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2 U.S. Natural Gas Demand Natural gas is considered by many as the transition fuel, or bridge, to a continually lower carbon-fueled and eventually hydrogen- fueled, economy. How well this clean, versatile energy source will meet this role will depend greatly on how long natural gas remains reliable and affordable. After years of stability, natural gas prices have recently become volatile and have been trending upward. Recent natural gas wellhead prices (monthly average for 2000 through 2002) have ranged from about $2 per thousand cubic feet (Mcf) to over $8/Mcf, in a roller coaster fashion (see Figure 2.1~. At the start of 2003, wellhead prices for natural gas again resumed their roller coaster climb, reaching an estimated $6.70/Mcf (average for March 2003) before once again heading down (EIA, 2003b). These increasing and volatile gas prices are raising concerns about the electric power market's high reliance on natural gas. They are also beginning to price industrial demand out of the market and are im- pairing investments in gas supply. Price instability is one reason natural gas companies are reluctant to make long-term contracts similar to those made by coal companies. Price volatility and supply reliability are of particular concern to the electric power sector. Future availability and prices for domestic electric- ity are linked to the outlook for gas supply, as essentially all new near- term power capacity and the great bulk of new long-term power capacity are projected to be gas fired. Because of higher prices and price volatility, projections of natural gas use for electric power generation have already been reduced in the most recent EIA (2003a) Annual Energy Outlook. The recently volatile and high natural gas prices have weakened the competi- 13

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4 U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY 9.0 - ~ 80 _ ICE a, ~ 6.0 .O 5.0 ~ ct 4.0 o CD 'A It ~ O Z ~ ~ It 2.0 s Z o 1.0 - 0.0 - 1 o o o o o o l ~ l o o o o C.) ~ ~ ~ tot Q V ~ ~ l l l ~ C\l C\l C\l Cal Ct) Ct) O O O O O O O O ~ ~ ~ O ~ ~ FIGURE 2.1 Monthly wellhead prices for natural gas for the period January 2000 to March 2003. SOURCE: EIA (2003d). live position of domestic industries utilizing natural gas, such as ammo- nia and methanol (particularly if feedstock ethane and propane are left in the gas stream). High prices for natural gas have also led the industrial sector to significantly reduce (and some sectors to curtail) its use of natu- ral gas in the past 5 years, particularly during the first half of 2003. Be- cause of price volatility, the natural gas production industry (awaiting assurance that the recent price rise is more than just a temporary phenom- enon) has been slow to respond to the market's price signals. The U.S. natural gas drilling rig count averaged only 746 rigs during the first quarter of 2003, up 11 percent compared to the first quarter of 2002, even though wellhead gas prices averaged $5.54/Mcf during this time, about two and one half times higher than the first quarter of 2002 (EIA, 2003c). Following a period of sustained higher wellhead natural gas prices, averaging $5/Mcf during the second quarter of 2003, and expecta- tions that prices will remain strong into 2004, development of natural gas is increasing, with over 900 rigs drilling for natural gas in the United States in tune 2003. A portion of the price volatility has been due to a lack of timely and comprehensive information on actual and expected gas de- mand, in a market where small volumes of surplus or shortage in the demand and supply balance can lead to significant short-term price vola- tility (Malt Simmons, Simmons and Company International, personal communication, 2003~. Projected consumption of natural gas is expected to remain flat for

