Monday, July 26, 2010

The Cost of Conversion from Oil to Natural Gas for Transportation

Here is a well thought out and detailed analysis of the T. Boone Pickens plan for getting the US off imported oil and stop the funding of terrorism. This analysis is done by Geoffrey Styles on his Energy Outlook blog:
I just finished reading the interview with Mr. Pickens in The American Spectator, published yesterday. The big shift in the Pickens Plan since the first time I examined it in detail is that he has switched his emphasis from using wind to free up natural gas to replace gasoline in cars, to using the abundant natural gas from our enormous shale gas reserves, which are already transforming the US gas and power markets, to replace diesel fuel in big-rig trucks. He is also in the process of lining up the legislative support to nudge this along much faster than market forces alone would. But does it make as much sense as he suggests when he talks about using $4.50 worth of natural gas to replace 7 gallons of diesel fuel at $3 per gallon?

Strictly in energy terms, that 7 gallons might even be a bit low. A million BTUs of gas (roughly 1,000 cubic feet or one MCF) would deliver as much energy to a truck as 7.8 gallons of diesel. And fundamentally, he's right that the recent price relationship between natural gas and crude oil makes gas a tremendous bargain, BTU for BTU. However, the prices he mentions in the Spectator interview constitute an apples vs. oranges comparison from both sides. Even if natural gas remained at a steady $4.50/MCF at the wellhead for the next 20 years, which seems unlikely despite the bounties of shale, that's not what you'd pay at the natural gas pump.

Start with the fact that it costs something to transport gas from the wellhead, wherever that might be, to market. Based on current pricing relationships, if gas starts out at $4.50, then by the time it's sold to a commercial account, which is probably how filling stations would be classified, it could cost as much as $9. And someone has to invest in the equipment to compress it to 3,000 or 3,600 psi and pump it into an 18-wheeler's tanks. Even with tax credits to help, a station owner will need to make a return on that investment, and some profit, too. Add another buck an MCF to cover that, and we're up to $10/MCF, which equates to $1.28/gal. of diesel. For a reality check on this, I took a look at, which shows the locations and pricing for stations selling compressed natural gas (CNG) for vehicles around the country, expressed in dollars per gasoline-equivalent-gallon (GGE). Prices range from roughly $1.25 to around $2, with a few outliers over $3. Since a GGE contains about 10% less energy than a gallon of diesel, you'd have to bump these prices up by about 10% to get the equivalent for a fair comparison.

Under $2 is still pretty cheap, but you shouldn't compare that to the $2.90/gal average retail price of diesel this week. The latter includes federal excise tax of $0.244/gal. and state excise and sales taxes that range from $0.08-0.49/gal. and average $0.281/gal. As best I can tell, CNG is taxed at the federal gasoline rate of $0.183/gal., while states seem to tax it to a much lesser extent than gasoline and diesel, as for example the $0.085/gal rate in Utah, compared to their state fuels tax of $0.245/gal. However, this is only viable as long as demand for CNG is tiny, relative to other fuels. If Mr. Pickens succeeds in displacing large quantities of diesel with CNG, then it will either need to carry a similar tax burden, or the lost revenues must be collected in some other fashion. If you strip out the taxes to get to an apples-to-apples price to compare diesel to CNG, it works out to around $2.50, give or take a dime or two, depending on location. So while CNG is still clearly cheaper than diesel, it's rarely $1/gal. cheaper on a truly comparable basis. This, together with conversion costs as high as the $65,000 per truck that Mr. Pickens cited, might explain why market forces alone haven't led to a rapid switch to CNG-fueled transport.

I've looked at the House bill containing the natural gas vehicle tax credits mentioned in the interview. It would cover as much as 80% of the incremental cost (over the diesel version) of a truck that can only burn CNG or LNG, up to $80,000, depending on weight. It would also extend the $0.50/GGE tax credit for CNG and LNG through 2027. These changes would drastically shorten the payout of an investment in a natural gas-powered truck, even if the per-gallon advantage of CNG appears to be somewhat less than Mr. Pickens suggests. That could move CNG into the truck-fuel market pretty quickly.

The remaining question is what the $7 billion investment Mr. Pickens wants the government to make in this proposition would buy us. He believes that converting the US heavy truck fleet to CNG would save 2.5 million bbl/day of diesel, or about two-thirds of the diesel and heating oil now sold in the US. That would have a much bigger impact on our oil imports than ethanol, although it's hardly an either/or proposition. I'm surprised that Mr. Pickens didn't go on to suggest that this benefit could be leveraged further by utilizing the resulting surplus diesel in diesel automobiles. Given their approximately 30% improvement in fuel economy vs. comparable gasoline vehicles, that could save an additional 750,000 bbl/day of gasoline, while reducing greenhouse gas emissions on those cars by about 20%. If you play all this out, then just under 5 trillion cubic feet per year of natural gas, or less than a quarter of current gas production, could save more than 3 million bbl/day of gasoline and diesel, or nearly a third of our net petroleum imports.

That sounds like a pretty good deal for $7 billion, though it could be made even better if the vehicle tax credits involved were converted into low-interest loans and loan guarantees, instead. If the main impediment to switching to gas is the up-front cost of natural gas conversions and the time involved in recouping that cost, then let's make it much easier for truckers to borrow the money for this purpose, and for banks to lend to them. Giving everyone taxpayer money to induce them to do what we want makes a lot more sense when the government has plenty of money to spend. With the US running large deficits and the private sector holding lots of cash earning next to nothing, we should use our tax dollars as efficiently as possible to achieve the same outcome. Otherwise, Mr. Pickens seems to be on to a sensible idea, and I wish him luck selling it.
This is an excellent example of why you need to pause when somebody is "selling" you an idea. The unscrupulous sell you a pig in a poke. T. Boone Pickens is fairly honest -- but he has a financial stake in convincing the government to go with his plan -- and what Styles has shown is that the "facts" need careful analysis because they aren't exactly how Pickens presents them.

The wonderful thing about the Internet is that if you search dilligently enough you can usually find some useful analysis. On the other hand, there is an awful lot of dreck and misleading "information" on the Internet. You have to have a fairly good nose for truth before you can usefully use it to check facts. The problem is there is no real authoritative knowledge clearly labeled on the Internet. You have to check facts against what you know and what you can otherwise find out and check credentials of those posting opinions (and even there, since there is no authentication of "credentials" you can't necessarily trust that somebody posing as an expert is in fact an expert).

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