The Influence of Gas-to-Liquids and Natural Gas Production Technology Penetration on the Crude Oil-Natural Gas Price Relationship David J. Ramberg, Y.H. Henry Chen, Sergey Paltsev and John E. Parsons Report No. 288 December 2015 The MIT Joint Program on the Science and Policy of Global Change combines cutting-edge scientific research with independent policy analysis to provide a solid foundation for the public and private decisions needed to mitigate and adapt to unavoidable global environmental changes. Being data-driven, the Program uses extensive Earth system and economic data and models to produce quantitative analysis and predictions of the risks of climate change and the challenges of limiting human influence on the environment—essential knowledge for the international dialogue toward a global response to climate change. 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This reprint is one of a series intended to communicate research results and improve public understanding of global environment and energy challenges, thereby contributing to informed debate about climate change and the economic and social implications of policy alternatives. Ronald G. Prinn and John M. Reilly, Program Co-Directors For more information, contact the Program office: MIT Joint Program on the Science and Policy of Global Change Postal Address: Massachusetts Institute of Technology 77 Massachusetts Avenue, E19-411 Cambridge, MA 02139 (USA) Location: Building E19, Room 411 400 Main Street, Cambridge Access: Tel: (617) 253-7492 Fax: (617) 253-9845 Email: [email protected] Website: http://globalchange.mit.edu/ The Influence of Gas-to-Liquids and Natural Gas Production Technology Penetration on the Crude Oil-Natural Gas Price Relationship David J. Ramberg*, Y.H. Henry Chen†, Sergey Paltsev‡ and John E. Parsons§ Abstract The paper examines conditions under which gas-to-liquids (GTL) technology penetration shifts the crude oil-natural gas price ratio. Technologies that enable direct substitution across fuels, as GTL does, may constrain the price ratio within certain bounds. We analyze the forecasted evolution of the crude oil-natural gas price ratio over the next several decades under alternative assumptions about the availability and cost of GTL and its natural gas feedstock. We do this using a computable general equilibrium model of the global economy with a focus on the refinery sector in the U.S. Absent GTL, a base case forecast of global economic growth over the next few decades produces dramatic increases in the oil-natural gas price ratio. This is because there is a more limited supply of low-cost crude oil resources than natural gas resources. The availability of GTL at conventional forecasts of cost and efficiency does not materially change the picture because it is too expensive to enhance direct competition between the two as fuels in the transportation sector. GTL only modulates the increasing oil-gas price ratio if both (i) natural gas is much cheaper to produce, and (ii) GTL is less costly and more efficient than conventional forecasts. Contents 1. INTRODUCTION .................................................................................................................... 2 2. RESEARCH DESIGN AND BASE CASE ............................................................................. 3 3. IMPACT OF GTL .................................................................................................................... 7 4. STRESS TEST: WHEN DOES GTL MATTER? .................................................................. 10 4.1 Low-cost natural gas production scenario (“LH”) ........................................................ 10 4.2 Low-cost natural gas production/low cost and highly efficient GTL scenario (“LL”) .... 13 4.2.1 Differences between the shifts in the oil-gas price ratios ................................... 18 5. CONCLUSION ...................................................................................................................... 19 6. REFERENCES ....................................................................................................................... 19 * Research Affiliate, Joint Program on the Science and Policy of Global Change, Massachusetts Institute of Technology, MA, USA. (Email: [email protected]) † Joint Program on the Science and Policy of Global Change, Massachusetts Institute of Technology, MA, USA. (Email: [email protected]) ‡ Corresponding Author. Joint Program on the Science and Policy of Global Change, Massachusetts Institute of Technology, MA, USA. (Email: [email protected]) § Sloan School of Management and the Center for Energy and Environmental Policy Research, Massachusetts Institute of Technology, MA, USA. (Email: [email protected]) 1 1. INTRODUCTION A tie between crude oil and natural gas prices has been documented by a number of researchers, including Serletis and Herbert (1999); Bachmeier and Griffin (2006); Asche et al. (2006); Villar and Joutz (2006); Brown and Yucel (2008); Hartley et al. (2008); Ramberg and Parsons (2012); Loungani and Matsumoto (2012); Brigida (2014).1 Many of these researchers attribute the tie to explicit competition between the fuels in key sectors—for example, Serletis and Herbert (1999); Pyrdol and Baron (2003); Asche et al. (2006); Villar and Joutz (2006); Brown and Yucel (2008); Hartley et al. (2008); Ramberg and Parsons (2012); Loungani and Matsumoto (2012). However, the linkage could arise in a number of ways, including the following: • Natural gas is discovered with crude oil in oil wells. This is a complementary linkage. • Natural gas is a feedstock to petroleum refining. This is another complementary linkage. • Natural gas and crude oil exploration compete for the same drilling rigs and labor. This is a competitive linkage. • Natural gas and petroleum-derived fuels are interchangeable in some industrial processes (such as dual-fuel boilers). This is another competitive linkage. • Natural gas and fuel oils compete for heating homes and buildings. • In some regions (such as Pakistan and Argentina), compressed natural gas is a significant competitor to diesel or gasoline in transportation. • An apparent linkage can also arise if global economic growth translates into correlated price trajectories through time even in the absence of direct fuel-to-fuel linkages. Some have documented changes in the tie between the two price series and attributed that to changes in one or more of these linkages—see Serletis and Rangel-Ruiz (2004), among others. The empirical challenge in this literature is to filter out the influence of extremely short-term volatility in order to identify the longer-term relationship. The challenge is made harder when the underlying technological and economic factors shaping the relationship are also changing through time. This paper studies the tie between oil and natural gas prices from a different perspective, modeling the underlying linkages and the evolving economic variables driving the two price series. We use a computable general equilibrium (CGE) model of the global economy in which crude oil and natural gas resources are inputs to production in a number of different sectors feeding into a number of different end uses. We introduce a gas-to-liquids (GTL) technology that offers the potential for direct competition between the two fuels in the transportation sector. GTL converts a natural gas feedstock into liquid transportation fuels— generally diesel—and petrochemical feedstocks (such as naphtha), thus creating an explicit 1 Formally, the tie is cointegration of the time series of crude oil and natural gas prices. Two or more non-stationary data series are considered cointegrated when the relationship between them can be characterized by a single stable equation. A non-stationary data series is one in which the mean changes substantially depending on the subset of the series chosen. This is a common feature of time series data, and especially of commodity price series, in which the average price tends to drift upward or downward over time. competitive linkage between natural gas and petroleum products in any sector that initially uses petrochemical feedstocks or diesel fuels. At different cost and efficiency levels, GTL should deploy to varying degrees, and its influence on the usage (and thus prices) of crude oil and natural gas can be tracked. Using our model, we analyze scenarios for the future price paths for the two fuels over several decades, and the ratio of the two prices along those paths, and we document whether the GTL technology significantly impacts that ratio. The structure of the remainder of