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AN UNCONVENTIONAL GLUT
Mar 11th 2010
Newly economic, widely distributed sources are shifting the balance of
power in the world's gas markets
SOME time in 2014 natural gas will be condensed into liquid and loaded
onto a tanker docked in Kitimat, on Canada's Pacific coast, about 650km
(400 miles) north-west of Vancouver. The ship will probably take its
cargo to Asia. This proposed liquefied natural gas (LNG) plant, to be
built by Apache Corporation, an American energy company, will not be
North America's first. Gas has been shipped from Alaska to Japan since
1969. But if it makes it past the planning stages, Kitimat LNG will be
one of the continent's most significant energy developments in decades.
Five years ago Kitimat was intended to be a point of import, not
export, one of many terminals that would dot the coast of North
America. There was good economic sense behind the rush. Local
production of natural gas was waning, prices were surging and an
energy-hungry America was worried about the lights going out.
Now North America has an unforeseen surfeit of natural gas. The United
States' purchases of LNG have dwindled. It has enough gas under its
soil to inspire dreams of self-sufficiency. Other parts of the world
may also be sitting on lots of gas. Those in the vanguard of this
global gas revolution say it will transform the battle against carbon,
threaten coal's domination of electricity generation and, by
dramatically reducing the power of exporters of oil and conventional
gas, turn the geopolitics of energy on its head.
DEEP IN THE HEART OF TEXAS
The source of America's transformation lies in the Barnett Shale, an
underground geological structure near Fort Worth, Texas. It was there
that a small firm of wildcat drillers, Mitchell Energy, pioneered the
application of two oilfield techniques, hydraulic fracturing
("fracing", pronounced "fracking") and horizontal drilling, to release
natural gas trapped in hardy shale-rock formations. Fracing involves
blasting a cocktail of chemicals and other materials into the rock to
shatter it into thousands of pieces, creating cracks that allow the gas
to seep to the well for extraction. A "proppant", such as sand, stops
the gas from escaping. Horizontal drilling allows the drill bit to
penetrate the earth vertically before moving sideways for hundreds or
thousands of metres.
These techniques have unlocked vast tracts of gas-bearing shale in
America (see map). Geologists had always known of it, and Mitchell had
been working on exploiting it since the early 1990s. But only as prices
surged in recent years did such drilling become commercially viable.
Since then, economies of scale and improvements in techniques have
halved the production costs of shale gas, making it cheaper even than
some conventional sources.
The Barnett Shale alone accounts for 7% of American gas supplies. Shale
and other reservoirs once considered unexploitable (coal-bed methane
and "tight gas") now meet half the country's demand. New shale
prospects are sprinkled across North America, from Texas to British
Columbia. One authority says supplies will last 100 years; many think
that is conservative. In 2008 Russia was the world's biggest gas
producer (see chart 1); last year, with output of more than 600 billion
cubic metres, America probably overhauled it. North American gas prices
have slumped from more than $13 per million British thermal units in
mid-2008 to less than $5. The "unconventional"--tricky and expensive,
in the language of the oil industry--has become conventional.
The availability of abundant reserves in North America contrasts with
the narrowing of Western firms' oil opportunities elsewhere in recent
years. Politics was largely to blame, as surging commodity prices
emboldened resource-rich countries such as Russia and Venezuela to
restrict foreign access to their hydrocarbons. "Everyone would like to
find more oil," says Richard Herbert, an executive at Talisman Energy,
a Canadian firm using a conventional North Sea oil business to finance
heavy investment in North American shale. "The problem is, where do you
go? It's either in deep water or in countries that aren't accessible."
This is forcing big oil companies to get gassier.
The oil majors watched from the sidelines as more entrepreneurial
drillers proved shale's viability. Now they want to join in. In
December Exxon Mobil paid $41 billion for XTO, a "pure-play" gas firm
with a large shale business. BP, Statoil, Total and others are sniffing
around the North American gas patch, signing joint ventures with
producers such as Chesapeake Energy. A wave of consolidation is likely
in the coming months, as gas prices remain low, the drillers seek
capital and the majors hunt for the choicest acreage.
Shale is almost ubiquitous, so in theory North America's success can be
repeated elsewhere. How plentiful unconventional resources might be in
other regions, however, is far from established. The International
Energy Agency (IEA) estimates the global total to be 921 trillion cubic
metres (see chart 2), more than five times proven conventional
reserves. Some think there is far more. No one will really know until
companies explore and drill.
The drillers are already arriving in Europe and China, which are both
expected to import increasing amounts of gas--and are therefore keen to
produce their own. China has set its companies a target of producing 30
billion cubic metres a year from shale, equivalent to almost half the
country's demand in 2008. Several foreign firms, including Shell, are
already scouring Chinese shales. After a meeting between the American
and Chinese presidents last November, the White House announced a
"US-China shale gas initiative": American knowledge in exchange for
investment opportunities. The IEA says China and India could have
"large" reserves, far greater than the conventional resource.
