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Thinking Ahead: A Friendly Handout for a Long Natural Gas Lecture

Professor Ferdinand E. Banks
ferdinand.banks@telia.com
June 26th, 2013

Today, as has been the case for the last few years, natural gas appears to be the most important topic in energy economics, and to a certain extent the most dynamic. As a result, I hope to begin the next academic year with a very long lecture that will provide my students with a comprehensive but elementary introduction to a topic that has achieved 'star quality' in many newspapers and business periodicals. However in case any of those ladies and gentlemen are not in the mood for comprehensive introductions, both they and passers-by will be offered this friendly 'handout', which they can examine before, during or after my lecture, and perhaps circulate to friends and neighbors.

Natural gas has been a useful energy resource for many decades, but lately it has achieved a kind of celebrity in the United States (= U.S.) due to the intensified exploitation of an activity called hydraulic fracturing (or 'fracking'), which involves producing natural gas from underground shale formations by pumping water, sand and chemicals into a 'well' at high pressure. There are chapters on natural gas in my textbooks (2000, 2007, 2013), and once I published a book on natural gas economics (1987), but until recently I was unable to muster a genuine interest in this subject. That changed when I examined an issue of the Energy Journal dedicated to natural gas, and saw that of the 14 papers it contained, only a few would have received passing grades in a remedial course at Boston Public.

That not unexpected surprise also made it clear to yours truly that he should upgrade and expand his previous work on this increasingly important subject. As a first step in doing this, I would like to suggest that everyone interested in shale resources should be on the alert for gross and most likely intentional misinterpretations of the economics of this resource, Rather than provide a string of examples in this short 'handout', I present a few friendly comments that serious students of energy issues should scrutinize very carefully, and if possible always have available in case they are on the receiving end of the lies and misunderstandings about natural gas and other energy topics that are in circulation in every corner of the world at the present time, and liable to turn up anywhere, at any time of the day or night.

  1. EUROPEAN AND RUSSIAN GAS. The story here is eventually going to be the same as with Russian oil. The end result of all the wishful thinking about putting the Russians (and OPEC) in their place where energy resources are concerned will come to nothing. Russian oil exports to China have increased by a huge amount since 2010, and mostly through the newly constructed Siberia-Pacific Ocean pipeline. Eventually large pipelines will transport natural gas to China over a similar route. Directing Russian energy resources to Asian markets makes unambiguous economic sense for both exporters and importers.

  2. China has the world's largest shale gas reserves, estimated today at a little over 36 trillion square meters (= 36Tm3). The announced intention in that country is to produce 6.5 billion cubic meters of shale gas annually by 2015, but since the average Chinese shale gas well consumes an average of 16,000 m3 of water, some very careful and imaginative management and regulation will be necessary in order to avoid serious water shortages, as well as other environmental problems. This might be one of the reasons for the extensive Chinese interest in energy resources outside of their country. Among other things, they need time to figure out how they are going to deal with this issue. Put more 'scientifically', the possession of these resources is equivalent to a financial call-option, and rather than exercise that option at the present time (by producing gas), the decision makers in China may have decided to wait for new information that might e.g. increase the productivity of the investment.

  3. It would be simply wonderful if the teaching of energy economics could be improved at the present time. I say this because as a result of its mediocrity, a surprising number of quasi-influential observers without training in engineering or economics have appointed themselves experts, and feel that they have the liberty to pontificate on the oil and gas future. Even the chief economic commentator of the (London) Financial Times, Mr Wolf, thinks that he qualifies for a ride on the shale gravy train, even though he doesn't know the difference between gas and a hole in the ground. What we have with gentlemen in his position is the implication that the production and management of items like shale gas is such a simple matter that its comprehension does not require any specialized training, and thus newspapers can take the place of textbooks.

  4. Just as grotesque, but equally relevant, many teachers of energy economics are totally unaware that lectures on academic economics, like mathematical demonstrations, require a suitable starting point. In mathematics these are axioms, or an accepted body of fact so unquestioned that they can serve as a foundation for proofs of more controversial claims. We are more fortunate in economics, because economic history often provides a logical beginning. As a trivial example, in the last 8 years, oil and gas firms have nearly doubled their ranking on Fortune Magazine's Top 500 list, and these enterprises now constitute a third of the top 50. This says something about the increasing importance of energy that cannot be said with the algebra in the bogus economic models of which many scholars are so fond! I can add that Royal Dutch Shell is now the largest firm in the world, with posted revenues of $489 billion in 2012.

