Since its nascent stage, there has been much scepticism surrounding the US shale gas industry to the point that the excitement surrounding shale plays was compared to that of the run-up to the US housing bubble which scaremongers predicted would soon burst. Approximately seven years after, the US continues to enjoy cheap and abundant natural gas supplies which have driven prices to historical lows. Natural gas price in the US is approximately one-third of the price in Europe and one-quarter of that in Asia giving a competitive edge to the country as energy-intensive industries benefit from lower energy costs. As other countries race to develop their own unconventional resources in an attempt to replicate the boom enjoyed by the US, the question arises as to if the US will be able to maintain this advantage relative to its competitors in the future. The factors supporting this competitive advantage so that it remains sustainable are as follows:
Reserves and geological data
In the US Energy Information Administration’s (EIA) most recent assessment of global shale resources, the US was found to have the fourth largest technically recoverable shale gas resource. While reserves are undeniably important, the insight to understand what is there and the creativity to extract it in a commercially viable way is also essential.
Economic recoverability is considerably influenced by several factors apart from geology. While the exploration and production of shale gas is not confined to the US, the US industry is quite well developed relative to the rest of the world. This is mainly because in addition to its prolific reserves the country benefits from the availability of many skilled independent operators and supporting contractors; an advanced gathering and pipeline infrastructure and the availability of water resources for use in hydraulic fracturing.
Moreover, the US has an extensive history of oil and gas development which has endowed the country with a comprehensive geological database. While several studies have shown that there are large shale resources outside North America, geological data in other countries are much less reliable making estimates very speculative.
Lower production costs
Development of shale resources can require a significant amount of investment. One of the main issues that will be encountered by many countries is the relatively higher cost of production as compared to the US.
The difference stems from advances in the techniques of hydraulic fracturing and horizontal drilling. These methods have been refined in the US and combined together in an innovative way allowing commercial extraction of shale resources.
Land-based exploration and production (E&P) industry
The US has an extensive land-based oil and gas E&P industry. As at February 2014, there were 1,714 land-based rigs in the US compared to 91 in Europe. Moreover, due to differences in regulation regimes and labour practices, rigs in the US take approximately one-third less time to drill and complete an onshore well.
Differences in Property Law
The US strongly benefits from the fact that subsurface mineral rights are in the hands of its citizens as compared to Europe and Asia where these generally belong to the state. This has the advantage of encouraging land-based exploration as landowners benefit financially from energy companies which purchase the rights to these mineral resources. As a result, citizens in the US generally support the development of hydrocarbon reserves as opposed to Europe and Asia where locals do not directly benefit from E&P activities.
Oil and Natural Gas Liquids (NGL) prices
During the period 2008 to 2013, natural gas prices plummeted by approximately 58% from $8.89 per million British thermal units (mmbtu) to $3.73. At such low prices, it becomes unattractive to invest in wells that produce only gas compared to those that produce oil or a combination of natural gas and NGLs. As a result, energy producers have begun focusing on liquids-rich parts of basins driven by higher oil prices (since these also influence NGL prices) which have resulted in the production of associated natural gas. As producers continue to engage in profitable liquid extraction in light of a high oil price outlook, it is expected that there will be corresponding increases in associated gas production.
On the other hand, the factors which have the potential to erode this competitive advantage are as follows:
The US de facto export ban
In recent times, there has been much clamour over the tight export restrictions surrounding US natural gas exports due to the differences in the perceived impact it would have on the economy. The US exports a significant amount of natural gas through pipelines to Canada and Mexico (both of which are partners under the North American Free Trade Agreement (FTA)) but its Liquefied Natural Gas (LNG) exports are negligible. As the US continues to evaluate applications to export LNG to non-FTA countries, it is expected that no matter how much production capacity is approved, the rise in the US natural gas price will be limited since potential importers will only purchase LNG from the US if the cost of the wellhead price plus infrastructural costs is less than the cost of competing supplies. It has been shown that exports to both Europe and Asia are only economical when US gas prices are in the range of $5-$6 per mmbtu given infrastructural costs. Moreover, it will take several years before the US actually starts to export LNG on a global scale and logistical challenges have the potential to stymie these efforts in the short to medium term.