Exploration is also under way in Austria, Germany, Hungary, Poland and
other European countries. The oil industry's minnows led this scramble,
but now the big firms are arriving too. Austria's OMV is working on a
promising basin near Vienna. Exxon Mobil is drilling in Germany.
Talisman recently signed a deal to explore for shale in Poland.
ConocoPhillips is already there. The first results from wells being
drilled in Poland, in what some analysts believe is a shale formation
similar to Barnett, should be released this year.
No one expects production of shale gas in Europe to make a material
difference to the continent's supply for at least a decade. But the
explorers in China and Europe present a long-term worry for those who
have bet on exporting to these markets. Gazprom, Russia's gas giant, is
the company most exposed to this threat, because its strategy relies on
developing large--and costly--gasfields in inhospitable places. But
Australia, Qatar and other exporters also face a shift in the basics of
their business.
CHOKED
These producers are already getting a taste of the global gas glut.
Almost in tandem with the surge in American production, recession
brought a slump in world demand. The IEA says consumption in 2009 fell
by 3%. In Europe, the drop was 7%. Consumption in the European Union
will grow marginally if at all this year and will not be sufficient to
clear an overhang of supplies, contracted through take-or-pay
agreements signed in the dash for gas of the past decade. IHS Global
Insight, a consultancy, reckons that the excess could amount to 110
billion cubic metres this year, almost a quarter of the EU's demand in
2008.
The glut has been exacerbated by the suddenly greater availability of
LNG. Importers with the infrastructure to receive and regasify LNG can
now easily tap the global market for spot cargoes. This is partly a
product of the recession, which dampened demand from Japan and South
Korea, the leading LNG buyers. But another cause is that many
exporters, not least Qatar, the world's LNG powerhouse, spent the past
decade ramping up supplies aimed at the American market. That now looks
like a blunder.
America is still taking some of this LNG, but the exporters' bonanza is
over before it ever really began. "You'll always find a buyer in North
America," says Frank Harris, an analyst at Wood Mackenzie, a
consultancy, "but you might not like the price." And LNG will grow
increasingly abundant as new projects due to come on stream this year
add another 80m tonnes to annual supply, almost 50% more than in 2008.
Qatar's low production costs mean it can still make money, even in
North America. Others cannot. In February, for example, Gazprom
postponed its Shtokman gasfield project by three years because of the
change in the market. Some of the gas from that field, in the Barents
Sea, was to be exported to America. But Shtokman's gas will be costly,
because the field is complex and its location makes it one of the
world's most difficult energy projects to execute. Some analysts now
wonder whether gas will ever flow from Shtokman.
China offers some hope for ambitious exporters, but even there the
outlook has become cloudier. The Chinese authorities want natural gas
to account for at least 10% of the country's energy mix by 2020 and are
building LNG import terminals. With that target in mind, Australia,
which has its own burgeoning conventional and unconventional gas
supplies, has been busily building an LNG export business. But warning
lights are coming on. In January, PetroChina let a deal to buy gas from
Australia's Browse LNG project expire. The original agreement was made
in 2007, when LNG prices were soaring in Asia, but China can afford to
be picky now. "Too many Australian LNG plants are chasing too little
demand," says Mr Harris.
The shift in the global market has left China well-placed to dictate
prices. This will be another blow to Gazprom, which has long talked of
exporting gas to the country. Indeed, while the Chinese and the
Russians have squabbled over the terms, Turkmenistan has quietly built
its own export route to China. Even if Beijing's shale-gas plans come
to nothing, supplies from Central Asia and new regasification terminals
along its coast may allow China to reach its natural-gas consumption
targets without pricey Siberian supplies.
The glut has weakened Gazprom's position in Europe, too. It has been
losing market share to cheaper Norwegian and spot-market supplies. In
2007 Gazprom talked of increasing its annual exports to the EU to 250
billion cubic metres. Now, says Jonathan Stern, of the Oxford Institute
for Energy Studies, Gazprom will probably only ever supply the EU with
200 billion cubic metres a year (it shipped about 130 billion in 2008).
The company forecast in 2008 that its gas prices in Europe would
triple, to around $1,500 per 1,000 cubic metres, on the back of rising
oil prices, which help set prices in long-term contracts. But the price
dropped to about $350 last year and is expected to fall again in 2010.
The weak market could last for another five years, believes Wood
Mackenzie. Gazprom has been renegotiating with leading customers,
injecting elements of spot pricing into contracts to make them more
attractive.
