First you have to learn the rules of the game. And then you have to play better than anyone else.
Albert Einstein
If you give enough time and money to an engineer, he will find a solution.
Technology in energy exploration and production has consistently pushed the boundaries of what we thought was possible, both in terms of volume and price. For example, what was once considered “science fiction”, such as extracting crude oil from depths of five thousand feet or more, or from shale formations, is today a reality.
There is a long history of “game changers”, all the way from offshore drilling, to deep-water, to ultra-deep-water, to “mining” Canadian oil sands, or more recently horizontal drilling and hydraulic fractioning, all of which have consistently pushed the boundaries of peak oil further and further into the future.
Yet, despite how impactful new technology has been in the past, it amazes me how we tend to disregard the potential and impact of future technologies. “Seeing is believing” or “a bird in hand is worth more than two in the bush” seem very entrenched in human nature.
And so, today, we remain very sceptical of our ability to develop “large known reserves” such as methane hydrates in Japan. Our perspective is probably not much different from what we thought about shale formations just 10 years ago or offshore ultra-deep 30 years ago. Well, just like in the past, the volumes and economic incentives are there. Engineers are investing money and time, and, who knows, perhaps solutions may not be as far away as we think.
New technologies are resulting in larger and more diversified energy reserves around the world, which in time will become production. In addition to the large and proven shale gas and tight oil reserves in North America, the potential for application in the rest of the world is huge. China, for example, has vast reserves, domestic and cleaner than coal. Despite the less favourable geology and other considerations, these will surely be developed over time, perhaps sooner than many expect.
History tends to repeat itself. Cycles of tightness are followed by cycles of excess. But these cycles often experience more “super-cyclical” behaviour, or quantum leaps, thanks to the development of “game changers”.
In the 1970s–80s, the development of the North Sea was a major engineering feat. In his book, North Sea Innovations and Economics, Ron Goodfellow explains that “through the latter half of the 1970s and into the 1980s the scale and problems of North Sea development drilling were crucial in the evolution and adoption of new technologies. This was the era when the major North Sea fields were being brought on stream with multiple platforms, often with two drilling rigs on each. The level of drilling activity was sufficient to encourage the development of new technologies which can now be identified with the North Sea”.1 It was precisely the challenge that encouraged engineers to come up with efficient and competitive solutions that are now used in hundreds of ultra-deep-water rigs all over the world, safely.
Thanks to the ingenuity of these engineers, production at deep and ultra-deep waters is perfectly viable technologically, commercially, and environmentally. Imagine how different the world would be if those efforts and developments had been banned or abandoned because of technical difficulties.
In the 1990s, the development of ultra-deep water, such as Brazil and Mexico, once again pushed the boundaries of what was thought technically and economically possible.
In the early 2000s, horizontal drilling and hydraulic fracturing opened a vast amount of resources that had been known for a long time, but were thought to be both technically and commercially unfeasible. This new technology is having a major impact, and it has become the largest growing source of crude oil via the so-called “tight oil” from shale formations.
Yet, even today many remain sceptical. Some think that fracking and shale are “just” a North American phenomenon. Yes, there are some constraints such as geology, water resources, environmental concerns, and property rights, but the proven reserves outside North America, and China in particular, are simply enormous and will be developed over time.
The scepticism and environmental concerns are common in almost every new technology. Remember the early developments of the offshore production, plagued with large-scale environmental disasters. Time after time, the industry has managed to find solutions to the challenges. And the incentives for China are there. Time will tell how quickly they develop them.
New technologies are often dismissed when extrapolating today's cost structure, thus overestimating marginal costs, but engineers have found new processes and techniques to improve and reduce costs across every part of the process.
The result is invariably higher volumes at cheaper prices than anticipated.
And do not forget about the potential savings from the optimization of existing techniques. The more wells you dig, the better you get at it. Problems become the need for solutions. Mistakes become lessons learnt. And so we keep producing more, cheaper, and safer.
