale deposit, was $3.37 per million BTUs. In Boston, it was $24.09 [9]. The price difference across regions can be resolved by actively maintaining existing pipelines and repairing gas leaks. This can reduce the cost of gas and will provide economic benefit to the public.

Improved Pipeline Network Also Leads to Higher Demand for Storage Capacity


An extensive pipeline network is able to transport gas throughout regions in the lower 48 states, but storage capacity is equally important to support fluctuating demands. Natural gas can be stored in underground storage facilities to meet seasonal demand fluctuations, provide operational flexibility for the gas system, and hedge price variations. In the case of the Marcellus Shale, planned investments in pipelines drive investments in underground storage. Storage is critical for the region because the geology of the Northeast prevents significant storage in this key demand region, which could create a storage bottleneck when moving gas from points West to Northeastern markets, particularly in the peak demand months in the winter [10].

Increasing shale gas production has driven the growth of underground storage capacities. Figure 3 breaks down the total capacity of the three types of storage facilities from 2008 to 2013 [14]. In 2013, 80.86% were depleted reservoirs facilities, 9.54% were aquifers and 9.60% were salt caverns. Total working gas storage capacity nationwide in 2013 was around 4.75 Tcf [14]. Since 2000, the Federal Energy Regulatory Commission (FERC) has certificated over 1,100 Bcf of new underground storage capacity, both in expansions of existing storage fields or as new storage sites. The FERC has pending projects that would add an additional 140 Bcf of storage capacity and is aware of the potential for more storage projects totaling an additional 70 Bcf of capacity [15].

Figure 4 portrays the distribution of facilities in the lower 48 states. Over 53% of the 4.75 Tcf working gas storage capacity is found in five states: Michigan, Illinois, Louisiana, Pennsylvania and Texas [10]. Storage development has generally occurred in the south central US, first to accommodate the expected increase in imported LNG and, more recently, to store the gas produced from the shale basins.

Among the growth of underground storage capacities, salt caverns are expected to dominate new storage development [15]. This is because salt caverns are typically located in the Gulf Coast, where production is most concentrated (See Figure 7). When compared to depleted reservoirs and aquifers, salt caverns provide higher withdrawal and injection rates relative to their working capacity. Therefore, salt cavern storage is expected to increase its share in new storage development, with the volume of salt cavern storage essentially doubling over the forecast period. The INGAA study estimates that approximately 589 Bcf of new storage capacity is required by 2035 to meet market growth at a cost of $5 billion [15]. Cavern construction is more costly than depleted reservoirs when measured based on dollar per thousand cubic feet of working gas capacity. But even so, salt caverns’ ability to perform several withdrawal and injection cycles each year reduces the per-unit cost of each thousand cubic feet of gas injected and withdrawn [16]. Of the 17 new sites under construction and planned between 2013 and 2015, 12 are new salt cavern facilities [17]. Continuing innovation in salt caverns, or storage technologies as a whole, could provide value for both consumers in lowering cost and producers in improving profitability.





Figure . U.S. working natural gas underground storage capacity [14]



Figure . U.S. Underground Natural Gas Storage Facilities, close of 2007 [18]

Government Initiatives to Incentivize Infrastructure Construction


The U.S. Government has taken initiative to incentivize infrastructure construction. Currently, government agencies involved in regulating gas pipelines and other gas infrastructure include the Federal Energy Regulatory Commission (FERC), U.S. Environmental Protection Agency (EPA) and the Pipeline and Hazardous Materials Safety Administration (PHMSA) under the United States Department of Transportation. These government bureaus have worked to a common goal to drive the growth of infrastructure development in the United States. In particular, the FERC has taken several measures to increase electric generation and natural gas supply in the Western part of the U.S. In the past, the Commission has provided a temporary waiver of its pipeline blanket certificate regulations to waive regulations that would require prior notice for the construction of certain facilities. The Commission also instituted a temporary waiver of its blanket certificate regulations that limit the types of facilities that can be constructed pursuant to either automatic authorization or prior notice [19]. These measures allow interstate pipelines to quick add capacity without undergoing the time-consuming process of certification of large projects. The FERC is also largely involved in passing the Energy Policy Act of 2005, which recognizes the need to streamline siting, and supports the continuation of fine-tuning so that infrastructure can be analyzed and permitted in a timely manner [15]. Under the Act, the Commission issued pricing reforms that are designed to promote investments needed in energy infrastructure [20].

