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Shale gas debate needs a dose of economic realism Print E-mail
Written by Jeremy Wakeford   
Friday, 16 March 2012

The end of February saw the expiry of the one-year moratorium on shale gas exploration in South Africa that was imposed by Mineral Resources Minister Susan Shabangu. The Shale Gas Task Team established by the Minister is due to present its report to Cabinet by the end of March. Thus, the great debate over shale gas and fracking – hydraulic fracturing – is set to hot up once again.

Thus far, the polarised debate in South Africa has been waged primarily between those keen to exploit a potentially vast source of energy and those worried about the environmental and health implications of fracking. What has yet to be adequately discussed is the economics of shale gas production. While it is still very early days in South Africa, experience in the US – where the modern shale gas industry is nearly a decade old – is a useful point of departure.

Many pundits have presented shale gas as a game changer in the US energy market. Certainly, shale gas production has risen dramatically, from less than one-billion cubic feet of gas a day (bcfd) in 2003 with the advent of horizontal drilling and fracking to almost 20 bcfd – about a fifth of US gas consumption – by the middle of last year.

As a consequence, the price of gas has fallen precipitously, from spikes of over $12 per thousand cubic feet in 2006 and 2008 to under $2.50 per thousand cubic feet at present.

But this early success has led to exaggerated claims about the future potential of shale gas, and also conceals problems that are emerging in the industry.

The first problem concerns resource and reserve estimates. Resources refer to the quantity of gas that could theoretically be extracted using current technology, while reserves have to be commercially viable at today’s prices. Experience in the US has shown that only about 10% of the total area of a gas-bearing shale formation yields economically productive wells.

The US Potential Gas Committee estimated in April 2011 that the country’s probable mean resources amounted to 550-trillion cubic feet. Arthur Berman, a Texas-based petroleum geologist who has extensively researched the gas industry, suggests that about half these are likely to become commercial, to be added to the 273-trillion cubic feet of existing proved reserves.

And in its 2012 Annual Energy Outlook, the US Energy Information Administration (EIA) downgraded its technically recoverable shale gas resource estimate by 42%.

Thus, contrary to claims by the industry – and frequently echoed by the Obama administration – the US does not have 100 years’ worth of natural gas reserves at current consumption rates, but more like 23 years, says Berman.

The second problem with the industry hype is that the overall decline rate for US natural gas wells is estimated at 32% a year, and the rate is considerably higher for shale gas wells – between 63% and 85% in the first year, according to Canadian gas expert David Hughes. This means that well drilling activity has to be maintained continuously just to keep the rate of gas output constant.

But drilling is an expensive business. Writing for Foreign Policy magazine, Chris Nelder cites analysis that “finds that nearly all operators need at least $4 per thousand cubic feet to break even while drilling new wells in existing plays, and at least $8 when one includes all costs, including leasing of gasfields, overhead and debt service”.

So, at current prices, many companies are running at a considerable loss. In late January, one of the largest shale gas producers in the US, Chesapeake Energy, announced its intention to reduce drilling; since then, others have followed its lead.

Berman warns that the US shale gas industry is exhibiting all the classic signs of a bubble, just like the gold rushes of the nineteenth century.

Berman and his colleague, Lynne Pittinger, have concluded that “shale gas will remain an important part of the North American energy landscape but its costs will almost certainly be higher, and its abundance less than many now believe”.

There are two lessons for South Africa. Firstly, the EIA’s technically recoverable resource estimate for South Africa of 485-trillion cubic feet is both premature – the figure was based purely on a desktop study compiled prior to any exploratory drilling – and potentially misleading, since technically recoverable reserves are usually much greater than economically recoverable reserves. Nonetheless, if just 10% of the technically recoverable reserves were economically viable, this would represent ten years of South Africa’s total primary energy supply, or provide feedstock for gas-to-liquid fuel production equivalent to nearly 50 years of current petroleum consumption. However, the second lesson from the US experience is that the consumer price of shale gas would likely be considerably higher than many people currently hope.

These economic considerations need to be weighed against potential environmental and social costs and benefits, and compared with alternative energy sources. These issues will be explored in subsequent columns.

Published in Engineering News , 16 March 2012

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