Despite cost inflation in the service industry, finding and lifting costs are more than adequate. US on-shore stands at $34/bbl and off-shore at $52/bbl, Africa at $45/bbl, and the Middle East at $17/bbl.2
I remember when I bought my first MacBook laptop, one of the things that impressed me the most was its magnetic plug. How many times had I tripped over a cable when my computer was charging, and dropped it. Well, it turned out that now when I tripped over, the magnetic plug would come off, thus protecting the computer. “Genius!” I thought. But it was only a few years later, as I was reading a book about Steve Jobs, that I learnt that he had actually “stolen” the idea from deep-fry cookers, which had been using them for decades. Yes, the consequences of tripping over the deep-fry cooker with boiling oil could be devastating. The deep-fry engineers got on the case, and came up with the idea of using magnetic plugs. A fantastic invention that was used within a narrow “niche” for decades, before it was applied to the computer industry. Beyond the obvious considerations of intellectual property, Steve Jobs had a relentless ambition to learn from his own industry and from other industries. “Artists copy. Geniuses steal”, as he was famously quoted.
The same dynamics of “innovation and imitation” apply to oil and gas engineering too. Look for example at horizontal drilling and fracking. They were initially developed to extract natural gas from shale formations, but engineers quickly realized that a similar technique could also be utilized in the extraction of crude oil. And look at the growth in light tight oil across North America.
Technology has been a key driver of exploration and production. Think of the developments in exploration. Since the early days of a pretty much “blind lottery” of prospecting, to today, where Brazilian engineers devised a way to “look through” a mile-thick layer of salt to find a supergiant field with estimated 5 billion to 8 billion barrels of recoverable reserves.3
Technology has also been a key driver of refining. Consider the simple distillation units, and how they have evolved over time with the addition of low pressure “vacuum” distillation, and adding both thermal and catalytic processes that allow us to convert the “raw” and often heavy and sulphurous crude oil into the clean refined products that we consume every day.
But technology also impacts demand. “Volume creates volume”, and new processes and techniques respond and take advantage of developments on the supply side. Look for example at electric cars where technology is addressing the many challenges to develop more powerful cars with greater autonomy and smaller batteries.
The “frontiers” of the industry often looked insurmountable, but more often than not the combination of time, money, and human ingenuity managed to conquer them. Offshore drilling, ultra-deep-water, horizontal drilling, and hydraulic fracturing (“fracking”) are game changers for both the natural gas and oil markets, but over the past century the limits have been pushed, facilitating incremental demand growth.
Hydraulic fracturing consists of the injection of large amounts of water at high pressure, combined with sand and small amounts of chemicals, which break up the underground rock and create exit pathways to the well, from otherwise trapped natural gas and oil.
The production of shale gas started quietly in the early 2000s, but by the end of the decade to the surprise of many, it was becoming a noticeable source of production and more than offsetting the declines in conventional natural gas. In 2000 shale was just 1% of US natural gas production and by 2012 it was 37%.
Furthermore, shale gas was proving to be even cheaper than conventional natural gas.
As a result of the shale revolution, North America's natural gas base is now estimated at over 100 years of consumption, and has reversed the situation from shortage into a substantial surplus.
Europe, despite having over 90 years of demand covered by domestic reserves, with the biggest potential in Poland, France, the UK, and Spain,4 is lagging in the development of the reserves.
Indeed, despite the economic success story of shale gas in North America, the rest of the world seems to be lagging behind. Part of the reason is the lack of political support, influenced by a dangerous mix of myths and realities which I now set out to clarify.
Progress is the product of human agency. Things get better because we make them better.
Susan Rice
Don't fear change, change fear.
Hydraulic fracturing is a proven and safe technology.
However, public opinion has been influenced by a range of alarmist and unfounded reports. There is even a documentary Gasland and a movie Promised Land, which were immediately refuted by the industry, scientists, and the US Department of Energy as inaccurate.
It is ironic that all these alarmist reports, such as the Cornell study, add as disclosure “we could not confirm accurately any of these claims”.5
Yet, public opinion seems to hold a “guilty until proven innocent”.
During the following sections, I will review and debate some of the main arguments used against shale gas. And no better place to start than water.
