Betting Big on a Boom in Natural Gas

Earlier this year the time came for Lloyd M. Yates, CEO of Progress Energy (PGN), to decide how the big Raleigh (N.C.) utility would meet the state's stringent smokestack laws. First he considered the easy solution: installing pollution scrubbers on the utility's old coal-fired plant in Sutton, N.C., at a cost of $330 million. Then his attention turned to natural gas, the price of which had plunged by two-thirds in the previous year. Sure, the recession accounted for some of the slide. But reports were also circulating of massive discoveries of natural gas in the U.S. Moreover, because the fuel emits half the carbon of coal, it seemed safe from the climate legislation being considered in Washington, which could impose steep penalties on emissions.

After weighing their options, Yates and his board decided against the scrubbers and opted to upgrade another coal plant to natural gas—a $900 million project. In Yates' calculations, that would satisfy the smokestack law and more than pay for itself over time. "It was like deciding whether to put a catalytic converter on a '52 Chevy," Yates says. "It was: 'When do you buy the new car?'"

The U.S. natural gas industry hopes that as Lloyd Yates goes, so goes the country. In summer 2008 the U.S. and much of the rest of the world were consumed by talk of peak oil and natural gas and fears that high fuel prices would persist forever. Today analysts still worry about the oil supply but far less about natural gas. U.S. gas producers, capitalizing on a technological breakthrough, have in recent years unlocked an enormous volume of natural gas in the shale rock under Colorado, Oklahoma, Pennsylvania, Texas, and other states. According to a July report by the Colorado School of Mines, the U.S. now holds 1,800 trillion cubic feet of natural gas, one third of it in shale, the equivalent of some 320 billion barrels of oil. That's more than Saudi Arabia's 264 billion barrels.

Of course, natural gas isn't interchangeable with oil and won't solve America's energy woes by itself. While natural gas can be used to heat homes and power vehicles, it's mostly used, like coal, to generate electricity.

But the supply estimates for natural gas are so vast and the plunge in prices so steep that they're forcing business leaders to rethink their long-term energy strategies—quickly. Utilities are debating whether to retrofit coal plants for gas. Big corporations such as AT&T (T) and UPS are beginning to convert large truck fleets from oil-based gasoline to natural gas. Even renewable-energy players are jumping in: As they try to coax more power from unpredictable wind and solar generators, they're finding that inexpensive natural gas helps keep their output steady.

It's not certain that the gas boom will fulfill its promise. "We don't know if it will be truly awesome or only theoretical in its impact," says David G. Victor, a professor and energy expert at the University of California at San Diego. While natural gas producers say they're sitting on the greatest volumes ever, they also face considerable barriers to getting their commodity to market. Prices are so low that many producers have closed their wells. Most utilities fitted with coal-burning units remain reluctant to invest in natural gas equipment. Critics say the water-intensive shale-drilling process poses risks to nearby drinking water supplies. And skeptics point to the late 1990s, another era when prices seemed permanently lowered, only to spike a few years later. "Utilities have been burned many times," says Andre Begosso, an energy strategist at Accenture (ACN), a consulting firm.

Yet the opening up of U.S. shale gas may make the current wave of discoveries different from those of the past. A technique developed in the late 1990s by tiny Mitchell Energy & Development is driving the action. Before hydraulic-fracturing, as the technique is called, gas that was encased in solid shale was untappable. Mitchell and others figured out how to inject the rock with water and chemicals to release the gas molecules. Another recent advance has made it possible for drillers to fan out horizontally, recovering gas from far larger areas than in the past. U.S. natural gas production rose 14% between early 2007 and mid-2008, in large part because of new fields such as the Barnett Shale in Texas.

And the shale boom is only in its infancy. In 2004, John H. Pinkerton of Range Resources (RRC) drilled the first such well in Appalachia, the Marcellus Shale, a 62 million-acre gas field spanning some 600 miles north to south. Since then Pinkerton has beefed up a one-person Pittsburgh office to 150 geologists, geophysicists, and engineers. Pinkerton says his production has quickly tripled, to some 90 million cubic feet a day. "We expect to double that next year, and again in the following years," he says.

In Raleigh, Progress Energy's Yates made his decision to shift to natural gas in the face of a state requirement to cut the utility's sulfur dioxide emissions in half, to 50,000 tons a year, by 2013. To do so in time, the utility had to act this year. After weighing the options it chose natural gas, in effect betting that prices would stay low for a while. Output at the plant will rise considerably, with a 950-megawatt natural gas unit replacing 397 megawatts of coal-fired capacity. And it will do so while also meeting the sulfur dioxide requirement: It will lower carbon dioxide emissions by 60% and nitrogen oxide by 95%, and will eliminate mercury emissions.

If Washington puts a cap on carbon emissions, Yates will likely face another decision on how to modernize Progress Energy's three other 1950s- and '60s-era coal-fired plants. Yates says natural gas will figure prominently in the calculations, while "we are not even considering coal because of its cost."