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U.S. NATURAL GAS DEMAND 15 the next 2 years, with an anticipated rebound in industrial production and continued growth in new natural gas-fired electric power countering energy conservation and loss of gas demand in the petrochemical sector (EIA, 2003a). However, the longer-term outlook for natural gas consump- tion is less certain and will depend greatly on its affordability by the in- dustrial sector, its competitive position for new power facilities, and the energy conservation and efficiency response to higher recent gas prices. In addition, proposed energy policies, such as the Bush Administration's Clear Skies Initiative, conservation, and international pressures to address carbon emissions and global climate change will further influence the de- mand and price for natural gas in coming years. This chapter examines the outlook for natural gas demand and the forces that will shape the role it may play in our domestic energy future. PROJECTING NATURAL GAS DEMAND Fundamental to any projections of natural gas demand are expecta- tions for economic growth, assumptions for overall energy consumption, and economic competition among the fuels. Growth of the U.S. Economy The output of the U.S. economy its gross domestic product (GDP)- is projected to increase by an average of 3 percent per year between 2001 and 2025 (EIA, 2003a). While this projected growth rate is less than what was achieved in the second half of the 1990s, it is comparable with long- term (years 2001 to 2025) economic growth expectations by other forecast- ers. For example, Global Insights, Inc. (GII, formerly Data Resources, Inc.- Wharton Energy Forecasting Associates) forecasts long-term GDP growth of 3.1 percent per year (EIA, 2003a). Shorter-term (years 2001 to 2012) eco- nomic growth expectations are 3.2 percent by the Office of Management and Budget and 3.1 percent by the Congressional Budget Office, both in line with near-term economic growth assumptions in the 2003 Annual Energy Outlook. Primary Energy Demand Primary energy use is projected to grow by an annual average rate of 1.5 percent between 2001 and 2025 (EIA, 2003a). As such, total domestic energy consumption would increase from 97 quads in 2001 to 139 quads in 2025. The slower growth in energy use compared to GDP growth re- flects an expected decline in energy intensity due to efficiency improve- ments in end-use energy applications, higher efficiencies in electric power

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6 1.25 - 1.00 0.75 - 0.50 0.25 - O- U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY — ' , \ History Projections 1970 1980 1990 2000 2010 2025 Year Energy use per capita Energy use per dollar of GDP FIGURE 2.2 Energy use in the United States per capita and per dollar GDP from 1970 to 2025 (index, 1970 = 1~. SOURCE: EIA (2003a, p. 5~. production, and shifts in the economy toward less energy-intensive in- dustries (see Figure 2.2~. The 2003 Annual Energy Outlook projections (EIA, 2003a) for annual growth in primary energy consumption of 1.5 per- cent are somewhat higher than the 1.3 percent annual growth projected by Gil (from 2001 to 2020~. Competition among Fuels Assuming natural gas prices moderate and become less volatile, natu- ral gas consumption is projected to increase faster than consumption of competing fuels coal, nuclear, petroleum, and renewables (EIA, 2003a). Consumption of natural gas is projected to grow from 22.4 Tcf (61 Bcf/ day) in 2002, to 27.1 Tcf (74 Bcf/day) in 2010, to 34.9 Tcf (96 Bcf/day) in 2025 (see Figure 2.3) (EIA, 2003a). This equates to an average annual in- crease in natural gas consumption of 2 percent per year and is faster than the expected growth in overall primary energy consumption. The bulk of

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U.S. NATURAL GAS DEMAND 60 50 40 o 30 20 10 o FIGURE 2.3 (2003a). 17 History .... ............ . ... - Proiections . . I.. ... ..; ~ ::s ,.......... a= ~~= 1970 1980 1990 2001 2010 2025 Year Petroleum -------- Natural gas Coal Nuclear Nonhydroelectric renewables Hydroelectric U.S. energy consumption by fuel for 1970 to 2025. SOURCE: EIA the increase is from electricity generation as the share of natural gas in this market, assuming natural gas is available at moderate prices, is ex- pected to increase from 17 percent in 2001 to 29 percent in 2025 (see Figure 2.4) (EIA, 2003a). In the past four years (1999 to 2002), the industry added 144 gigawatts (GW) of electricity generation capacity, of which 138 GW has been natural gas-fired. Assuming natural gas prices remain moderate, as forecast by the 2003 Annual Energy Outlook, 80 percent of the new electricity generation capacity of the 428 GW projected to be needed by 2025 would be fueled bv natural gas, if available and competitively priced. OUTLOOK FOR U.S. NATURAL GAS DEMAND Historical Perspective The overall consumption of natural gas increased moderately but steadily during the 1990s from 19.2 Tcf (53 Bcf/day) in 1990 to 22.4 Tcf (61 Bcf/day) in 1999, an annual average increase of 1.5 percent per year (see

