Shale Gas Revealed

Relevance

North America has a surplus of natural gas production, and LNG imports, which dried up, have only recently started picking up again. This situation was almost unthinkable a couple of years ago. The reason, according to mainstream media, is the “sudden” appearance of vast quantities of shale gas. The story goes that the U.S. has enough gas to remain self sufficient and Europe may also be in a similar situation. Enthusiasts gush that shale gas has the potential make a significant contribution to the reduction of global warming; wrestle away from coal its domination of power generation; and dramatically reduce the power of OPEC and conventional gas exporters.

The U.S.’s Barnett Shale (Texas) has played a pioneering role in the development of shale gas and Mitchell Energy, a leading firm, helped to develop new technologies to access gas trapped in difficult to exploit rock formations. The Barnett Shale play produces about 6% of all natural gas produced in the lower 48 States. Three factors have come together to make shale gas production economically viable:

  1. Advances in horizontal drilling techniques.
  2. Advances in hydraulic fracturing.
  3. Stronger natural gas prices resulting from global supply and demand factors.

America’s lower 48 states have a wide distribution of highly organic shales containing vast resources of natural gas, so the future for shale gas would seem to be bright. But with the current depressed natural gas prices and environmental concerns, can we be so sure?

Analysis

Shale Gas Geology

Shale can consist of a multitude of different rock types. Of the shale deposits that have been exploited to date, most have a high clay content that has hardened. Therefore shale has been traditionally seen as a source rock or seal rock for conventional gas reservoirs. More recently though shale has become to be seen as an unconventional source of natural gas in its own right (alongside other unconventional sources such as coalbed methane and tight sandstones). Many geologists consider shale gas drilling as the exploitation of the source rock, rather than of a reservoir rock.

Shale gas deposits typically have a lower permeability and larger organic matter content than conventional reservoirs. And the gas in a shale reservoir will typically occur in two modes: adsorbed on organic matter within the shale bed (as is similarly found in coal bed methane) and as free gas in porosity within the shale matrix (as is found in conventional reservoirs). Its low permeability means that shale rock requires specialized drilling techniques to enable production.

Because shale deposits usually have too low a permeability to allow significant gas flow to a well, most are not commercial sources of natural gas. But, on the upside, the geological risk of not finding gas is low. Shale gas areas are often characterised as resource plays (as opposed to exploration plays). Finding organic-rich, gas-prone shale is therefore generally not difficult; but finding the permeable ‘sweet spots,’ the most brittle and fracturable strata, or the most gas-saturated sediment is more challenging.

Production in commercial quantities from many shale gas deposits requires fractures to provide enhanced permeability. Shale gas has been produced for years from shales with natural fractures; but increased production in recent years has been due to modern technology in hydraulic fracturing to create extensive artificial fractures around well bores.

Resources assigned to shale gas projects in the United States are in the range 35–250Tcf for each project with recoverable reserves being about 5%–20% of resources, given the current state of the technology. Proponents claim that the latest drilling technology makes these fields economic to develop. This has led to higher estimates for U.S. gas reserves, up from 30 years to 100 years at current usage rates.

Shale Gas Technology

One of the reasons for heightened interest in shale gas deposits is the increased use of a drilling technique known as hydraulic fracturing. In hydraulic fracturing water and sand are pumped down a well to create fractures that liberate more gas from the rock. This mix of water and chemicals is blasted into the rock formation to create fissures in the gas-bearing rocks. This technique has made it much easier and cheaper to extract gas from shale. Horizontal drilling is also used with shale gas wells to expose the maximum well surface area to the formation. The drill bit initially penetrates the earth vertically before moving sideways for hundreds or thousands of feet. Lateral lengths up to 10,000 feet within the shale are possible using horizontal drilling.

The blasting a cocktail of chemicals and other materials into the rock shatters it into thousands of pieces, creating cracks that allow the gas to seep to the well for extraction. A “proppant”, such as sand is introduced to prevent the pressure induced formation fractures from closing once the pressure is bled off, thus maintaining a path through which the gas can reach the wellbore.

Shale Gas Economics

In 1996 shale gas wells in the U.S. produced 0.3Tcf, or 1.6% of U.S. gas production. By 2006, this had almost quadrupled to 1.1Tcf per year or 5.9% of U.S. gas production. In 2005 there were 14,990 shale gas wells in the U.S. and a record 4,185 shale gas wells were completed in the U.S. in 2007. Also in 2007, shale gas fields included the second (Barnett/Newark East) and thirteenth (Antrim) biggest sources of natural gas production in the U.S.

Shale gas tends to cost more to produce than gas from conventional wells, because of the expense of hydraulic fracturing and of horizontal drilling. However, this can be offset somewhat by the low geological risk of shale gas wells.

Only as prices surged in the period leading up to 2008 did such drilling become commercially viable in a much more meaningful way. Economies of scale and improvements in technology have halved the production costs of shale gas, making it cheaper even than some conventional sources. This has led to an almost exponential increase in Barnett Shale gas production since the late 1990s.