SHTOKMAN SHTYMIED
Moreover, Europe's need for new pipelines to guarantee supplies
suddenly looks less pressing. Construction of Nord Stream, Gazprom's
flagship project to export gas directly to Germany through the Baltic
Sea, will begin next month. It is due to come on stream in 2011. The
scheduled doubling of its capacity to 55 billion cubic metres a year is
in doubt, says Mr Stern, because Shtokman was to have supplied the gas
for it.
Demand is a bigger problem. Even without recession or European shale,
the assumption that Europe's consumption will keep growing is looking
shaky, because the EU's efforts to boost efficiency and reduce carbon
emissions are making gradual headway. Edward Christie, an economist at
the Vienna Institute for International Economic Studies, says the EU
could be importing a third less natural gas in 2030 than the European
Commission forecast in 2005. That makes the case for additional supply
lines much less compelling. The IEA expects rich European countries'
demand to grow by only 0.8% a year in the next two decades, against
1.5% for the world as a whole (see chart 3).
An age of plenty for gas consumers and of worry for conventional-gas
producers thus seems to be dawning. But two factors could reverse the
picture again. The first surrounds the uncertainty about how fruitful
shale exploration will be outside North America. A clearer
understanding of the geology will emerge from pilot wells in the coming
months. Second, there are reasons for caution above ground, too.
Despite natural gas's greener credentials than oil's or coal's, shale
drilling has critics among environmentalists, who worry that water
sources will be poisoned and landscapes despoiled.
The industry says cement casing of wells and the depth to which they
are drilled make the practice safe and relatively unobtrusive. But so
far it has been drilling mainly in North America, where land is
plentiful and people are accustomed to the sight of oilmen's detritus.
In densely populated Europe, the rapacious rate at which shale plays
must be drilled to sustain production is less likely to be tolerated.
Even in America, opposition to shale gas is rising. New York state has
imposed a moratorium on drilling in its portion of the Marcellus Shale,
which it shares with Pennsylvania. Lawmakers in Congress want to study
the ecological impact of fracing. The Environmental Protection Agency,
a federal body, also raised concerns about "potential risks" to the
watershed.
The path of demand in gas's new age is hard to predict, but abundant
new sources could bring about profound change in patterns of energy
consumption. Some of the downward pressure on price will ease: despite
sedate growth, the LNG glut should dissipate, probably by 2014, says Mr
Harris; and low prices will kill more projects, clearing the inventory.
France's Total thinks global demand will recover strongly enough to
require another 100m tonnes a year of LNG by 2020, on top of plants
already planned. However, the Energy Information Administration, the
statistical arm of America's Department of Energy, predicts decades of
relatively weak prices.
If this is correct, it makes sense, for both environmental and economic
reasons, for the country to gasify its power generation, half of which
comes from coal-fired plants. This could be done cheaply and quickly,
because America's total gas-fired capacity (as opposed to production)
already exceeds that for coal. Put a price of only $30 a tonne on
carbon, say supporters, and natural gas would quickly displace coal,
because gas-fired power stations emit about half as much carbon as the
cleanest coal plants. The IEA agrees that penalising carbon emissions
would benefit natural gas at the expense of dirtier fuels.
There would be political obstacles. The coal lobby remains strong in
Washington, DC. Climate legislation struggling through Congress even
includes provisions to protect "clean coal", a term covering an array
of measures, so far uncommercial, to reduce emissions from burning the
black stuff. Ironically, oil companies that were once suspicious of
proposals to control carbon now regard a carbon price or even a carbon
tax as a potential boon to their new gas businesses.
A more radical idea, and one that would have ramifications for the
global oil sector, is to gasify transport. T. Boone Pickens, a
corporate raider turned energy speculator, has launched a campaign to
promote this, and has support from the gas industry. By converting
North America's fleet of 18-wheeled trucks to natural gas, says Randy
Eresman, boss of EnCana, a Canadian gas company, America could halve
its imports of Middle Eastern oil. EnCana is promoting "natural gas
transportation corridors": highways served by filling stations offering
natural gas.
All this is some way off. The coal industry will not surrender the
power sector without a fight. The gasification of transport, if it
happens, could also take a less direct form, with cars fuelled by
electricity generated from gas.
A gasified American economy would have profound effects on both
international politics and the battle against climate change.
Displacement of oil by natural gas would strengthen a trend away from
crude in rich countries, where the IEA believes demand has already
peaked as a result of the recent spike in oil prices. Another
consequence of the energy market's bull run, the unearthing of vast new
supplies of gas, could bring further upheaval. If the past decade was
characterised by the energy-security concerns of consumers, the coming
years could give even the world's powerful oil producers reason to
worry, as a subterranean revolution shifts the geopolitics of global
energy supply again.
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