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The Texas economy: the prospects for natural gas substitution.

It is now widely appreciated that among the fossil fuels, natural gas pollutes least. Measured in terms of carbon dioxide equivalent per Btu of energy, the air pollution resulting from coal combustion is three times that of natural gas. In the case of oil products, the pollution is one and a half times that of natural gas. It follows that substantial substitution of natural gas for coal and oil products would significantly reduce air pollution. Presumably, a sound environmental policy using market-based instruments would induce some such substitution.

The question then arises: what are the prospects for natural gas substitution? The approach to the answer is in two parts. The first, fully addressed in this article, has to do with the magnitude of coal and oil product use in processes where natural gas is a technical, if not currently an economic, alternative. The second, only partially addressed here, concerns the size and quality of the natural gas resource base, hence the economic feasibility of substantial substitution for other fossil fuels.

In this discussion, we shall be concerned only with primary sources of energy-the fossil fuels (coal, oil, and natural gas), plus nuclear, hydro, solar, and wind power-but especially the fossil fuels. Much of the energy consumed by end users is in the form of electricity. But electricity is a secondary source, generated by one or more primary sources. Thus, it would be double counting to add electricity to the consumption of primary sources. In this connection, it should be noted that the substitution of electricity for a fossil fuel in some end uses-say, in home heating-does not mean a reduction in fossil fuel consumption if the electricity is generated by a fossil fuel. Indeed, the contrary is true because the generation of electricity involves a large heat loss. It requires three Btus of oil, for instance, to generate the equivalent of one Btu of electricity in modem plants.

The following three figures show the percentage distributions of (1) the principal primary sources of energy, (2) the principal uses of the fossil fuels, and (3) the principal primary sources used in electric utilities, transportation, and the remaining sectors as a whole. All of the percentages are for the year 1989, the latest period for which fully comparable data are available. Taken together, these figures provide some indication of the possible scope and industrial location of natural gas substitution.

Starting with figure 1, we see that in 1989 oil supplied the largest percentage of U.S. primary energy. (Solar and wind energy are omitted as negligible.) Only in the case of oil are imports important, accounting for about half of 1989 oil consumption. Natural gas imports, predominantly by pipeline from Canada, account for only 7 percent of natural gas consumption. All of U.S. coal consumption is domestically produced; indeed, about 12 percent of the nation's coal production is exported.

Figure 2 shows the principal uses of oil, natural gas, and coal in 1989. (Hydro and nuclear power need not be charted here because all of it goes to generate electricity.) Part (a) indicates that transportation consumes more oil than industry, residential and commercial uses, and electric utilities combined. In part b), we see that industry and residential and commercial establishments are, by far, the largest users of natural gas; electric utilities and transportation claim much smaller percentages. In contrast, electric utilities, as illustrated in part (c), consume most of the coal in the United States. Industry is a distant second, and consumption by residential and commercial establishments and transportation is virtually nonexistent.

Turning to figure 3, we see in part (a) that electric utilities satisfy most of their primary energy demands with coal and nuclear power. Part b) shows that transportation needs are met with oil, almost to the exclusion of gas. The remaining sectors, represented in part (c), meet about half of their primary energy needs with natural gas; the remainder, with oil and coal.

These figures indicate quite clearly that the largest technical scope for natural gas substitution is to be found in two sectors: the generation of electricity, where coal is by far the dominant fossil fuel, and transportation, where oil has a virtual monopoly. If natural gas could be substituted for one-half of the coal used in generating electricity and one-fourth of oil products used in transportation, the share of natural gas in total primary energy consumption would rise from 24 percent to 41 percent. At current rates of total energy consumption, that would mean a 70 percent increase in natural gas consumption, to be supplied by some combination of increased domestic production and imports.

So the next question is: what are the prospects for increased domestic production and imports of natural gas?

Between 1960 and 1989 domestic oil production rose 8 percent while domestic natural gas production rose 43 percent. Since 1986 domestic oil production has been falling and imports now account for about half the nation's consumption. Domestic natural gas production, in contrast, has strengthened somewhat in the same period. While import prices constrain the domestic price of oil, it is primarily domestic coal prices that constrain the domestic price of natural gas. If coal were priced to reflect relative environmental damages, the electric utility demand for natural gas and its price would rise, with major environmental gains. If oil prices reflected the risk attached to imports, the demand for natural gas in transportation would rise also, according both environmental and security benefits. In any case, the above price and production record suggests that, during the last three decades, there has been less of a quantitative and qualitative domestic resource base constraint on the development of new capacity in natural gas than in oil-that, at a Btu price commensurate with that of oil (roughly $3.00/mcf), domestic natural gas capacity and production could and probably would be much larger. Estimates of the natural gas resource base (the amounts remaining to be discovered and produced with current technology at a given price) are consistent with this inference. The most recent estimate of the natural gas resource base recoverable at $3.00/mcf (Gulf Coast Wellhead price as of this writing: $1.20) in the lower 48 states alone is 604 tcf, about 35 times the current annual rate of consumption.[1] There is undoubtedly a large additional base in Alaska awaiting a pipeline through Canada (with its own substantially exportable base) to be evaluated. We lack a comparable estimate of the oil resource base, but one recent estimate, based on a price of $24.00/bbl West Texas Intermediate price as of this writing: about $20.50) and including Alaska, is 120 billion barrels, about 20 times the current annual rate of consumption.[2]

The above analysis leads us to believe that there is substantial scope for the substitution of natural gas for other fossil fuels, especially in the electric utility and transportation sectors. If exploited, this substitution would bring significant environmental benefits and perhaps a bonus of reduced reliance on foreign oil. As yet unanswered questions include: (1) the size of the increase in the real price of natural gas likely to result from a rational market-based environmental program, and (2) the exploration and development response of the domestic natural gas-producing industry to this enhanced incentive. In subsequent articles, we shall try to provide at least approximate answers to these questions. 1. National Research Council, Future Directions in Advanced Exploratory Research (Washington, D.C.: National Academy Press, 1987). 2. Ibid.
COPYRIGHT 1991 University of Texas at Austin, Bureau of Business Research
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Author:McDonald, Stephen L.; Mohammadioun, Mina
Publication:Texas Business Review
Date:Aug 1, 1991
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