Monday, March 3, 2008

Alaska Natural Gas Pipeline Construction Still Only An Idea

David M. Reaume is a Washington state-based economist who was based for many years in Juneau, Alaska and is very up on the possibility of building a natural gas pipeline from Alaska to the Mid-west USA.

In November the average U.S. city gate price for natural gas stood at $8.05 per thousand cubic feet, or mcf. Some divining that I have done suggests that an average real -- inflation-adjusted, 2007 dollars -- U.S. city gate price of about $9 per mcf qualifies as a minimum "Go Price," where by the Go Price I mean one just high enough to give a positive incentive for producers to get the gas to the pipeline, assuming that the state and the federal government also pitch in.

Accepting that an average real city gate price of $9 per mcf is only a rough estimate of the critical Go Price, how likely is it that we will hit that price in a few years, and how likely is it that it will stay at or above that price for the long term? The answer depends on how one models future natural gas prices.

If, for example, we look at a simple time trend in real natural gas prices over the past 20 years we find that recent peaks are likely to be transitory. But this ignores the fact that the world might have changed greatly over the past five or 10 years. Given the heavy concentration of natural gas reserves outside the United States and Canada, there is some reason to suspect that natural gas prices might eventually return to something like their historical relationship to crude oil prices. After all, about 43 percent of the world's natural gas reserves are located in Iran (16 percent) and Russia (27 percent), two countries that have strong incentives to price their natural gas in step with OPEC's pricing of crude oil.

So what would happen if we abandon simple time trends and look at natural gas prices in relationship to crude oil prices? In particular, what would happen if the average real U.S. city gate price of natural gas found its way back to its historical relationship with the average real U.S. price of crude oil? Good things for pipeline construction. If the price of crude oil were to average $80 per barrel -- in inflation-adjusted 2007 dollars -- the corresponding average U.S. city gate price for natural gas would eventually rise to $9.50 per mcf.
But that might be asking too much given that there is no shortage of analysts who think that crude oil prices are due to drop sharply as the world economy slows down. A more reasonable target may be the $9 per mcf number that my divining suggests may represent a critical value for the proposed pipeline. To reach $9, the average U.S. price of crude oil would only need to stay above about $60 per barrel, both again in inflation-adjusted dollars. That is no sure thing but does not seem too far out of reach even though the December "Energy Outlook" from the U.S. Department of Energy forecasts zero gain in real natural gas prices for the next five years.

Would I bet on pipeline construction getting the go-ahead in the next three or four years? No, but I would not bet against it either. Gov. Sarah Palin is on the right track. Line up a contractor. Then if prices do respond favorably the stage is set. Is $500 million in pre-construction incentives a waste of money? I don't think so, given the stakes and the potential benefits to Alaskans. But then I don't live in Alaska anymore. Only Alaskans can decide.

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