The Magazine

Get Out Your Sweaters

The coming natural gas shock.

Dec 5, 2005, Vol. 11, No. 12 • By WILLIAM TUCKER
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PRESIDENT BUSH MAY HAVE BEEN blamed unfairly for the hurricane that hit New Orleans, but there isn't going to be anywhere to hide when the next "natural" disaster hits--the Natural Gas Shock of 2005-06. Natural gas is now selling at $12 per thousand cubic feet, up from $2 in 2002. But that's just the beginning. The industry has not fully recovered from the hurricane damage to its Gulf Coast facilities. This winter, as supplies tighten with the cold, the price could soar far higher.

The effects will be unevenly distributed. Homeowners will pay more--perhaps twice as much as last year, depending on the weather. Electric rates may go higher. But the real impact is going to be felt in the industrial sector, where devastating layoffs are already occurring. "We need to declare a national crisis," says Andrew Liveris, CEO of Dow Chemical, which is moving the "center of gravity" of its manufacturing base to Europe and the Middle East, where gas is more plentiful. "Dozens of plants around the country have closed their doors and gone away, and are never coming back."

Alan Greenspan has been warning about our failed and fouled energy policy for years, but no one has paid much attention. Least attentive of all are congressional Republicans who--in an act of near dementia--pulled a provision for opening up the Arctic National Wildlife Refuge for gas exploration out of a 2005 House budget bill. They may want to change their minds by next February.

Our natural gas production peaked in 2001, just as our oil production peaked in 1970. It probably isn't going back up. Sure, some new discoveries offshore and in Alaska may slow the decline--just as opening Prudhoe Bay slowed the drop in U.S. oil production during the 1980s. But in terms of domestic production of oil and gas, we're probably over the hill. Imports from Canada have picked up the slack since the late 1990s, but Canadian production has also peaked.

As happened with oil, we're going to be relying on the Middle East, Asia, Africa, and South America. Unfortunately, gas isn't as easy to import as oil. It must first be liquefied at minus 260 degrees F, transported in special tankers (each carrying the energy of a small hydrogen bomb), then offloaded at special liquid natural gas terminals. The United States has four such ports, with 16 more on the drawing board, but environmentalists and local opponents are blocking them at every turn. The ability of federal authorities to override these state and local objections is another provision timorous Republicans just ripped out of the energy bill.

So natural gas is going to be in short supply for a long, long time. The bleeding in the economy won't end soon. It's part of a pattern you might call the "gentrification of America." Think of a quaint 19th-century factory town that upscale people from a neighboring city have just discovered for its charming old homes. But they don't like living amid the smells and clutter of the remaining industries, and once they control the town council, they start passing zoning and antipollution laws that drive those industries away. The brick factories are soon reclaimed as coffee shops and headquarters for clean, quiet software firms, while the dirty old industries--and their jobs--go "somewhere else." That's what's happening to America right now.

The fatal turn took place in 1979 when the country abandoned nuclear power as the result of Three Mile Island. At the time, the only real possibilities for powering our electrical plants were coal and nuclear. Coal was dirty, but environmentalists convinced themselves that it was a "bridge" to a solar future a generation or two down the road. They could live with it. "Clean coal" became the fuel of choice, while nuclear was consigned to outer darkness.

Then came acid rain. That led to sulfur scrubbers--which still clean only 40 percent of the nation's coal. Next came global warming. That wasn't even a "pollutant" but the inevitable byproduct of burning a billion tons of coal a year (up from 600 million in 1976). By the early 1990s, the solar future wasn't getting any closer, and the coal bridge was getting longer and longer. So environmentalists turned to natural gas.

In 1979, natural gas hadn't been on the table. Distorted for 30 years by federal price controls, the gas market was in complete chaos. A natural gas "shortage" during the winter of 1976-1977 had caused factory and school closings all over the Midwest. Sorting through the mess, newly elected President Jimmy Carter was appalled to discover that Texas was burning gas to generate 60 percent of its electricity while gas supplies were being rationed in Michigan. Faced with punitive price controls, the Texas Railroad Commission had decided to keep its gas at home.

The outcome was the Power Plant and Industrial Fuel Use Act of 1978, which banned natural gas in utility boilers. Gas was too precious a resource to be wasted on electricity. At the same time, Congress declined to extend natural gas price controls in the 1978 Natural Gas Policy Act, but did stretch them out for about a decade.

President Reagan did his best to accelerate price decontrol, and finally achieved it in 1987. Predictably, production rose steadily from 16.1 trillion cubic feet in 1986 to 19.6 in 2001--although it never regained the all-time peak of 21.7 in 1973. Eyeing this growing supply, environmentalists decided they had the answer to acid rain and global warming--substituting natural gas for coal.

Since 1992, more than 70 percent of the new utility boilers built in the United States have burned natural gas. The percentage of gas going to electricity has risen from 14 percent in 1988 (there were a few grandfathered plants) to 25 percent today. The use of gas for electricity has now surpassed residential consumption and is rapidly closing in on industrial use, which has declined 13 percent since 1997.

The rising demand for gas by power plants has decimated whole sectors of manufacturing, which use natural gas as a feedstock as well as a fuel. The fertilizer industry has been gutted, with more than half the manufacturing plants leaving the country. The American Chemistry Council estimates 100,000 job losses since 2000 due to increasing gas prices. Dow alone has shuttered 23 plants. Every kind of plastics manufacturing is affected. Simmons Bedding cannot obtain polyurethane for its mattresses. Goodyear has cut U.S. tire production 30 percent. Rescue workers in New Orleans couldn't get water to hurricane victims because of a shortage, not of water, but of water bottles. The 1.2 percent jump in consumer prices in September--the biggest increase in 25 years--is almost certainly the result of higher gas prices rampaging through American industry.

"But isn't this just the free market at work?" you might ask. "If burning gas for electricity is more efficient, shouldn't we just do it?"

There are several reasons this is not true. First, electric rates in most states are still regulated by public service commissions, which are readily passing the costs through to customers, especially because burning gas promotes "clean energy." Second, some states have become so enthralled with using gas to solve their pollution problems that they have tacked on all kinds of hidden subsidies, such as mandating that pipelines charge utilities their lowest rates for transmitting supplies.

Finally, market optimization presupposes a free substitution of other resources. The chemical and pharmaceutical industries have no substitute for gas feedstocks in their manufacturing processes. The utilities have one obvious substitute--nuclear power--but it is blocked for political reasons.

Remarkably, the nuclear industry has managed to make a vast contribution anyway--tripling generation from 251 billion to 788 billion kilowatt-hours over the last 25 years, increasing nuclear's share of electrical generation from 11 percent to 20 percent. All this has been accomplished by completing plants that were in the pipeline and improving the performance of existing reactors.

Still, a huge hole remains. It is hard to imagine this country having any kind of industrial future without a revival of nuclear power.

William Tucker is a contributing editor to the American Enterprise.