China in the Driver’s Seat on Direct Coal-to-Liquids Production

Coal is here to stay. More in some countries than others. In places like China, while coal is still king, its role appears to be slowly morphing to liquid fuels such as gasoline and diesel. With the world’s third largest reserves of coal after Russia and the U.S., China sees the future in coal-to-liquids (CTL) fuels in order to reduce dependence on foreign oil and to maintain robust domestic CTL production as an alternative to petroleum. Despite environmental and economic costs of producing liquid fuels from coal, China’s state-run Shenhua Group began profiting from its first direct coal-to-liquids (CTL) facility in Inner Mongolia Autonomous Region, China, and producing 216,000 tons of refined oil products in the first quarter of 2011. Although China wavered to use the CTL technology in 2008 due to high production costs and concerns with water use, its push forward resulted in stable production for the past nine months, bringing in 100 million yuan ($15.38 million) in earnings in the first quarter of 2011 to Shenhua.

Direct-liquefaction CTL, which converts coal to liquid fuels by way of heating finely ground coal above 400 degrees Celsius with hydrogen and a suitable catalyst and further processing to obtain naphtha and middle distillates, has not been widely used in the world yet. The reasons include high production costs, technical challenges, comparatively cheap global oil prices that make it difficult to invest in expensive CTL technology, as well as its carbon footprint, which would not be insignificant due to emissions from hydrogen production and thermal loss. There have been long-standing concerns with toxicity and carcinogenicity of liquids produced from direct CTL fuel production, which still warrant detailed studying. For these reasons, the CTL industry has not developed in the U.S., another country with vast coal supplies.

It is unlikely that CTL will gain much traction in the U.S. in the near term, particularly given its massive shale oil and gas production that have further displaced coal in its energy mix. But China’s continued experimentation with direct CTL production to make it economically viable and less taxing on the environment, or failure to do so, would be worth monitoring and taking a note. The true cost-benefit analysis of the direct CTL technology and any serious attempt to develop or invest in it in the U.S. might occur when domestic natural gas prices begin to rise from their current historic lows as well as sustained high crude oil prices.

The Elephant in the Room: Fuel Exports

Much has changed in the U.S. energy landscape that some of the unthinkable scenarios of the yesteryear might just be realistic these days. For example, the U.S. is beginning to flirt with the idea of potentially exporting natural gas, coal and maybe even crude oil.  At least in the words of the newly appointed head of the Energy Information Administration (EIA), Adam Sieminski, the U.S. should be open to crude oil exports to benefit its economy, particularly because the “selling the U.S. oil abroad could help provide a market for light sweet crude produced from shale formations in places like North Dakota, since the Gulf coast refining hub is more suited to process heavier crudes.” While Sieminski’s proposition on oil exports will need to overcome the U.S ban on selling most unrefined crude oil under the Mineral Leasing Act of 1920 and the Outer Continental Shelf Lands Act, which make oil exports nearly impossible, the possibility of exporting natural gas and, especially, coal appears to be less far-fetched, partly because they have created a huge glut in the country.

Proponents of the idea of exporting natural gas from shale formations, production of which increased from nearly nothing to 23 percent of all U.S. gas production in 2010 with prices hovering around $2.8 per million British thermal units, point out that prices and profits are likely to stay depressed for decades without alleviating the glut of natural gas. They have a point. Given that the surge in shale gas production began inevitably eating into the coal market in the U.S. with its record low prices and coal-to-gas switching, King Coal maybe looking at markets abroad as well, particularly since demand for coal is rising in Europe. Reportedly, U.S. coal companies “are spending at least $530 million to increase their coal-export capacity in order to meet high overseas demand.”

Exporting U.S. energy sources may not be swift, but it will be unavoidable provided that the gas glut and unused coal stay idle in the U.S. market. And too bad that it is not receiving as much attention in the government as it should. Even if opponents of natural gas exports argue that keeping gas prices low would be key to many industries, including domestic manufacturing and transportation sectors, few politicians on both sides of the aisle appear to be opposed to gas exports. But even fewer politicians openly state their support to exports lest should they be accused of causing domestic price hikes.  And even if there is an eventual agreement to export natural gas, it looks like there will be cap on the amount. As Cheniere Energy won the bid to build an LNG export terminal in Louisiana to begin operation in 2015, political will to agree on exporting fossil fuels in the U.S. may emerge by that time. Perhaps, it will be ushered in further with influential figures such as Sieminski. When that day comes, the ultimate question will be how much energy should be exported.

