A multi-front revolution is underway in the international energy market that should deliver much cheaper energy prices including petrol pump prices over the next decade.
At the heart of it is technological innovations that are game changers on several fronts: fracking and shale oil and gas extraction; multi-well pad drilling for oil and gas; solar energy where the economic viability has improved dramatically; hydrogen-sourced energy that offers enormous potential but will take longer to be a game changer than solar; and fascinating but possibly red-herring developments with how nuclear energy is produced.
The big loser will be coal.
The big winners will be global economic growth and V8 car sales.
In part one of this three part series of Ravings I review a number of the issues related to fracking and shale oil and gas. Part two will be on solar energy.
Fracking has a bad name in environmental circles, but to put this issue in perspective, the US is currently enjoying gas prices that are below one third of the level they would if fracking hadn't been invented.
US gas prices are well under half the level faced by European consumers of Russian gas because of fracking.
It is driving a renaissance of manufacturing in the US that is boosting employment significantly.
But the fracking revolution will go global and this Raving shows how this is already starting to happen. Fracking is occurring in NZ already but not on the scale to have a major impact on local gas prices.
But even if there aren't any major new finds in NZ as a result of either elevated exploration or because of the new technologies being used to extract oil and gas, we should in time benefit from much cheaper energy and petrol/diesel prices because of global developments.
I am not an energy expert, although I have worked with several. I follow international energy market developments reasonably closely because of the exciting prospects in the pipeline.
This Raving draws on reading I have done on the topic over the last 1-2 years. Technological innovation is the quiet revolution occurring in many industries including the international energy industry that should get down energy costs over the next decade, make a significant contribution to economic growth and help the environment.
"Hydraulic fracturing also hydrofracturing, fracking, or fraccing) is a well-stimulation technique in which rock is fractured by a hydraulically pressurized liquid. A high-pressure fluid (usually chemicals and sand suspended in water) is injected into a wellbore to create cracks in the deep-rock formations through which natural gas, petroleum, and brine will flow more freely. When the hydraulic pressure is removed from the well, small grains of hydraulic fracturing proppants (either sand or aluminium oxide) hold the fractures open once the deep rock achieves geologic equilibrium.
The hydraulic fracturing technique is commonly applied to wells for shale gas, tight gas, tight oil, and coal seam gas. Such well-stimulation is common throughout the exploitation of the field to greatly increase the flow rate. Stimulation is intensified to extend the period before production declines.
Hydraulic fracturing began as an experiment in 1947, and the first commercially successful application followed in 1949. As of 2012, 2.5 million hydraulic fracturing operations had been performed worldwide on oil and gas wells; over one million of those within the U.S.
Hydraulic fracturing is highly controversial, proponents advocating economic benefits of readily accessible hydrocarbons, and opponents concerned for the environmental impact of hydraulic fracturing including contamination of ground water, depletion of fresh water [see page 7], degradation of air quality, triggering of earthquakes, noise pollution, surface pollution, and the consequential risks to health and the environment." (Source: http://en.wikipedia.org/wiki/Hydraulic_fracturing )
Fracking has resulted in dramatically lower US gas prices and the world will follow
The US has front-run fracking over the last decade, with a dramatic impact on domestic gas prices. US natural gas prices used to be dramatically more volatile than the West Texas oil price prior to fracking playing a major role, but there was a definite link between the two prior to 2009 (left chart).
Between 1998 and 2008 the correlation between the two was 0.80, which compares to a maximum possible correlation of 1.0 (i.e. it was high), but since 2009 the correlation has been mildly negative at -0.18. As the extraction of especially gas via fracking exploded in the US a dramatic gap has opened up between US oil and gas prices.
Fracking has been a dramatic game changer for US domestic gas prices. To put it in perspective, if the gas price was in line with the oil prices it would be around three times higher than it is today. No wonder energy-using manufacturing industries are experiencing a renaissance in the US.
The left chart above shows the massive international competitive advantage the US has in terms of gas prices, with the Russian gas price being relevant to European consumers. US gas isn't being exported because of legislative restrictions and a lack of infrastructure. Export licences are being approved and contracts to supply gas in the future have been signed. Some Asian buyers panicked and signed up for so much future supply they are now trying to sell some of it to European consumers.
