long-term marginal costs of extraction, distant futures prices for crude oil
moved lower, on net, during the 1990s. Prices of the most-distant (sevenyear)
futures fell from a bit more than $20 per barrel before the first Gulf
War to less than $18 a barrel on average in 1999. Between 1991 and 2000,
although spot prices ranged between $11 and $35 per barrel, distant futures
exhibited little variation. It appeared for a while that we had reached
the long-term price-stability nirvana that oil companies have sought since
*The long period (1986-99) of subdued oil prices lessened the need for and the attraction of
oil industry jobs. The number of employees engaged in oil and gas extraction fell from a peak
of 271,000 in July 1982 to 118,000 by the end of 2003. Employment recovered markedly
through 2007. Labor supply has not caught up to demand; thus, since the fall of 2004, average
hourly earnings of oil industry workers have risen far faster than those of the nation as a
whole.
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the days of John D. Rockefeller. But it was not to be. Long-term price stability
has, of course, eroded noticeably since 2000. Distant futures prices
have risen sharply. In June 2007, prices for delivery in 2013 of light sweet
crude exceeded $70 per barrel. This surge arguably reflects the growing
presumption that increases in crude-oil capacity outside OPEC will no longer
be adequate to serve rising world demand, especially from emerging
Asia. Additionally, the longer-term crude price has presumably been driven
up since 2000 by renewed fears of supply disruptions in the Middle East
and elsewhere.
Because of the geographic concentration of proved reserves (threefifths
in the Middle East, three-fourths in OPEC), much of the investment
in crude-oil productive capacity required to meet future demand, without
prices rising unduly, will need to be undertaken by national oil companies
in OPEC and other developing economies. Meanwhile, productive capacity
does continue to expand, albeit gradually, and exploration and development
activities are ongoing, even in developed industrial countries.
Conversion of the vast Athabasca oil sands reserves in Canada to actual
productive capacity, while slow, has made this unconventional source of oil
competitive at recent market prices. However, despite improved technology
and high prices, proved reserves in the developed countries are being depleted
because additions to these reserves have not kept pace with oil
extraction.
B
B
efore I borrow the oracle's crystal ball to peer into the future of petroleum,
we must survey the rest of the energy complex with which oil is
inextricably intertwined.
Compared with oil, the natural-gas industry is relatively new. Through
much of the early history of petroleum exploration, drillers could not tell
whether a successful hit would turn up valuable crude oil or natural gas,
which was wastefully "flared," or burned off, for lack of transport facilities.
But after many of the transportation hurdles had been surmounted, gas
production for market surged more than sixfold between 1940 and 1970.
In recent decades, natural gas has blossomed into a major source of energy,
reflecting its myriad new uses in industry and as a clean-burning source of
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THE AGE OF TURBULENCE
electric power. In 2005; natural gas supplied nearly three-fifths as much
energy as oil. In contrast to oil, the natural gas consumed in the United
States is almost solely produced in the United States and Canada, from
which in 2006 the United States imported a fifth of its twenty-two trillion
cubic feet of consumption. The reason for the emphasis on domestic production
is that natural gas is still much harder to handle than oil. It is difficult to
transport in its gaseous form through pipelines and is particularly challenging
in its cryogenic form when transported as liquefied natural gas (LNG). It is
also difficult to store: in gaseous form, it requires deep salt caverns.
At times, in recent years, supply has not kept pace with the growth of
demand. Indeed, the inventories of natural gas held in storage caverns were
drawn down to record lows during the winter of 2003. As a consequence,
spot prices of gas spiked. The very technologies that have improved our oil
and gas drilling success rates have also enabled us to drain newly discovered
gas reservoirs at an increasingly rapid pace. Data for Texas, for example,
show that since 2000, output from new wells declined by more than 60
percent after one year of operation. That compares with roughly 25 percent
in the early 1980s. As a result, merely to hold net marketed gas production
stable, new discoveries and the drilling activity associated with
them have had to rise.
The combination of demand for gas in our power plants—where its use
tends to be less damaging to the environment than the burning of coal or
oil—and continued demand from households, commercial establishments,
and industry has put significant pressure on the natural-gas reserve base.
Until recently, virtually all new electric power facilities on the drawing board
had been gas-fired or "dual-fired," able to burn gas or oil. To meet higher
anticipated needs, the always-present tension between energy requirements
and environmental concerns will doubtless grow in the years ahead.
U.S. natural-gas prices, even seasonally adjusted, have historically displayed
far greater volatility than prices of crude oil. Doubtless this reflects,
in part, the relatively primitive state of global trade in natural gas—oil's
broader and more diverse market tends to damp down wild swings in price.
Over the past few years, despite markedly higher U.S. drilling activity, the
U.S. natural-gas industry has been unable to expand production noticeably,
4 50
THE LONG-TERM E N E RG Y S O U E E Z E
and we have also been unable to increase imports from Canada.* Significant
pressure on prices has ensued.
North America's still-limited capability to import LNG has effectively
restricted our access to abundant gas supplies elsewhere in the world. Because
of that limitation (in 2006, LNG supplied only 2 percent of U.S.
consumption1), we have been unable to continue to compete effectively in
such industries as ammonia and fertilizer when natural-gas prices spike in
the United States and not in other countries. The difficulties associated
with inadequate domestic supplies will eventually be resolved as consumers
and producers react to the signals provided by market prices. Indeed,
the process is already under way. Moreover, as a result of substantial cost
reductions for liquefaction and transportation of LNG, significant global
trade in natural gas is emerging—a very promising development.