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18 FIGURE 2.4 (2003a). U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY 4,000 3,000 in o s ~ 2,000 o y o . _ . _ 1 ,000 o History Electricity Demand 5,252 1 ,392 _ c 1 970 Projections 2025 , _ ~ ~ _ _ ~~ I <~/,~//~ - - - , ,, ,, ~,~ ........... l l 1970 1980 1990 2001 2010 2025 Year Petroleum -------- Natural gas Coal Nuclear ........... Renewables U.S. electricity generation by fuel for 1970 to 2025. SOURCE: EIA Figure 2.5) (EIA, 2003c). Much of the growth was due to increased use of natural gas for electric power, including industrial use of combined heat and power. During this time, natural gas prices at the wellhead were rela- tively low and stable, averaging less than $2.00/Mcf and ranging from $1.55 to $2.32/Mcf (in nominal dollars). Ten years of stability in natural gas prices and predictability in de- mand came to a halt in late 2000. Low rainfall in the northwest led to a decline in hydroelectric power production. Electricity generation from hydroelectricity was 266 billion kilowatt-hours (kwh) in 2000, down from 309 billion and 414 billion kwh, respectively, in the previous 2 years (EIA, 2003a). The year 2000 also saw a cold winter, following two mild winters. Heating degree-days in year 2000 were 4,460 compared to 4,169 and 3,951 in the previous 2 years (EIA, 2003c). Driven by increased electricity and heating demand, consumption of natural gas jumped by 1.1 Tcf (3 Bcf/ day) to 23.5 Tcf (64 Bcf) in 2000 (EIA, 2003a). With the increase in demand

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U.S. NATURAL GAS DEMAND 35 ~ 30 25 _` O' 20 - he 15 10 5 O - History Projections Consumotion ~- ................................................................... Pr~ucti~F~ ........................................................................................................................................................ Pipeline ~ ~ ~ ~ ~ ~ T ~ ~ Natural Gas Net Imports, 2001 and 2025 6- (Tcf) 5- 4- ~ 3 - 1~ _ 2 1 O- 2025 2001— pa_ _~ Liquefied Natural Gas l 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Year 19 2020 2025 FIGURE 2.5 Natural gas production, consumption, and imports for 1970 to 2025. SOURCE: EIA (2003a). came major increases in natural gas wellhead prices that averaged $5.77/ Mcf in December 2000 and $8.06/Mcf in January 2001 (EIA, 2003e). Over- all, wellhead prices for natural gas averaged $3.70/Mcf in 2000 and $4.02/ Mcf in 2001, up considerably from $2.19/Mcf in 1999, the last year of stable natural gas prices (EIA, 2003c). The higher natural gas prices induced con- servation as well as the beginning of demand destruction in selective in- dustrial sectors, reducing natural gas demand and causing a temporary decline in gas prices. In 2002, natural gas prices (at the wellhead) aver- aged $2.96/Mcf as gas consumption stabilized at 22.4 Tcf (61 Bcf/day) (EIA, 2003c). Recent Situation Preliminary data indicate that natural gas consumption may remain relatively flat for 2003 and 2004. Meanwhile, natural gas prices (at the wellhead) are expected to average $5/Mcf in 2003, declining to about $4.30/Mcf in 2004 (EIA, 2003c). With working natural gas in storage at the end of the winter heating season at 680 Bcf, the lowest end of March gas storage level since 1976 (the first year recorded by the EIA), it is not sur- prising that gas prices are expected to remain strong through 2004 (EIA, 2003c). With higher domestic gas production and lower demand during