Challenges of China’s Fuel of Choice

The Chinese economy has grown by an average of 10 percent a year over the past two decades, crossing the milestone to become the second-largest economy and energy user in 2010 after the U.S., as well as the world's largest emitter of greenhouse gases. Stable energy supplies being at the core of China’s rise, they remain pivotal to its continued economic growth, especially coal, oil and gas. While coal still constitutes around 68 percent of China’s energy use, Chinese policymakers and energy executives lean more and more towards cleaner fuel sources, particularly natural gas. According to International Energy Agency’s June 2012 report, the share of natural gas is set to rise in China’s energy mix, which is expected to have strong implications on the country’s energy usage in the years to come.

Analyzing the new role of natural gas in China, my new article published in Oilprice looked into China’s natural gas policy, main players in its gas market and problems it faces with the rise of Central Asian gas imports (full article can be accessed here). I concluded that mounting natural gas demand, combined with the official endorsement of clean energy sources, is bound to solidify the position of natural gas in China’s energy mix in the years to come. But liberalization of domestic natural gas prices will be absolutely key to attracting private investment to successfully develop domestic gas and to continue importing this energy source without hurting Chinese energy companies.

Why U.S. Shale Gas Will not Be a Cookie Cutter Model

A new report of the International Energy Agency (IEA) on unconventional natural gas earlier this month predicted that “global exploitation of shale gas reserves could transform the world's energy supply by lowering prices, improving security and curbing carbon dioxide emissions.”  But unconventional gas revolution may fall short of its promise if social and environmental issues are not adequately addressed. The IEA report points out many common concerns about shale gas extraction in the U.S. and other countries.  Chiefly among them are groundwater and air pollution, dangers of structural faults in well drilling, disposal of flowback water, and emissions of polluting gases from wells, which are some of the factors of public skepticism about the industry’s safety.

As more countries begin to tap shale gas, the learning curve promises to be steep.  Countries with major shale gas reserves, such as China, Australia, Poland, and Canada, are aware of the long lead times, high capital and operational costs, necessary price environments to attract investment, and the importance of overcoming regulatory and environmental constraints before this resource becomes a reality.  Just this week, Europe’s biggest shale potential in Poland came under question and confusion after ExxonMobil pulled out of shale exploration in this Eastern European country due to unsatisfying findings, legislative foot dragging and complex geology.

Conditions that existed in the U.S. to revolutionize this industry may not exist in other countries to easily replicate its success, which include geological differences, inadequate or lack of access to equipment, water, manpower, and infrastructure as well as complex land ownership issues. Because maturity of the shale gas industry outside the U.S. will take anywhere from five to ten years before it reaches commercial production levels, developments in this unconventional gas sector in America are likely to set the tone to other countries.  In other words, what happens in the U.S. shale gas is bound to have ramifications on the trajectory of the industry elsewhere because the U.S. is far ahead of the rest of the world in exploiting this energy source. 

As much as there is enthusiasm and effort to follow the footsteps of the American unconventional gas evolution, a possible serious incident in the U.S. shale gas may set the newly emerging industry back in the rest of the world.  Given an already complex set of costs and public concerns over hazards of shale gas in many countries, an incident in one country is likely to cause more stringent regulations, and even more moratoria, in others.  In such a scenario, costs of drilling and operations are likely to be even higher for investors and operators with an added challenge of winning hearts and minds of the distrustful public.  The U.S. may have brought down the costs of taking natural gas out shale rocks, but its global success and acceptance will hinge on minimal mistakes and no major disasters.

Obama's Energy

As the election day draws closer, U.S. President Barack Obama’s record on energy is increasingly under scrutiny with mixed conclusions. The left praiseshis record to date, as the right remains highly criticalof it. The point of contention is not just the yoyoing oil prices and the delayed Keystone XL pipeline. It is also about debate over domestic oil and gas production and Obama’s support of renewable energy. Although unconventional oil and gas production saw a major increase in recent years, leading to a creation of many jobs in the shale gas and oil sector, as well as reduction of oil imports for the first time in a long time, the American Petroleum Institute (API) insistedthat the “White House is lying to the American public when it says its policies are responsible for increased oil production.” According to API’s PresidentJack Gerard, “Obama is taking credit for policies enacted under the previous administration.”

