Pop we shale

Just another gas bubble

Unsurprisingly, our leaders let greed triumph over sustainability yet again.

Recently, here in Belgium, a search for shale gas has been initiated in layers of the Namurian Shale at a depth between 2 and 4 kilometers. Earlier, at the start of July, Flemish minister-president Kris Peeters — in a joint trade mission with Dutch minister-president Mark Rutte — had visited the Upstream Research Center of ExxonMobil in Houston, Texas, to discuss the issue. In the U.S., the exploitation of shale gas has caused a boom in natural gas production and a sharp decline in U.S. gas prices, while European gas prices continue to rise. As a result, U.S. companies have been gaining a competitive advantage to European companies, who are now exerting pressure on Europe to follow the same route. Due to the rise in both oil and natural gas production, the International Energy Agency (IEA) has stated that the U.S. will outstrip Saudi Arabia as the world’s top oil producer by about 2017, and become a net oil exporter by 2030. President Obama has even claimed that, mostly owing to the shale gas boom, the U.S. has a supply of natural gas that can last them nearly 100 years. Of course, this is all just another bubble, a new Ponzi fraud, constructed by industry along with the same Wall Street banks and their “market analyst” accomplices responsible for the dot.com bubble and the real estate securitization bubble. Deliberate overproduction served to drive gas prices down so Wall Street could take advantage from mergers, acquisitions, other transaction fees and share prices. At the same time, industry still has to service high levels of debt because of unrestrained borrowing justified by inflated projections. As former Wall Street analyst Deborah Rogers put it in a recent report from the Energy Policy Forum:

“It is highly unlikely that market-savvy bankers did not recognize that by overproducing natural gas a glut would occur with a concomitant severe price decline. This price decline, however, opened the door for significant transactional deals worth billions of dollars and thereby secured further large fees for the investment banks involved. In fact, shales became one of the largest profit centers within these banks in their energy M&A portfolios since 2010. The recent natural gas market glut was largely effected through overproduction of natural gas in order to meet financial analyst’s production targets and to provide cash flow to support operators’ imprudent leverage positions.
As prices plunged, Wall Street began executing deals to spin assets of troubled shale companies off to larger players in the industry. Such deals deteriorated only months later, resulting in massive write-downs in shale assets. In addition, the banks were instrumental in crafting convoluted financial products such as VPP’s (volumetric production payments); and despite of the obvious lack of sophisticated knowledge by many of these investors about the intricacies and risks of shale production, these products were subsequently sold to investors such as pension funds. Further, leases were bundled and flipped on unproved shale fields in much the same way as mortgage-backed securities had been bundled and sold on questionable underlying mortgage assets prior to the economic downturn of 2007.”

In 2009 already, Arthur Berman — a veteran petroleum geologist specialized in well assessment — presented a paper at the Association for the Study of Peak Oil and Gas (ASPO) discussing the rapid decline of shale gas wells compared to the estimates of the operators. The highest production rates of natural gas wells are always recorded in the beginning, and the production rate shows a steep decline thereafter. Hence, correctly modeling this decline is essential to correctly project the estimated ultimate recovery (EUR). What is troubling is the fact industry usually utilizes an Arps empirical decline formula with a b-factor higher than 1, resulting in a hyperbolic decline that is only realistic for the first years of production, leading to overly optimistic results regarding EURs and commercial well lifes. A recent analysis by Berman and Lynn Pittinger indicates that, based on detailed review of both individual well and group decline profiles for the Barnett, Fayetteville and Heynesville shale plays, industry reserves are over-stated by at least 100 percent. The average EUR per well is only about half that commonly claimed by operators.

“Our analysis of shale gas well decline trends indicates that the estimated ultimate recovery (EUR) per well is approximately one-half of the values commonly presented by operators. The average EUR per well for the most active operators is 1.3 billion cubic feet (Bcf) in the Barnett, 1.1 Bcf in the Fayetteville, and 3.0 Bcf in the Haynesville shale gas plays.
The primary difference between our analysis and the typical well profile proposed by operators is that we observe predominantly exponential (weak to moderate hyperbolic) decline in most of the individual well decline trends, rather than steadily flattening hyperbolic decline. For the Barnett and Fayetteville shale plays, we identify a two-stage exponential decline based on decline curve analysis (DCA) of individual wells; for the Haynesville Shale we observe predominantly exponential decline for individual wells.”

