FORUM: Opportunities and challenges in shale gas
November 2014 | SPECIAL REPORT: ENERGY & NATURAL RESOURCES SECTOR
Financier Worldwide Magazine
FW moderates a discussion on opportunities and challenges in shale gas between Hamish McArdle at Baker Botts, Chris Faulkner at Breitling Energy Corporation, Pedro Nunes at EUREKA Secretariat, Simon Talbot at Ground-Gas Solutions Ltd., and Bruce Rutherford at Jones Lang LaSalle (JLL).
FW: What key trends have you seen in the shale gas market over the last 12-18 months?
McArdle: Globally, I would distinguish two key trends in this period, the first being technological development and application, and the second regulatory clarity in emerging shale markets. All of this is overlaid by business as usual in the US market. As the investment curve for the shale industry trends upwards, this is incrementally higher in the applicable support industries such as water treatment and waste management. These sectors are anticipating a surge in demand for their services, and are looking for first mover advantage in product and technology development. The danger for them is delay in exploration and development approval in the upstream. In the last 18 months in Europe, and specifically at the European Commission level, the industry has received some much needed clarity through the broad conclusion that exploration can proceed on the basis of existing national and European Union law – at least for the next 12 to 18 months – following the publication of the EU’s Recommendation and Communication. There is now a period of limited certainty as to the prevailing regulatory regime that should apply to shale gas development in Europe, and it is supporting some limited, but at present not material, investment decisions in those European countries that are active supporters of the industry’s development.
Faulkner: The biggest trend over the past year to year-and-a-half has been the staggering production numbers coming out of the US thanks to fracking and new shale plays. Demand for shale gas will continue to increase as the world gets smarter about burning coal for power, and the US will continue to dominate the shale gas market, not only in production, but also in revenues as well. In addition to the power generation sector, which will make up a majority of shale gas usage volume, we can’t overlook what will soon be the fastest growing segment for natural gas use, and that’s in transportation. As the demand for alternative transportation fuels grows, as it already has in the EU and other countries, the demand for both compressed natural gas (CNG) and liquefied petroleum gas (LPG) will continue to soar.
Nunes: Over the last year, the United States has continued to focus on shale gas to achieve greater competitiveness, attracting foreign investment in energy-intensive industries, which are moving from Europe to the US to escape high conventional energy prices and to therefore benefit from the low energy costs enabled by the shale gas revolution. Also, the greater security of supply owing to oil shale development has transformed the US from an importer to an exporter of primary energy. And last but not least, it is a cleaner energy system, as gas-fired power generation causes much less pollution than coal-fired generation. In parallel, as coal is in much less demand for electricity production in the US, but European utilities continue to exploit it for conversion to power, emissions are increasing in Europe, and decreasing in the US.
Talbot: While the US continues to forge ahead with shale gas and oil production, the exploration and development of shale gas resources in Europe have almost ground to a halt due to the level of public concern and political caution. In the UK this caution has led to the tightening of regulatory controls and significant delays in the granting of planning permissions and the issuing of permits for shale operations. The consequences have been significant delays and financial uncertainty which have damaged operators’ and supply chain companies’ balance sheets. However, in contrast, the civil war in Ukraine and the escalating crisis in Syria and Iraq are proving powerful political reasons why energy security, in the form of home grown shale gas, is proving increasingly attractive to governments and opposition parties alike. The geopolitics of energy have rarely been more important.
Rutherford: There is growing awareness that the US has more than enough gas to allow us to export natural gas without having a negative impact on domestic prices. Geologists now see that we could increase our production of natural gas by as much as 500 percent. Our demand for natural gas, in response to low gas prices, is increasing, but it is not increasing anywhere as close to 500 percent. That divide is creating an export opportunity for the industry. The demand for natural gas is increasing, primarily, to produce electricity, but also for transportation uses. Over the next 10 years we are going to see a dramatic increase in the demand for natural gas as a source of transportation fuel. This is something that is just beginning, but we’re going to continue to find ways to be creative in our use for natural gas. Inexpensive natural gas is also the tipping point for making American manufacturing the low cost provider on the planet. As a result of our huge supplies of natural gas, the US is in a position to become the dominant manufacturing provider for, I think, lifetimes to come.