The Pipeline and Hazardous Materials Safety Administration (PHMSA) under the United States Department of Transportation has also identified $33.25 million in federal funding for pipeline safety technology since 2002, around $4 million per year. The improvement in technology could drive down investment costs and improve timeliness for planning and operating infrastructure development [10].

Local states also implement policy mechanisms to pay to upgrade and replace existing pipelines. For example, states like Colorado use a tracker system that changes rates in response to the utility’s operating costs. Also, the Georgia Public Services Commission has permitted Atlanta Gas Light Company to institute a surcharge on customer bills throughout its service territory to help fund pipeline replacement, improvement, and pressure increases through the Georgia Strategic Infrastructure Development and Enhancement (STRIDE) Program [21].

Government’s incentivizing schemes have proved to have effect on infrastructure development. As an example, in 2006, FERC issued Order 678 which sought to incentivize the building of more storage by changing its regulations on market power requirements for underground storage. Since the order was issued, total storage capacity has increased by 169 Bcf, or 2% of overall storage capacity. This compares to a 1% increase in the previous three-year period [10]. Therefore, government should continue their efforts in creating incentives for producers to invest in more infrastructure development.

Therefore, given the recent increase in the domestic supply of natural gas, infrastructure development must quickly adapt to meet the increasing demand from consumers. Infrastructure development provides huge economic benefit on the use of natural gas. Building new pipelines is essential to enhance the nation’s pipeline network to ensure efficient and rapid natural gas transportation to households and businesses. Furthermore, maintaining existing pipelines is also important to prevent gas leaks that would result in lower the costs to consumers. Storage technology must also be invested to ensure adequate supply can reach to new regions of the nation. Increasing policy support and funding from the government are needed to support the rapid development of natural gas infrastructure. As the development of infrastructure catches up with the domestic supply of natural gas, it will allow the nation to not only increase the use of natural gas (which emits less carbon than other non-renewable resources), but also stabilize gas prices across regions.

Economic Impact on the U.S. Economy


The natural gas industry contributes to the US economy on many levels. From upstream activities such as oil and gas extraction and well drilling, to downstream activities like refining, product sales and pipeline constructions, the natural gas industry has not only directly impacted the U.S. economy, but it has also indirectly impacted the economy.

Here, we define direct impact as the effect of the core industry’s output, employment and income. Any changes in the purchasing patterns or activities by the unconventional oil and natural gas segment initiate the indirect contributions to all of the supplier industries that support unconventional activities.

To see the direct and indirect impacts, this section breaks down the industry’s contribution on a national level, as well as by state and industry. On a national level, the natural gas industry directly and indirectly adds-value to national GDP growth, employment, labor income and tax revenue. Since natural gas resources are not available in all regions in the lower 48 states, analyzing the economic impact of natural gas industry by region and state can also be meaningful. Lastly, this section will also look at how the Barnett Shale transforms Texas’ economy; we will see that natural gas has a large upside economic benefit that will continue its trend.

Economic Impact on National Level


We have identified three reports that analyzed the economic impact of the natural gas industry on a national level. The PwC, on behalf of API, publishes a report in 2011 that studies the economic impact of the oil and gas industry to US economy in 2009 [22]. PwC subsequently published another report in 2013 that analyzed the oil and gas industry’s economic impact in 2011 [23]. Since PwC’s studies are very comprehensive, it is widely used by other studies as a benchmark. In this section, we will be comparing these two reports with the IHS Report (2009) that analyzed the contributions of natural gas industry to US economy in 2008.
GDP Growth

Table . National-level studies on value added on oil and gas industry, $billion

Study

Scope and Year

Direct

Indirect and Induced

Total

PwC (2013)

Oil and gas in 2011

551.02

658.37

1,209.39

PwC (2011)

Oil and gas in 2009

464.57

617.13

1,081.70

IHS (2009)

Natural gas in 2008

172.14

212.60

384.74

According to PwC, the oil and gas industry produced $465 billion of direct value added and $617 billion of indirect and induced value added in 2009. In total, this accounts for 7.7% of GDP. The value-added on oil and gas industry has increased in 2011, in which the total impact has risen to $1,209.39 billion. This represents an 11.80% growth from 2009. The industry’s impact in 2011 accounts to 8% of US GDP [22].