According to the US Department of Energy, over the past 60 years, more than one million wells have been “fracked” in the United States.6 Not even once has a state or local department found evidence of water pollution of aquifers, and five lawsuits have been dropped recently in the United States due to lack of evidence.7
Critics argue that fracking may damage drinking water aquifers, but fracking takes place a mile or more below drinking water aquifers and is separated from them by thick layers of impermeable rock. As Robert W. Chase put it: “Some mistakenly say the practice can pollute water tables which lie just a few hundred feet or less below the surface. Fracking is done well below 7,000 feet, and solid rock separates the oil and gas deposits from shallow groundwater aquifers. This rock buffer makes contamination from fracking virtually impossible”.8
In addition, wells are built with at least four layers of steel casing and concrete and are cemented in place, creating a solid divider between gas production and any fresh-water aquifers. The industry is currently using more than 5000 tons of steel and cement to protect the groundwater.9
Fracking can be done with water or other liquids. The general trend in the industry is to disclose the liquids and chemicals, with average 90% water, 9.5% sand, and the remaining 0.5% a mixture of chemicals.10 Of these chemicals, the majority (hydrochloric acid, ethanol, methanol, ethylene, and sodium hydroxide) can be recovered in the extraction process. The water is often treated, which reduces the need for chemicals and therefore minimizes any risk of contamination even further.
Energy Secretary Steven Chu recently asserted: “We believe it's possible to extract shale gas in a way that protects the water that protects people's health. We can do this safely”.11
It is important to understand correctly what is in fracking fluids and why concerns are overstated12 as well as how industry develops nontoxic fracking fluids.13
There are also environmental concerns around the water that “comes back” to the surface.
The industry actively manages the flow back via any of the following three alternatives: reinject it into deep disposal wells; water treatment facilities; or recycle back into operations.14
In traditional oil and gas states, the wastewater has often been reinjected. But in some places, such as some parts of Pennsylvania, the geology does not lend itself to reinjection, so water is either put through local treatment facilities or trucked out of state for reinjection in more suitable fields.
Aboveground water management is being developed along with production, and following the completion of new large-scale water treatment facilities, the industry is now recycling 70% to 80% of the flow back.15
There is also intensive focus on innovation, such as developing new methods to reduce the amount of water going in and to treat the water coming out, and the drilling of more wells from a single “pad” to reduce the footprint.
The CEO of Nestlé said “the world will run out of drinking water before it runs out of oil”.16 Indeed, for large countries like China, India, and Pakistan, the issue of “water scarcity” may be around the corner. However, similar to oil, there is no scarcity of water on a global scale. There is an issue of uneven distribution of the water resources. Some areas have excess water, and other areas have shortages. To address this issue, during the 1930s the United States made large investments with water networks between Colorado and California.17 A similar investment process needs to take place in China, between the north and south.
The water industry requires large investments in infrastructure. But the problem is that the price of water is too low, which prevents the necessary investment and maintenance. To prove the point, look at water leakage. London is thought to have more than 50% losses in the network due to old water infrastructures and an estimated 646 million litres lost a day from water leakage.18 A third of London's water infrastructure is 150 years old. There is technology, such as membranes, that could be used to address this issue, but current prices are not high enough to incentivize the right behaviour or investment in infrastructure. Government debt and fiscal pressures are adding to the problem.
Nevertheless, as demand for water exposes the bottlenecks in the water infrastructure, countries will have to allocate and prioritize its usage between household, industry, and agriculture.
According to a report by the UK's Tyndall Centre for Climate Change, fracking operations carried out on a six-well pad would require 54,000–174,000 cubic metres of water.19 This presents the problem of water shortage in Europe, particularly parts of Central Europe. Production may cost more than $2/MMBtu, and given the enormous cost of water in Europe, represents nearly 60% of the cost of drilling.20 However, the use of water is shrinking fast and fracking uses less every year, as well as improving its recycling processes.
Interestingly, water required to frack all US wells is 0.1% of the total21 and falling, while 4% of water consumption globally is used as a cooling agent in power generation.22
In 2012, the US National Research Council issued a study on seismic activity and concluded that “even those man-made tremors large enough to be an issue are very rare. In more than 90 years of monitoring, human activity has been shown to trigger only 154 quakes, most of them moderate or small, and only 60 of them in the United States. That's compared to a global average of about 14,450 earthquakes of magnitude 4.0 or greater every year … Only two worldwide instances of shaking, a 2.8 magnitude tremor in Oklahoma and a 2.3 magnitude shaking in England, can be attributed to hydraulic fracturing”.23
The report was chaired by Murray Hitzman, a professor of economic geology at the Colorado School of Mines, who concluded that “There's a whole bunch of wells that have been drilled, let's say for waste water and the number of events have been pretty small. Is it a huge problem? The report says basically no”.24
Furthermore, quoting Robert W. Chase's excellent “Five Myths about ‘Fracking’”: “William Leith, senior science adviser for earthquake and geologic hazards at the U.S. Geological Survey, told National Public Radio recently: ‘Fracking itself does not put enough energy into the ground to trigger an earthquake. That's really not something that we should be concerned about'”.25
Oil and gas waste water disposal wells, on the other hand, do have a history of causing tremors, most recently in Youngstown, Ohio. However, by reducing the volume of water injected and the depth of wastewater injection wells, and avoiding earthquake-prone areas, the risk of inducing tremors, however small, can be reduced.26
A more recent concern is the possible “migration” of natural gas towards the surface of water wells. This is a controversial subject.