FW: How are developments in the shale gas space impacting upon the conventional energy market? What contribution is shale gas making to the energy mix?
Faulkner: The impact is big now, and will only get bigger. For as long as we can remember, burning coal has been the main energy source for power plants. With the abundance of clean-burning natural gas available now at low prices, it makes not only financial sense, but also environmental sense for electric-generating plants to convert to natural gas. And that revolution has already begun, not only in the US, but around the world.
Rutherford: There is a growing conversion of coal fired power plants to natural gas. Gas offers a less expensive cost and has a lower impact on the environment. This is contributing to ever-cleaner air in the United States. A collateral effect of that is the closing of old nuclear power plants that can no longer compete with the cost of electricity produced by natural gas. The cost differential for a thousand kilowatt-hours is $67 for gas, $100 for coal and $108 for nuclear. And this is only going to get worse for nuclear power because nuclear’s maintenance costs continue to escalate. Coal has dropped below 40 percent as the source of our nation’s energy production as a result of shale gas taking over coal’s contribution, and nuclear power has dropped below 15 percent. Hydroelectric, solar, wind and geothermal combined constitute about 15 percent, with gas making up the difference; and contribution of gas is growing.
Talbot: It is clear that conventional energy companies are increasingly interested in a future European shale gas sector. Centrica, GDF Suez, Total and Ineos have all invested in UK licence areas. This speaks to confidence that shale gas will be successfully developed in the UK. I believe the UK will be a first mover in Europe before it is progressively developed in Poland and throughout the rest of Europe. The political language is also developing with shale gas identified as an ‘important part of the energy mix’. It is being identified as a complementary energy to wind and solar and not as an alternative to ‘green energy’. I believe that in the UK, shale gas will be developed and will increasingly replace the dwindling North Sea gas production. As such, it will be a stabilising influence on energy prices.
Nunes: Shale gas is having a profound impact, directly and indirectly. Directly, it is increasing participation in the energy mix of the US, displacing coal, which is being used less and less – but more and more in Europe. Coal power plants in the US are being converted to gas, while gas power plants in Europe lie idle due to the low wholesale price of electricity resulting from the injection of renewable power – coal power plants are being revitalised, benefitting from the low cost of imported coal. So emissions are growing in Europe and falling in the US. The high price of imported gas in Europe – to the order of US$10 per MMBTU against the US price of US$4 per MMBTU – is reducing the competitiveness of the European economy.
McArdle: How to treat unconventional oil and gas investment is an interesting debate within major international oil and gas companies where the company’s value and historic basis of performance is directly linked to conventional oil and gas reservoirs, and reserves. There is clearly tension building between those who are advocates of the shale industry at any cost, perhaps because of the statistics that underlie global shale resources, or from fear of missing the boat in terms of new technologies, or fear of being excluded from the main reservoirs when licensed, and those who take a more conservative view to the industry, and see valuable investment being diverted to opportunities that are untried and untested, at least outside of the US, to the disadvantage of existing and new conventional oil and gas opportunities.
FW: Environmental concerns are a major cause of opposition to shale gas exploration and extraction. In what ways are shale gas operators addressing general criticisms, environmental issues and safety concerns?
Nunes: The genuine environmental problems related to fracking should be weighed against the benefits obtained in terms of improved security of supply, economic competitiveness and the reduction in emissions, when compared with coal-fired power generation, as is happening in the United States. More investment should be made in technologies that will progressively solve the negative effects of fracking. The value of shale oil and gas, as is the case with many new technologies, is too important to be ignored. Its impact on the reindustrialisation of Europe is fundamental. This industrial renaissance will simply not happen if the disparity in energy costs between Europe and its main competitors, particularly the US, continues.