The impacts of the oil and gas industry are felt throughout the economy. In forecast to future trend of gas industry and its contribution to US GDP, a report by McKinsey Global Institute estimates that between now and 2020, shale gas and oil will add $380 billion-690 billion, or two to four percentage points, to America’s annual GDP, creating 1.7 million permanent jobs in the process [24]. Another report by the IHS predicts a $533 billion boost to GDP by 2025, creating around 3.9 million jobs.


Labor Market

Table . National-level studies on employment in oil and gas industry, ‘000s

Study

Scope and Year

Direct

Indirect and Induced

Total

PwC (2013)

Oil and gas in 2011

2,590

7,242

9,833

PwC (2011)

Oil and gas in 2009

2,192

6,968

9,160

IHS (2009)

Natural gas in 2008

622

2,206

2,828

In the US, jobs in the energy sector have nearly doubled since 2005. After the recent recession, energy sector jobs have grown at a faster rate than any other industry [24]. According to IHS Global Insight, the total natural gas employment was nearly 3 million in 2008 [25]. PwC’s report estimates that, at the national level in 2011, the oil and natural gas industry’s operations directly and indirectly supported 8.4 million full-time and part-time jobs in the national economy. Further, the industry’s capital investment supported an additional 1.4 million jobs in the national economy. Combining the operational and capital investment impacts, the oil and natural gas industry’s total employment impact on the national economy amounted to 9.8 million full-time and part-time jobs in 2011, accounting for 5.6% of total US employment [23].

A report by Interstate Natural Gas Association of America (INGAA) projects that an investment of $641 billion for midstream infrastructure will yield an annual average of roughly 432,000 jobs across the United States and Canada throughout its projection period, 2014 to 2035. These jobs include those necessary to manufacture and construct infrastructure, and the indirect and induced jobs linked to that process [26].

Labor Income

Table . National-level studies on labor income in oil and gas industry, $billion

Study

Scope and Year

Direct

Indirect and Induced

Total

PwC (2013)

Oil and gas in 2011

203.6

394.0

597.6

PwC (2011)

Oil and gas in 2009

176.3

357.24

533.55

IHS (2009)

Natural gas in 2008

70

111

181

IHS’s report estimates that in 2008, the natural gas industry alone contributed $181 billion of labor income [25]. According to PwC, the US oil and natural gas industry’s direct labor income in 2011 is estimated to be $203.6 billion, which represents a 15.5% growth from 2009. Indirect and induced impact on other industries is $394.0 billion [22].


Tax Revenues

Oil and gas companies pay significant taxes. Not only do they pay the standard federal and state corporate income taxes like other companies pay, upstream companies also pay severance and ad valorem taxes based on the amount of hydrocarbon they produce. They also pay bonuses and royalties to the owners of the mineral interests from whom they are leased. Interestingly, the largest mineral interest owners are the federal and state governments. In addition, oil and gas companies also pay significant other taxes directly, such as excise fuel taxes, sales, property and use taxes [27].

A report by IHS Global Insight estimates that in 2012, unconventional gas activity contributed around $31 billion in federal, state and local tax receipts. By 2020, total government revenues contribution to reach $58 billion. The same report estimates that cumulatively, unconventional gas activity will generate more than $1.36 trillion in tax revenues between 2012 and 2035 [28]. To put in context, $31 billion in associated federal taxes is sufficient to fund close to 80% of the U.S. Department of Interior annual budget ($11 billion), the US Department of Commerce budget ($11 billion), and NASA’s budget ($18 billion) combined [28].


Economic Impact by Region and State


Since gas wells are concentrated only in certain areas of the US, not all states are economically impacted in the same extent. Indirect and induced effects of the industry typically occur within a state, and then cross into other states. Therefore, the state analysis reflects how higher diversification of industry exhibits a higher multiplier effect [27].

From a research conducted by the IHS, in 2012, among the states that produce natural gas, the top 10 states that generated the most jobs through unconventional oil and natural gas activity created a total of nearly 1.2 million jobs. This figure is expected to increase 70% and exceed 2.3 million by 2035 [29]. Table 4 provides the list of the top 10 producing states, as well as its current and projected jobs created. Based on 2012 data, Texas is the state that accounts for the most jobs attributable to the oil and gas industry (32.94%), followed by Pennsylvania (5.87%), California (5.52%), Louisiana (4.52%), Colorado (4.44%) and so on [29]. These 10 producing states accounted for 75% of the total value added to US GDP in 2012. Certain states’ unconventional oil and gas activities also drive unemployment down. North Dakota, for example, has the lowest unemployment rate among all states in 2013, which is just 3% [30].