Methane has been found in water wells in gas-producing regions but there is no agreement on how this can happen. Some cases of methane contamination in water wells have been tied to shallow layers of methane, not the mile-deep deposits of shale gas where fracking takes place. In other cases, water wells may have been dug through layers of naturally occurring methane without being adequately sealed. It is difficult to know for certain because of a lack of baseline data, i.e., measurements of a water well's methane content before a shale gas well is drilled in the neighbourhood.
Gas developers are now routinely taking such measurements before drilling begins in order to establish whether methane is pre-existing in water aquifers.
A new question concerns whether there are significant “fugitive emissions” and if these emissions should be captured. The main component of natural gas is methane, a gas associated with global warming when released into the atmosphere, but reduced emission completion (REC) technologies can now capture the emerging gas at the wellhead and are increasingly being used.27
Some anti-fracking groups say that shale gas and oil are uneconomical. I shed a tear at their concerns about other people's money.
Shale gas is a sector where private investors and entrepreneurs risk their own money. Tens of billions of dollars are put to work in shale gas, with no subsidies, no government funding, financed with private capital, and very little debt. According to research by UBS and Goldman Sachs, the average return on invested capital (ROIC) of the shale gas sector since 2010 has never been worse than 5% …with gas prices falling 21% in 2010 alone!28 Compare that to any utility in Europe, or any renewables company ex-subsidies, or coal companies.
The EIA estimates tight oil in the United States has estimated reserves of 24 billion barrels,29 which given the current state of the technology with hydraulic fracking techniques and recycled water, are economically viable at $60/bbl.
Chesapeake estimates that in order to achieve 10%30 rates of return, it will require oil prices of between $30/bbl and $50/bbl, depending on the basins. If we assume $100/bbl, each well repays its total investment cost in eight months. Three times faster than a conventional oil well.
Governments around the world have taken dramatically different positions with respect to fracking.
US politicians have strongly supported the development of fracking. The United States recognizes the multiplier effect through the creation of jobs and cheaper electricity and industrial fuels. According to CERA, shale gas has created 2.1 million jobs, $75 billion in tax revenues, $283 billion in GDP, and raised household income by $1200 per year.31
Ironically, the defenders of subsidized energies and intervention in energy price mechanisms forget the effect of shale gas on energy bills and are suddenly worried about investment returns.
The development of US shale gas and tight oil is widely recognized as a major competitive advantage against Europe, Japan, and China. A competitive advantage that may last for a long time, with deep and possible irreversible repercussions.
Europe is estimated to have 156 tcm (trillion cubic metres) of shale gas reserves.32 That means over 90 years of demand covered.
However, in Europe, the development of shale gas has been highly politicized. Similar to nuclear power, politicians across key countries have taken the “not in my backyard” approach to shale gas.
“Moratoriums have been imposed in France (July 2011), Bulgaria (January 2012) and Romania (May 2012), whilst the Netherlands has put shale gas drilling on hold for a further year as an investigation is carried out into the environmental risks.”33
It is ironic that Europe wants energy independence, cheap and environmentally friendly energy, and should be looking to develop its natural resources efficiently in a clean and competitive manner. Instead, politicians and lobbyists across Europe are looking to ban shale and continue to favour heavily subsidized technologies.
The economic impact of high energy costs is a disaster for Europe. Energy costs paid by businesses and consumers are the highest among the OECD countries, limiting its ability to compete.
