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Saturday, August 7, 2010

Gas vs Oil

The shift from oil to gas is predicted partly due to the increasing scarcity of oil fields. This scarcity has been brought about because of the fact that national oil companies are sitting on up to 90% of ‘easy oil’ (oil that can be extracted with little expense or hassle). More often than not these national oil firms aren’t allowing foreign firms a slice of that oil. This is making oil firms look for more unconventional and trickier sources, especially deepwater oil fields in the Gulf of Mexico and the West Coast of Africa. Even Canada’s tar sands are being seen as a new source of oil. This increasing scarcity of obtainable oil is bound to raise the cost of oil extraction, making gas, a substitute, relatively more attractive.

Oil is also riskier business – firms have to make ‘binary decisions’ about whether to invest tens of billions in an oil field when the price of oil in five years is unknown. With gas, there is less risk – it only takes US$5 million to set up a shale-gas well. This represents a shift in the business models of big energy firms from few, large projects to many, small shale wells. The big advantage of shale wells is that energy firms can easily alter their output (by drilling more wells) in response to changing demand and prices. Shorter response times are good for the industry as a whole as it means that supply-demand equilibrium will be reached faster.

Despite the fact that building a LNG (liquefied natural gas) export plant could cost as high as US$20 billion (similar to the cost of an oil well), the structure of the gas industry is such that new LNG plants only go ahead after the developer has secured long-term contracts of even 20 years or more. Again, this mitigates the risk of even costly gas plants.

With growing demand for electricity in the developing world, there is likely to be a rise in the number of gas fields. The largest (and, some analysts say, only) barrier to pumping gas to areas like China is the infrastructure – the pipes to pump the gas.

Another reason why gas is an attractive prospect is imminent government policy. Carbon taxes are likely to be imposed in the near future as governments try to reduce the welfare loss caused by polluting oil wells. A $30/tonne carbon tax would make gas cheaper than oil for power stations – gas is half as polluting as coal. Double the tax and gas could compete with nuclear and wind power.

What the specialists say: oil consumption will rise only 0.5% annually to 2030; gas consumption will be 55% higher in 2030 than now.

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