Shale gas – a game changer for the energy industry

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Should shale gas live up to its promise, much will change throughout the world. Even the global configuration of trade and power will be altered as the US shifts from being an importer of energy to being an exporter. How all this will affect the environment is still not clear.

In November 2012, while the world focused on the US presidential elections, the International Energy Agency (IEA) released the World Energy Outlook 2012 that projects the emergence of the US as the world’s energy superpower – a finding that arguably carries more significance in decades to come than the presidential elections do.

The IEA reported that “by around 2020, the US is projected to become the largest global oil producer (overtaking Saudi Arabia until the mid-2020s)…The result is a continued fall in US oil imports, to the extent that North America becomes a net oil exporter around 2030.”

This projected spectacular turnaround of the US away from its high dependence on imported energy (currently 20% of its total energy needs) is possible primarily because of its discovery of large deposits of shale gas.

What is shale gas?

Conventional gas is usually trapped in a reservoir of impermeable rock and production is usually done by drilling through that rock. However, shale gas is natural gas that is trapped within fine grain sedimentary rocks. Such shale formations (“plays”) can be rich sources of natural gas and petroleum, and many are widely distributed across the US and the world.

The role of technology

While shale gas has long been discovered and identified, only recent progress in production technology has enabled it to emerge as a viable energy source. Shale gas is produced using hydraulic fracturing (“fracking”) – a process of spraying high pressured water, chemicals and sand into the well to open up the cracks and release the hydrocarbons trapped in shale plays so that natural gas can flow to the well.

This combination of horizontal drilling and hydraulic fracturing has enabled shale gas production to become commercially viable. Shale gas has been produced for about a decade from the Barnett Shale in Texas, and large shale formations have recently been found, including the huge Marcellus shale in Eastern US. As a result, the natural gas production in the US is expected to grow substantially.

Global implications

ECONOMICS AND WORLD TRADE Since 2008, the US has emerged as the largest gas producer in the world. The combination of higher output from shale gas, a slowing economy and a reduction in speculative activity has caused natural gas prices to fall.

At its lowest level in 2012, natural gas in the US traded at around one-fifth of import prices in Europe and one-eighth of those in Japan. With such a huge discrepancy, there will be arbitrage opportunities, and infrastructure projects are positioning the US as a major exporter. For example, the Seaway pipeline, which was built in 1995 to transport crude from Freeport, Texas to Cushing, Oklahoma, has now reversed its flow to transport the rising stocks in the latter to the main US refining centre on the Gulf Coast, ready for export. Additionally, the proposed Keystone XL pipeline connecting Canadian oil sands with Texas’s Port Arthur will pass through major shale plays, thereby creating an export channel for shale gas. Indeed, the opportunity to sell North American shale gas to Asian customers has prompted Petronas to pay C$5.2bil to take over Canada’s Progress Energy Resources Corp and to bid for full control of MISC, one of the world’s largest LNG transportation operators.

Historically, natural gas prices are priced regionally and in long-term contracts spanning decades due to huge capital outlay, energy security reasons and limited flexible distribution mechanism. However, with the emergence of shale gas and the significant pricing anomalies between regions, price relationships between regional gas markets are set to strengthen. Therefore, natural gas trade is likely to become more flexible as contract terms evolve in the future, perhaps moving away from the long-term contracts model that Malaysia has adopted. Indeed, Singapore is developing its LNG infrastructure to become a natural gas trading hub and has recently set up an investment unit with S$1bil to target LNG trading, exploration, storage and shipping1.

Having cheap shale gas also enhances the competitiveness of the economy. Energy subsidy, as witnessed by the successful industrialisation in Malaysia, can be an effective industrial policy. With ample and cheap energy, the US will be in a strong position to reverse the outsourcing of manufacturing activities overseas. If manufacturing in the US takes off again, it will significantly affect trade flows and the balance of trade across the world. This will add additional boost to the positive effect of being an energy exporter.

However, there is no guarantee that US manufacturing will be revived as the inflow of oil and gas proceeds might actually stifle the development of manufacturing, i.e. the infliction of the Dutch disease. The ultimate outcome will depend on US policies.