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20 U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY the second quarter of 2003, approximately 1,100 Bcf of natural gas has been added to storage. While the recent rate of injection into storage has been impressive, the volume of working gas in storage is still about 15 percent below the 5-year average, providing the basis for continued high near-term gas prices and its associated loss (and possible destruction) of industrial demand. Longer-Term Expectations In the longer term, consumption of natural gas has been projected by the EIA (2003a) and other forecasting organizations to once again grow and to grow steadily, reaching 27.1 Tcf (74 Bcf/day) in 2010, 32.1 Tcf (88 Bcf/day) in 2020, and 34.9 Tcf (96 Bcf/day) in 2025. The majority of this consumption increase is projected to be from the use of natural gas for electric power generation and from the restoration of domestic industrial demand (see Figure 2.6~. Over 60 percent of the 11.7 Tcf (32 Bcf/day) of projected growth in annual natural gas consumption, between 2002 and 2025, would be from these two sectors (see Table 2.1~. 12 10 ~c' t ~ 4 History Projections o 1990 1995 2000 2005 2010 2015 2020 2025 Year Industrial Residential Electric Commercial generators CNG vehicles FIGURE 2.6 Natural gas end-use consumption by sector for 1990 to 2025. SOURCE: EIA (2003a).

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U.S. NATURAL GAS DEMAND TABLE 2.1 Projected U.S. Natural Gas Consumption in Tcf for 2002 to 2025 Sector 2002 2010 2020 2025 Residential 4.9 5.5 6.0 6.2 Commercial 3.2 3.7 4.2 4.4 Industrial 7.1 8.9 10.1 10.9 Electric generation 5.5 6.8 9.4 10.6 Other 1.7 2.2 2.4 2.8 TOTAL 22.4 27.1 32.1 34.9 SOURCE: EIA (2003a). 21 The most critical assumption underlying EIA's projected growth in natural gas consumption (EIA, 2003a) is that natural gas prices will de- cline from current high levels and remain relatively moderate, between $3 and $4/Mcf (in real-year 2001 dollars) (see Figure 2.7~. Another key as- 4.5 - 4.0 - 3.5 - 3.0 - 2.5 - 2.0 - 1.5 - 1.0 - 0 5 - History IVY me . Projections AEO2003 ,.. ..~................................................................................................... 1 .55 ~ Nominal dollars 1995 2025 O- 1 1 1 1970 1980 1990 2000 2010 2025 Year FIGURE 2.7 U.S. average annual natural gas wellhead prices for 1970 to 2025 in 2001 dollars per thousand cubic feet. SOURCE: Figure was prepared for Annual Energy Outlook 2003 Press Release, November, 2003. Data are from EIA (2002a, 2003a).

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22 U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY gumption behind the projected increase in natural gas consumption is that natural gas will continue to be used in already installed electric power plants and will win the lion's share of the expected new electric power capacity. High-efficiency natural gas combined-cycle power plants have, for some time, had a competitive advantage over new coal and nuclear power plants. This cost advantage is expected to generally remain in place through 2025 (EIA, 2003a) (see Figure 2.8~. Regional differences in fuel prices, incentives (or requirements) for using renewable energy such as wind power, and a desire to maintain a mix of fuels, have enabled coal and renewables to capture a portion of the future market in electric power. However, the cost advantage of natural gas in power generation be- gins to erode once wellhead natural gas prices climb above $4/Mcf, un- less substantial progress continues to be achieved in the efficiencies of advanced gas combined-cycle power plants. With current wellhead natu- ral gas prices above $5/Mcf and projected to be $4/Mcf in the year 2025, considerable uncertainty exists as to whether natural gas will continue to "win" in the power generation growth market (EIA, 2003a). The past 2 years have also seen a loss in industrial demand for natural gas of 1.2 Tcf (over 3 Bcf/day), with a possibility that much of this loss is permanent due to high volatile natural gas prices. As such, the longer- term consumption of natural gas in the industrial sector may well be con- siderably less than projected by the EIA (Malt Simmons, Simmons and Company International, personal communication, 2003~. On the one hand, higher natural gas prices would shift the critical electric power and industrial markets toward other fuels. On the other, concerns about global warming and constraints on carbon emissions would tilt the balance back toward natural gas. Advanced carbon capture and storage technology could help the economic position of coal in a car- bon-constrained world and help balance the competition. Comparison with Other Forecasts The projections for natural gas consumption and prices in the 2003 Annual Energy Outlook (EIA, 2003a) are, in general, quite comparable with other major forecasts, such as those by Global Insights, Inc. (GII) and the Petroleum Industry Research Association (PIRA) (see Table 2.2~. This is due in part to the fact that the basic assumptions for economic growth, primary energy demand, electricity demand, and future natural gas prices in these forecasts are similar: · The projection for year 2015 natural gas consumption of 29.5 Tcf in the 2003 Annual Energy Outlook is essentially the same as by Gil and 2 percent higher than by PIRA.

