Thursday, May 24, 2012

An Example of the Free Market at Work: Separating Natural Gas Liquids from Raw Natural Gas


In Milton Friedman’s classic TV series “Free to Choose”, the reoccurring theme was that economies thrive and grow when individuals are free to choose how to satisfy their wants, needs and desires. A great example of this phenomenon is occurring right now in the US, especially in states like Texas, North Dakota, Pennsylvania, West Virginia and eastern Ohio.
No government agency is controlling the price of hydrocarbons, and there is no direct subsidy for hydrocarbons. But companies are, nonetheless, figuring how to produce the right amount of the right product for the market while generating positive rates of return on investment. In fact, the rate of return on investment for drilling in the liquid-rich parts of the Marcellus Shale can be quite large (>100%/yr.) Note that this calculation can be found at the following site. Though, it should also be noted that, if you drill in an area low in higher hydrocarbons, you are likely to obtain a negative rate of return on investment because of the near historically low price of natural gas in inflation-adjusted dollars.
Given that it’s the natural gas liquids that determine the economic viability of drilling in the Marcellus and Utica shales, it’s important to give an overview of the technology behind separating natural gas liquids from the raw natural gas so that those people who are not familiar with the oil&gas industry can learn more about midstream operation, i.e. the steps taken after the gas has left the ground and before it’s in a condition to sell on the market.

Sunday, May 13, 2012

The Economics of Drilling in the Marcellus Shale

For those of you who like taking risks for the chance of high returns on investment, the Marcellus Shale is a great place to make or to lose a lot of money.
The economic viability of drilling in the Marcellus Shale is highly dependent on the amount of C3+ hydrocarbons, such as propane, butane and higher hydrocarbons.
Using the following estimates for drilling costs and drilling production, one can estimate the rate of return on investment for drilling at different locations in the Marcellus Shale.

Upfront drilling cost = $3.5 million
Land Lease = $100 thousand
Initial gas flow rate = 3.5 million scf/day which is roughly 50 mole/sec   (Note that there is significant variability in this value in relation to the $3.5 million upfront drilling cost. Rough estimates would be $1 per 1 scf/day initial production plus or minus 30%, depending on the location.)
Monthly decline in production = 10%    i.e. Production in month X = 90% times Production in month (X-1)    (Once again, there is significant variability in the drop in gas production, but 10% per month is a rough estimate.)
Re-fracturing Cost = $1 million at the start of month 13
Lifetime = 30 months  (Note:  you could also re-fracture a second or a third time and make the lifetime >30 months, but this doesn't effect your monthly rate of return on investment significantly.)
Royalties = 10% of sales   (Depends on the agreement with the local landowners)

If the gas composition if ~95% methane and if the price of natural gas is $2.5/mscf, then the monthly rate of return on investment is approximately -4%/month or a yearly rate of return on investment of -40%/yr. This would be a huge waste of money.
However, the key is to chose a location in the Marcellus Shale that is high in higher hydrocarbons. For example, there are locations in the Marcellus Shale in which the gas composition is more like the following:
74% methane, 15% ethane, 5% propane, 2% butane, 1% pentane, 1% hexane+, and ~2% CO2/N2. On an energy basis, this gas is only ~50% methane. When there's this much propane/butane, the drilling company can make a significant amount of money by selling the natural gas liquids (NGL). The net effect is that the effective '$ per mscf of gas flow' is around $6.60/mscf rather than $2.5/mscf    (note mscf=thousand cubic feet at standard pressure and temperature.  0.8 scf of gas is approximately 1 mole of gas.)
When there is significant amounts of higher hydrocarbons, the rate of return on investment is approximately 7%/month or ~130%/yr. You can double your money is less than a year if you find a location in the Marcellus Shale that is high in higher hydrocarbons.
That's a huge different in rates of return on investment:   -40%/yr to +130%/yr.   (And this range of RROI didn't even account for the variability in normalized initial production,  $/scf/day.)

So, for those of you that are interested in investing in the Marcellus Shale. Make sure you do your homework before investing in a company. Drilling just for methane is a losing proposition right now. It's the higher hydrocarbons that makes drilling economically viable, not the methane.

Note also that the the Marcellus Shale regions that are ~95% methane would be economically viable (i.e. IRR = 15%/yr) using the assumptions listed above at a price of natural gas of $4.25/mscf  (~$4.25/MMBTU...$4.25/GJ). Therefore, one would expect that the price of natural gas would stay below $5/GJ for quite some time. It is likely that there are a lot of site in Ohio, WV, PA, and NY in which the economic assumptions above are valid. So, don't bet on the price of gas going above $4.5/GJ for quite awhile.

Monday, May 7, 2012

The Energy Bank

Many of my posts revolve around the idea that money is the capability to do mechanical and electrical work. In many of my posts, I discuss how the Federal Reserve should maintain our currency such that there is a zero percent inflation in the price of mechanical and electrical work, i.e. that a true zero inflation currency is one in which $1 can always buy you the same amount of work on average (while gasoline and electricity prices will fluctuate hour-by-hour and day-by-day, the yearly average price of electrical and mechanical work would remain the same because the Federal Reserve would print or remove currency from circulation to maintain yearly average prices.)

But this idea is obviously too large a concept to be easily implemented. It involves so many people, all with desires for different levels of inflation. So, I've been working on ways to implement an inflation-proof currency at a smaller-scale, one where you don't have to wait for the Federal Reserve to implement such a program.

So, how do lots of people today try to implement inflation-proof currency? Some groups implement a local currency and some people accept payment in precious metals. Other people don't leave money sitting in checking accounts; they just purchase gold/silver or even better, they constantly re-invest their money into CDs and bonds. The problem is that many of these attempts to fight inflation are ad hoc, high risk and fail to appreciate the fact that money is the capability to do work.