Talbot: The US shale gas experience has by and large been seen to be highly beneficial but the lack of robust regulatory controls in the US, together with only a gradual evolution of best practices, have led to a number of pollution incidents that have caused high degree of public concern. Much of this has been fuelled by the lack of reliable environmental monitoring data. In this vacuum opponents to shale gas have been able to spread significant misinformation and operators have had a hard time redressing the balance. To counter public concern, operators are now putting a huge effort into developing best practice in environmental management systems. At the heart of these systems is independent environmental monitoring before, during and after shale gas operations. Full disclosure on site operations and information sharing as part of engagement with local communities is beginning to tip the balance of public opinion in the UK in favour of shale gas.
McArdle: There is no single answer to public concern about shale exploration and development and specifically fracking operations. Whilst there are clear trends to what unites opponents of the industry, the issues ultimately come down to more local concerns when analysed. There remains a generally low level of public understanding about the industry, extraction technologies and the long term environmental impact of the industry at the local and national level. Perhaps learning from the US experience – or indeed from renewables such as wind farming – the industry appears to have appreciated, at least in Europe, that things cannot move quickly when public trust must be won, and that this requires significant investment of time and resources, addressing concerns that may not be well founded, or required to be addressed by law, and working closely with the applicable regulatory agencies. On specific issues where it is possible to address public concerns, such as publishing fracking chemicals, industry is taking a pragmatic view.
Rutherford: There more than 430 initiatives in the United States today at the local or state level to limit or eliminate hydraulic fracking. These are primarily born of misinformation and misunderstanding because fracking is not the issue. The industry is working hard to educate everyone on how this process works. The first oil well was ‘fracked’ in 1946, and we have fracked more than 1 million oil wells since then without one single case of ground water contamination. What we have had are a few minor cases of gas escaping from a few vertically drilled wells. There are also cases were gas and methane has leaked into water supplies naturally, in cases where the naturally occurring methane source was very close to the surface. There have been environmental issues related to the injection of drilling fluid into existing abandoned wells, and we are experiencing seismic activity in Oklahoma and Texas because of this injection, some of the activity is in the 3.0 to 4.0 Richter scale range; that is low intensity seismic activity but still quite noticeable. Now that’s not serious, but it’s disconcerting. We’re learning now that’s it’s not the injection per se, but the way in which we’re injecting it. The industry is starting to adopt safety methods to prevent that seismic activity from occurring. But more importantly, the industry is learning how to recycle its fracking water and fluids. They have very strong economic incentives to do so as that fluid is becoming a very expensive part of creating a well.
Faulkner: Our industry has not been doing a very good job when it comes to informing the general public about what hydraulic fracturing is all about, and all the positives that are happening as a result. We are doing our best to change that by telling our side of the story – specifically, that frack fluid is safe, environmental damage is virtually non-existent and major earthquakes are not the result of fracking. To really get the truth out to everyone, it will take an industry-wide effort.
FW: What legal issues face companies looking to enter the shale gas sector? With particular regard to hydraulic fracturing, what steps have authorities recently taken to regulate the process?
Talbot: Following the 1988 Piper Alpha disaster the UK government implemented the recommendations of the Cullen inquiry and established a regulatory system that removed regulatory conflicts of interest and established a goal setting approach to health and safety and environmental protection. The current system has separate regulatory controls for licensing, planning, health and safety and environmental protection. The result is the UK’s on-shore petroleum sector is arguably the most highly regulated in the world. Against the backdrop of intense media attention and highly organised anti-shale gas groups, the UK government has sought to ensure that the regulatory controls adequately cover shale gas and hydraulic fracturing processes and they have issued new regulatory guidance. Operators now face 15 separate regulatory steps before they can commence drilling operations. There are clear time and financial implications to this approach, particularly around the uncertainty of success at the planning application stage.
Faulkner: It’s not an easy process for companies not already in this sector to enter it and be successful, without a full knowledge of all of the governmental regulations that go along with it. Many municipal and state governments that are located in areas where fracking has been going on for years have realised what a boon it is to their economies in terms of increased revenue, job growth and stunning infrastructure growth. It is these communities which have eased regulations and made it easier for companies to work the shale plays. In other areas where fracking may not yet have started or is being considered, people are frightened by either a lack of information or misinformation put out there by protesters who don’t really have a grasp of what fracking is all about. Knowledge is power, and knowledge comes about from getting accurate information.
