Andreoli on Oil and Fuel: Considering a natural gas powered fleet? The devil is in the details

The natural gas market outlook has been a frequent topic covered in this column over the last two years. Over this time, I have consistently argued that although natural gas is abundant, natural gas prices will inevitably rise because the costs of production do not support the “glut” prices that have resulted from the fracking boom.

Natural gas prices matter, of course, because the price differential between natural gas fuels and diesel presents an opportunity for some—not all—fleets to enjoy significant net savings by replacing diesel powered trucks with natural gas powered alternatives.

My colleagues at Mercator and I have developed a model that calculates the net present value (NPV) and internal rate of return (IRR) for potential investments in natural gas powered trucks. Before describing the model, I will first review how the natural gas and diesel markets have developed over the last twelve months.

It’s certainly no secret that a glut of natural gas emerged toward the end of 2011, and this glut lasted through 2012. Signs that the market was beginning to work through the natural gas glut began to appear in the early months of 2013, however, and as the amount of natural gas in storage declined from a five-year high to the five-year average between January and April, Henry Hub spot prices jumped 38 percent, rising from roughly $3.20 to $4.40 per Mcf (thousand cubic feet).

Since then, spot prices have oscillated, but overall the average since April has been $3.80 per Mcf. And at these low prices, it does not make sense to drill in anything but the most productive sections of shale plays, so we should expect prices to rise in the future.

At $3.80, the average price over the last six months has been 38 percent higher than the average price through all of 2012. Of course, the wellhead price of natural gas is just one component in the retail price of compressed natural gas (CNG) and liquefied natural gas (LNG). Regarding the latter, LNG is currently only readily available in California.

Currently, on a diesel gallon equivalent (DGE) basis, California’s prices for LNG range from just $2.19 to $4.09; this amounts to a difference in excess of 87 percent. Outside of California, pump prices are even more wide-ranging. One DGE of LNG can be purchased for $1.99 in Houston, but the same quantity will send you back $9.64 in La Crosse, Wisc.

Never will you find such a disparity in diesel prices within the same city because markets are well developed (high competition). And unlike LNG, which literally boils off and is lost to the atmosphere if it sits for more than a few days and its temperature rises above -260 degrees Fahrenheit, diesel is stable. Clearly, LNG price volatility has both a geographic and temporal component that is not matched by diesel.

By comparison, CNG is far more readily available than LNG, and unlike LNG, CNG is stable. Once compressed, it can be stored for decades. Similarly, retail CNG prices are more stable than LNG prices. That said, even within a region, there is significant price variation. In the greater Los Angeles area, current natural gas prices range from $2.26 to $3.59 on a DGE basis, a difference of 59 percent. Again, you are not likely to see such a disparity in diesel prices within any particular region.

The average CNG retail price across the Los Angeles region is $2.91 on a DGE basis. At the national level, the average price is closer to $2.50 (DGE). The retail price for CNG is comprised of eight main components: the commodity price; transport to the utility’s city gate; the local gas company service fee; taxes and special assessments; compression (using electric pumps); maintenance and repair of the compression/retail facility; the amortized cost of capital and equipment; and the retail markup.

Each of these components varies by location, and the wellhead price component is the only variable cost. On average, the commodity price component only accounts for 20 percent to 30 percent of the retail CNG price. Consequently, CNG prices are far more stable than natural gas spot prices. The same is true of diesel prices, which are far less volatile than oil prices.

Since January 2012, CNG prices have fallen into a fairly narrow band, especially considering the volatility shown in the commodity price. According to data from the Clean Cities Alternative Fuel Price Report, that reports average prices every two or three months, CNG prices varied by only 4 percent from the minimum price to the maximum price.

By comparison, and according to the same data source, the maximum diesel price was 10 percent greater than the minimum. Given the timing of the data, we can expect that both CNG and diesel volatility was greater than reported; however, the lesson is that CNG prices are, in fact, less volatile than diesel prices. In short, while retail CNG and LNG prices may be more stable on average, geographic variability can be extreme and should be considered in any investment analysis.

In addition to CNG prices being less volatile, CNG is consistently less expensive on an energy equivalent basis than diesel. Since January of 2012, the average retail price differential was $1.65 per DGE, and the minimum and maximum price differentials were $1.49 and $1.85, respectively.

Of course transitioning to a CNG (or LNG) powered fleet is neither without risk nor without cost. On the risk side, there is a not insignificant chance that the price differential between natural gas fuels and diesel could narrow rather quickly—and, in the process, turn a good investment bad.

On the cost side, natural gas power plants are more expensive. And because the energy content (Btu per gallon) of CNG and LNG is significantly less than the energy content of diesel, for a CNG or LNG alternative to achieve the same range as a diesel truck requires that for every gallon of diesel, 3.7 gallons of CNG must be carried and 1.72 gallons of LNG must be carried.

The larger and more complex CNG and LNG tanks are notably heavier than the diesel equivalent and significantly more costly as well. In some cases, the additional weight of the tanks will decrease the payload capacity.

In addition to having different tank configurations, CNG and LNG have different refueling requirements. Because LNG is cryogenically liquefied, drivers must use protective gear (facemask, gloves, closed-toe shoes) and receive specialized training. Because CNG tanks must be filled through pressurization, and pressurizing a gas causes the temperature of the gas to increase, which in turn causes its volume to expand, fast-filled tanks achieve maximum pressure when the tanks are less than totally full.

In order to completely fill the tanks, a slow fill technique that can take six to eight hours is required. Consequently, if you don’t have your own refueling facility, the practical tank volume is decreased by as much as a quarter.

The investment model developed at Mercator and referenced earlier generates an incremental discounted cash flow forecast and estimates the payback period, net present value of the investment, and the internal rate of return for the investment using nearly twenty user-defined inputs including:

• Incremental natural gas spot prices and diesel prices, which vary by region
• Type of power plant (CNG or LNG) and displacement
• Tank size and configuration
• Fleet characteristics including number of trucks/tractors, average payload, average miles per year, average trip distance, and average fuel economy (for diesel, the model estimates the natural gas equivalent)
• Fueling technique (slow or fast filling CNG)
• Financial considerations such as the discount rate, the price differential between truck/tractor models, salvage period, residual value, and the incremental cost of capital

Running various realistic fleet and pricing scenarios through the model produces intriguing results. We find that for some fleets, the decision to switch to natural gas is almost risk free—meaning that the net present value of the investment is positive under most likely fuel price scenarios. We also find that for other fleets, transitioning from diesel to natural gas will not provide a positive return on investment even under pricing scenarios weighted to favor natural gas alternatives.

Evaluating natural gas powered alternatives to diesel-powered trucks and tractors is a complicated task, but in some cases, the financial rewards for making such a transition can be significant. But even in such cases, the value of such an investment must be weighed against competing investment opportunities, which is typically accomplished by comparing the internal rates of return between competing investments.

Depending on where and under what conditions your fleets operate, natural gas powered trucks/tractors may make a terrific investment, but the devil is in the details.