Across the OECD countries, Europe is incurring 100% of the burden of carbon dioxide through the European Carbon Scheme, and 70% of energy subsidies. Europe could save 900 billion euros (equivalent to almost all the government debt of Spain) and achieve its objective of reducing carbon dioxide emissions by 80% by 2050 if, in addition to further renewable energy, the continent developed its shale gas reserves according to the “Making the Green Journey Work” sector study.34
Ironically, the conventional gas industry in Europe has joined coal and solar lobbies against shale gas. None of them are interested in cheap gas prices, because they have seen – with horror – how gas prices in the United States have plummeted due to the shale gas revolution, and therefore obliterated the use of coal for power generation and the grants of succulent subsidies as abundant energy reduced power prices.
And the potential for shale in Europe is significant. In Poland, for example, Wood MacKenzie estimated 48 trillion cubic feet of unconventional gas35 (tight and shale) which, if confirmed, would mean an increase in European gas reserves of 47%.36 Poland is currently very dependent on Russian gas and imports more than 75% (11.6 bcm/year).37 The development of unconventional gas reserves could enhance both the energy security and economic situation. Furthermore, Poland can become a net exporter as European countries take advantage of the geographical proximity and lack of geopolitical risk. No surprise that many of the oil and gas majors such as Total, Chevron, ExxonMobil, Marathon, Talisman, and Conoco, and independent exploration companies are already expanding in Poland as the government has awarded over 85 exploration licenses.
According to the EIA, Ukraine is thought to have the third largest shale gas reserves in Europe, at 42 trillion cubic feet.38 Chevron has been actively prospecting in Zamosc. Most of the projects are still in the exploration phase and are far away from development but the potential could be phenomenal.
The last time I met with the management of Statoil and Chesapeake in March 2014 they were confident of the geology, but not optimistic about political support. Both are analysing more than 15 new areas in Germany, France, and the North Sea, among others.
I visited Shanghai for the first time in the early 2000s. I had been to Beijing several times before, and was expecting Shanghai to be a very large city, but what I saw left me speechless. From the top of my hotel in the Pudong area, I could see literally hundreds and hundreds of modern skyscrapers expanding in all directions. It made Manhattan look like a small town.
I was even more shocked when my Chinese colleague told me: “Did you know that 10 years ago this whole area was a rice field?”. It was very hard to believe. “If someone had told me 10 years ago that Pudong would look like this today, I would have laughed and said they were crazy”. It was the first time I realized how powerful centralized planning could be. Once the Chinese set their mind to do something, they do it. It became crystal clear to me then.
And then my Chinese colleague told me: “Do you see those fields over there, in the far distance?”. I nodded. “Well, the government is planning to develop it in a similar way to Pudong”. Shanghai was to become the largest harbour in the world, ahead of Hong Kong and Singapore. The urbanization of China and the migration of the people to cities like Shanghai was simply scary. But I believed him.
So when the National Development and Reform Commission of China (NDRC)39 unveiled what looked like ambitious strategic plans to explore and develop China's huge shale resources, I believed them.
And China has the largest shale gas reserves in the world, at 25 trillion cubic feet.40
And yes, China is determined to develop them. They face significant challenges such as deep gas deposits with complex geology, lack of domestic technology for horizontal multi-stage hydraulic fracturing, high human population density, significant capital investment and longer lead time to commercial production, which may result in slower capital recovery; while government incentives are not yet in place, and given reserves are in central and west China, far from demand, more pipeline capacity and coverage is needed.
But all these barriers can be surmounted with the right amount of capital, incentives, help of international oil companies and, of course, time.
It is too early to call the end of coal in China, but certainly domestic shale gas is a major development that will have a dramatic impact across all those industries and subsidies.
The State Owned Enterprises (SOE) such as PetroChina, Sinopec, CNOOC, and other smaller players, such as Yanchang Petroleum, have already discovered shale gas and have agreements for cooperation with large and experienced companies such as Shell, Statoil, ConocoPhillips, BP, Chevron, and ExxonMobil.
Interestingly, China is pushing ahead with its support for natural gas vehicles. A sign, perhaps, of the commitment and expectations of its natural gas supply.
The IEA puts it simply: “As long as consumers are willing to pay for it and resources are there, consuming some energy to produce energy is fine”.41
“A hydraulic fracking published paper shows the energy return on investment (aka EROI) with a total input energy compared with the energy in natural gas expected to be made available to end users is similar to or better than coal”.42
Shale gas is a game changer. A powerful flattening force and a relevant factor in the energy security of supply battle, allowing traditional importers to develop their own resources.