Rutherford: One of the biggest advantages companies have in the US is property rights. You own property. You own it all the way to the centre of the Earth, so you can contract for the mineral rights underneath your land. That doesn’t exist in other countries. It’s one of the reasons our energy advantage will continue for decades from now because other countries have greater difficulty figuring out mineral access and property rights. If you are a company looking to enter the shale industry, acquiring the rights to significant reserves in sufficient quantity to be efficient is a daunting task and a formidable barrier to entry. So this is an operational and a legal challenge, but mostly it is a barrier to entry. The fracking regulations, at both the state and national level, are not a barrier to entry.
McArdle: The more significant legal issues that face companies wishing to participate in shale gas operations are faced by those who wish to lead operations as operator on behalf of a joint venture group. Operators are required to meet minimum financial and technical requirements – or competence and knowledge – and of course the shale industry being a new industry in most countries, there are few companies with a proven track record of operating onshore shale wells and applying fracking technologies. For this reason it was expected that there would be a transfer of skills from the US, with a number of US companies entering the European market, and to some extent this was seen in the early stages of the industry’s development in Poland, but less so in the UK. This may still change. It is a mistake to make the assumption that significant changes to regulations and laws have been made to accommodate hydraulic fracking technology outside of the US.
Nunes: There has been progress in Poland and the UK, but still a difference in legal frameworks, in the regimes of land propriety and in demographic density are major hurdles challenging the launch of this game-changer in the global energy scene in territories outside North America. Another critical obstacle is public acceptance of this technology – this can pose a significant risk to investors.
FW: Can you provide an insight into current M&A and investment activity in the shale gas sector? What factors are driving this activity?
Rutherford: One recent example is that of Whiting Petroleum acquiring Kodiak, making Whiting the largest producer in the Bakken. What drove the acquisition and what drives this sort of M&A activity? Usually, it’s getting access to the reserves that your competitor owns, and we are likely to see more of this consolidation. We also saw ExxonMobil make an acquisition of XTO in order to get access to their gas reserves. ExxonMobil has seen what our research has shown. Even though the 1800s were the age of coal, the 20th century was the age of oil, this century is going to be the age of natural gas. The big, long term future is in natural gas, and you’re going to see more activity as companies come to see this opportunity.
Nunes: We are not following the evolution of the industry, and how it organises itself to face this great challenge. What seems important is that the winners in this game are small and medium companies, and not so much the bigger oil majors. The technology is still very much tailor-made and more a handicraft than an industrial process. A lot of trial and error is needed to succeed. As the technology progresses, a more industrial approach will be forthcoming.
McArdle: M&A activity in the shale gas sector remains reasonably buoyant in the US, where consolidation of portfolios is taking place, along with downsizing by some early international entrants that picked up large acreage positions. Globally, the position remains patchy and is largely driven by the status of the national regulatory regimes which, if showing inconsistency or inadequate support for industry, then depresses investment interest. You will still find a large number of international oil and gas companies maintaining a cautious approach to shale gas investment, because in most parts of the world there is very little proven exploration activity and therefore little data from it, and this necessarily acts as a brake on significant investment.
Talbot: In the UK there were approximately 160 onshore petroleum licences let under previous licensing rounds to around 30 companies. These companies include small and medium sized companies with many of the smaller operations funded exclusively by investor finance. While there is now good information on the UK’s shale gas resources published by the British Geological Survey, in practice there is extremely limited good geological information to inform and support reserve estimates. The considerable regulatory hurdles have led to company resources being expended on planning and permit applications and community engagement activity instead of on drilling exploration holes. The result of this has been acceleration in farm-in agreements and company acquisition. Understandably much of this activity is driven by larger revenue streams from conventional oil and gas production. I believe that following the 14th onshore licensing round there will continue to be a consolidation of licence areas by a few key players who will have the resources to get through the regulatory hurdles and exploration phases to full scale production.
FW: How has the success of shale gas in the US been replicated in other regions, if at all? What regions are providing lucrative returns for firms and investors, and which regions do you expect to champion the technology in the future?
