Would you build a buy-and-hold financial portfolio from only junk bonds and no Treasuries by considering only price, not also risk"Cheap gas" reflects only the bare spot price of thecommoditywithout adding the value of its pricevolatility. Yet such competitors as efficiency and renewables have no fuel and hence no fuel-price volatility: Once built, they're as financially riskless as Treasuries. Of course, much gas is sold not at spot but on long-term contract, especially to its biggest user--electricity generators. But for other players, it's vital not to become the patsy in the poker game: Basic financial economics says asset comparisons must value and equalise risk.
This article was originally posted by Rocky Mountain Institute on its blog, The Outlet.
One way is to compare fuel-free competing technologies with constant-price gas. A broker will take the price-volatility risk for a fee based on the market's risk valuation, discoverable from the "straddle"--the sum of the prices of simultaneously sold put and call options. A year ago, when the cheap gas mania was taking hold, gas-price volatility five years out was worth more than recent spot gas prices.
Even today, with lower price and volatility (whose value automatically falls with price), gas's price volatility alone, over a time horizon appropriate for comparison with durable assets, is worth roughly what gas now sells for. Omitting price volatility thus understates gas's true cost (excluding its fixed delivery costs) by about twofold--a very material error.
A leading promoter of shale-gas fracking, asked about this at a recent financial conference, replied: "Trust me!" Gas, he claimed, would remain very cheap for a very long time. So how much gas would he contract to sell for a constant US$2-3 per thousand cubic feet for 20–30 years, backed by solid assets unlinked to hydrocarbon prices.
Predicting gas supply and demand is unlikely to get much easier. Abundant domestic gas could paradoxically exacerbate price volatility. One reason is trade. Unlike oil, bulk gas has been delivered almost entirely by regional pipelines, de-linking prices between the major markets in Asia, Europe, and the US. But huge new export facilities will abruptly send liquefied gas toward the best price, rippling supply adjustments across the global network. US. gas, for example, may veer to Japan, where gas fetches US$16 because it's still (for now) contractually linked to oil prices.
Exporters would get a windfall; other Americans would pay higher gas prices. Since major shale gas reserves are not just in North America but also such places as China, Argentina, Mexico, Australia, and South Africa, easier global capital markets or faster nationalgas development could speed gas globalisation, with all its benefits and travails.
Demand is no easier to predict. Finding gas in places previously "unpiped" will create additional thirst. So will competition in electricity, where gas took a 10th of coal's market during 2005--10 (though nuclear prospects evaporated years before gas prices fell). Energy-intensive industries like petrochemicals and ammonia nimbly shift global marginal production toward cheaper gas.
A trend to reward utilities for cutting customers' bills, not selling them more gas and electricity, has spawned huge new efficiency industries. Those, plus new building codes in half the states, are flattening electricity demand growth. Conversely, new markets are emerging: One major heavy truck maker expects 25 percent of its 2012 sales to burn natural gas. This tangle of savings, shifts, and substitutions further clouds the crystal ball.
Finally, add to these imponderable moving parts all of fracking's technical, regulatory, and environmental uncertainties. Can we really believe we have irreversibly shifted to a "new normal" of low, stable gas prices, so this time will be different.
BY: Amory Lovins and Jon Creyts, Rocky Mountain Institute