In terms of GDP, these 10 states contributed $178 billion in 2012, which accounts for 75% of the total US value added from unconventional oil and gas activity across the nation. Furthermore, for Texas and North Dakota, unconventional oil and gas activities in 2012 represented around 7.4% and 15% of the states’ total economic activities respectively [29]. The contribution to economic growth is expected to roughly double over the 10 years. IHS’ report also expects technological advancement to be fueling the industry’s expansion, which would improve productivity in states such as Ohio and North Dakota [29].

Table . Unconventional oil and gas producing states: top 10 employment contributions [25]

(Number of workers)













2012

2020

2035

Texas

576,084

929,482

733,179

Pennsylvania

102,668

220,635

387,360

California

96,553

153,658

187,270

Louisiana

78,968

97,418

150,903

Colorado

77,622

121,398

175,363

North Dakota

71,824

114,240

57,267

Oklahoma

65,325

149,617

225,387

Utah

54,421

51,859

67,052

Ohio

38,830

143,595

266,624

Arkansas

33,100

52,539

56,418

Top 10 Total

1,195,396

2,034,442

2,306,822

US Total

1,748,630

2,985,176

3,498,694


Case Study: Economic Impact of Barnett Shale in Texas


Texas has consistently outperformed the other states in creating jobs since the beginning of 2008’s financial crisis and the discovery of the Eagle Ford Shale play. From July 2009 to June 2011, 49% of all new jobs created in the U.S. came from Texas, and most of those jobs were the result of the state’s oil and natural gas activity [31]. PwC’s study found that Texas’ oil and natural gas industry supports, directly and indirectly, 1.9 million jobs in 2011, which is 13.6% of the state’s total employment that year. In the same year, Texas’ labor income supported by the oil and natural gas industry was $144 billion, which is 18.7% of the state’s total labor income [23]. In particular, supporting jobs by hydraulic fracturing and horizontal drilling activities have reached 576,084 in 2012. It is expected to rise 27.3% by 2020 [32].

Among the various oil and gas sites in Texas, the Barnett Shale contributes a significant portion of the economic growth of the region. The Barnett Shale is located at Northern Texas. Since drilling activity began to escalate in the early 2000s, Barnett Shale has contributed to Texas’ economy tremendously. More than 15 Tcf of natural gas have been produced from the Barnett Shale since 2001 [33]. The Perryman Group, an economic research and analysis firm based in Texas, conducted a study in both 2011 and 2014 on Barnett Shale’s economic impact in Texas. Studies found that despite reduced drilling and fluctuating natural gas prices, Barnett Shale production increased by $700 million since the last study was conducted in 2011. The study of the fiscal contributions of the Barnett Shale finds that the current regional gains in business activity and tax receipts related to oil and gas exploration include $11.8 billion in gross product per year and more than 107,650 permanent jobs [33]. For the state of Texas as a whole, the report estimates that activity within the Barnett Shale has generated $120.2 billion in GDP and over 1.1 billion jobs since 2001. Tax revenue to both local and State government is estimated to close to $11.2 billion [33]. Over the next decade, the Perryman Group expects activity in Barnett Shale to continue generating an extra $153.4 billion in value-added and creating 1.4 million more jobs in Texas [33].

Therefore, through estimating the natural gas’ extraction and production activities on national and regional level, we are able to understand the industry’s enormous economic impact to the U.S. economy. As exploration and production activities have already created millions of jobs and billions value-add to US GDP, these trends are expected to continue for the next decades.

The Impact of Shale Gas on the Electric Generation Industry


Over the past decade, natural gas has become increasingly important in the electric generation industry. This is apparent by looking at the trends in the composition of fuel sources (Figure 8), as the total amount of electricity being generated by natural gas has been steadily increasing [34]. While coal has been the largest source of electricity in the past, the use of coal has declined as the use of natural gas has increased.
Figure . US total electricity generation by energy source [34]

The large amount of unconventional gas on the market has led to one direct and immediate impact on the electricity industry: lower natural gas prices. This, combined with an increase in average coal prices, has led to the predictable switching from coal to natural gas for electricity generation. Figure 9 highlights the gradual increase in average coal prices, even as the average cost of natural gas has dramatically fallen over the past decade [34].





Figure . Average cost of fossil fuels to electricity generation [34]
From inspecting Figure 8 and Figure 9, it is apparent that 2012 is a remarkable year. Not only was the difference between the amount of electricity generated by coal and natural gas the smallest over the past decade, but the difference in the costs of coal and natural gas were also the smallest as well. The data represented by the two figures suggest that the spread in prices is correlated with the share of natural gas used in electricity generation. Intuitively, this makes sense, as a smaller spread incentivizes electricity producers to switch from coal to natural gas.