McArdle: The success, and speed of success, of shale gas development in the US has not been replicated elsewhere in the world. This is principally because shale gas development in the US was a factor of a number of relatively unique characteristics, which included an established onshore conventional oil and gas industry, significant historic exploration of shale and application of fracking technologies, availability of investment capital, a benign regulatory environment, low levels of public opposition, and a system of land and minerals ownership that is more open to engagement with the industry, access to an established domestic energy industry and infrastructure and of course good quality, significant and relatively easily exploitable shale resources. These factors rarely occur together elsewhere.
Faulkner: The success of shale gas in the US is unprecedented. The technology was developed and perfected in America, and it has taken a while for it to spread to other oil-producing nations. The next closest country to being online with it is the UK, where it is being met with mostly open arms by the government, but getting pushback from protest groups, again not totally informed as to the benefits. The UK is partially dependent – as is quite a bit of the EU – on Russia for oil and gas, and with recent developments and sanctions, it is possible that the current supplier to the UK may not have the availability of supply that it has had in the past. There is no doubt that once the technology and know-how are developed to a point where it can be exported, many other countries will take advantage of it. Right now, there is so much work going on domestically, as well as so many shale plays, most of the producers are finding it more financially viable to stay in their own backyard for now. But that will eventually change.
Talbot: The success of the US shale gas sector, with its contingent positive impact on jobs, energy prices, balance of payments and expanding domestic petrochemical industry, will be replicated with varying success elsewhere in the world. Ironically, the US has had difficulties in maximising its shale gas and shale oil success due to transportation issues. Much more pipeline infrastructure is needed to reduce inefficient rail transportation. Elsewhere, the key issues for successful shale gas development are public acceptance, water resources and transportation infrastructure. Europe, while having a high population density, generally has good gas pipeline infrastructure and available water resources for hydraulic fracturing. The UK is particularly well placed due to a well established gas distribution network, with 83 percent of all homes heated by mains gas. This means that any shale gas development will never be more than a few kilometres from the gas network. For this reason I believe the UK is a potential ‘quick win’ for shale gas development despite its tight regulation.
Nunes: For the time being, only in Canada have we seen more progress. Strong investment in Argentina, Poland and China has not yet delivered the same success as in the US. The US has a 10-year advantage vis-à-vis other countries, but probably, Argentina, Poland and China will be in the following wave.
Rutherford: There isn’t another area that compares to the boom we are now experiencing here in the US. The largest natural gas field in the world is in Qatar. The second largest field in the world is the Marcellus Shale region here in the United States, and underneath that is an almost equally large formation known as the Utica Shale formation. There are giant gas formations in and around Australia, particular in the Timor area. These are offshore formations, but the extraction costs with these are enormous. Qatar has the problem of transporting its gas to the westernised industrial economy, a problem we do not have in the US. Our pipeline network, even though it is the most robust in the world, is old and at capacity. This energy boom has surprised us, and it means the pipelines need to be expanded. The industry is going to have to make a tremendous capital investment so that our pipeline can sustain the boom for many years to come.
FW: Overall, what key issues should investors and operators consider before committing to the shale gas space?
Rutherford: If I were a shale company, and I were interested in buying another company or its reserves, the first thing I have to take into consideration is that the technology in the industry has advanced to the point that this is no longer an exploration and production industry. In 2012, there were 50,000 oil wells drilled on the planet. Of those, 46,000 were in the continental United States, and of those, 12,000 were drilled in Texas. In that year, the last 3341 wells drilled in Texas all hit oil. Not a single dry hole in 3341 tries. That illustrates how the technology has advanced to take a lot of the risk out of finding oil. So if I were an investor looking to buy a company or get involved in an operation, I would be focusing on how advanced their particular use of technology has become.
Talbot: Shale gas is present on every continent and in most countries. It has the potential to dramatically change geopolitics and the world’s power balance over the next 50 years. The possibility now exists for countries with shale gas and shale oil to become largely energy self sufficient and this is a very exciting prospect. Those countries such as the UK and Poland which have energy policies that strongly support the development of shale gas resources will make shale gas development happen. The question is: over what timescale? The factors that affect timing include the development of effective and streamlined regulatory controls, public perception, existing infrastructure, availability of water resources and the presence of a flexible and responsive supply chain. The countries and regions that have all of the above represent good investment opportunities.
