Unconventional Gas: Cheap Gas Coming?

2010/09/25

In the last decade America has rapidly developed a new source of gas found naturally in rocks. It now provides a fifth of national needs. Such gas is present in Europe too, and whether or not it is practical to extract it, it is already having an effect on future supplies.

In the last decade America has rapidly developed a new source of gas found naturally in rocks. It now provides a fifth of national needs. Such gas is present in Europe too, and whether or not it is practical to extract it, it is already having an effect on future supplies.

Gas has obvious advantages as an energy source. It is plentiful, relatively clean environmentally, easy to handle, with very high efficiency when converting into useful energy. It has also recently hit the headlines as a result of what is being called the ‘shale revolution’. This refers to a dramatic increase in domestic gas production in the United States.

Last year, US natural gas production was 593 billion cubic metres compared to 524 billion in 2006. This sharp increase was completely unexpected. Before 2007, everyone thought US domestic gas production was about to slip into terminal decline with imports rising dramatically.

The reason for this change lay in the development of unconventional gas resources. These include tight gas, shale gas and coal bed methane. Tight gas is contained in low porous rocks. Shale gas is found in shale rocks that are both the source of the gas and the means of its storage. Shale gas was central to the increased production story, going from less than one percent of US production in 2000 to twenty percent by last year. Coal bed methane is natural gas found in coal deposits that are of marginal commercial value for producing coal.

In all three cases, this unconventional gas needs assistance to flow to the surface and different drilling techniques – horizontal as opposed to vertical – and hydraulic fracturing: the high pressure injection of water, chemicals and sand into the rock structures to free the gas.

The potential resources of such gas are huge. Last year, proven conventional global gas reserves equalled 185 billion cubic metres, while the National Petroleum Council’s 2007 estimate for tight gas, for coal bed methane and shale gas was some five times greater than those conventional reserves.

chathamhouse.org.uk

REVOLUTION OVER HERE?

The question now is whether the US shale revolution might be feasible elsewhere. In particular, there is great hype in western Europe, where unconventional gas exploration is just beginning, notably in Poland. If a shale revolution did happen, it would be a serious game changer.

Western Europe, which is two-thirds dependent on gas imports – a figure expected to rise – could become self-sufficient. Russia’s gas exports would face serious competition, undermining efforts to use energy to promote state power. Global gas prices, already falling following the shale revolution in the US, could drop even further. This might encourage the major gas exporters to create an Organization of Gas Exporting Countries (OGEC) to defend their revenues.

All these possible consequences are conditional on whether the US shale experience can be replicated. A number of favourable circumstances exist in America but are not present in Europe. There was a huge amount of geological data from old cores kept from previous drilling. Shale plays – shale reserves are called plays rather than fields reflecting the large geographic areas involved – overlay conventional oil and gas fields which had been extensively explored.

Onshore oil and gas operations in Europe have been limited. US shale plays are large and relatively shallow, whereas in Europe they are small and deep, with high clay content. Clay is not conducive to hydraulic fracturing, a key technological ingredient to release the gas.

In 1980, the US Crude Oil Windfall Profit Tax Act introduced a nonconventional fuel production tax credit of $3 per oil barrel equivalent. Before 2000, this accounted for around a quarter of domestic gas prices and was a significant incentive. No such tax breaks exist in Europe, except in Hungary.

Indeed, European petroleum legislation completely ignores unconventional gas and would therefore require significant redrafting. In the US very large areas were licensed for shale exploration, in Europe, traditionally oil and gas operations are only allowed in small areas.

LOCAL DISRUPTION

Because of much faster field depletion, shale needs far more wells than conventional fields and is therefore much more disruptive locally. The US has a low population density – 27 people per square kilometre compared to England with 383 – which is used to oil and gas operations in the neighbourhood; not so in Europe.

In the US landowners directly benefit from oil and gas produced from their land. Again, not so in Europe, where the state owns sub-soil hydrocarbons. Thus there is likely to be considerable local opposition in Europe to the very intrusive operations required.

There is also concern over local environmental issues, given the potential damage to ground water from the hydraulic fracturing chemicals. Until recently, ground water damage was not an issue in the US, although it is becoming so. In Europe the story is likely to be more serious and local opposition to such methods could be strong.

A crucial part of the US story, also missing in Europe, was the existence of a vibrant service sector, given unconventional gas depends heavily on new technology such as horizontal drilling and hydraulic fracturing.

At the height of the Barnett Shale Play in North Texas in 2008, 180 drilling rigs were operating. In the whole of Europe, there are only one hundred rigs. The major oil companies may anyway try to divert many of these to Iraq to meet work commitments in last year’s service contracts.

Overall, the prospects for a shale revolution in Europe look thin. However, the hype has created huge investor uncertainty in gas. Already US investors in liquefied natural gas regasification plants have been badly hurt as the demand failed to materialise. Faced with such uncertainty, it is likely that current potential investors in gas transport options – pipelines and liquefied natural gas – will wait to see what may or may not emerge on unconventional gas.

If the shale revolution happens, then Europe can happily float on a cloud of cheap gas for a long time to come. But if Europe fails to replicate the US experience, there will be serious problems as future gas supplies suffer from insufficient investment today resulting from the uncertainty created by a possible shale gas revolution.

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