Reverse engineering the natural gas supply debate

While Congress was in recess, the Department of Energy approved its third liquefied natural gas (LNG) permit and promised to continue to move the review process forward for remaining applications in a timely manner. 

 Predictably, news reports focused on concerns from industrial gas users that the export demand for U.S.-produced gas will increase prices and undercut manufacturing competitiveness. Lost in the discussion are two perspectives: first, that elevated demand is driving supply and creating the gas glut we have today, and second, that the biggest threat to the natural gas supply is uncertainty over whether the market will be strong enough to accommodate continued, high production. Let me explain.

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In the 1970s, Washington responded to high natural gas prices by regulating how gas would be used, including curtailing its use in powering electric generation. It wasn’t until gas markets were deregulated in the 1990s that natural gas was again used in electricity. The result was a dramatic demand spike in the early 2000s. The corresponding price increase resulted in a dramatic short-term economic hardship for industries sensitive to the price of natural gas. 

With still-fresh memories of being traumatized a decade ago by a supply shortage, industrial users are understandably uneasy about the prospect of shipping their supply overseas. But the reality is that today’s natural gas production boom is a result of the price spike that occurred during the transition to deregulation and the realization that there was a market for additional gas production. The economic and investment incentive for new technologies, which have so radically changed the natural gas supply equation, were driven not by limited market access, but by those who saw a demand for gas.

A decade ago, on the heels of a number of major studies, one in which I was involved, it was projected that America would need to begin importing liquefied natural gas to satisfy demand. These import projections, coupled with the prospect of expensive LNG import prices, gave a green light to pursue new technologies to perfect extracting gas from shale deposits. Instead of bringing LNG from places like Qatar to meet demand, which was what policymakers had anticipated, demand created the price incentive to pull natural gas out of the ground here at home. Once producers realized that the cost of using comparatively expensive technology to domestically produce gas would still be lower than the import price of LNG, the rush was on.

The current supply surge is absolutely being driven by demand, and future supply will be driven by even more demand. Attempts to reverse engineer the “supply demand” curve and argue that limited markets and low prices stimulated supply should be viewed with a healthy dose of skepticism. 

By all estimates, U.S.-produced natural gas is plentiful and can supply domestic demand at favorable prices for the foreseeable future. For industrial users, history tells us their supply risk lies not with excessive demand, but with potential regulation that could pose barriers to market opportunities and continued resource development.

Looking forward, creating natural gas market opportunities to justify future production by way of LNG exports will be critical to maintaining adequate domestic supply for industrial users. Production developed for overseas shipment will ultimately serve as a critical buffer against localized production losses and demand spikes. Just by diversifying supply from the Gulf Coast, there is a lower risk of a hurricane-related disruption. Similarly, a sudden shift in demand driven by a continued migration from coal to gas generation, or even toward alternative fuel vehicles, can be accommodated from gas that is scheduled for export.

Unfortunately, while industrial gas users expend energy on putting the brakes on natural gas exports, they have unwittingly laid the groundwork to jeopardize the supply of gas they seek. Ironically, as advocates for free market strategies, these consumers have hopped into bed with those who oppose burning fossil fuels under any circumstance and those who object to hydraulic fracturing techniques that are being used to extract shale gas. Such an unholy alliance of environmentalists and industrial policy advocates has the real potential to inadvertently create a perfect coalition to derail the nation’s natural gas boom.

As such, it might be worth those who are dependent on reliable and affordable natural gas to move beyond their recent history and take a longer-term view that recognizes the impact of demand on supply.

Maddox is a former senior official at the U.S. Department of Energy and a fellow at the American Action Forum.