Of course, this has serious implications for the economic feasibility of these shale plays, especially considering current U.S. gas prices. The EUR per well in each shale play is the most important factor determining the breakeven gas price. And according to Berman, assuming fully burdened costs including land acquisition, this price ranges from about $8 to $9 per thousand cubic feet (Mcf) for the three plays mentioned above. With point-forward costs — hence for new development on existing leases -, which include only well drilling, completion costs and variable operating costs, the price would range from $5 to $7 per Mcf. Yet the U.S. spot price — this is the price for immediate delivery — of gas is currently only $3.75 per Mcf, and except for two brief moments in 2010, it has remained below $5 per Mcf since February 2010, going as low as $1.82 per Mcf. If Berman’s assessment is accurate, shale gas has been unprofitable since 2008, on an averaged annual basis. Even data from a presentation by the CEO of gas operator Range Resources at the 2012 Goldman Sachs Global Energy Conference showed that gas needs to sell for at least $4 per Mcf to be able to turn a profit. But even when operations are not profitable, new wells have to be drilled to sustain the operating cash flow that services the debt shale operators acquire as a result of high capital costs, since the older wells deplete at alarming rates. Furthermore, it is impossible to raise money for continuing operations unless operators can present rising reserves and production. Drilling new wells is a way of at least preventing overall production from declining, allowing the reporting of acceptable figures. In addition, Wall Street values oil and gas companies on the basis of their proven reserves, an estimate of how much oil and gas they have in the ground. By drilling a single well, companies can then count nearby future well sites as part of their reserves, and higher reserves generally lead to a higher stock price, even though some companies are losing money each quarter and piling up billions of dollars in debt. As Rex Tillerson — CEO of ExxonMobil — revealed at a meeting of the Council on Foreign Relations: “We are all losing our shirts today. We’re making no money. It’s all in the red.”

The industry has also been driven to keep drilling because sometimes the contracts they signed to acquire a lease or to acquire the necessary cash to invest, stipulated they had to continue producing gas to reach certain targets, no matter how low gas prices fell. The reason for early, smaller operators to sustain full-throttle production despite economic infeasability, is to be able to hold on to their lease and offload the increasingly unprofitable shale assets to bigger companies before the bubble bursts. The major companies do have a sound reason to be interested in shale gas, since they are looking to turn the U.S.-produced gas into liquefied natural gas (LNG) for export around the world, and primarily to Asia, where the spot price for LNG is currently around $15 per Mcf, potentially making it a very lucrative export. The reason for this large spread in natural gas prices is the fact that, in most of the world, they are indexed to crude oil prices. In the U.S. on the other hand, there is a “gas-on-gas” market mechanism, according to the Henry Hub benchmark, which has caused the emergence of a large divergence between oil and gas prices since 2009. However, increased natural gas exports could lead to higher U.S. natural gas prices and lower domestic demand, ultimately suppressing shale gas production. And considering the already questionable claim that the production of shale gas could aid us in the fight against global warming, one should take notice of the fact that about 25% of natural gas’ energy is combusted in the process of converting it into LNG and even more energy is wasted in the transportation process. This should make any sane person question the entire idea.

Regarding the profitability of shale plays, further complication is presented by the production of associated natural gas liquids, estimated to add $1 per Mcf after processing. Operators mix the revenues from “dry” gas with those from natural gas liquids, masking the true profitability of gas production. And if the wells are shut down after their liquids play out, this could leave a significant portion of the anticipated gas reserves never to be produced due to commercial inviability. Finally, realized prices — the prices that result from hedging production volumes in advance of sales — have often been high because of high spot prices through mid-2008 and favorable hedge positions for much of the following period, counterbalancing some of the losses on production. Shale gas operators have also been prone to the employment of complex “creative” accounting. Instead of the usual calculations that clearly state the net profit per Mcf of gas produced, the financial reports filed with the Securities and Exchange Commission (SEC) show an intricate set of statements which are often incomprehensible to the average investor. What’s more, major capital costs have been excluded through off-book accounting, and some operators have even used variable production payment schemes to recognize borrowed cash up front, then failed to account for it as debt and actually claimed it as an asset. Yet the truth is that shale gas ventures are costly and profits are marginal at best. As Berman recently put it:

“I believe that we are seeing the slow liquidation of these organizations but they cannot let the investment public know that this is what is occurring, hence the cornucopian rhetoric about the shale revolution and North America becoming the next Saudi Arabia — pure poppycock, of course. Will the recent write-downs and announcements affect investors? Probably not for now.”

