“Shale gas is the most important energy development since the discovery of oil“
As already pointed out in our previous special reports, we believe that shale gas is on one hand one of the most important factors of our future energy supply and on the other hand one of the most attractive investment opportunities. Geologists believe unconventional gas to exceed the conventional reserves by a factor of 10. We believe that whatever is deemed “unconventional” gas today will soon be “conventional” gas due to technological progress . We are also convinced that the European energy and gas market will undergo dramatic changes in the coming years, and that the dependence on Russian gas will be a thing of the past. Currently we seem to see the beginning of this transformation process.
If shale gas can really gain a foothold in (Eastern) Europe on a sustainable basis, this would come with extensive effects for Europe. On the one hand the frequent threats by Russia to suspend deliveries would become obsolete, and on the other hand the prices should take their cues from the market prices in the future. At the moment the gas prices in Central Europe are about 100% higher than in America.
In contrast to oil and other commodities, there is no global market for natural gas. The gas market is still local and thus not globally integrated. The oversupply of natural gas and the success of LNG (liquefied natural gas ) will keep the pressure on the gas exporters and thus the pegging to the oil price may soon be a thing of the past. Also, the long-term contracts – a customary form of contract in Europe – are now subject to gradual adjustment. For example Gazprom and E.On agreed to peg the prices a least partially to the spot prices. We regard this as an important development, which should continue to pick up momentum.
Gazprom has recently mentioned the rising influence of unconventional gas in Poland, after its earlier (mostly) negative campaigns. The fact that Gazprom feels threatened by the shale boom is also exemplified by the company’s plans to suspend the development of the Shtokman gas field by another three years. Gazprom now expects the field to become operative by 2018. And the fields of the Yamal peninsula should commence production later than anticipated as well, especially since the costs of both projects have risen dramatically and are now hardly profitable at current gas prices. The following chart illustrates the enormous dependence of many European countries on the Russian gas supplies.
Percentage of Russian gas supplies in terms of total consumption
Source: Gazprom (2009), IEA, BP, Erste Group Research
Shale gas in the USA – the blue print for the European gas sector?
"We usually find oil in new places with old ideas. Sometimes, also, we find oil in an old place with a new idea, but we seldom find oil in an old place with an old idea. Several times in the past we thought we were running out of oil whereas we were only running out of ideas."
Parke Dickey, American geologist, 1910-1995
The USA turned into the biggest natural gas producer in 2009, passing Russia. Half of the supply is already derived from unconventional sources, i.e. CBM (coal bed methane), shale gas, and tight gas. Currently shale gas accounts for about 15% of the US gas supply. This figure could grow to almost a third, given that the two fields Marcellus and Haynesville indicate rising production rates. T. Boone Pickens even expects a market share of 50% by the year 2020, whereas the EIA is slightly more pessimistic in expecting shale gas to cover about 45% of the entire supply by 2035.
US gas market 1990-2035e
Source: EIA
Often the high water consumption and the fear of contaminated ground water are cited as main counter-arguments. However, we believe that is mere scaremongering. Shale gas tends to be found in depths of several kilometres, whereas ground water tends to be close to the surface (up to maximum depths of 300 metres). If the cementation and lining of the drill hole are done properly, there is no risk to the ground water. This is where the producers have learnt from their initial mistakes. And the often-criticised water consumption involved in the fracking procedure is a case of over-dramatisation as well. The comparison with industrial sites, mining companies, or the energy sector puts the high water consumption into perspective. An average drill hole requires about 15mn litres of water. An 18-hole golf course for example needs the same amount of water in two to three weeks . On top of that the water management technologies are constantly progressing, leading to a significant decline in water consumption.
We have recently heard rumours in the USA about a halt of production and significantly more stringent regulations for shale gas. We believe that this is an exaggeration, given that shale gas has meanwhile turned into an enormous economic factor. According to API gas production would fall by up to 57% in the case of a stricter legislation. The natural gas industry employs almost 600,000 people and contributes USD 385bn to the GDP. Just recently President Obama has also underlined the crucial strategic relevance of the industry. Vehicles powered by natural gas and natural gas stations are supposed to benefit from tax breaks and subsidies.