Although the average cost of coal has consistently been lower than the average cost of natural gas, as shown in Figure 9, natural gas may still be economical if the spread between the two is small enough. This is because the heat efficiency of natural gas-powered plants is typically more efficient than those of coal-powered plants. As of 2012, the average operating heat rate for coal plants was 10,498 Btu/kWh, compared to that of 8,039 Btu/kWh for natural gas plants.





Figure . Average operating heat of coal-powered plants vs. natural gas-powered plants [35]

Figure 10 shows the changes in average operating heat rate for coal and natural gas plants in the 10-year period from 2002 to 2012 [35]. And while the efficiency for natural gas-powered plants has continued to improve (a lower number is better), coal-powered plants have become increasingly inefficient. The increasingly better efficiency of natural gas-powered plants compared to coal-powered plants is another dimension that explains why more natural gas is being used for electricity generation.

So far, we have established that natural gas generated electricity, under certain conditions (the spread between coal and natural gas prices is low enough and a given natural gas power plant is efficient enough), is economically preferable to coal generated electricity. But it remains to be seen who benefits from this switch: are end-users benefitting, are producers benefitting, or is it a combination of both?

Looking at the average retail price of electricity to customers can tell us whether or not the switching from coal to natural gas has benefitted end-users. Figure 11 shows the average retail prices to residential, commercial, and industrial customers, as well as a weighted average of the four in the 10-year period from 2002 to 2012 [36].





Figure . Average retail price of electricity to different end-users [36]

As we can see, the red line (total weighted average) shows that the average retail price of electricity has slowed beginning in 2008. This coincides with the increased consumption of natural gas and the decreased consumption of coal in 2008 as shown in Figure 8. While it appears that residential electricity prices have still increased since 2008, the average retail price of electricity for the transportation, commercial, and industrial sectors have all stayed level or decreased since 2008.

The relationship between decreasing electricity prices and decreasing natural gas prices can be shown more clearly by comparing states with an increasing share of electricity generated by natural gas, compared to all other states. Research by the Federal Reserve Bank of Kansas City has shown that in states with increasing share of electricity generated by natural gas, residential electricity prices declined an average of 6 percent, while all other states increased an average of 5 percent [37].

While the figures only pertain to residential electricity prices, it is reasonable to assume that the same relationship holds across all sectors: that an increasing share of natural gas electricity generation leads to lower electricity prices. Thus, it is safe to claim that the extraction of large amounts of natural gas from shale reserves has led to a decrease in electricity prices.

Projecting future electricity prices and the impact of natural gas proves more difficult. In 2012, the cost of natural gas was 86 percent of the total production cost of electricity, while the cost of coal was 76 percent of the total production cost [37]. Thus, future electricity prices will largely depend on the future prices of both natural gas and coal. While coal prices have stayed relatively constant, natural gas prices have traditionally been much more volatile (Figure 9). Furthermore, it appears that the historically low prices of natural gas in 2012 are unsustainable, as projections from the reference case of the Annual Energy Outlook 2014 project for a real annual growth rate of 3.7 percent from 2012 to 2040. However, electricity prices are only expected to increase at a real annual growth rate of 0.4 percent from 2012 to 2040 as the share of natural gas consumption is expected to overtake coal around 2035 [38].

There are many positives of using natural gas in the electricity generation industry. First and foremost, natural gas has been a downward pressure on the price of electricity, as natural gas prices have fallen dramatically due to the dramatically increased supply. Furthermore, the price of natural gas is not expected to rise greatly in the future, and the shift to natural gas is likely to be sustained in the future. In the residential sector, lower prices means that families spend less on electricity, increasing their disposable income. In the commercial and industrial sectors, lower electricity costs translates to lower overhead costs and lower production costs, increasing the profitability and competitiveness of businesses.


The Impact of Shale Gas on the Manufacturing Industry


In 1997, industrial consumption of natural gas in the United States was 8,510,879 million cubic feet (MMcf). Consumption levels gradually fell to 6,167,371 MMcf in 2009, before rising up to 7,413,918 MMcf in 2013 [39]. One simple explanation for the change in industrial natural gas consumption is price. As prices of natural gas rise, manufacturers may find alternative sources of energy or fuel for their factories. In cases where alternative sources of energy may not be economically viable, factories may even have to close. On the other hand, as prices of natural gas fall, manufacturers may find natural gas more attractive.