As can be seen in the figure above (Source: Bloomberg), coal’s share in total US power generation tumbled from 52.3% at the beginning of 2004 to 40.4% at the end of 2013 while natural gas’s share almost doubled from 13.8% to 26.1% over the same period. The shale gas revolution has pushed natural gas prices so low that US electricity generators have spurned coal in favour of natural gas. Low gas prices, slow growth in electricity demand combined with mounting regulations by the US Environmental Protection Agency (EPA) is projected to lead to the retirement of approximately 60 gigawatts of coal-fired capacity by 2020. This is expected to increase as the EPA continues to build on its existing stringent regulations. As coal-fired plants are decommissioned, this will create opportunities to switch to Combined Cycle Gas Turbines (CCGT) to fill the gap created as well as to meet incremental electricity demand in the future. This will place upward pressure on gas prices in the short term but it will be limited since current infrastructure places a ceiling on the amount of coal-to-gas switching that can occur and the demand for natural gas peters out at higher gas prices.
While the shale gas revolution has brought a number of economic benefits including that of a possible manufacturing renaissance, the technique of fracking has stirred fierce opposition due to the perceived environmental and health risks it poses. This has led to some places prematurely enforcing bans on the practice.
At present, environmental regulators are investigating these concerns in an attempt to address any threats associated with this technology. It is anticipated that no matter the outcome of these investigations, procedures and policies will be put into place to help the industry to continue to develop this resource safely. This has the potential to feed into higher costs for producers which can be passed on to consumers through higher prices.
It is envisaged, however, as regulation continues to increase, it will drive further industry innovation towards cost effective solutions to the problems surrounding fracking thereby mitigating any price increases that may occur.
Natural gas in the form of Compressed Natural Gas (CNG) can be used as a transportation fuel. At present, a number of firms in America are seeking to reduce costs by switching to gas power. However, while the interest in CNG continues to grow, logistical challenges such as the shortage of filling stations and the cost and size of fuel tanks continue to restrict demand.
In conclusion, it is expected that the US will maintain its competitive advantage in the foreseeable future. While the environmental factor has the potential to push natural gas prices higher in the short to medium term, it will not erode the benefits from fracking unless there is a complete ban on the process-a scenario which is highly unlikely. It is anticipated that in the medium to long term as demand for natural gas rises in the petrochemical, power generation and transportation sectors and as the US begins to ramp-up LNG exports, natural gas price will rise in the US. At the same time, as other countries begin to produce natural gas from unconventional sources, relative prices will begin to fall in these countries narrowing the natural gas price gap. However, this will not occur uniformly as some countries (for example, some European Union member states) have structural issues which can keep the energy price gap wide for several years. In the end it is inevitable that the law of one price will prevail but this will not occur until many years well into the future.
1. AEO2014 projects more coal-fired power plant retirements by 2016 than have been scheduled, U.S. Energy Information Administration, February 14th 2014.
2. American Industry and Fracking, From sunset to new dawn, The Economist, Nov 16th 2013
3. Baker Hughes North America Rig count (http://phx.corporate-ir.net/phoenix.zhtml?c=79687&p=irol-reportsother)
4. BofA, Bernstein reduce U.S. gas price outlook, blame Marcellus Shale, Platts (McGraw Hill Financial), Bill Holland and Keiron Greenhalgh, August 22nd 2013.
5. Energy: The toll on coal, Pilita Clark, James Wilson and Lucy Hornby, Financial Times, September 30th 2013.
6. Frantic fracking sends US gas prices in freefall, Gregory Meyer, Financial Times, August 6th 2013.
7. How to push world gas prices down to US levels, John Dizard, Financial Times, December 9th 2012.
8. Industry advancing waterless fracking, Oilgram News, Volume 92, Number 8, January 13th 2014.
9. International Rig Counts, Baker Hughes (http://phx.corporate-ir.net/phoenix.zhtml?c=79687&p=irol-rigcountsintl)
10. Macroeconomic Impacts of LNG exports from the United States, NERA Economic Consulting, AGI Energia, April 23rd 2013.
11. One Way to Solve Fracking’s Dirty Problem, MIT Technology Review, September 24th 2013
12. Shale Gas in Asia: Significant Reserves, substantial challenges, Jennifer Tomsen and Marc Davies, Bloomberg Law, 2013.
13. Technically Recoverable Shale Oil and Shale Gas Resources: An Assessment of 137 Shale Formations in 41 Countries Outside the United States, U.S Energy Information Administration, June 13th 2013 (www.eia.gov/analysis/studies/worldshalegas/ )
14. The Natural Gas Boom: Cheap Energy but at what cost? Knowledge@Wharton, University of Pennsylvania, April 30th 2013.
15. US has potential to be world’s biggest oil producer, Ed Crooks, Financial Times, September 8th 2013.
16. US LNG exports: Waiting is the hardest by the Lex team, Financial Times, March 10th 2014.
17. Why capacity limits coal-to-gas switching for power generators, Market Realist, Ingrid Pan, November 4th 2013.
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