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U.S. NATURAL GAS DEMAND in o Q l US Cal lo Cal in in ~ 0 in <,, 8 ~ X ~ . > 1 Us ~ CO Cal ~ o ~noq-~eMol!>~ Had squaw Food on on o vet au ° ~ 0 au o au vat c' 5- ~o vat ~ vat to 8 ~ o ¢ ~ .. au ~ bow no ·Q ~ ., . P ~ au O au ~ o 5- au au au au au au au o to ° - ° ., o 23

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24 U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY TABLE 2.2 Comparisons of Forecasts and Assumptions Basic Demand Factors Annual Energy Outlook 2003 GII PIRA Economic growth (%; average annual 2001-2025) Primary energy demand (%; average annual, 2001-2025) Electricity sales In 2015 (billion kwh) Natural gas in 2015 L48 wellhead price (2001 $/Mcf) Consumption (Tcf) 3.0 1.5 4,481 3.55 29.5 3.1 1.3 4,583 3.14 N/A 29.4 28.8 SOURCE: EIA (2003a). · The 2003 Annual Energy Outlook expects somewhat (14 percent) higher gas prices in the year 2015 than does GII. Given their relatively moderate expectations for natural gas prices, all three of these major forecasts expect that natural gas consumption will approach 30 Tcf in the middle of the next decade. Given the loss of indus- trial demand and the history of residential and commercial energy con- servation when faced with high volatile prices, there is considerable uncertainty as to whether natural gas will meet these consumption expec- tations. Some workshop participants commented that, with higher gas prices, they were now questioning the 30-Tcf projections or thought there would be a delay in reaching the 30-Tcf level. Whether natural gas can meet these expectations requires that it remain reliable and affordable. The section titled "Sensitivity Analyses" will examine several of the forces that may shape the future price of and demand for natural gas. OUTLOOK FOR CANADIAN AND MEXICAN NATURAL GAS DEMAND To a large extent the United States is part of an integrated North American natural gas market with Canada and Mexico. As such, changes in demand for natural gas in these two countries will directly affect the outlook for the U.S. demand.

