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Vol. 15, No. 48 Week of November 28, 2010
Providing coverage of Alaska and northern Canada's oil and gas industry

Still hope for gas pipeline

Study for DNR suggests future L48 gas prices will support gas from North Slope

Alan Bailey

Petroleum News

Amid current speculation about the future of the Alaska oil and gas industry, as oil production from the North Slope slows down and exploration drilling comes to a near standstill, it has become popular to add what some view as fading hopes for a future North Slope gas line to a general list of woes.

For, as the burgeoning development of plentiful supplies of so-called shale gas in the Lower 48 has caused a paradigm shift in the North American gas market, the price of Lower 48 gas has plummeted to levels below the projected transportation rates on a gas line from the Arctic, perhaps rendering the gas line uneconomic.

Objective analysis

In the interests of taking a rational look at the prospects for future Lower 48 gas prices, to replace worry-driven conjecture by objective analysis, the Alaska Department of Natural Resources commissioned consulting firm Black & Veatch to prepare a report on the future of North American gas prices in the context of the new shale gas revolution.

And the Black & Veatch analysts have found that, although there are major uncertainties around future North American gas markets, it is likely that gas prices in Alberta, Canada, will climb to somewhere between $5 and $7 per thousand cubic feet by 2020, with prices continuing to climb thereafter. And with a possible fee of $3.50 per thousand cubic feet for treating North Slope gas and carrying it by pipeline to Alberta, those gas prices could make a North Slope gas line viable, Antony Scott, a commercial analyst with Alaska’s Division of Oil and Gas, told Petroleum News Nov. 22.

DNR wanted an authoritative set of data, against which to benchmark the gas line project and had obtained funding from the Alaska Legislature for the Black & Veatch study, said Mark Myers, Alaska Gasline Inducement Act coordinator.

“This is a very robust study,” Myers said. “It’s like no other study we’ve seen out there in the literature.”

And Scott emphasized that the study tried to be unbiased in its views of future gas markets and, if anything, had underestimated the future cost and pricing of shale gas.

Technical breakthrough

Shale gas technology involves the extraction of natural gas from the impervious rocks where gas forms, rather than using the conventional approach of drilling into porous and permeable reservoir rocks that have trapped gas as it bubbles through subsurface rock strata. The use of high-tech horizontal drilling techniques that allow a well bore to pass for long distances through a shale gas horizon, coupled with the use of water and chemicals to fracture the rock, thus releasing the gas from the rock lattice, have been key enabling technologies in shale gas development.

The coupling of technical breakthroughs in shale gas production with the realization that vast areas of gas shale underlie various regions of the United States and Canada has triggered the shale gas revolution and caused a massive uptick in estimates of North American natural gas resources.

However, despite much hype about shale gas, with implications of vast gas supplies at rock-bottom prices, shale gas development still only has about a 10-year track record, with most of that record relating to one shale unit, the Barnett shale in Texas, Scott explained.

“It’s really important to recognize that outside of the Barnett we’re in extremely early days of the shale gas story,” Scott said.

But, after assessing various natural gas scenarios, the Black & Veatch analysts have concluded that shale gas production would figure large in any future North American natural gas supply situation.

“No matter what, there’s an awful lot of shale gas that is going to be relatively inexpensive to produce,” Scott said.

Price impact

The arrival of shale gas in the North American gas market, converting tightening production from conventional gas fields to a growing gas glut, caused gas prices that had climbed to levels approaching $8 per thousand cubic feet by 2008 to suddenly collapse, dropping to below $4 currently.

And the import of liquefied natural gas into the Lower 48, thought just a few years ago to be an inevitable growth industry as domestic supplies of natural gas decline, has now been pushed into the background.

“If you look at the price environment … it becomes hard to tell a story in which LNG finds an attractive home in North America,” Scott said.

Key drivers behind Black & Veatch’s view of future Lower 48 natural gas markets are the assumptions that the now-known abundant supplies of North American natural gas, coupled with an environmental preference for the use of gas rather than coal as a fuel, will push up the use of natural gas for electricity generation. On the other hand, while there are major uncertainties regarding future gas demand levels, there are also major uncertainties in estimates of the future costs of developing new shale gas resources.

For example, the supply of water for shale fracturing and the subsequent treatment and disposal of water produced from gas wells has represented a fairly modest cost element in the development of the Barnett shale, but will likely become a major cost factor in the development of shale gas in other basins.

