Producing energy from domestic sources is good for the economy, good for national defense and good for jobs. But with the advent of hydraulic fracturing technologies, newly accessible natural gas in the Marcellus, Utica and other formations has become physically and financially stranded.
While the country is awash in cheap natural gas, companies such as Cheniere Energy Partners (CQP) and Dominion Resources (D) are considering multi-billion dollar capital expenditures to ship surplus natural gas to foreign countries.
There is another solution: Make diesel, jet fuel, and other fuels from natural gas. The process is called gas-to-liquids (GTL), and the technology has been around for decades.
According to the Energy Information Administration, the GTL process begins with the reaction of natural gas with air in a reformer to produce syngas -- synthetic gas -- which is fed into a Fischer-Tropsch reactor in the presence of a catalyst, producing a paraffin wax that is hydrocracked into products. Distillate -- kerosene, jet fuel and diesel -- is the primary product, ranging from 50% to 70% of the total yield.
According to Upstream, Royal Dutch Shell (RDS.A) is already in the GTL business. Qatar and Shell jointly own the Pearl GTL facility, which sold its first commercial shipment last June. This $19 billion facility is expected to process 1.6 billion cubic feet of natural gas per day to deliver 120,000 barrels per day of distillate liquids.
The South African firm Sasol Limited (SSL) is also in the business. The New York Times reported that Sasol plans to spend more than $1 billion to buy an interest in Canadian shale gas fields. It will use those fields to explore turning natural gas into diesel, jet fuel and other liquids.
As with everything energy, the economics of GTL come down to production costs. For Sasol's facilities, the cost to convert natural gas into synthetic fuels is about $0.50 a gallon. This is in contrast to the $0.30 a gallon it costs refineries to create similar products. Given the cost difference, it appears the price difference between gas and oil feedstocks would determine whether GTL economics work.
There is a huge price difference in the U.S. Currently, wholesale ultra-low sulfur diesel is trading at $3.30 per gallon, or $3.30 for 139,200 British thermal units (BTUs). In contrast, wholesale natural gas is trading at about $2.30 for 1,000,000 BTUs. Using diesel as the benchmark, wholesale natural gas is trading at $0.32 per diesel gallon equivalent. Add $0.50 for the GTL process to convert gas to diesel or jet fuel, and the total production cost for the synthetic fuel falls under $1.00 per gallon. The difference between $1.00 per gallon and $3.30 per gallon is $2.30. That difference is also the gross margin for GTL facilities operating in North America.
Gross margins would be needed to pay capital costs. The EIA estimates that the capital costs for GTL plants range from $20,000 to $45,000 per barrel of daily capacity. By comparison, the cost of a conventional petroleum refinery is around $15,000 per barrel per day capacity.
As with liquefied natural gas, financial challenges prevent investors from fully backing GTL projects. Banks need certainty; they want developers to guarantee gross margins long enough to repay investors. This requires multi-year feedstock contracts and offtake agreements -- guarantees from buyers that they will purchase portions of future resource development.
This is why it makes sense for larger exploration-and-production companies such as Chesapeake Energy (CHK) to own and operate their own GTL facilities. They already own the feedstock; their financial gamble is limited to the offtake risk.
Even the offtake gamble could be mitigated by a nation that's anxious to accelerate energy independence. The federal government is one of the largest consumers of transportation fuels in the world, and it is always in need of low-cost energy. Given its huge demand for energy, the government is in an excellent position to guarantee developers a minimum price, say $2.50 a gallon, in return for ongoing discounts for fuel. That minimum guarantee could be enough to make new GTL facilities bankable.
The nation is struggling to become energy independent. The current plan in Washington is to spend billions of dollars to convert or replace millions of conventional engines with costly natural-gas engines. This plan also requires building out a duplicate refueling infrastructure to service natural-gas vehicles and conventional vehicles.
Why not replace the front end of the refueling value chain with GTL facilities? This approach takes advantage of the nation's vast resources of natural gas without requiring massive change for engines and infrastructure.