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U.S. NATURAL GAS DEMAND 25 Changes in Canadian Natural Gas Demand Currently, Canada consumes 3 Tcf (8 Bcf/day) of natural gas annu- ally. With a productive capacity of 6.4 Tcf, this enabled Canada to ex- port a net 3.6 Tcf/year (10 Bcf/day) to the United States in 2002, ac- counting for 16 percent of U.S. gas consumption (Greg Stringham, Canadian Association of Petroleum Producers, personal communication, 2003~. For the past decade or so, Canadian natural gas consumption has grown relatively moderately, from 2.1 Tcf (5.8 Bcf/day) in 1990 to its cur- rent level. However, because of increased growth in gas-fired electricity generation and significant expansions in oil sand development, Canada's internal demand for natural gas is expected to increase substantially in the next several years (Greg Stringham, Canadian Association of Petro- leum Producers, personal communication, 2003~. In 2002, oil sands provided nearly 0.8 million barrels per day of pro- duction and consumed 300 million to 400 million cubic feet per day (MMcf/day) of natural gas, as part of the extraction, separation, and up- grading process. Approximately $7 billion (Canadian) is being spent on construction of new oil sand facilities and expansions, with another $25 billion (Canadian) announced. At a ratio of 0.5 to 1 Mcf of natural gas for every barrel of oil sands produced and assuming that natural gas remains the "fuel of choice," the use of natural gas by the oil sands industry is projected to reach 500 to 1,000 MMcf/day (0.3 Tcf /year) by 2010 and will be considerably higher in future years. Technology is key in the oil sands development. Recent promising advances in technology and greater use of petroleum coke could substantially reduce gas consumption in new oil sands projects (Greg Stringham, Canadian Association of Petroleum Pro- ducers, personal communication, 2003~. Changes in Mexican Natural Gas Demand Currently, Mexico imports about 700 MMcf/day (0.26 Tcf/year) of natural gas from the United States. In the near term, from now to 2010, Mexico is expected to maintain its natural gas imports from the United States at about this level (EIA, 2003a). In the longer term, and particu- larly if LNG terminals are installed in Baja, California, Mexico's natu- ral gas demand is expected to be met by growth in its internal produc- tion and by LNG imports, enabling the flow of gas to reverse (EIA, 2003a). However, considerable uncertainty surrounds the outlook for Mexico's natural gas consumption, particularly given its plans for eco- nomic growth and improved environmental practices (EIA, 2003f).

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26 U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY SENSITIVITY ANALYSES The outlook for U.S. natural gas demand depends on numerous as- sumptions and expectations, including the rate of domestic economic growth, future natural gas and competing energy prices, pending energy legislation and policies, and the reliability of natural gas supplies. As shown by recent events, the factors governing gas demand can change dramatically as new information and conditions emerge. Example of Rapid Changes in Demand Assumptions An example of how rapidly and significantly basic assumptions on natural gas demand can change is illustrated by the events that followed the National Petroleum Council's 1992 study on natural gas (National Petroleum Council, 1992~. This study set forth two bounding forecasts for the year 2000 gas demand. The "low case" scenario with a demand esti- mate of 18.5 Tcf for 2000 projected little growth in natural gas demand from 1990. The "high case" scenario with a demand estimate of 20.8 Tcf for 2000 had modest expectations for growth. Actual natural gas consumption in 2000 was 24.3 Tcf, 2.6 Tcf higher than projected for the "high case." Clearly, many of the assumptions under- lying the natural gas demand forecast in the study quickly became out- dated. When the National Petroleum Council updated its study in 1999, it noted that the low case scenario "had proven to be so far from actual results that it did not merit further study or analysis." And even the high case scenario "had proved to be too low to capture the real growth that occurred in the 1992-98 period" (National Petroleum Council, 1999~. Assessment of Key Uncertainties One approach for examining uncertainty in projections of demand is to use sensitivity (or "delta") analyses to evaluate the impact of assump- tions or actions on the baseline projection. To gain insight on key uncer- tainties, sensitivity analysis is performed for three cases: (1) higher and lower economic growth; (2) changes in the pace of technological progress and the size of the accessible natural gas resource base; and (3) a carbon constrained future, similar to the expectations set forth in legislation pro- posed by Senators McCain and Lieberman.~ A fourth sensitivity analysis, iSenate bill 139. A bill to provide for a program of scientific research on abrupt climate change, to accelerate the reduction of greenhouse gas emissions in the United States by establishing a market-driven system of greenhouse gas traceable allowances that could be