  5. Oil in the 'lower-48' of the U.S. peaked in 1970, as predicted by M. King Hubbert. But not long after the giant Prudhoe oil strike took place, and with the total U.S. production increasing once more there was talk about output in the U.S. surpassing the previous peak. That story is not as familiar as it should be, especially the part about the former peak never being reached again! Natural gas in the U.S. had not peaked when the so-called shale revolution appeared, but there had been talk about forthcoming shortages, and the need for increased natural gas imports. The theory being offered now is that the sky is the limit for the U.S. gas and oil sectors, but in my humble opinion some of the arguments offered to promote this contention are to a certain extent crank. Please allow me to suggest that it might be a good idea for decision makers to mull over the history of oil production in the last 40 years ago if they are serious about obtaining an insight into how an essential extraction industry functions.

  6. 6. A PhD student at the University of Chicago once published a paper saying that an OPEC type approach for natural gas - a GAS-PEC - could not take place. As far as I am concerned, that prediction is not correct. and it would have been lovely if his teachers at that noble institution of higher learning had provided him with some additional tutoring on this subject, because I am sure that he - as compared to many of his teachers - is sufficiently intelligent to receive and appreciate instruction on energy economics if it were provided by the right person. By the right person I mean somebody like myself! At the present time the Gas Exporting Countries Forum undoubtedly has ambitions to eventually function like OPEC, or a quasi OPEC. Professor Alberto Clo of Bologna University has corrected some loose terminology on my part, and made it clear that OGEC (Organization of gas exporting countries) is the name likely to be chosen if - or most likely when - this gas forum transmutes into a formal cartel. Among the present members of the Forum, and likely members of OGEC, are Algeria, Qatar, Venezuela, Libya, Iran, Nigeria, Russia, The United Arab Emirates, and Trinidad-Tobago. These countries controlled well over 66 per-cent of natural gas reserves the last time I gave a lecture on this topic, and when I can muster enough energy to examine the latest gas statistics, I expect to find that members or potential members of that forum now control more.
  1. According to Jeffrey H. Michel, the leading energy economist in Germany, the real estate laws in Germany are such that e.g. shale gas extracted in Hamburg - and probably many other places in Germany - could in theory be transported to Russia in a pipeline, and from there it might end up in Asia where the price is higher than in Europe (2013). It is a long way from Germany to Asia, but not too long when billions of dollars are on the table. Of course, just because investors are willing to finance an extremely long pipeline, it is not certain that it will go where it should go. The once widely celebrated Nabucco Pipeline that was supposed to end up in Austria so that it could add to the gas supply in central Europe, is now scheduled to have its terminus in Italy, although that country is faced with an oversupply of gas from North Africa.

  2. A MISUNDERSTANDING OF THE YEAR. The manager of Oil Price Com, James Stafford, apparently believes that he knows more about energy economics than I do, because when I criticized one of his 'experts' for claiming that the U.S. is swimming in exploitable oil, he referred to my work as garbage, though hopefully not like some of the garbage I had to collect and put on garbage trucks for a month or so after being expelled from the infantry leadership school at Fort Ord (California). Stafford also seems to believe that carbon capture in the United States - or more correctly 'carbon capture and storage (CCS)' - is a “winning gamble”. However, on the basis of what I know about the one-time intentions of the large Swedish utility Vattenfall, CCS might be a candidate for the scam of the century. A good candidate for 'truth of the century' (thus far) is what is taking place in Germany with solar energy. The giant corporation Siemens says that it is shutting down its solar power division after heavy losses over the past two years. It has also been announced in that country that solar subsidies will end by 2018. The opinion here is that there are countries in which solar subsidies are justified - but not countries as far north as Germany!

  3. As reported by Financial Times journalists Ajay Makan and Ed Crooks, shale oil companies in the U.S. are “burning off enough gas to power all the homes in Chicago and Washington DC combined.” What this waste of resources and possible damage to the environment tells me is that instead of the present American president shouting to the high heavens about 100 years of natural gas, which is a goofy estimate, he should use his remaining years in office to convince voters that if possible they should elect a president without energy economics pretentions, and he or she should attempt to safeguard the invaluable resources of their country. One way to do this is to forbid or tax the export of crucial energy resources. For instance, Sweden should tax the electricity it exports.