Figure . The relationship between price and consumption of industrial natural gas [40]

Figure 12 shows an inverse relationship between price and consumption of industrial natural gas. The relationship between the two variables is quite strong, with a correlation coefficient of -0.74. In the explanation given above, manufacturers react based on the price of natural gas. However, supply is more inelastic in the short run, due to possible factors such as preexisting contracts in the supply chain and the fact that capital is typically fixed in shorter timeframes. Thus, the industrial consumption of natural gas, a proxy for industrial output, should be reactionary based on the price of natural gas. In fact, the correlation coefficient between price and consumption of natural gas, when given a delay of one year, becomes a more robust -0.88, supporting the explanation that natural gas consumption is inversely related to natural gas price.


One particular sector that highlights the important of natural gas prices is the production of ammonia. Ammonia has many uses, including in fertilizers, cleaners, and as a refrigerant. Natural gas makes up between 70-90% of the cost of producing ammonia, and as a result ammonia production is highly affected by swings in the price of natural gas [41]. Indeed, in the time period from 2000-2006, as industrial natural gas prices rose (Figure 12), annual U.S. production of nitrogen-fixed ammonia fell from 11,800,000 tons to 8,190,000 tons [42]. During the same time period, the number of ammonia plants in the U.S. fell from 40 to 25 [43]. As the price of industrial natural gas began to fall in 2008, annual U.S. production of nitrogen-fixed ammonia increased from 7,870,000 tons to 8,730,000 tons in 2012 [42]. While only 77 percent of production capacity was used in 2006, it increased to 85 percent in 2012 [41][42].

When considering capital investment opportunities for new ammonia production plants, the size of plant effects the cost structure due to economies of scale. It is estimated that the cost of natural gas is around 50 percent of the levelized cost for a plant that produces 516,000 tons of ammonia, and that proportion increases as the size of the plant increases as well [44]. Low natural gas prices will support new plants to be constructed in the U.S. Until recently, no new ammonia plants had been constructed in the U.S. for over twenty years. In 2013, Incitec Pivot Limited announced plans to construct an $850 million ammonia plant in Louisiana. In the same year, CF Industries announced plans for a $1.7 billion fertilizer plant in Iowa [41].

The boost in industrial output is not only restricted to ammonia or the fertilizer industry. The American Chemistry Council estimates that as of September, 2014, a total of 197 chemical industry investment projects have been publicly announced, valued at $125 billion. They estimate these projects will lead to an increase of 407,000 direct and indirect jobs, as well as $274 billion in new economic output [45]. Even if these projections are optimistic, it is clear that low natural gas prices as a result of shale gas have had a positive impact in at least some areas of the U.S. manufacturing industry.

Although low natural gas prices may be beneficial in some industries, its effect may be limited in scope. One study published by The Institute for Sustainable Development and International Relations identified four manufacturing sub-sectors that use a significant amount of natural gas as feedstock. These four sub-sectors are petrochemicals, nitrogenous fertilizers, plastics materials and resins, and other basic organic chemicals, but combined together they only represent less than 0.5 percent of U.S. GDP. Even including other sectors that consume a significant amount of natural gas and its derivatives as a fuel, the number only increases to 1.2 percent of total U.S. GDP and less than 8.7 percent of the U.S. manufacturing sector [46].

Since natural gas is not significantly used in the majority of the U.S economy, the authors project that the long term effect of shale gas on the U.S. economy will be limited to a 0.84 percent overall increase between 2014 to 2040. Considering that the Federal Reserve projects a target of a 2.0-2.3 percent increase in real GDP in the long run, an increase of 0.84 percent over 27 years is minimal [47]. In another study published by Stanford, the impact of shale gas was even less, providing an overall boost of about 0.46 percent from 2014 to 2035 [48].

The large amounts of shale gas have caused a decrease in the price of natural gas. As natural gas price has an inverse relationship with industrial gas consumption, shale gas has led to increased productivity in the manufacturing sector. One example of this is the production of ammonia and the larger petrochemical sector as a whole. Low natural gas prices have also encouraged the investment of new chemical industry investments in the United States. However, sectors that consume a significant amount of natural gas are minuscule when compared to the larger U.S. economy. In that respect, shale gas has a positive, but limited impact on specific sectors of the manufacturing industry in the U.S.


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