GEOPOLITICS
As the US lessens its dependence on oil imports from the Middle East, it may also decrease its involvement in the Middle East. While some argue that the US is the source of instability in that region, the withdrawal of the US from Middle East will likely hasten the manoeuvring of other countries to replace American influence. This might create another bout of instability in that region. While oil imports to the US decrease, oil imports in developing countries, especially in Asia, will continue to grow as they industrialise. This will increase inter-regional oil trade (20% from 2011 to 2035 per IEA’s projections) and tie the fortunes of countries more closely together.

FINANCE
Some have argued that with the high US national debt and fiscal profligacy, the US dollar’s demise is inevitable. However, with the US emerging as the energy giant, pricing energy in US dollar will continue to be the natural choice.

Some have also argued that since large shale formations have also been discovered in China, the Yuan will someday usurp the US dollar as the world’s reserve currency. According to the US Energy Information Administration, China has 1,275 trillion cubic feet (36 trillion cubic metres) of recoverable shale gas resources in just two basins, exceeding the reserves in the US and Canada combined. However, despite major Chinese energy companies buying into shale gas assets in North America, the roll out of shale gas in China may be more difficult due to China's complicated geology, scarce water resources and lack of foreign participation.

With the US being the sole military superpower, the top energy producer and economic powerhouse, the likelihood of the US dollar to remain as the world’s reserve currency remains high.

ALTERNATIVE ENERGY
Post-Fukushima, shale gas discovery is very helpful in the transition away from nuclear power for electricity generation. The abundance of shale gas is likely to keep the price of natural gas depressed. That price has fallen from over US$13 per million British thermal units in July 2008 to about US$4 per million British thermal units in April 2013. This will affect the viability for alternative energy such as wind and solar. Therefore, shale gas will likely defer the break-even point for some alternative energy producers.

Environmental issues

Natural gas is a cleaner burning fuel, and emits substantially lower carbon dioxide and sulphur dioxide than coal or oil. Replacing coals with natural gas has thus enabled utility companies to reduce carbon dioxide emission. Hence shale gas is a positive development for the environment.

However, there are some environmental concerns in the production process of shale gas. The fracturing of wells requires a large amount of water, and large-scale production of shale gas may affect the availability of water for other uses. Although increasing volumes of water are being recycled and reused, freshwater is still required in high quantities for the drilling operations as dirty water is more likely to damage the equipment and result in formation damage that reduces the chance of a successful well. The need for freshwater is a growing issue, especially in water-scarce regions and in areas with high cumulative demand for water, leading to pressure on sources and competition for water withdrawal permits. The pressure to increase efficiency is high as industry demand for water grows with the development of more wells.

Besides, additional chemicals are mixed with the water before being sprayed. Hence there are risks of water contamination if the wastewater is not treated properly. The concern of water contamination has prompted France and Bulgaria to impose nationwide moratoriums on shale gas production through fracking. However, the UK is allowing fracking and has even offered tax incentives for onshore shale gas exploration and production in its latest budget.

Moreover, according to the US Geological Survey, hydraulic fracturing “causes small earthquakes, but they are almost always too small to be a safety concern. In addition to natural gas, fracking fluids and formation waters are returned to the surface. These wastewaters are frequently disposed of by injection into deep wells. The injection of wastewater into the subsurface can cause earthquakes that are large enough to be felt and may cause damage.”

Conclusion

Shale gas is likely to impact the energy sector significantly in years to come. This development is likely to have significant implications for the world of politics, world trade, business, finance and the environment. The development is significant enough to draw the heads of Gazprom and Lukoil2 to openly dismiss shale gas as a threat to their businesses. Hence, this is a development worthy of our continuous attention.


1
www.rigzone.com/news/ oil_gas/a/125604/Singapores_ Temasek_Sets_Up_LNG_ Investment_Firm_Pavilion_Energy

http://rt.com/business/shale-gasgazprom- us-088/

Lim Kim-Hwa is a fellow at the Penang Institute, a fellow in Finance and Financial Reporting at the University of Cambridge and a chartered accountant (ICAEW). He was a portfolio manager and an assistant professor at the University of Cambridge.



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