The translation of the shale experience to the European case
The scepticism vis-à-vis shale gas is still enormous in Europe. But the sentiment was similar in the USA at the beginning of the 90s. After the USA had gone beyond a “tipping point”, i.e. a critical mass, substantial growth ensued. Production per drilling rig in the USA has almost risen exponentially as a result of improved technologies in production and higher expertise with regard to the geological specificities of shale gas deposits. Improving expertise also results in falling costs. While the costs of the Barnett Shale eight years ago amounted to USD 5/mmBTU , they have meanwhile fallen to USD 3/mmBTU. In 2004 average drilling time was 110 days, today it is 18 days. In addition, many studies substantiate the notion that costs as low as USD 2.5/mmBTU are possible, which means that the production of shale gas would partially be cheaper than the production of conventional gas. Currently we can see the transfer of technology from the USA to Europe. Therefore we assume that the development of shale gas in Europe should progress much more swiftly.
Schematic diagram: conventional gas vs. unconventional gas
Source: EIA
The American Association of Petroleum Geologists assumes Western Europe to hold unconventional gas reserves of almost 15bn cubic metres. This would easily ensure enough supply for the coming decades. However, it is not possible to expect Europe to emulate the development in the USA 1:1. The availability of drilling rigs represents a possible bottleneck. Some 100 active land rigs were available in Europe in 2010, whereas in the USA the number was 2,500 according to Baker Hughes. The low number of rigs of course causes inflated prices in Europe. On top of that there is a lack of experienced engineers and geologists. We also believe that the population might be critical of shale drilling in the beginning. The population density in Europe is vastly different than that in the USA. The average population density in the USA is 32 people per km², whereas in the UK it is 255, in Germany 225, in Poland 122, and in the Ukraine 78. Given that the shale layers in Europe tend to be located in greater depths than in the USA, water consumption will also be substantially higher. The geological structures are in parts similar to the USA, which is probably why the US companies have been acquiring so aggressively in order to apply for licences. At the moment a fight for the information hegemony is going on in Europe, given that only a few companies have reliable seismological and drilling data and thus knowledge about the geological specifications at their disposal.
Poland – the “Sheikdom at the Vistula”?
At the moment the sector focuses on the unconventional gas resources in Poland. If they were only remotely as big as currently predicted, Poland would turn into a net exporter of gas within just a few years. The bandwidth of estimates reaches from 1.4bn (Wood/Mackenzie) to 3bn cubic metres (Advanced Resources International). This would equal the Polish annual consumption of the next 100 to 200 years. Even if demand were to increase by 40% over the next five years – as for example expected by the state-held PGNiG – Poland would have a comfortable supply at its disposal. Commercial production could commence already in two to three years, although any significant volumes will probably only be produced in seven to ten years.
Initial drilling results in the South Eastern part of Poland (Markowola) have confirmed the high expectations. According to officials, Poland already fancies itself the “second Norway”, or the “Sheikdom at the Vistula” . Drillings are currently executed in Lebien (3 Legs Resources), Slawno (BNK Petroleum), and Markowola (PGNiG). On top of that, a number of global players have taken their positions. Eni has recently reported the takeover of Minsk Energy Resources and thus gained excess to three licences, i.e. to almost 2,000 km² in the Polish Baltic Basin. The company wants to embark on six drillings in 2011 and translate their Barnett Shale experience to Europe.
Next Stop: Ukraine
Now that the “sweet spots“ in Poland are gone, Ukraine should be the next stop of the “shale gas caravan”. Geologists have found striking similarities between the Lublin Basin and the Barnett Shale in Texas. In fact the thicker Silurian layers suggests a substantially higher potential than in comparable deposits in the USA. In the Lublin Basin the layers seem to be almost ten times as thick (1,300m) as in average US shale. Experts also expect sizeable shale gas and CBM reserves in the Dnieper-Donetsk Basin. For example Mykola Zlochevsky (Minister of Environment and Natural Resources) and Eduard Stavytskyi (Chairman of Nadra of Ukraine) consider it the biggest shale gas deposit in the world. According to WoodMackenzie the Lublin Basin could contain 3 trillion cubic metres’ worth of reserves. Chevron also wants to jump the Ukrainian shale gas bandwagon and is currently in negotiations . The Ministry is also in initial negotiations with Shell and ExxonMobil in order to set up a joint venture for shale gas and CBM .
Due to the current dependence on Russian gas imports the development of these gas reserves would be of utmost importance to Poland and Ukraine to guarantee their future supply. The projects seem to be backed by political support, as confirmed by Yuriy Boiko, Minister of Energy, who within the next five years wants to produce an additional 20bn cubic metres of natural gas from shale gas and CBM. This is equal to half of the gas imports from Russia.