Future US gas exports are already playing a part in getting down international gas prices. Pressure from Asian gas consumers and especially Japanese consumers is helping bridge the gap between US gas prices and international prices. This may be having an impact on Russian gas prices. The right chart above shows that up until late-2013 the Russian gas price remained closely linked to the West Texas oil price. The best fit was the oil price leading the gas price by six months with an extremely high correlation of 0.97. Where the oil price went the Russian gas price largely followed six months later. But a gap has started to open up between the Russian gas price and the oil price, although this may only be partly because the threat of the US exporting cheaper gas is starting to impact on international gas prices. The prospect of the US exporting gas is a threat to Australian gas export plans.
The US revolution is resulting in a dramatic fall in US net oil imports at the same time US consumption has stopped growth (see this link for a good CNBC article that also provides some info on the boost to US manufacturing from cheap gas prices). The chart below is sourced from the original NBC article (i.e. before it became CNBC - I apologise for the poor quality of the chart). Reduced US imports means international producers have to export more to other markets, which includes Canada and Mexico that are boosting or planning to boost production via fracking. There are plans for major new pipelines and port facilities in Canada so it can export shale gas to Asia and especially Japan.
There are environmental and financial risks associated with the US fracking revolution, but the financial incentive for the US to expand the use of fracking is likely to win out and the same is likely to be the case around the world to varying degrees (see below). The world gas market will become more integrated, as discussed below, meaning price differentials will narrow. Prices around the world probably won't fall to current US levels, but they should fall significantly, aided by the march of technology.
US and global shale gas potential thanks to fracking
The US still has some major areas to apply fracking and boost oil and gas extraction from shale rock and "tight" formations. Here a video that provides background info on fracking as well as the huge potential to increase extraction of oil and gas using fracking from the "Petroplex" area in Texas. I recommend watching this video, but ignore the tail-end plug for investing in a related company.
There is great scope for debate over how much US oil and gas production will increase, with this link to a Reuters' article that reviews this potential, but there is massive upside potential. The map below shows how extensive shale gas reserves are in the US.
It isn't all plain sailing, with challenges to fracking in addition to the environmental ones. Some areas are producing more than can be currently shipped.
Extracting shale oil and gas has high upfront costs and it is possible some operators will fail, while gas prices may have to increase more to make larger-scale future extraction possible.
High US costs of extracting oil from shale formations and high debt levels are a threat to some companies, with the threat increasing if oil prices fall more and interest rates increase.
But technology is coming to the rescue in the form of "multi-well pad drilling" or "octopus" drilling that dramatically reduces upfront costs (both land and drilling platform) and dramatically increases recovery rates (see this video about octopus drilling but again ignore the trailer offering investment advice, while this link is a brief Santos video about using multi-well pad drilling to extract coal-seam gas in Australia).
The US is granting export licences for gas while the potential for shale oil and gas extraction around the world is massive (see the map below that excludes Russian reserves). But it will be some time before other countries catch-up with the US.
There are technical challenges to adopting US shale techniques (e.g. different geology that means difference techniques are needed) and the US companies aren't giving away their secrets.
There are major infrastructure challenges (e.g. the lack of infrastructure to transport the gas from where it lives to the factories and homes that will use it).
But the potential returns are so large the obstacles will be overcome. In the case of China part of the motivation is to reduce the massive reliance on coal-sourced energy because of the air pollution caused by coal.
The map below shows known "world" shale gas resources and was produced by the US Energy Information Agency (EIA), it may be slightly dated but it shows that there is lots of the stuff around the world even when Russia is excluded. The following text explains the map: "In total, the report assessed 48 shale gas basins in 32 countries, containing almost 70 shale gas formations. These assessments cover the most prospective shale gas resources in a select group of countries that demonstrate some level of relatively near-term promise and for basins that have a sufficient amount of geologic data for resource analysis. The map shows the location of these basins and the regions analyzed. The map legend indicates four different colors on the world map that correspond to the geographic scope of this initial assessment:
- Red colored areas represent the location of assessed shale gas basins for which estimates of the 'risked' gas-in-place and technically recoverable resources were provided.
- Yellow colored area represents the location of shale gas basins that were reviewed, but for which estimates were not provided, mainly due to the lack of data necessary to conduct the assessment.
- White colored countries are those for which at least one shale gas basin was considered for this report.
- Gray colored countries are those for which no shale gas basins were considered for this report." [This includes Russia where there is major potential - see below.]
