Me gusta la gasolina

Last week's special report in The Economist was on the shale gas bonanza and was quite an enlightening read. It got me to think about one conversation I had with my dad about shale gas exploration. He mentioned that the US should drill uninhibitedly for as much gas as possible, not for the sake of having an abundant supply of another energy source, but for the sake of lowering the price of gasoline. If a physics PhD who spent over a decade in chemistry academia didn't know the difference between natural gas and gasoline, others might not fare so well either. (It's possible he's just been brainwashed by the endless stream of nonsense coming from politicians.)

 Despite both being called "gas" colloquially, natural gas and gasoline have very different sources and end uses at the moment. Natural gas comes straight from the ground as methane and other gasses (in the sense that they're not liquids or solids). That gets processed into propane, butane, etc. for electricity generation, home cooking/heating, and transportation though that has not caught on yet. Gasoline comes from crude oil that is pumped out of the ground, and is one of many products that is a result of crude oil refinery. Gasoline is almost solely used for transportation. Now you can understand why having all the natural gas in the world won't affect gasoline prices much: you can't just fill up your car with natural gas even if it was free. Only a handful of buses and trucks are designed to run on natural gas (for now, due to technological issues; more on that later), so as long as we keep making cars that burn gasoline, you have only one choice.

*Tangent: One of my favorite stories regarding prices of related commodities is a great lesson in assuming prices of similar goods must behave the same way. In the 80's, airline companies had been hedging their jet fuel costs by buying heating oil futures. Both jet fuel and heating oil are refined from crude oil, albeit by different processes. The catch was, their markets had completely different personalities. Jet fuel is only used by airplane operators, which means there were few market participants. Heating oil, on the other hand, is bought and sold by every home energy and utilities company, so there are many market participants. Now, the airlines wanted to protect themselves from a rise in jet fuel prices, and they noticed that heating oil prices moved in tandem with jet fuel prices as they had theorized. Unfortunately for them, Saddam Hussein decided to invade Kuwait, which sent jet fuel prices skyrocketing, and a mild winter kept heating oil prices low. Needless to say, they lost a ton of money when their hedge failed to recoup their operational losses. (This is also called basis risk in trading circles)

One hiccup in the natural gas market related to the technological issue I mentioned above is the difficulty in transporting and storing it. It's a gas, like a burp or a fart, not a liquid like oil or gasoline. It needs special equipment to keep it compressed so it's useable, which is why it's not feasible on cars yet. And because liquefying it requires even more expensive equipment to cool it and maintain at -162 C, the shale gas produced in America is no good to Europeans, who are starting to ban shale gas extraction, and Asians, who have yet to do much shale gas exploration. I have no doubt that some MIT professor or Exxon Mobil engineer will figure out a solution one day to make natural gas fungible like crude oil.

This post is getting quite long already, but I just wanted to mention something briefly about crude oil. Even though we can ship crude oil around the world, not all crude are created equal. There are 3 major benchmarks of crude oil: West Texas Intermediate, North Sea Brent, and Dubai crude, which differ in sulfur content and other properties. All else equal, refiners prefer WTI to Brent to Dubai. So as a word of caution, the next time you hear a politician exclaim, "Doing XYZ will send oil prices so high, it'll cripple the American economy!", think about which oil price will be affected the most. Though their prices are strongly correlated, it's not always the case. For a long time, WTI was worth slightly more per barrel than Brent crude because oil refiners preferred WTI for its lower sulfur content (or "sweetness"). Recent Middle East tensions have (rightly) increased the prices of all oil, but Brent crude soared as much as $30/barrel higher than WTI. Currently, Brent is about $15/barrel higher, which means Brent has dropped much more from its peak than WTI has.