China also bets on shale gas
China alone wants to more than double the share of gas in the next decade and to massively reduce especially the combustion of coal, which is very harmful to the climate. Coal currently accounts for 80% of energy demand, whereas gas makes up only 1%. Beijing has come to realise that both CO2 and sulphuric emissions would have to be reduced drastically and local gas production would have to be supported. Unconventional gas is supposed to play an important part in this scenario and to cover 30% of Chinese gas demand by 2020 . PetroChina has recently announced that it wanted to step up the production of CBM by a factor of 12 to a total of 4mn cubic metres by 2015. The overall CBM resources of China are estimated at 37bn cubic metres.
The technology transfer for this development has already started. CNOOC and PetroChina have acquired numerous CBM and shale projects in the USA and Australia and established joint ventures. This highlights the fact that an agreement was entered into last year with the US government within whose framework China would be assisted in developing shale gas resources. On top of this PetroChina also invested USD 5.4bn in Encana, the leading Canadian gas producer. In this transaction, PetroChina has taken over 50% in the Cutbank-Ridge Shale project in British Columbia. The deal makes sense for both parties, given that the Canadians depend strongly on the US market and can thus diversify, and PetroChina benefits from the technology transfer. The fact that an LNG plant was being built in Kitimat seems to have put the seal on the cooperation.
Chinese gas production until 2020
Sources: BernsteinResearch, „The Long View: Bernstein Asia-Pac Energy – Lift Off For China’s Unconventional Gas Revolution“
Wood Mackenzie expects natural gas consumption in China to soar from 9 bcf/day today to 43 bcf/day in 2030, i.e. to increase by a factor of almost 5x. This is to be achieved on the one hand by substantially higher domestic production, and on the other hand by higher pipeline capacities from Central Asia and increased LNG imports. This was also a main issue in the recently published five-year plan. According to the latter, China should follow the example of the USA and turn into an essential producer of unconventional gas. Official Chinese statements have set the goal of defining 50 to 80 shale projects and exploring and developing close to 30 projects by 2020.
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Gas consumption per capita (as of 2009)
Sources: BP Statistical Review 2010, Bloomberg, Deutsche Bank, Erste Group Research
Shale gas: summary
“Shale Gas will Rock the World“
The global paradigm shift to shale gas seems to have come out of the starting blocks. Time will tell whether shale gas will be only a temporary solution on the way to renewable energies or indeed a prime energy source. But we are optimistic and believe that it will represent an essential part of a long-term energy solution. Generally speaking, gas should continue to gain importance and acceptance. The IEA forecasts a rising share of gas as part of the energy mix in its three models until 2035 in all three scenarios. We think that natural gas – and particularly shale gas – will act as an important bridge in order to be able to replace fossil energy carriers in the long run. This is also supported by the study of the Department of Future Analysis, according to which “natural gas perpetuates the challenges in safety politics created by peak oil and thus turns into a political secondary currency. The political weight of supply relations in natural gas records an appreciation.”
Source: BP Energy Outlook 2030
We expect the European shale gas production to increase substantially already from 2015 onwards. Shale gas will not be able to fully solve our energy problem, but it will be able to mitigate the situation profoundly. If the supply of gas rises in the long term, demand will adjust accordingly. T. Boone Pickens for one has promoted a radical idea. He recommends that all American trucks switch to liquefied gas. According to Pickens, this could cut the dependence on oil imports from the Middle East in half. As part of the improved production techniques and numerous new technologies, production costs were reduced substantially as well in the USA, which means that production would also make economic sense if the gas prices were to fall. We believe that the majority of projects would break even at USD 3.5mmBTU.
The long-term ecological implications should not be underestimated either. Natural gas is by far the cleanest fossil energy carrier. Especially in comparison with unconventional oil (e.g. oil sand) gas is ecologically clean and on top of that energy-efficient. The combustion of gas generates no soot, and the CO2 emissions are substantially below those of oil or coal. A gas-fired power plant emits almost 50% less CO2 than a coal-fired power plant. Thus it would probably be the simplest and most inexpensive solution in order to cut emissions, to shut down all coal-fired power plants and replace them with gas and steam turbines. The coal industry will therefore be one of the biggest losers, given that many planned coal-fired power plants will now not be built as a result of the measures intended to cut back on CO2 emissions. Lambert Energy estimates that this way the targets of the climate summit in Copenhagen might be met or even over-fulfilled . BP expects the share of gas in the European power generation to possibly rise from currently 42% to 65% in 2030. Given that the worldwide exploration has only just started, we are only at the beginning of a long-term development. We therefore believe that the shale gas sector represents one of the most attractive investment opportunities in the energy industry.
“Shale gas will impact the gas industry with the same force the Internet has impacted communication“ Ken Chernin
By. Ronald Stoeferle of Erste Group
Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.