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U.S. NATURAL GAS DEMAND TABLE 2.3 Expectations for Natural Gas Demand and Long-Term Wellhead Prices Caused by Differences in Assumptions for Economic Growth 27 2010 Actual Reference Low 2002 Case Growth 2025 High Reference Growth Case Low High Growth Growth Demand (Tcf) 22.4 27.1 26.3 Wellhead Price 2.96 3.29 3.17 ($/Mcf) 28.1 34.9 3.59 3.90 31.8 37~4 3.83 4.50 SOURCE: EIA (2003a). examining the impact of alternative world oil prices on natural gas de- mand and prices, showed that even significant differences in world oil prices would have only very modest impacts on U.S. natural gas demand and prices (EIA, 2003a). Sensitivity Analysis 1: Economic Growth A fundamental uncertainty is future growth in the U.S. economy. While the 2003 Annual Energy Outlook (EIA, 2003a) reference case uses an average annual growth rate of 3 percent (from 2001 to 2025), the report also includes low (2.5 percent) and high (3.5 percent) economic growth cases. These relatively modest annual differences in expectations for eco- nomic growth have a major impact on long-term gas demand and prices (see Table 2.3~: · Higher or lower economic growth would cause gas demand to go up or down from the reference by about 1 Tcf in 2010 and by 2.5 to 3 Tcf in 2025. · Higher economic growth would cause wellhead prices for natural gas in the year 2025 to increase by about 15 percent, from $3.90 to $4.50/ Mcf (in constant 2001 dollars). used interchangeably with passenger vehicle fuel economy standard credits, to limit green- house gas emissions in the United States and reduce dependence upon foreign oil, and en- sure benefits to consumers from the trading in such allowances.

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28 U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY Sensitivity Analysis 2: Technology and Resources The rate of technological progress and the size of the accessible re- source base are two factors that can be affected by energy policies and the level of research and development investment. Technological Progress In the past, investments in research and development have led to im- portant advances in natural gas exploration and production technology. These technologies have improved exploration success rates, lowered well drilling and completion costs, and improved gas recovery per well. These advances have enabled the industry to access new natural gas supplies from geologically complex unconventional gas resources and deep off- shore waters while keeping costs lower than they otherwise would have been. The analysis shows that a relatively modest change in the rate of technological progress, from the current trends imbedded in the reference case, would have significant impacts on future natural gas prices and de- mand (see Table 2.4 and Figure 2.9~. · In a low technology progress world (15 percent decline in the rate of technological progress from the technology trends imbedded in the ref- erence case), the wellhead price for natural gas would be $4.60/Mcf (in the year 2025~. This higher price drives out over 2 Tcf of annual gas de- mand (in the year 2025) and places natural gas in a much less favorable competitive position in the electric power market (Mary Hutzler, EIA, personal communication, 2003.~. · In a high technology progress world (15 percent increase in the rate of technological progress), the wellhead price for natural gas would be TABLE 2.4 Expectations for Natural Gas Demand and Long Term Wellhead Prices Due to Low and High Rates of Technological Progress 2010 Actual Reference Low 2002 Case Tech 2025 High Reference Low High Tech Case Tech Tech Demand (Tcf) 22.4 27.1 26.4 27.6 34.9 32.7 36.7 Wellhead price 2.96 3.29 3.64 2.97 3.90 4.60 3.76 (2001; $/Mcf) SOURCE: Mary Hutzler, EIA, personal communication, 2003.

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U.S. NATURAL GAS DEMAND Natural Gas Welihead Price, 2012, and 2025 (2001 $/Mcf) 40 - 35 - 30 - ~c, 25 - t u, 20 - by 15 - 10 - 29 $5 $4 $3 $2 $1 $0 . c /_; Writ.> / 2012 ~ Consumption 5- O- Production 2002 Technology Slow Technology ..... Reference Rapid Technology--------- 6 5 4 3 2 1- O- t<~ Natural Gas Net Imports in 2025 (Tcf ) EEL Pipeline Liquefied Natural Gas l 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 History Projections FIGURE 2.9 Natural gas production, consumption, and imports for 1970 to 2025 in trillion cubic feet as a function of technological progress. SOURCE: Mary Hutzler, EIA, personal communication, 2003. Data are from EIA (2003a). considerably lower, at $3.76/Mcf (in the year 2025~. This would provide significant savings to consumers (annual savings in costs of $18 billion in the year 2010 and $31 billion in the year 2025) as well as significantly lower finding and development costs for natural gas producers (Mary Hutzler, EIA, personal communication, 2003~. Resource Base Considerable uncertainty and controversy exists with respect to the size of the underlying natural gas resource base, particularly with respect to unconventional natural gas (Keith Shanley, Stone Energy, personal communication, 2003; Ben Law, Pangea Hydrocarbon Exploration, per- sonal communication, 2003~. Equally uncertain is the portion of this re- source that will ultimately be accessible, unconstrained by either physical or technical limits.