The cost of a well in the Barnett Shale is around $5M, and Chesapeake has noted that the economic gas price for such a well is over $4/MMBtu at Henry Hub. With other shales more expensive than Barnett, industry observers are now starting to question the commercialization of the gas. Estimates for production costs of Marcellus Shale (in the Eastern U.S.) range from $6/MMBtu to $8/MMBtu. Production of European shale gas is estimated to be viable at a gas price of around $9/MMBtu. Another problem with shale gas is the relatively high first year decline rates of its wells. Thus exploitation shale gas fields requires many, closely spaced wells. Decline rates are also increasing over time.

North American gas prices have slumped from more than $13/MMBtu in mid-2008 to around $4/MMBtu today, and will remain soft for the foreseeable future. The clear conclusion is that at the lower recession induced demand and current supplies, domestic U.S. gas prices may not be high enough to support full shale gas exploitation. Gas prices in Europe are also not currently high enough to support meaningful exploitation.

Environmental Concerns with Shale Gas

Along with costs, the other problem with shale gas is the potential environmental impact of its production. Water, sand and chemicals are pumped into the ground under pressure, to crack the shale and create gaps so the gas can flow out. The resulting volume of contaminated water is generally kept in above-ground ponds to be removed by tanker, or injected back into the earth.

The contaminated water issues of shale drilling are now starting to be seriously questioned at all levels. The concern is that such water may find its way into supplies, poisoning water intended for human consumption. New York City has halted drilling in its water supply catchment area in the Catskills.

There are also environmental concerns with the high density onshore drilling activity that shale gas deposits require. Closely spaced wells may be acceptable in the sparsely populated and remote areas of Texas, but are less suited to Western Europe with its high population density, where concerns about spoiling the landscape are higher (and water issues are closely monitored from existing onshore hydrocarbon exploitation activities).

Potential leakages of methane gas from shale gas wells are also attracting attention. These could offset the CO2 reductions and climate benefit of switching from coal to shale gas.

The Impact of the Global Gas Market on Shale Gas

Gas is now the preferred fuel for power companies planning to build capacity. Gas power plants are the cheapest and quickest to construct, using a proven technology that can be built for less than $1M/MW of capacity (compared to $4M/MW for a new nuclear plant and $5M/MW for an offshore wind turbine). Gas fired plants are perceived by the power industry as very flexible, straightforward, and carrying a very low risk for investors.

When the environmental benefits of gas are added in it is small wonder that in 2008 the so called “dash for gas” showed little sign of slowing. For shale gas resource holders in the U.S. and Europe, located as they are in the heart of the world’s two largest gas consuming regions, the prospects probably looked bright.

Indeed, this year the U.S. overtook Russia to become the world’s biggest gas producer for the first time in nearly a decade (although it should be noted that most Russian production is exported and European demand has fallen). The technology development that allows investors to exploit its huge shale gas resources has resulted in increased production and a drastically reduced requirement for imported LNG.

Endorsement of potential further technological developments in shale gas, and an expectation of stiffening gas prices in the future, has come from the majors. In December ExxonMobil agreed to a $41B deal to buy XTO, the shale gas specialist, while BP, Statoil and Total have each struck deals with Chesapeake Energy to tap into its U.S. shale assets.

Even politicians were starting to get in on the act when in November 2009 U.S. President Barack Obama agreed to share U.S. shale gas technology with China and to promote U.S. investment in Chinese shale gas developments.

However, just as production of shale gas in the U.S. surged ahead, a recession induced by the financial crisis resulted in a sharp drop in world demand for gas. The IEA says U.S. gas consumption in 2009 fell by 3%. In Europe, it fell on average by 7% and by up to 12% in some countries. Europe’s efforts to boost efficiency and reduce carbon emissions are also adding to demand destruction. The result has been a collapse in the price of gas and significant gas demand growth is not expected to pick up again for some time.

In the meantime supplies of LNG are growing increasingly abundant as new projects come on stream this year, adding another 80MT to annual supply, about 50% more than in 2008. Low cost LNG production from Qatar is still economically viable, even when exporting into the low price Gulf Coast of the U.S. Other planned LNG projects have been put on the shelf. Gazprom recently postponed its Shtokman project by three years because of the change in the world gas market.

Demand destruction has meant that Europe’s need for new pipelines from Russia is less urgent. Construction for the Nord Stream project, a Gazprom initiative to export gas to Germany via the Baltic Sea, begins soon. It is due to come on stream in 2011. However, stiff competition from gas supplies from countries such as Qatar, Nigeria and Algeria means that Russia’s share of the European gas market is likely to dip from 29 per cent to 24 per cent during this decade and then stabilise around current levels, a respected gas industry consultancy has reported.

Conclusion

New technology development, lower costs and a firming U.S. gas price meant that shale gas production, particularly in the U.S., raced ahead in the decade leading up to 2008. Since 2008 gas demand destruction and lower prices meant that imports of LNG to the U.S. dried up (only recently restarting). Investment in shale gas, and gas from other sources in the region, resulted in an over supply of gas to the U.S. market. However, new LNG volumes are coming on to the world market this year which will add further downward pressure to prices in the U.S. and Europe, where demand destruction has also been witnessed. Lower cost LNG is becoming available from Qatar and other countries and it is by no means certain that U.S. shale gas will remain competitive in such a high supply/low demand growth market environment. Economics and environmental considerations mean that the future for shale gas is far from assured in the U.S. and elsewhere, and it may be many years before we see a repeat of the recent growth in shale gas production.

27 May 2010

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