Shale Revolution in the United States

This article is to be published by the Boston College Finance Magazine - 2013 Edition

Originally Dated: Apr 07, 2013

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

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[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)

[12] Frac Focus Chemical Disclosure Registry: http://fracfocus.org/welcome

[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)