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Vol. 17, No. 3 Week of January 15, 2012
Providing coverage of Alaska and northern Canada's oil and gas industry

Facing some realities: consultant questions Lower 48 shale boom

Amid the understandable euphoria that surrounds the burgeoning shale gas industry in North America, a contrarian voice can perhaps help temper enthusiasm with some hard facts. And on Jan. 6, at the Alaska Support Industry Alliance Meet Alaska Conference, Arthur Berman, a consultant with many years of experience in the gas industry, presented his downbeat views on the shale gas phenomenon, views that run counter to those of many shale gas enthusiasts but that raise interesting questions about the realities of shale gas development.

Questionable claims

Claims about scale of the shale gas phenomenon are highly questionable, Berman said.

“It’s unclear that shale gas production will support even the short-term expectations of abundance,” he said.

The marginal cost of shale gas production is two to three times the current price of gas in North America; and published estimates of recoverable reserves may be overstated by a factor of two he said.

People have picked up the idea that shale gas will provide the United States with a 100-year supply of natural gas. But this forecast comes from taking the probable shale gas resource volume and dividing that by the annual gas consumption. Unfortunately, however, gas resources in place are not the same as the volumes of gas that could realistically be produced. An optimistic assumption that half of the known resources could actually be developed, on top of current proven reserves of shale gas, leads to a forecast that shale gas supplies might last, not for 100 years, but for 20 to 22 years, Berman said. And that assumes a constant rate of gas consumption — add in the possibility that consumption will increase, and the life of the shale gas supply shortens further, he said.

Variation in potential

Part of the difficulty in estimating shale gas resources arises from variations in resource potential across a shale gas play, Berman said. The Barnett shale in Texas, for example, forms a gas play with a total area of 9 million acres. But only a relatively small percentage of that total play consists of core areas with the optimum geology to make the play work. And with success not assured even within the core, drilling for new gas resources involves a high level of risk, Berman said.

Similarly, only about 20 percent of the Haynesville shale, another prominent shale play, has the potential to be commercial, he said. While less than three years ago people claimed that the Haynesville would deliver a gas resource larger than the gas cap in the giant Prudhoe Bay field, a recent Oil and Gas Journal article has suggested that the Haynesville resource might be just 3 trillion to 9 trillion cubic feet, Berman said. However, Berman also commented that this resource estimate did appear to be unduly low.

Complex and costly

Even if shale gas can only provide 20 to 22 years of supply for the U.S., that still represents a very large resource. However, although the resource is large, the technical complexity and cost of developing the resource is high relative to the development of more traditional gas fields. Shale gas is not being developed because it is better than conventional gas; it is being developed because conventional gas is running down, Berman said.

Wells in shale plays such as the Spraberry in west Texas or the Bakken in North Dakota cost $10 million apiece, Berman said, adding that he had heard that the average completion for an Eagle Ford shale well costs $6.5 million, in addition to the drilling of the well.

And then there is the production decline rate of the wells, a factor that Berman characterized as “the elephant in the room.” Berman said that his company had investigated decline rates of the 8,800 to 8,900 shale gas wells that have been drilled to date and has concluded that, on average, gas production declined by 44 percent per year. That compares with decline rates of around 23 to 24 percent for a typical well in a traditional gas field, he said.

“You have to drill all of the time on these (shale) plays,” Berman said.

Replacement cost

And that translates to cost. Based on current overall production decline rates in the United States, it is necessary to find 22 billion cubic feet per day of new production at a cost of $22 billion per quarter, just to keep overall production levels constant, Berman said. Unfortunately the combined cash flow of the top 34 U.S. publicly traded companies involved in the shale gas industry is just $12 billion, a figure $10 billion below the needed investment level, he said.

Moreover, the Oil and Gas Journal article about the Haynesville shale said that 80 percent of the accessible reserves for a shale gas well are typically produced within the first two years of production.

“So if you haven’t paid back your well in two years you’re screwed,” Berman said, adding that a company could continue to operate a well for decades, if it wanted to operate the well at a loss.

Loss making

And, according to Berman, loss making is what characterizes the current North American shale gas industry. Whereas North American gas prices hover around five dollars per thousand cubic feet, and some shale gas companies have claimed that they can make a profit at a price of three dollars, an analysis of data submitted to the Securities and Exchange Commission indicates that the shale gas production cost is somewhere around seven to eight dollars per thousand cubic feet, Berman said.

Much shale gas development occurred a few years ago when natural gas prices were rising. And even when gas prices collapsed in the mid-2000s, gas futures contracts used to hedge price fluctuations maintained profits for gas producers for a while.

“But that’s over now,” Berman said. “For the past 12 to 18 months gas prices have been too low for profits and now we have this magical thinking that somehow says … ‘Oh well, don’t worry about that. We can now break even at lower prices for some reason, because of efficiency.’”

High land costs

And meantime the price of land prospective for shale gas development has gone through the roof, with people paying up to $30,000 per acre for the right to drill, Berman said.

“An amazing amount of capital has been bet on shale and much of this is in the form of debt,” he said. “How in the world do you ever dig yourself out of the capital expenditure hole that you’ve dug?”

To obtain capital, specialist shale gas companies are forming joint ventures with other companies who, attracted by the potential to invest in the world’s largest gas market, bring cash to the party, Berman said. But the shale gas companies move from one play to the next, spending perhaps two to three times what they are making, he said.

“The circus can’t stay in town for very long because after a while everyone knows that the bearded lady doesn’t really have a beard,” he said.

Diversified portfolios

Large diversified oil companies have also become involved in the shale gas industry, but these companies pursue shale gas plays as relatively small, high-risk portions of their overall exploration and development portfolios, Berman said. Shale gas resources provide much needed reserves replacement for some companies. And, for countries lacking domestic energy resources, expensive unconventional gas production may be a justified cost of obtaining essential energy supplies.

One symptom of the poor current economics of shale gas development is the fact that none of the shale gas producers have been willing to sign long-term gas supply contracts at current prices with electric utilities that are considering future gas-fueled power generation, Berman said.

And although concerns about drinking water contamination from hydraulic fracturing of shale gas wells appear overstated, there are concerns about the disposal of fracking water, contaminated by pollutants from the shale, Berman said. And the perception that fracking is bad will inevitably add cost and time to shale gas development, he said.

Here to stay

However, despite his critique of the shale gas industry, Berman emphasized that, with the United States needing energy, shale gas development is here to stay. It isn’t a question of shale gas plays being bad he said. In fact, the big winners in the shale gas industry are the service and support companies, with these companies set to reap the rewards of continued high levels of expenditure on shale gas drilling. And, eventually, higher gas prices could provide a way out of the current viability swamp.

But for now Berman expressed caution. When things appear too good to be true they usually are, he said.

—Alan Bailey

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