The current discussion of Peak Oil and the time of its arrival tends to obscure the situation that exists in the natural gas market.

A theme of Economic Undertow is that Peak Oil took place in 1998, a year where the average price of crude oil was lower in inflation adjusted dollars than the 1946 price. I believe the dollar measurement is more useful than measuring actual physical production flow because it measures supply against the backdrop intensity of demand. Since an outcome of Peak Oil is always predicted to be a sharp (or devastating) relative increase in oil prices, why not look at past oil prices? Why not examine historical patterns to uncover supply/demand relationships?

Price measures production relative to the intensity of demand. If there are lots of buyers for a good the price of it will be bid upward. If there is a supply overhang, then the price will fall until the market clears.

The difference between the rate of increase or decrease of physical supply measured against the rate of increase or decrease of demand – is instantly determined by price. The producers and users make the measurements themselves and do so with materials in hand. Price measure of product availability is too useful to ignore.

This Economic Undertow viewpoint does not negate the importance of physical production but puts it in context. It allows for fluctuations in physical production – or in oilfield measurements – and links it to the relative demand at any given time.

There is another discussion of Peak Oil here.

Since the outcome of physical production is reflected in price – oil depletion resulting in sharply higher relative prices – using price history to ‘rate’ production makes equally good sense. In 1998 the demand was such – even with consumption at high levels – that the excess of supply to demand was such that the equilibrium price was very low, both in absolute terms and in adjusted dollar terms.

At the same time the barrel-per-day physical production of that period was only a few million bpd less than the 2005 physical peak. Since 1998, the demand for petroleum has increased somewhat faster than the increase in petroleum production. The convergence of supply and demand curves between then and now resulted in a long secular run-up in price, culminating with the ‘spike’ of $147/barrel in the summer of 2008.

One might also observe that the energy markets ‘priced forward’ the physical production peak in oil production. Price allows a peak oil observer to put the period of maximum output to run from 1999 to 2008 and call that the ‘Peak Oil Plateau’. Certainly, there have been momentous activities taking place in the world’s general economy. This could certainly be ascribed to reactions to both the physical peak and declining availability. Certainly, the cheap oil is ten years gone!

Likewise, natural gas prices have fallen significantly from their highs of last summer. This should sound an alarm bell;

U.S. Natural Gas Wellhead Price (Dollars per Thousand Cubic Feet)

Go to the EIA web page for monthly wellhead price figures.

The declining price pattern is not identical to the pattern of low prices in oil beginning in 1985 that culminated in the 1998 lows, however the relationship between supply and demand in gas suggests that there is a large supply overhang in this market. The current price is not only lower than the ‘Spike Price’ of last year but also the ‘Trend Price’, which would be somewhere between $6 and $8/thousand cubic feet (kcf). Following the potential trend lower from 2008 suggests that the underlying trend rose steadily from $2/kcf in 2000 to a high +$6 level. The trend price is now declining steadily and might reach the $2/kcf level. This decline suggests the peak in gas production is taking place right now … against the background of substantial demand.

There are two reasons for this low price pattern:

One is the discovery of highly- productive tight shale gas- carrying formations that are being produced with more effective recovery techniques.

Another reason is the effect of the economic downturn on commercial gas users. For example, large numbers of residences and retail stores are vacant, and most heat with natural gas. The decline has also effected manufacturing users. Natgas demand has declined along with the economy but the amount consumed is still within historical levels.

You can also see the demand levels on a monthly chart and table at the Energy Information Adminstration.

U.S. Natural Gas Total Consumption (Million Cubic Feet)

There is controversy whether the price trend in natural gas is a reprieve from increasing overall energy price increases or simply an anomaly. An article by Gail Tverberg in The Oil Drum measures an overall increase in gas supply, with much of this coming from unconventional shale plays:

If there is an increase in overall natural gas production, one might reasonably assume that the increase in unconventional natural gas is finally overpowering the decline in conventional production. EIA data by state and information from company financial reports both point to success with shale gas, particularly Barnett shale in Texas. If the recent increase in production in fact relates to shale gas, this would tend to tie what is happening now to what the Navicgant Consulting, Inc.(NCI) analysis is forecasting for the years ahead.

Navigant Estimates

NCI in its report does not make an estimate of total US natural gas production. Instead, it makes estimates of shale gas and tight gas production, in very general terms. In Figure 1, I put these estimates together with some rough estimates of the remaining pieces to get an estimate of expected future natural gas production. (I used a 3% annual decline rate for conventional natural gas.)

NCI’s forecast of shale gas production is in terms of how much sustainable production might be expected from the various shale formations:

Alternatively, energy expert Matt Simmons downplays the future productivity of shale gas: remarking it is

“mostly hype –it depletes fast, not easy to produce and basin plays have uneven quality.”

Regardless, the current price is an indicator that the availability peak in natural gas is here coincident with the actual physical peak in production. It would be prudent to consider the present to be ‘Peak Gas’ and prepare accordingly.

Jim Kingsdale wrote a prescient article in September, 2008, discussing a ‘gas glut’. He points out:

Ironically, there is little sign of US steps to export natural gas to Europe even with the probability of gas shortages taking place there again this winter and a longer- termed supply dependency on Russian NG. The use of natural gas as a transportation fuel as well as a support for unconventional petroleum production both in the US and Canada would tend to press prices higher. While transportation use is low now and the economic means to shift the auto fleet from gasoline use to NG is dented, there is increasing political pressure to exploit ‘massive’ and ‘inexhaustible’ NG supplies for auto use. We have heard these words used before!

This time the auto industry must be kept clear of this fuel and its use reserved for purposes that provide a return rather than representing simple consumption. Auto use would mean increased demand pressure on prices, negatively effecting both home heating and cooking – the largest domestic use for gas – as well as electricity and nitrates (for fertilizer) production. As NG availability declines from peak, auto demand would crowd out the other users accelerating depletion. At some point, NG would be unavailable for auto use anyway. Remaining marginal NG would become too costly for most users or simply unavailable.

If this is ‘Peak Gas’ the next step is to prioritize and thereby gain some time to act. An outcome of peak anything is a shift from a total consumption regime – where all products are priced to allow consumption across all categories – to an allocation regime where goods are expensive and the purchase of some excludes the purchase of others.

Some uses need to be excluded purposefully. The priorities need to be set for using gas for food/fertilizer production, home and business heating and electrical generation as well as for use as a chemical feedstock. Private auto fuel conversions or dual- fuel systems must not be allowed under any circumstances with large fees and fines posted as a consequence for such conversions. NG use for public service vehicles would be an exception but strictly limited. The prospect of hundreds of millions of cars burning NG nation- or worldwide reduces the prospect of using gas as a transition fuel from our current dependence on crude oil to renewable alternatives.

The Department of Energy has its head in the sand about this, but immediate steps taken now can prevent more hardship as natural gas becomes marginally less available. This is one area where pressing the authorities might bear fruit.