This article is to be published by the Boston College Finance Magazine - 2013 Edition
by Debashis Das (MSF-2014) , Tracy To (MSF-2014)
Introduction
The
United States is sitting on a large amount of oil and natural gas reserves. These
reserves have been further increased by the newly-discovered Bakken Shale and
the Utica Shale formations. Coupled with the new technology of horizontal
drilling and hydraulic fracturing (also known as ‘fracking’), this opens up new
potential for companies in this this industry and for the country. The supply
glut has helped push natural gas prices down which is beneficial for a host of
secondary industries, including electric power generation utilities, chemical
companies, steel companies, etc. The shale revolution in the U.S. is creating many
jobs in places like North Dakota, where due to the Bakken Shale formation, the
unemployment rate is lower than average for the rest of the country. This article
looks at the different shale regions, how natural gas is extracted from the
shale formations, what drives the price of natural gas, i.e. the different
aspects of supply and demand and also the environmental aspects of horizontal drilling.
US Shale Regions
The
major oil and gas shale formations in the continental US includes: Bakken
Shale, Barnett Shale, Eagle Ford Shale, Haynesville Shale, Marcellus Shale, and
the Utica Shale formations. The Bakken Shale formation, located in Montana and
North Dakota, is estimated to hold 4.3 billion barrels of oil and is the
largest oil find in U.S. history. The estimates may grow as more companies
drill and find oil in that region. The formation ranges in depth from 4500 –
7500 feet with an average thickness of 22 feet. In 2009 Bakken Shale in North
Dakota produced 80 million barrels of oil making it the fourth largest oil
producing state after Texas, California and Alaska.
In
Texas, Barnett Shale, the nation’s most developed shale gas play, is estimated
to hold 43.4 trillion cubic feet (Tcf) of natural gas and has already produced
more than 4.8 Tcf. It stretches across 6500 square miles and its natural gas
reserves are enough to power all of Texas’s homes for almost 200 years. Also in
Texas, the Eagle Ford Shale formation which did not become productive until
2008 has an estimated 21 Tcf of natural gas and 3.35 billion barrels of oil
reserves. This shale formation ranges in depth from 5700 to around 10,200 feet
and covers around 3000 square miles.
Surpassing
the Barnett Shale formation, the Haynesville Shale gas formation located in
western Louisiana, east Texas, and south-western Arkansas has an estimated 74.7
Tcf of shale gas reserves and ranges between 10,500 and 13,500 feet in depth.
The area encompasses more than 9000 square miles, is about 200 to 300 feet
thick and is considered to be the second largest natural gas shale formation in
the United States.
The
Marcellus shale formation, stretching across 5 States (New York, Pennsylvania,
West Virginia, Ohio and Maryland), is estimated to contain 410 Tcf of shale
gas. The total area is around 95,000 square miles and the depth is from 4000 to
8000 feet. The thick organic-rich shale intervals are concentrated in the
northeastern Pennsylvania, coincident with where the highest leasing activities
are.[1] The
Utica Shale formation, a relatively new shale discovery is located few thousand
feet below the Marcellus shale. Utica Shale, believed to be larger and thicker
than Marcellus based on the early testing results, is still under evaluation.
Much of the exploration in the Utica Shale formation is occurring in eastern
Ohio where this shale formation is closest to the ground. It is estimated to
hold more than 15 Tcf of natural gas and 5.5 billion barrels of oil as per Ohio
Geological Survey.
Shale Gas – Extraction Process
Today,
hydraulic fracturing is used extensively for shale oil and gas extraction and
use a combination of water, oil, sand, and chemicals as a fluid through
concentric steel tubes to create fractures in the rock. The fluids most commonly
used in the hydraulic fracturing process are water, sand and chemical additives,
which include sodium chloride (table salt), ethylene glycol (present in
household cleaners), borate salts (used in cosmetics), sodium/potassium
carbonate (used in detergent), guar gum (used in ice-cream) and isopropanol
(used in deodorant).[2] The
hydraulic fracturing fluid is injected into the well at very high pressure to
open cracks into the shale rocks. The sand remains in the fractures, holding
the fissures open and allowing the oil and gas to flow into the well, along
with the fluids. Figure 1 illustrates the process of hydraulic fracturing or
‘fracking’.[3] With
hydraulic fracturing and horizontal drilling, much shale resource once
considered inaccessible has becomes available. Additionally horizontal drilling
has drastically reduced the footprints the exploration and production (E&P)
company’s leave on the surface with the drilling pad site is much reduced.