At the liquefaction end of the process, new investments are in the works
across the globe, especially in Qatar, Australia, and Nigeria. Enormous tankers
to transport LNG are being constructed, even without commitments from
specific long-term delivery contracts. The increasing availability of LNG
around the world should lead to much greater flexibility and efficiency in the
allocation of natural-gas resources. According to tabulations by BP, worldwide
imports of all natural gas in 2006 were only 26 percent of world consumption,
compared with 63 percent for oil. LNG accounted for 7 percent
of world natural-gas consumption. Clearly, the gas industry has a long way to
go before trading on a world market will be able to supply unexpected
needs through a quick diversion of product from one country to another,
thereby checking big swings in prices. In the end, such international price
damping for natural gas will require a yet-to-be-developed broad spot market
in LNG. Today almost all waterborne natural-gas trade is still under longer-
term contracts. Spot cargoes are currently modest in size but growing. An
effective spot market will require a robust futures market for delivery of
LNG, with certified storage locations around the world for contract deliv
*Canada's expansion of the Athabasca oil sand deposits and the energy inputs needed for that
expansion have soaked up a good deal of the Canadian gas supply.
tin 2006, two-thirds of our LNG imports came from Trinidad, our major long-term supplier.
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ery adjusted for transport costs. Spot cargoes can be traded and delivered
under contract, and LNG futures markets will eventually arbitrage against
current piped-gas markets in the United States and the United Kingdom.
Such a market is still a long way off; but it will be required if natural gas is
to gain the same supply flexibility that exists in petroleum products. For
example, following Katrina, the void in U.S. markets for gasoline was
quickly filled with spot shipments from Europe.
The larger question, of course, is what increased world trade in LNG
and expanded capacity for U.S. imports of LNG will do to natural-gas
prices in the United States. Prices of LNG for imports under long-term
contracts follow the Henry Hub spot price in America without its alternating
price spikes and dives.* With a global spot market in LNG, prices would
be more volatile than these long-term contract prices, but I suspect far less
volatile than the prices at Henry Hub.
In addition to increased supplies from abroad, North America still has
numerous unexploited sources of gas. Major quantities of recoverable gas
reserves are located in Alaska and the northern territories of Canada, and
reserves of coal-bed methane and so-called tight sands gas in the Mountain
States are significant. Gas-to-liquids technology offers major future benefits
through the conversion of natural gas into liquid transportation fuels.
But for now, rapid advancement of this technology is being delayed by the
sharp rise in all energy project construction costs, and by difficulties in scaling
up pilot plants to industrial size.
In the more distant future, perhaps a generation or more ahead, lies the
potential to develop productive capacity from natural-gas hydrates. Located
in marine sediments and the Arctic, these icelike structures store immense
quantities of methane. Although the size of these potential resources
is not well measured, estimates from the U.S. Geological Survey indicate
that the United States alone may possess two hundred quadrillion cubic
feet of natural gas in the form of hydrates. To put this figure in perspective,
*Henry Hub is the Louisiana location on the natural-gas pipeline that is used as a reference
point for pricing gas.
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THE LONG-TERM E N E RG Y S O U E E Z E
the world's proved reserves of natural gas are on the order of six quadrillion
cubic feet.
Long-term shortages of gas and oil have inevitably stimulated renewed
interest in the expansion of coal, nuclear power, and renewable energy
sources, the most prominent of which are hydroelectric power from dams
and the energy generated through the recycling of waste and by-products
from industry and agriculture. Solar and wind power have proved economical
in small-scale and specialized uses, but together account for only a tiny
fraction of energy use.
The United States has large reserves of coal, primarily dedicated to
electric power generation. But the burning of coal in power plants has been
restrained by concerns about global warming and other environmental
damage. Technology has already alleviated some of these concerns, and
given the limited range of alternatives, coal is likely to remain a major fallback
in the energy future of the United States.
Nuclear energy is an obvious alternative to coal in electric power generation.
Though low prices for competing fuels and concerns about safety
have been a drag on the nuclear industry for years, nuclear plants do not
emit greenhouse gas. Nuclear's share of electricity production in the United
States increased from less than 5 percent in 1973 to 20 percent about a decade
ago, a level it has since maintained. Given steps that have been taken
over the years to make nuclear energy safer and the obvious environmental
advantages it offers in reducing C0 2 emissions, there is no longer a persuasive
case against increasing nuclear generation at the expense of coal.
The major challenge will be to find an acceptable way to store spent
fuel and radioactive waste. Nuclear power induces fears beyond any rational
calculation. To be sure, there are the frightening stories of Soviet nuclear
facilities constructed with little regard for safety. The inhabitants of secret
cities not on the map of the USSR were exposed to nuclear radiation in
their water and air for decades. Nuclear power is not safe without a significant
protective infrastructure. But then, neither is drinking water. The safeguards
at nuclear power plants in the United States are such that the public
has never suffered a radiation-induced death or serious injury owing to a
breakdown. The closest call, of course, was Three Mile Island, which caused
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a great scare in 1979. But after extensive study, no evidence of increased
thyroid cancer was found, and seventeen years after the event, a U.S. district
court rejected such claims and was upheld by the U.S. Third Court of
Appeals. The political verdict, however, was: guilty.
Nuclear power is a major means to combat global warming. Its use
should be avoided only if it constitutes a threat to life expectancy that outweighs
the gains it can give to us. By that criterion, I believe we significantly
underuse nuclear power.
There can be very little doubt that global warming is real and man-
made. We may have to rename Glacier National Park when its glaciers disappear,
in what now looks to be 2030, according to park scientists. Yet as an
economist, I have grave doubts that international agreements imposing a
globalized so-called cap-and-trade system on C0 2 emissions will prove feasible.