Politics and politicization of energy aside, while the Obama administration made mistakes on some key matters, e.g. shelving Keystone XL or blowing money on Solyndra and other less than economically sensible solar projects, it did not interfere with the production of shale gas and oil that transformed the energy landscape of the U.S. It is important to remember that as much as any U.S. President would be keen to have an exclusive access to a magic red button to bring up or down oil prices, they are not – and will never be – under his or her control. It is a deliberate misrepresentation to put globally-driven high oil prices on a president of a country, unless that president is a cause of a major world event, such as war, natural disaster or depletion of oil.

At this point, nothing major in the energy sector is likely to happen before the November elections. So, the focus should be on the outlook of the U.S. energy policy that goes beyond bumper stickers of the extreme left or right. As the unconventional energy business matures, the level of regulation at the state and federal jurisdictions is likely to remain a source of contention both sides of the aisle. If Obama is re-elected, his record on energy will be further put to test, depending on how his administration regulates the shale gas and oil industry, how many drilling leases on federal lands will be issued, when onshore drilling permits will come to life, what happens with clean energy, and how the right and left will react to them. Obama’s challenge will be living up to the “all of the above” plan and providing leadership to develop an unpoliticized comprehensive energy policy for the country.

The Vision Thing

As U.S. oil and gas production is back in the game, there is growing faith that achievement of full energy independence is just over the horizon. According to the U.S. Energy Information Administration’s (EIA) Annual Energy Outlook 2012, net imports of energy have been declining in the U.S., which is largely attributed to an increase in domestic oil and natural gas production. EIA anticipates an increase in U.S. crude oil output from 5.5 million barrels per day (mbpd) in 2010 to 6.7 mbpd by 2020. Echoing this positive scenario, a recent conference of the International Association of Drilling Contractors was upbeat that U.S. unconventional oil and gas production would bring net imports to zero in the next 6-7 years, the only wildcards being a possible geopolitical problem, such as war with Iran, and stricter limitations on drilling imposed by the Environmental Protection Agency (EPA).

The confluence of the Great Recession and affordability of drilling techniques and technologies such as hydraulic fracturing and horizontal drilling was a silver lining in a cloud of declining oil production in the U.S. over the past 40 years. While reliance on more domestic energy sources and less on foreign ones is good news, it is unclear whether the U.S. will learn to be a prudent energy user or continue taking energy sources for granted and expect gasoline prices to be permanently below $3 a gallon. There is still a danger that a potential accident from the production of unconventional energy sources may have a backlash on the industry and slow it down with regulations that would carry huge ramifications on the economy.

More importantly, it is uncertain whether the newfound energy bonanza will hamper development of a sorely missing comprehensive energy policy in this country that would not rely on short-term gains and low energy prices or politicization of one resource over another at election times. There is no guarantee that the abundance of unconventional energy will not taper off in coming decades with the level of energy use in the U.S. up to now.

Happiness is Multiple Pipelines

North Dakota appears to be becoming a modern day Titusville. Topping Alaska in oil production, North Dakota is now a number two oil producer in the nation, just behind Texas and ahead of California thanks to the boom in shale oil. With 152.9 million barrels of crude oil output in 2011, this Midwestern state is enjoying the lowest unemployment rate in the U.S. at 3.3 percent, drawing a massive inflow of migrant workers from all over the country, and increasing in per-capita income by 78 percent, which is twice the national average. The only complaint of North Dakotans these days has to do with crowded roads and restaurants and shortage of hotel rooms due to boom in oil workers.

While U.S. is witnessing highest levels of oil production in years, with no signs of abating in the foreseeable future, distribution of oil abundance is likely to remain a challenge in the near term. The pipeline system in the country is inadequate to carry oil freely across the states since most of it traditionally was set up to bring refined oil and gasoline from the coasts to inland. Now the problem is moving massive amounts of oil from shale production in Texas and North Dakota, leading to a bottleneck in the U.S. major crude oil storage in Cushing, Oklahoma. As a result, the price differential between Midwestern and East Coast oil prices has been substantial.

An upcoming reversal of the Seaway pipeline from Oklahoma to Texas will provide cheap domestic oil to the refineries there, which would help reduce oil imports. While the reversal of Seaway may help balance the price of West Texas Intermediate (WTI), a North American benchmark in oil pricing, the situation is calling not only to be careful in assuming that it will bring down oil prices and keep them stable, which are still affected by international developments, but also to get serious with building more pipelines to move rising domestic crude across the country.