Natural
gas (primarily methane) extracted from a well has liquefiable hydrocarbons
(e.g. propane, butane, etc.) as well as other contaminant gases (carbon
dioxide, hydrogen sulfide, etc.) and is referred to as ‘wet natural gas’.
Natural gas from which these components of liquefiable components and
contaminants are removed is referred to as ‘dry natural gas’. This separation
is done at a natural gas processing plant close to where the gas is extracted.
This dry natural gas is consumer grade and sent through pipelines for
distribution to consumers or for liquefaction for export purposes.
Figure 1. Hydraulic
Fracturing Process
Natural Gas – Supply, Demand & Price Stability
Natural
gas prices hit a bottom of around $1.90/MMBtu (per million British thermal
units) in April 2012 from a high of around $14/MMBtu during the commodities
boom of 2007 – 2008. There are a few reasons for this price fluctuation including
the state of the economy, supply and demand scenario, variations in weather
patterns in winter and summer, imports, severe weather conditions (e.g.
hurricanes which are normal and hits the Gulf coast, often leads to shutdown of
production facilities), storage capacity, alternate fuel usage and industrial
and consumer demands.
A
common measure of the long-term viability of U.S. domestic crude oil and
natural gas is the remaining technically recoverable resource, also called
remaining TRR. Estimates of TRR are often not certain, specifically for the new
sites where few wells have been drilled. The remaining TRR consists of ‘proved
reserves’ and ‘unproved resources.’ Proved reserves of crude oil and natural
gas are the estimated volumes which are expected to be produced with certainty
under existing economic and operating conditions. Unproved resources are
additional volumes expected to be produced without consideration of economics
or operating condition. As wells are drilled, unproved resources become proved
reserves and ultimately contribute to the production figures. Estimates of
unproved resources can change significantly as more is learned about the fields
where drilling continues. The unproved reserved has dropped to 482 Tcf in the Annual
Energy Outlook 2012 report (as of 1/1/2010) from 827 Tcf as of 1/1/2009.[4]
Nevertheless, the proved reserves of U.S. wet natural gas at December 31, 2010
increased to 318 Tcf from 284 Tcf at December 31, 2009, a 11.9 % increase.[5]
The Energy Information Administration (EIA) expects that natural gas
consumption in the U.S. will average around 70 Bcf/d in both 2013 and 2014.
Closer to average temperatures in 2013 and similar forecasts for 2014 (compared
to record-warm temperatures in 2012) have led to higher than average usage of
natural gas for commercial and residential heating.
U.S.
Dry Natural Gas Production totaled 24.05 Tcf following 22.9 Tcf in 2011,[6] an
increase of 5.0% in 2012, 7.8% in 2011, 3.4% in 2010 and 2.3% in 2009
year-on-year as shown in Figure 2. Figure 2 also shows the record production
levels achieved in 2011 and in 2012 surpassing the previous record production
levels from the early 1970’s. The increase in production is attributed to
various factors, including more cost-efficient drilling techniques such as
horizontal drilling, which have resulted in an increased output from the shale
formations. In the long run increase in supply will push prices down and will
deter exploration and production companies to increase their drilling acreage.
This will reduce the gas output thereby decreasing production and hence
maintain the equilibrium between supply and demand.
Figure 2. U.S.
Dry Natural Gas Production historical data (1930 – 2013)
It
is surprising, but true that although U.S. is awash with natural gas through
its various shale formations, the country still imports natural gas for its
domestic usage through pipelines primarily from Canada and Mexico and also as
LNG (liquefied natural gas) from Africa, the Caribbean, and the Middle-East.
Imports increased from the mid-80s to around 2007. Since that time, imports
have decreased due to various factors, including a weak economy, high storage
levels, and increasing production here in the U.S as shown in Figure 3.[7]
Economic
growth can fuel consumption of natural gas and hence positively affect the
demand and support higher prices. Higher demand exists from industrial and
commercial sectors during times of strength in the economy. Steel plants use
natural gas as their plant fuel and similarly, companies in the chemical sector
[e.g. Dow Chemical (NYSE:DOW) or Lyondell Basell (NYSE:LYB)] and fertilizer
companies use natural gas as their raw feedstock. Economic downturns, as well
as the cyclical nature of these industries, can have a negative effect on demand.