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30 U.S. NATURAL GAS DEMAND, SUPPLY, AND TECHNOLOGY TABLE 2.5 Expectations for Natural Gas Demand and Long Term Wellhead Prices Caused By Differences in Assumptions for the Size of the Resource Base 2010 Actual Reference 2002 2025 Low Case Resource Reference Low Case Resource Demand (Tcf) 22.4 27.1 26.6 34.9 32.9 Wellhead price (2001;$/Mcf) 2.96 3.29 3.54 3.90 4.84 SOURCE: Mary Hutzler, EIA, personal communication, 2003. · The analysis shows that a 25 percent lower-than-expected U.S. natural gas resource base, due potentially to smaller or less accessible tight gas sand resources, would increase gas prices in 2025 by nearly $1.00/Mcf (see Figure 2.10) (Mary Hutzler, EIA, personal communication, 2003). · With a low natural gas resource base and higher gas prices, gas consumption would decline by 2 Tcf in 2025, with an even larger drop in domestic production. Significantly increased reliance on natural gas im- ports would be required to balance demand and supply (see Table 2.5) (Mary Hutzler, EIA, personal communication, 2003~. Carbon Emission Constraints The long-term outlook for natural gas could change substantially should constraints emerge on carbon emissions. As the cost of using higher carbon-based fuels (such as coal and oil) increases (or faces limits on its use), the preference for using natural gas would increase. · The analysis shows that with carbon constraints, natural gas de- mand would increase by 2.4 Tcf in 2020 and 1.5 Tcf in 2025 (see Figure 2.11~. · With carbon constraints, natural gas wellhead prices would be about $0.50/Mcf higher in 2020 ($3.90/Mcf versus $3.42/Mcf in the refer- ence case). By 2025 the price difference would narrow to about $0.30/Mcf ($4.21/Mcf versus $3.90/Mcf in the reference case) (see Table 2.6~. · In a special sensitivity run prepared for this study, the EIA showed

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U.S. NATURAL GAS DEMAND TABLE 2.6 Expectations for Natural Gas Demand and Long-Term Wellhead Prices Caused By Differences in Assumptions for Carbon Emission Constraints 33 2020 2025 Actual Reference Carbon Reference Carbon 2002 Case Constraints Case Constraints Demand (Tcf) 22.4 32.1 Wellhead Price 2.96 3.42 (2001; $/Mcf) 34.5 34.9 36.4 3.90 3.90 4.21 SOURCE: Mary Hutzler, EIA, personal communication, 2003. that higher levels of progress in natural gas supply technologies could significantly reduce the impact of carbon emission constraints on natural gas prices (Mary Hutzler, EIA, personal communication, 2003~. SUMMARY Considerable expectations exist for natural gas to once again become and remain a reliable and affordable future source of energy supplies. The essential question is whether the expectations of moderate natural gas prices of $3.50/Mcf and the strong annual natural gas demand of 30 Tcf in the next decade can be realized. Considerable debate exists with respect to future industrial gas demand, competition among fuels in the electric power market, and the maturity and size of the remaining natural gas resource base. Still, the analysis above shows that factors over which the United States has significant influence, such as assuring a favorable pace of technological progress in natural gas exploration and production and providing reasonable access to the natural gas resource base will greatly determine future natural gas prices and demand. In addition, a strong underlying energy and natural gas database, and a continually improving analysis and modeling system will be essential for providing reliable, up-to-date guideposts on these issues of importance to the indus- try and the nation.