Nunes: First of all, investors and operators need a great deal of persistence, resilience and capacity to manage public opinion and the reputational threat associated with aggressive negative campaigns against fracking. These same threats caused the freezing, in practical terms, of the nuclear renaissance – despite it being one of the more effective means to combat climate change. Second, they must have the complex logistics needed to permit commercial operation, in terms of transportation and water availability. Third, they need the financial strength to continue until commercial exploitation repays the initial investment.
McArdle: Investors and operators both want short to medium term certainty that they will be able to pursue early stage exploration and, where exploration results are promising, that they will be the beneficiaries of and be capable of pursuing next stage development. They want to see a legal and regulatory regime that is supportive of the industry and will not be changed arbitrarily. Also, a general public within a particular country that is understanding of the industry and not unreasonably hostile. In developing the trust of the public, the industry itself has work to do and cannot rely on government and regulators to deliver. Access to developed energy markets will be important, as will the ability to finance the significant long term expenditure that characterises shale exploration and development, which unlike unconventional oil and gas development, is not so front loaded, as shale gas wells have to keep being drilled through the life of the shale development.
Faulkner: Investors and operators should do their homework regarding regulations, community activism in their area, and be aware of all of the financial risks that are involved in entering an industry with which they may be unfamiliar. Not every hole is a gusher, and not every well drilled is going to be a goldmine. As with any investing opportunity, try to gain as much knowledge of the subject as possible before jumping in. But with the right knowledge, this is a good time to be in this industry.
Hamish McArdle is a partner at Baker Botts. Hamish McArdle has wide ranging experience in the UK and international energy sector where he advises clients on all aspects of the energy value chain including large-scale projects and corporate and commercial matters, with a particular focus on those associated with the upstream and midstream oil and gas sectors and LNG. Mr McArdle advises leading energy companies in the structuring and negotiation of oil and gas development projects and transactions. He can be contacted on +44 (0)20 7726 3430 or by email: email@example.com.
Chris Faulkner is CEO of Breitling Energy Corporation. Chris Faulkner is the chief executive officer, president and chairman of Breitling Energy Corporation (BECC), an oil and natural gas company based in Dallas, Texas. Author of ‘The Fracking Truth – America’s Energy Revolution: The Inside, Untold Story’ and producer of the fracking documentary Breaking Free, Mr Faulkner was named Industry Leader of the Year in 2013 by the Oil & Gas Awards for the Southwest Region and Oil Executive of the Year in 2013 by the American Energy Research Group. He can be contacted on +1 (214) 716 2600 or by email: firstname.lastname@example.org.
Pedro Nunes is the head of EUREKA Secretariat. Dr Pedro de Sampaio Nunes, Grand Officer of the Order of Merit of Portugal, is the head of the EUREKA Secretariat. He has an international extensive experience in industrial applications of technology, especially in energy. A civil engineer, he was previously Portuguese Secretary of State for Science and Innovation and a director at the European Commission, responsible for several R&D programs focused on energy. He can be contacted on +32 2 777 0950 or by email: email@example.com.
Simon Talbot is the founder and managing director of Ground-Gas Solutions Ltd. Simon Talbot is a professional geologist and chartered engineer with 30 years experience with much of this concentrating on ground-gas contamination issues. He has a first degree in Geology from University of Manchester and a Masters in Engineering Geology from University of Leeds. He can be contacted on +44 (0)161 232 7465 or by email: firstname.lastname@example.org.
Bruce Rutherford is an international director at Jones Lang LaSalle (JLL). Bruce Rutherford is an International Director of Jones Lang LaSalle and a specialist in Tenant Representation. He is also a Global Energy Practice leader for the firm. He works with clients to create real estate solutions to complex business problems. Mr Rutherford has managed city and regional master plans totalling more than 20 million square feet of corporate and regional headquarters transactions. He has extensive market experience across North America and Asia Pacific. He can be contacted on +1 (713) 888 4071 or by email: email@example.com.
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