Figure 3. U.S.
Natural Gas Imports historical data (1970 – 2013)
Natural
gas in underground storage fields also plays a critical role in the supply and
demand equation and helps maintain the price equilibrium. During sudden demand
spike situations, either due to weather conditions (hot or cold) or pipeline
outage issues, reserves are released to meet the additional needs in the market
and thus support price stability. Natural gas levels in storage typically
increase from April – October and decrease during the heating season from
November – March. This ‘saw-tooth’ pattern repeats every year and is shown in Figure
4.[8]
Prices
of other alternative fuels also have an effect on natural gas prices
specifically that of crude oil and coal. Between the EPA coming down hard on
the usage of coal and strict emission standards in power plants, there has been
a push to move into the cleaner, natural-gas-based electricity generation. This
trend has been helped by lower natural gas prices and higher supply, thus
creating demand.
Figure 4. Lower
48 states Natural gas Working Underground Storage historical data (1994 – 2013)
Higher
crude oil prices will tend to move some of the demand over to natural gas. An
example of this is 18 wheeler trucks, which could run on natural gas and not
only save on diesel fuel costs as compared to the cheap natural gas, but also
pollute the atmosphere less. T. Boone Pickens (hedge fund investor) has been
pushing for government subsidies in the trucking sector for years but this has
yet to be passed, although it is gaining support from the president and politicians
from both parties. Clean Energy Fuels Corp (NASDAQ: CLNE), which is majority
owned by T. Boone Pickens, has been installing natural gas stations for
refueling purposes. More and more companies like United Parcel Service, Inc.
(NYSE:UPS) and others have started adopting natural gas based vehicles,
although the number is not large currently.
Export & Import Landscape
Cheniere
Energy (NYSE: LNG) is the first company to get approval from the Federal Energy
Regulatory Commission (‘FERC’) for the construction and operation of a facility
which would liquefy and export domestically produced natural gas from the
Sabine Pass LNG (owned 100% by Cheniere) terminal located in Louisiana. The
Sabine Pass terminal has regasification and send-out capacity of 4.0 billion
cubic feet per day (bcf/d) and storage capacity of 16.9 billion cubic feet
equivalent. This approval would help to add even more capacity to the current
Sabine Pass LNG terminal. Cheniere has also entered into a long-term contract
for sale of LNG on the order of 16.0 mtpa (million tons per annum) to the
following: BG Gulf Coast LNG (5.5 mtpa), Gas Natural Fenosa (3.5 mtpa), Korea
Gas Corp (3.5 mtpa) and GAIL India Ltd. (3.5 mtpa).[9]
Earlier in 2012, Cheniere entered into a contract with Blackstone Capital
Partners, an affiliate of the popular private equity firm The Blackstone Group,
whereby Blackstone Capital Partners agreed to fund the equity needed for the
expansion of the Sabine Pass LNG terminal project, highlighting the importance
of this project to the investment community. Net imports (imports minus
exports) have been falling and are at its lowest level since 1992 as shown in
Figure 5,[10] which
is good for the overall U.S. economy as it becomes less dependent on foreign
reserves of natural gas.
Figure 5. U.S.
annual average natural gas net imports (1973 – 2011)
Environmental Aspects of Shale Gas Drilling
Although
natural gas is a relatively clean energy which, in use, releases fewer
emissions than does coal or oil, its production process can create
environmental impact if proper precautions are not employed. Among all, the
potential of water impact is the most concerned. As the hydraulic fracturing
process uses large volumes of water, which later results in waste water, there
can be impacts on drinking water resources and aquatic ecosystems. As mentioned
earlier, hydraulic fracturing fluids consist of water, oil, sand, and chemicals.
In case of spills or leaks from the storage on site where the fluid is placed
before injection, or through the injection well, surface water and underground
aquifers may be contaminated on contact with the fluids. Once the fracturing is
completed, the hydraulic fracturing waste water is withdrawn and returned to
the surface. In addition to the fracturing fluid, the flow back fluid can
contain natural gas, high levels of total dissolved solids (chemicals), metals,
and naturally occurring radioactive materials.[11]
Typically, this waste water is recycled for use in fracturing fluid,
transported to treatment facilities, or disposed of by injection into deep
wells. The environment impact would be severe should the waste water be
improperly handled and discharged to surface soil or water during storage for
reuse, transportation to treatment plants or disposal into wells. Besides, historical cases suggest that waste
water injection into deep wells induces earthquakes, and that there is a
correlation between the magnitude of the largest earthquake and the total
volume of waste water injection.