The goal of this post is to discuss two ways that groups of people can invest their money so that it doesn't matter if the Federal Reserve continues to allow inflation to be >2%/yr. My main conclusion is that if you invest wisely, then you can avoid getting hit with an extra 2-3%/yr tax on your cash assets (or more if we see QE3). [Note that inflation is basically a tax on those people who don't invest wisely. Inflation is basically a tax on the middle class, i.e. people who have most of their money sitting in checking, savings, money markets and CD accounts. Inflation doesn't normally hit the rich or poor as much as it hits the middle class, so the goal here is to discuss ways that people can invest their money such that it's inflation-proof  (Note:  I'm not going to tell you to purchase gold or silver. In fact, the world would be a much better place if people stopped using gold/silver for investment purposes. This would lower the price of gold/silver so that it could be used for a much better purposes, such as catalysts for chemical reactions.)


Option#1:  Start your own energy currency
   With this option, you and a group of people start your own currency that is tied directly to the amount of energy assets you owe. As more people start using the currency, you take in more energy assets and print more money. There would be strict rules on how much money you could print, so that the yearly average conversion between $ and MWh of work remains nearly constant. Certain towns have started their own currencies. What would be unique to an energy currency would be the rules dictating how much currency could be printed as any given time.

Option#2: Start your own energy bank   (or energy credit union)
   Create a bank (or credit union) that takes in deposits from normal people, and invests that money into energy assets. To cut down on costs and to allow it to grow, make your energy bank an online bank like ING. [Note: from here on out I'm going to use the word bank, but I really mean either a for-profit bank or a non-for-profit credit union.]

Saturday, May 5, 2012

Together let us explore the stars

The title for this post is a quote from President Kennedy’s 1960 inaugural address to the nation. The main focus of this post is to give a brief history of the cooperation and competition between the Soviet Union and the US during the Cold War in the area of space exploration. Throughout the 1950s, 60s and 70s, there were successes and there were set back for cooperation between the two superpowers. It’s important to understand the past in order to help guide policy actions for the future. This might help guide policy with respect to China in order to achieve greater cooperation, or at least coordination, in space access and space exploration. It is especially important to understand what works and what doesn’t work as far as international cooperation on major space program so that the cost of exploring the solar system (and populating other planets) can be shared between the major countries. Since the goal of life is for life to grow and to expand, we need a coordinated method of populating other planets in the solar system. This means working with other countries who do not share our views/values, and it also means working with people in the US who do not share our own personal views/values. You don’t have to agree with other people in order to cooperation with others. You just need a version of tit-for-tat or tit-for-two-tats and perhaps some sort of binding legal foundation, so that one side of the deal isn’t being taken advantage of. 
     There are a lot of ways that cooperation has yielded benefits to both of the participating countries. For example, using US expertise in satellite equipment and tracking capability and Russian expertise in converting its former ICBM rockets into launch vehicles, the International Launch Services company is a joint US-Russian partnership that can fairly cheaply launch satellites into orbit. Another example is Sea Launch, which was a partnership as of 2010 between Boeing, Russian space companies and even a Norwegian company that designed the mobile, sea-based launch platform. 
     It’s often said by people who want to see expanded government funds for space exploration that having a competition will be good for space exploration, but the people saying this often forget that there is great deal of duplication, waste, and anxiety associated with space competition, and this can often set back space development. So, my goal with this post is to give a brief summary of the history of cooperation between the Soviet Union and the US. If you are interested in a brief history of the competition between the US and the Soviet Union in the 1950’s, check out this post I wrote about the history of the Sputnik / Vanguard era. I think that there is a lot to be gained from cooperation in space access/exploration between the major superpowers. There is already a lot of cooperation between the U.S. and the E.U., Canada, England, Japan, and Russia, but there is only limited US involvement with China, India, and Brazil. In fact, until 1994, the US actively attempted to stifle Brazil’s military-based space agency because of fears that their rockets could be used to carry nuclear weapons. In 1994, Brazil created a separate civilian organization to avoid this problem. (Cooperation between nations is often set back due to stupid reasons.) 
     Space exploration is not the only example of where coordinated action between countries can be beneficial. Examples of current international collaboration include the fusion reactor ITER, the large particle collider CERN, and the International Space Station. (Note that, in previous posts, I’ve stated that nuclear fusion can be a promising way to destroy long-lived by-products of nuclear fission reactions. With that having been said, we need to actually test this hypothesis to see if nuclear fusion can actually decrease the amount of radioactive material and can actually compete economically as a combined (a) electricity power source and (b) nuclear waste recycling plant. ) The lessons learned from the Int’l Space Station and ITER will also help the world as it develops future projects, such as cooperation on Moon/Mars colonies. Before delving into the essay, I’ve listed some the main highlights from the paper:

1)   It is important to realize that just because a certain administration may be for (or against) cooperation doesn’t mean that the public is for (or against) cooperation.

2)   A lesson to be learned from the 1960s is that a bureaucratic organization such as NASA needs to be pro-active in its attempts to create programs and should not send laundry lists to the President about space policy goals. In fact, it makes a lot more sense for NASA to directly communicate with the public: this includes programs like NOVA, but it could also include reality TV shows in which NASA projects compete (like singers compete on American Idol/The Voice) for the public’s vote. The projects with the most public votes get the most funding.

3)   It is symbolic that the final flight of the Apollo spacecraft program, which was created for the purpose of beating the Russians to the moon, was the first docking between spacecraft built by different nations. The Apollo-Soyuz Test Program preceded and was an essential first step for the international space station and hopefully for permanently-manned colonies on other planets.