China has started to make early progress with fracking and has the advantage of being able to largely ignore some of the environmental fallout. This needs to be viewed in the context of the drive in China to reduce the reliance on coal that is reported by make-up 70% of energy supply, with coal having a much larger negative environmental impact.
This link below explains some of the challenges in China, but it is a bit dated.
"Demand for natural gas is set to nearly double within five years in China but the emerging market giant will meet half that with domestic supplies, the International Energy Agency said Tuesday. … demand for cleaner-burning natural gas was likely to grow in China as air quality concerns prompted authorities to take measures to reduce pollution." (Source.)
Russia will in time become a major playing in shale oil (and gas) production: "According to BP analysts, Russia may become one of the world's chief countries in shale oil production. Tax incentives are already in place, the only stumbling block is the technology. According to a BP forecast, in 20 years' time, Russia will become the world's second largest tight oil producer. The company's experts estimate that by 2035 it will be producing 800,000 barrels of shale oil a day.
When it comes to shale oil, there is a confusion in terms between Russia and the United States. What is known in the U.S. as shale oil, meaning that it is produced from oil shale, has been since Soviet times known in Russia as tight or unconventional oil.
Russia's oil majors confirm BP experts' predictions by declaring that they view unconventional oil production as a priority. A source at Rosneft said that the company's estimated reserves of shale oil stood at about 1.4 billion tons." (Source.)
The current embargos on Russia will have a negative impact on oil and gas exploration: "Fresh U.S. and EU sanctions imposed on Moscow will bring an abrupt halt to exploration of Russia's huge Arctic and shale oil reserves and complicate financing of existing Russian projects from the Caspian Sea to Iraq and Ghana." (Source.)
But Russia and China have signed major deals, including plans for massive spending on a pipeline and port facilities that will increase Russia's ability to make use of the massive potential it still has to increase oil and gas production via exports to Asia (here and here). It will take some time, but the global gas market will become much more integrated over the next decade, which should mean less disparity between gas prices in different parts of the world (i.e. the US will lose the current major competitive advantage it currently has). It may result in higher US prices, but should mean significantly lower gas prices outside of the US.
Things are moving slowly in Australia because of environmental constructions, but it could in time become a significant player in the global shale gas market if it can be cost competitive (see here and here): "New draft regulations which pave the way for the start of commercial shale gas fracking have been released in Western Australia. WA is estimated to have one fifth of the world's shale gas reserves, natural gas which is released by fracturing shale rock thousands of metres below the earth's surface."
Even the UK is trying to get in on the game: "Britain is on track to "accelerate” its shale gas programme, according to Michael Fallon, the energy minister, as he confirmed a new licensing round for oil and gas explorers will take place next year [2014]. The Government will next year [2014] launch the UK’s 14th onshore licensing round, he said, announcing that engineering consultancy AMEC has been hired to do the environmental assessment of plots' suitability for exploration. The last such licensing round closed in February 2008, meaning this will be the first to take place since the shale gas revolution in the US, which has been at the forefront of the drive to extract methane gas trapped in layers of shale rock."
Japan and India are working together to get down Asian gas prices (here).
As the fracking boom goes global it should mean not only cheaper gas prices outside of the US and maybe somewhat higher prices in the US, it should also mean lower energy prices more generally (see this link for a Reuters' article that partly links the latest fall in the oil prices to the gas revolution in the US).
Fracking and shale oil and gas are only a part of what will shape global energy prices over the next decade and beyond driven by technological advancements.
The next Raving will look at the advancements being made with solar energy that should have a negative impact on oil prices and positive impacts on global economic growth and the environment.
The water threat to fracking; enter cryogenic fracturing and hydrogen-sourced energy
Fracking uses lots of water and parts of the west coast of the US have been experiencing a protracted drought that is playing a part to fuelling opposition to fracking that could end up being a significant obstacle (see this link - you may need to use Google or Firefox rather than Chrome to open this link as I couldn't get it to open with Chrome). This link has reference to a report about a new fracking technique that could partly solve the water problem: cryogenic fracturing.
This link is a better source of info about cryogenic fracturing. Water is the solution when it comes to hydrogen-sourced energy that will be covered in the third Raving in this series of Ravings on the energy revolution. Where this march of technology leads to in the energy field I can't tell, but the possibilities are both fascinating and enormous and it appears to be time to start taking the potential sources of lower energy prices seriously.
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*Rodney Dickens is the managing director and chief research officer of Strategic Risk Analysis Limited.