While
FracFocus, the national hydraulic fracturing chemical registry, discloses
chemicals that are used in hydraulic fracturing, and also provides public
access to the official state chemical disclosure for 10 states,[12] a
report highlights that energy companies didn’t report thousands of their oil
and natural gas wells as having been hydraulically fractured on FracFocus.org.”[13]Air
quality is also impacted near natural gas production areas. Emission of a high
volume of volatile organic compounds (VOCs), hazardous air pollutants (HAPs)
and methane are associated with the waste water returning to the surface.
Conclusion
Shale
oil and gas production in U.S. has risen to record levels over the last few
years due to improvements in drilling technology. Due to the abundance in
supply from the existing and the recently discovered shale formations,
improvement in drilling techniques and technologies, stalled economic activity
and various other reasons including seasonal change in demands, prices have
fallen drastically from their 2007-2008 highs, although lately it has risen
back up from the lows of April 2012 when the price fell below $2/MMBtu. Lower
natural gas prices are a boon for some of the industries, including chemical,
steel, fertilizer and power generation utility companies. Exploration and
Production companies drilling for natural gas, need to ensure proper precaution
when horizontal drilling for oil and gas in the shale regions, to avoid water contamination.
The current shale reserve estimates are good enough to support the needs of the
U.S. for many years to come and is prompting companies to export natural gas
globally to other places where because of less supply it demands higher prices,
e.g. China, Japan and other places in Asia. Politicians in this country should
take a closer look and take necessary steps to ensure that the U.S. can reap
the full benefits of what exists in abundance naturally, including passing laws
to promote liquefied natural gas export and opening up areas where natural gas
can be used easily. This would help the U.S. to boost employment thereby
reducing unemployment rate as companies drill more natural gas which finds
usage in different industries within this country and outside globally as well.
Notes
[1]
Marcellus Shale – Appalachian Basin Natural Gas Play: http://geology.com/articles/marcellus-shale.shtml
(accessed April 06, 2013)
[2]
Understanding Fracturing Fluid: http://www.energyfromshale.org/hydraulic-fracturing/hydraulic-fracturing-fluid
(accessed March 31, 2013)
[3] What Is
Hydraulic Fracturing?: http://www.propublica.org/special/hydraulic-fracturing-national
(accessed March 31, 2013)
[4] U.S.
Energy Information Administration (EIA), Annual Energy Outlook 2012: http://www.eia.gov/forecasts/aeo/pdf/0383(2012).pdf
, 57 (accessed March 31, 2013)
[5] U.S.
Crude Oil, Natural Gas, and NG Liquids Proved Reserves: http://www.eia.gov/naturalgas/crudeoilreserves/index.cfm
(accessed March 31, 2013)
[6] U.S. Dry
Natural Gas Production data: http://www.eia.gov/dnav/ng/hist/n9070us2A.htm (accessed March 31, 2013)
[7] U.S.
Natural Gas Imports: http://www.eia.gov/dnav/ng/hist/n9100us2a.htm
(accessed March 31, 2013)
[8] Lower 48
States Natural Gas Working Underground Storage: http://www.eia.gov/dnav/ng/hist/nw_epg0_sao_r48_bcfw.htm (accessed March 31, 2013)
[9] FERC Approves the Sabine Pass Liquefaction Project: http://phx.corporate-ir.net/phoenix.zhtml?c=101667&p=irol-newsArticle&ID=1683624&highlight=
(accessed March 31, 2013)
[10]U.S.
natural gas net imports at lowest levels since 1992: http://www.eia.gov/todayinenergy/detail.cfm?id=5410 (accessed March 31, 2013)
[11] Natural
Gas Extraction – Hydraulic Fracturing: http://www2.epa.gov/hydraulicfracturing#wastewater
(accessed April 06, 2013)
[13] Benjamin Haas, Jim Polson, Phil Kuntz & Ben
Elgin, “Fracking Hazards
Obscured in Failure to Disclose Wells”, August 14, 2012: http://www.bloomberg.com/news/2012-08-14/fracking-hazards-obscured-in-failure-to-disclose-wells.html (accessed April 06, 2013)
