with Walter Kemmsies
Energy is involved in every economic transaction and therefore affects not only transportation operations but the markets they serve. While the implications of rising energy demand are far too great to be discussed here, even in at a high level, it is worth focusing on one tangible issue, namely the possibility that natural gas will gain share of the transportation sector’s fuel consumption.
Oil prices have risen substantially in the last decade to levels not consistent with global supply-demand trends. According to the International Energy Agency, global production has increased faster than consumption over the past 10 years. Viewed in isolation one might attribute this to refinery issues, financial speculation, geopolitical tensions and other factors. However, other commodity prices have risen as much.
Rising commodity prices are unlikely to be specific to any single industry factor but rather the substantial growth of underdeveloped economies like those in emerging Asia. Oil consumption in emerging markets exceeded that of mature industrialized economies for the first time in 2008 and this trend is likely to continue. Global freight movement infrastructure does not appear to have adjusted fast enough to accommodate the fast growing demand for raw materials from emerging markets, which is likely to account for a substantial portion of the rise in raw materials prices. Of course, the other reason for this trend is higher production costs since additional supply is coming from places that are harder to reach, such as oil from deep below the ocean’s surface.
One major exception to generally higher commodity prices is natural gas. Due to deployment of improved horizontal drilling technology, U.S. production companies have been able to tap into substantial reserves trapped in various reserves in the United States. These locations not only have natural gas but oil as well. However, oil is a globally traded product and demand in other parts of the world and given U.S. dependence on imported oil, among other factors, prices have not come down much despite higher production.
On the other hand, natural gas prices have declined precipitously from an average level of $8.85 in 2008 to $3.20 over the last 12 months. Weather patterns can be blamed for some of the decline but the main reason for this trend was production growing significantly faster than consumption. Storage costs have also increased.
The ratio of diesel to natural gas prices, on a per BTU basis, averaged 3.2 times until 2008. Since then diesel prices have not come down but natural gas prices have. In the last 12 months the ratio has averaged 9.3 times. On a gallon of gas equivalent basis it has been significantly cheaper to use natural gas.
The cost advantage of natural gas has raised interest in converting heavy vehicle fleets from diesel. The cost differential that has prevailed in the last year has meant the cost of conversion can be recovered over a period of time between one-and-a-half to three years. New engine sizes are currently being introduced to the market which should make it easier for potential consumers with different requirements to be able to convert.
Fleet conversion demand also depends on refueling options. Until recently these have not been plentiful. Most conversion has been done for fleets of city buses, garbage trucks and delivery truck fleets, exemplified by Frito-Lay’s recent announcement that it would convert its local fleets. These vehicles have generally used compressed natural gas. Some companies have recognized the potential for long distance heavy trucks to convert as well. These vehicles generally use denser liquid natural gas. Clean Energy is installing LNG pumps at fueling stations along major freight movement corridors. Railroads have also indicated they are looking to convert locomotives to LNG.
Besides the cost, there are additional factors such as tighter emissions standards, which increase the demand for natural gas vehicles. Furthermore ultra-low sulfur fuel lowers the gas mileage of trucks.
Thus far natural gas has not captured a significant share of the transportation industry’s fuel consumption. Data from the Department of Energy indicates natural gas supplies 3 percent of total U.S. transportation consumption and less than 1 percent of highway consumption.
Transportation is the largest consumer of refined petroleum products in the United States but in terms of total energy use it is on par with industrial demand, such as for manufacturing which includes the production of petroleum and natural gas. However, analyses by some companies indicate that given the cost structure of natural gas production in the United States, a lot of the increase in demand could be met at a price in the neighborhood of $4 to $4.5 per million BTUs. It seems that if transportation’s consumption doubled or even tripled this would not impact prices significantly.
The other fear is that oil prices may decline due to growing U.S. production, which would reduce the benefits from switching. Some U.S. and international agencies believe the United States could become the largest producer of oil in the world by 2020. However, what matters is not the amount of oil produced but instead the amount of ultra-low sulfur diesel that could be produced. Since that production capacity is limited, it’s hard to see prices declining enough to eliminate the advantages of switching to natural gas.
Despite the current production capacity and cost structures it is possible that the cost advantage of natural gas for transportation could be eliminated. However, at this point in time it’s more likely that the conversion trend will continue. Transportation industry participants would be wise to consider how this will affect their competitiveness and to do so now.
Kemmsies is chief economist at Moffatt & Nichol, a marine infrastructure engineering firm. He can be reached at (212) 768-7454 or by email.