Statements like president Obama’s claim of “natural gas that can last the U.S. nearly 100 years” are simply ridiculous in the light of reality. A more realistic estimate would lie anywhere between 11 years and 21 years, depending on how much of the proved undeveloped reserves will be produced, which will also be influenced by economic factors. And even that may be stretching it, as the figure doesn’t even take into account the possibility of increasing natural gas consumption over the coming years. It seems to me that the entire shale gas “revolution” is primarily a way to keep the economy afloat, allow a chosen few to reap large profits, and postpone truly addressing climate change. Which brings me to a much more important problem. Three months ago, president Obama revealed the “Climate Action Plan” his administration will follow to address the problem of global warming. To those few who still had any hope of real change being possible, it was an incredible disappointment, as first and foremost it is a strong stimulus for the fracking industry and the global shale gas market. As stated in the plan:

“Burning natural gas is about one-half as carbon-intensive as coal, which can make it a critical ‘bridge fuel’ for many countries as the world transitions to even cleaner sources of energy, …”

Of course, this is a claim that can only be made by looking through rose-colored glasses. When you take into account the entire life cycle of shale gas and the possibility of significant methane emissions, some researchers warn it could be dirtier than coal when considering shorter timespans. It could be a bridge to nothing aside from continued global warming. As stated in this report from Cornell University researchers Howarth et al.:

“Methane contributes substantially to the greenhouse gas (GHG) footprint of shale gas on shorter time scales, dominating it on a 20-year time horizon. The footprint for shale gas is greater than that for conventional gas or oil when viewed on any time horizon, but particularly so over 20 years. Compared to coal, the footprint of shale gas is at least 20% greater and perhaps more than twice as great on the 20-year horizon and is comparable when compared over 100 years.”
“The large GHG footprint of shale gas undercuts the logic of its use as a bridging fuel over coming decades, if the goal is to reduce global warming. We do not intend that our study be used to justify the continued use of either oil or coal, but rather to demonstrate that substituting shale gas for these other fossil fuels may not have the desired effect of mitigating climate warming. Finally, we note that carbon-trading markets at present under-value the greenhouse warming consequences of methane, by focusing on a 100-year time horizon and by using out-of-date global warming potentials for methane. This should be corrected, and the full GHG footprint of unconventional gas should be used in planning for alternative energy futures that adequately consider global climate change.”

There have been some critical responses to this report, and some of the counterarguments that have been raised are valid. The strongest criticism has come from a commentary by another group of researchers from Cornell University, Cathles et al. Howarth et al. have responded to this critique, a response to which Cathles et al. have published yet another reply. I will summarize the most important points here:

“We argue here that their analysis is seriously flawed […] High leakage rates, a short methane Global Warming Potential (GWP), and comparison in terms of heat content are the inappropriate bases upon which Howarth et al. ground their claim that gas could be twice as bad as coal in its greenhouse impact. Using more reasonable leakage rates and bases of comparison, shale gas has a GHG footprint that is half and perhaps a third that of coal.” — Cathles et al.
“We stand by our approach and findings. The latest EPA estimate for methane emissions from shale gas falls within the range of our estimates but not those of Cathles et al. which are substantially lower. […] Our analysis covered both electricity (30% of US usage) and heat generation (the largest usage), and we evaluated both 20- and 100-year integrated time frames for methane. Both time frames are important, but the decadal scale is critical, given the urgent need to avoid climate-system tipping points. […] When used to generate electricity, the shale-gas footprint is still significantly greater than that of coal at decadal time scales but is less at the century scale.” — Howarth et al.
“The data clearly show that substituting natural gas for coal will have a substantial greenhouse benefit under almost any set of reasonable assumptions. Methane emissions must be five times larger than they currently appear to be before gas substitution for coal becomes detrimental from a global warming perspective on any time scale. The advantage of natural gas applies whether it comes from a shale gas well or a conventional gas well. Scientifically the prescription for reducing greenhouse emissions is clear: substitute gas for coal while minimizing methane emissions using proven and available technology, and then move toward low carbon energy sources as quickly as technically and economically feasible.” — Cathles et al.

Analyzing this exchange in more detail would needlessly lengthen the discussion. I would conclude both parties have strong and weak points in their argumentation, and there simply is a lack of independent data — especially for methane emissions — to draw strong conclusions. It must be said, however, that the Howarth et al. report relies on some dubious assumptions, and the conclusion that natural gas could be dirtier than coal is not very well-founded. On the other hand, it is disconcerting to know that Cathles is a “climate skeptic”, and hence holds a view contrary to what is the overwhelming consensus among climate researchers on a topic that has been researched very extensively. In my own view, natural gas probably does have a significantly lower GHG footprint than coal, but mostly in the very long term and if it could be combined with strict regulation of the shale gas industry. Sadly, this is quite unrealistic considering the power of lobbying, and there are other factors that have to be brought into the equation.