A few other utilities are making the shift to gas or considering doing so. Tampa Electric (TE) has transformed its coal-fired Gannon Power Station into a natural gas unit at a cost of $750 million. In April, developers of the Highwood Generating Station near Great Falls, Mont., dropped plans to burn coal and chose natural gas for a new plant. Portland (Ore.) General Electric (POR) is proposing to build two new natural gas plants.

Most utilities, however, remain on the sidelines. Natural gas prices have been so volatile over the years that executives are unwilling to make a long-term commitment. That's because if they lock in a guaranteed supply at higher prices than today's and prices don't rise to that level, they might have to raise the rates they charge customers. That wouldn't be an easy sell to regulators, who "are not keen on cost-recovery for wrong-way bets on supply contracts," says James Owen, spokesman for the Edison Electric Institute, an industry lobbying group.

Oddly enough, natural gas is finding more popularity among utilities that embrace renewable energy. Fears that cheap natural gas might take investment from costlier solar and wind power have proven overblown; instead, utilities are building both. Because gas turbines can vary their output with precision, they complement wind farms and solar fields that generate irregular power flows. The result is a more stable and reliable energy supply.

Florida Power & Light (FPL), the nation's largest renewable-energy developer, is building a solar thermal power plant that will be the nation's second largest. The Juno Beach (Fla.) company put its new facility next to an existing gas-fired plant so that when a cloud passes in front of the sun, the gas plant can keep the power flow steady. Public Service Enterprise Group, (PEG) a major mid-Atlantic utility, is developing gas and renewable projects simultaneously. "The ease of dispatching gas-combustion turbines makes them perfect complements" for wind and solar plants, says PSEG CEO Ralph Izzo.

General Electric (GE) has targeted a line of fast-start gas turbines at renewable projects. As part of a $320 million investment, Topeka (Kan.)-based Westar Energy (WR) has paired four of those turbines with 300 megawatts' worth of wind capacity spread around the region. It's a wind-rich area, where gusts not only die suddenly but also get too brisk, forcing the turbines to shut down for safety. In either event, gas turbines can kick in to maintain power. Westar committed to build the turbines back in 2006, when gas was double today's price. Now, with prices so low, "they offer an extra benefit, supplying regular power too," says Greg A. Greenwood, a vice-president at Westar.

Natural gas is also making a small dent in the transportation market. AT&T (T) in March announced that it would be replacing 8,000 service vans with natural-gas-powered vehicles. The 10-year, $350 million upgrade came as part of a $565 million alternative-fuel vehicle initiative started last year. Rising gasoline prices are turning skeptics into believers. From April to July the average price of a gallon of gasoline jumped by 22%, to $2.46, while the price of compressed natural gas for cars rose just 6%, to the equivalent of around $1.73. "When the price of gas rises at the pump by a cent and you're buying about 80 million gallons of fuel a year, it gets pretty expensive," says Jerome Webber, AT&T's vice-president for fleet operations. The company is betting the new vehicles will save it 49 million gallons of gasoline over the next decade. Transportation giant UPS, meanwhile, deployed 300 new natural gas vehicles in February alongside 800 already on the road.

The market for natural gas vehicles is limited by the dearth of fill-up stations in the U.S. Just 1,100 of the country's 162,000 stations sell natural gas, according to Natural Gas Vehicles for America. But that number is growing. Clean Energy (LNE), a Seal Beach (Calif.)-based company backed by T. Boone Pickens, has installed 184 natural gas stations in North America and plans to add up to 80 more in the next two years. Utah's Questar Gas has built 20 along that state's I-15 corridor and plans six more over the next 18 months.

Of course, the CEOs of natural gas outfits understand that such inroads don't amount to much compared with the massive reserves still sitting underground. They've descended on Washington in recent months to persuade lawmakers to create incentives for gas use in a climate-change bill moving through Congress. By boosting demand over the long term they hope to strengthen their position vs. Big Coal and Big Oil.

Whether or not they succeed in D.C., the shift away from coal and toward natural gas seems likely to continue, at least for a while, as the price and policy dynamics point in its favor. Says PSEG's Izzo: "We're building gas turbines because...there's no other option in the near term."

With Brian Burnsed in Washington

Business Exchange: Read, save, and add content on BW's new Web 2.0 topic networkShale Gas: Good or Bad for the Environment?Cheap natural gas is "the single biggest game changer for climate action in the next two decades," writes Joseph Romm, of the Center for American Progress, on his blog. If the U.S. were to replace half its coal-fired plants with gas, it would cut all the emissions called for in proposed climate legislation by 2020. But such a shift could pollute local water, land, and air. Amy Mall of the Natural Resources Defense Council runs a blog that catalogs the environmental effects of natural gas drilling.To read both, go to:

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