Inconsistent data

But inconsistencies in the way in which finding and development costs for shale gas are reported make it difficult to assess whether those costs are compatible with current gas price levels, and Black & Veatch thinks that current prices may be artificially low.

“Current market prices for natural gas in North America may not provide adequate return for full development of shale resources in North America,” the Black & Veatch report says. “Significant levels of current shale production appear to be driven by requirements to drill to maintain acreage positions.”

Published shale gas finding and development costs in the Lower 48 range from $2.06 to $2.35 per thousand cubic feet, but these numbers do not appear to include factors such as land lease costs and water costs. Estimated costs of $3.25 to $4.25 per thousand cubic feet in western Canadian basins are likely nearer the full cost, although there are differences between cost reporting rules in Canada and the United States, Black & Veatch says.

And an examination of the production history of the Barnett shale provides some revealing insights into possible future shale-gas cost trends.

Essentially, Barnett shale production has seen a series of significant technical breakthroughs, each of which has caused a sudden jump in gas production. But the rate of increase in production has dropped back sharply after each technology-induced spike. And, contrary to popular belief, the cost of finding and developing additional volumes of Barnett shale gas appears to have increased rather than decreased over time.

Rising cost

The explanation for this conundrum seems to lie in the production characteristics of shale gas resources. In essence, a shale gas well achieves high initial production rates as the fractured shale rapidly releases its gas content. But, with the rock being relatively impermeable, that initial production rate drops off quite rapidly, requiring increasing effort to stimulate existing wells and the drilling of new well bores to sustain overall production levels.

The result is a production cost profile that curves upwards as more and more of the gas resource is accessed, until a law of diminishing returns places an upper cap on the total volume of gas that can be viably extracted from a particular shale gas resource, the Black & Veatch analysts concluded.

Recognizing the importance of individually considering the unique characteristics of each shale gas basin, the Black & Veatch analysts applied the upward curving cost model to each of the various U.S. and western Canada basins, to assess future gas production costs in different basin scenarios. Estimated water costs factored high in the distinctions between the scenarios — potential situations ranged from unlimited water access and the disposal of untreated water down wells, as for a Barnett shale development, to limits on water supplies and the need for the treatment of produced water, as would be required for developments in the Marcellus shale in Pennsylvania.

Additional costs, all subject to significant uncertainty and regional variation, include land access and government taxes.

Rising demand

But future demand for natural gas in North America should support the anticipated gradual rise in shale gas costs.

Black & Veatch has its own Lower 48 gas demand forecast that assumes gas demand for electricity generation will rise at an annual rate of 3.2 percent, with greenhouse gas regulation tending to drive the replacement of coal-fired generating capacity by gas-fired power plants. In 2010 the Energy Information Administration, apparently barred from considering potential changes in government energy policies, came up with a lower growth rate of 0.5 percent, on the assumption that there would be no future restrictions on greenhouse gas emissions.

And although the Black & Veatch projection of total demand from all uses of gas through to 2035 also exceeds the equivalent EIA projection, the Black & Veatch projection is “within the fairway” of several independent gas demand forecasts, Scott said.

“Power generation demand is going to be a really big story,” he said. “It’s going to matter a lot.”

Then, when it comes to the interplay between gas costs, gas demand and gas prices, the actual level of gas demand and the actual finding and development costs would appear to be the likely dominant future drivers of gas prices. And Black & Veatch assembled low, medium and high gas price scenarios, using a standard North American gas model to project, for each scenario, likely annual gas prices at different market hubs, together with likely annual production volumes from each shale gas basin, through to 2040.

Price scenarios

The low-price scenario assumes the relatively low EIA projection of future gas demand, together with low water costs; low finding and development cost escalation, along the lines of conventional gas fields; and modest tax rates. The medium-price scenario uses Black & Veatch’s shale-gas cost escalation model, together with Black & Veatch’s projection of future gas demand. The high-price scenario adds in increased environmental restrictions over access to shale gas resources, somewhat higher tax rates and relatively high water costs.

The low-price and high-price scenarios projected into 2020 result in the $5 to $7 per thousand cubic feet price range that may come into play in Canada at around the time when completion of a North Slope pipeline could be in the offing.

“Except in very extreme events we believe the Alaska (gas line) project — given what we know about the tariff structure today, the cost of producing gas at Prudhoe and Point Thomson — it looks like it should work,” Myers said.

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