In assessing the potential impact of shale gas on the global temperature of our planet, an important issue is the fact that, despite being a much more potent GHG, methane persists in the atmosphere for a much shorter period than carbon dioxide. Yet, the next decades could very well be critical in fighting climate change. There are some concerns we could soon reach a tipping point in global warming, heating the earth enough to melt a vast store of methane frozen in the arctic. It would at least seem cautious to do an in-depth investigation of the exact magnitude of the methane emissions associated with the production of shale gas before adopting a climate action plan that is centered around this industry. A recent study sponsored in part by the Environmental Defense Fund (EDF) and published in the prestigious Proceedings of the National Academy of Sciences (PNAS), did find well pad emissions to be lower than estimated by Howarth et al. However, even in this case there remains a lot of doubt as to whether this assessment reflects reality or a best-case scenario that could only be accomplished by the most rigorously enforced regulation of industry. Arguments can be made against the way the study was set up and against the fact the EDF was far from the only sponsor of the study, two observations which might not be unrelated. Some of the other sponsors are Anadarko Petroleum, BG Group, Chevron, Encana, Talisman and ExxonMobil subsidiary XTO Energy. Other studies have found much higher methane emission levels, although these have not been industry-wide but rather more localized. Regardless, more studies are needed to be able to conclusively determine these methane emissions and the impact of the shale gas boom on global warming.

Of course, the entire argument of pitting coal versus natural gas is not intended to defend the continued usage of coal to generate energy, but rather to argue for an increased utilization of renewable energy. That is the real issue at hand here. Switching to natural gas might or might not put off the problem for a while, but it is certainly not a measure that in itself will be sufficient, and could work counter-productive because at these low prices, it hinders efforts to make more use of solar, wind, tidal and geothermal energy. Despite the claims that natural gas has been responsible for U.S. energy related CO2 emissions falling in 2012, it has been shown that the contribution of natural gas in this CO2 reduction was limited to merely 26%, because it replaced not just coal but also zero carbon energy sources. And there are other problems. One is the fact that the fracking process entails the use of large quantities of fresh water. Water, which despite some industry claims, is barely recycled and irreversibly contaminated. Another is the fact that groundwater in the vicinity of wells can become contaminated, an issue which the Obama administration has tried to cover up. When fracking fluid is spilled, it can even enter surface water and kill aquatic organisms, as it did in Kentucky.

To return to where this article started off — the exploration of the possibility to extract shale gas in Belgium -, it must be noted that the shale gas in Europe is expected to be much more expensive to extract than in the U.S., because the geological conditions are less favorable and regulations are tougher. For example, the shale gas deposits in Poland — thought to be the most expansive in Europe — are 1.5 times deeper than in the U.S., which would triple drilling costs. ExxonMobil, Marathon Oil and Talisman Energy have already left Poland after disappointing results, but recently an exploration company has announced it is extracting about 8000 cubic meters of shale gas per day at a test well in the northern part of the country. This is not an amount that can be considered for commercial production, but nevertheless the best result for shale gas extraction in Europe up till now.

In any case, it would seem that there are many more downsides than upsides for Belgium to exploit their own possible shale reserves, which are not that vast to begin with. It is high time we defeated our addiction to fossil fuels, and focused all our efforts on renewable, clean energy. This is simply the only way to create a future that is truly sustainable.

Update:

A new study published in PNAS has found that total US methane emissions as previously estimated may be off by 50%:

“Successful regulation of greenhouse gas emissions requires knowledge of current methane emission sources. Existing state regulations in California and Massachusetts require ∼15% greenhouse gas emissions reductions from current levels by 2020. However, government estimates for total US methane emissions may be biased by 50%, and estimates of individual source sectors are even more uncertain. This study uses atmospheric methane observations to reduce this level of uncertainty. We find greenhouse gas emissions from agriculture and fossil fuel extraction and processing (i.e., oil and/or natural gas) are likely a factor of two or greater than cited in existing studies. Effective national and state greenhouse gas reduction strategies may be difficult to develop without appropriate estimates of methane emissions from these source sectors.”

This, of course, has serious negative implications for the Obama administration’s “Climate Action Plan”, and lends credence to the position of Howarth et al., even though more studies are needed to specifically determine the methane emissions associated with fracking, and to address the question of whether these emissions can be significantly reduced in practice. Another interesting finding is the fact that the emissions caused by cattle are up to twice as large as previously thought as well, providing even more evidence to argue for the necessity of humanity as a whole to promote diets low on meat. In any case, the “bridge fuel” story is making less and less sense.