In the long but brilliant non-technical lecture that I have begun circulating, I will make it clear that much of what I hear or read about natural gas is bunkum. Shale natural gas is a valuable resource, but on the basis of evidence as opposed to dreams, not as valuable has often depicted. The history up to now of gas production in the U.S. and elsewhere (e.g. Poland and Argentina) are very different, and not favourable for gas, but the idle chatter about engineers and managers in the U.S. mastering the technology while engineers and managers elsewhere are mystified is sheer foolishness.

The CEO of the giant (and successful) firm Exxon has stated flatly that fracking has failed to perform in a satisfactory manner in China and Europe, and Mr Tillerson has also said that some shale formations in the U.S. have also proved difficult to exploit by fracking. This is one of the reasons for the hesitation in adopting natural gas as the main fuel for factories and vehicles. That adoption (investment) does not make economic sense until managers and engineers have the same confidence in the long-run availability of shale gas as propagandists who are being paid to make fools of the voters.

A year ago I attended a boring and pretentious meeting on natural gas at the Stockholm School of Economics. I thought that the emphasis would be on shale gas, but that turned out to be only a digression, and I ended up listening to half-baked lectures and comments by self-appointed experts that were received by many members of the audience as if they were holy writ. As to be expected, when the Q & A began, I attempted to set everybody straight on the past, present and likely future of shale gas, supplying both answers as well as questions, but I am afraid that my efforts were not accorded the admiration they deserved by the sponsors of that tiresome spectacle.

Before completing this handout, I would like to congratulate myself for my present approach to this subject. Congratulations Fred! You've done some great work this academic year, but that is nothing as compared to what you can achieve in the future if the mediocrities and losers let you. Many years ago, at a conference or workshop in Vienna, an American business executive called me a fool for the belief I had in shale, and which I expressed in my book 'The Political Economy of Oil' (1980), as well as the brilliant lecture on oil that I gave earlier that day. His argument was that there was not enough water in his part of the U.S. to exploit shale the way that Professor Banks erroneously/stupidly believed. I have heard this argument many times, and it deserves consideration.

When the shale gas circus began in the U.S. a few years ago, I immediately turned to the subject game theory in order to augment my knowledge of the extractive industries, remembering at the same time that John von Neumann - often called 'the best brain in the world' - was the founder of modern game theory. More important, in a discussion held in London during WW2, von Neumann told Jacob Bronowski that game theory was not the impractical and sometimes silly mathematics that we often put or see on whiteboards and blackboards in courses dealing with that subject, but was about lies, deception and bluffing. Well, try to keep in mind that lies, deception and bluffing is what a considerable part of the shale revolution is probably - though not certainly - about so far, although I would like to confess that it would really be lovely if it morphed into something that would enhance the common good instead of making billionaires of a few dissatisfied and/or frustrated millionaires.

REFERENCES

Angelier, Jean-Pierre (1994). Le Gaz Naturel. Paris: Economica.

Banks, Ferdinand E. (2013). Energy and Economic Theory. Singapore, London and New York: World Scientific. (Forthcoming).

______. The Political Economy of World Energy: An Introductory Textbook'. (2007). Singapore, London and New York: World Scientific.

______ .(2004). 'An introduction to the economics of natural gas'. The OPEC Review 24-38. (March).

______. (2000). Energy Economics: A Modern Introduction. Dordrecht: Kluwer Academic Publishers.

______ .(1987) The Political Economy of Natural Gas. London and Sydney: Croom Helm.

______. (1980). The Political Economy of Oil. D.C. Heath & Co. Lexington and Toronto: Lexington Books.

______. (1977). Scarcity, Energy and Economic Progress. D.C. Heath & Co. Lexington and Toronto: Lexington Books.

Clarren, Rebecca (2013). 'Fracking is a feminist issue'. MS (Spring).

Cobb, Kurt (2011). 'Can we believe everything we've heard about shale gas? OilPrice.Com.

Crooks, Ed, (2013). 'Gas export opponents ignite US shale debate'. Financial Times (March 26).

Hughes, J. David (2013). Drill Baby Drill. Post Carbon Institute (February).

Mazur, Karol (2012). 'Economics of shale gas'. EnergyPulse (3 October).

Michel, Jeffrey H. (2013). 'Fracking und die Europäische Energieversorgung.' Stencil. Ing. Büro für Energieforschung.

Neumann, John von and Oscar Morganstern (1944). The Theory of Games and Economic Behavior. Princeton: Princeton University Press.

Stevens, Paul (2010). The Shale Gas Revolution: Hype and Reality. A Chatham House Report (September).

Professor Ferdinand E. Banks
ferdinand.banks@telia.com
July 26th, 2013




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