This policy brief, which will be followed by a companion piece, was commissioned by Oxford Analytica and published in the end of 2009. The other piece, which deals with the impact of the new gas finds on the LNG and Pipeline sectors will be posted in the next few days.
SUBJECT: How huge new US unconventional gas developments will change markets.
SIGNIFICANCE: Recent evaluations based on production data for the Appalachian Basin Marcellus Shale formation estimate potential gas production at 489 trillion cubic feet. Other newly discovered gas sources will ultimately push US unconventional reserves to well in excess of current Russian proven reserves. Although this resource, and several other massive unconventional finds, will take years to develop, the impact on US, North American, and global gas markets will be enormous.
ANALYSIS: Since 1971, when US gas production peaked at 24.08 trillion cubic feet (Tcf), rising demand combined with a gradual decrease in production led to a steady increase in gas imports. Still, even with the decline in production, the US is currently the second-largest world producer (behind Russia) and imports only 13% of its total demand. Traditionally, Canada provided approximately 90% of these imports, but Canadian conventional gas production is now also tapering off. This downward trend in conventional North American gas production defined energy markets for the better part of the last two decades. However, this dynamic may now be upended by massive new ‘unconventional gas’ discoveries in the United States, displacing imports and altering the global gas market.
Gas and power generation. Gas currently plays an important role in the US energy mix:
- It constitutes 23% of the country’s fuel mix — behind oil and coal — and generates 22% of domestic electricity.
- While burning gas does produce ‘greenhouse’ gases (GHG), it emits half the CO2 per megawatt hour (MWh) of coal.
- Compared to oil and coal, combustion of natural gas liberates much smaller amounts of sulphur dioxide and nitrogen oxides, and virtually no ash.
Consequently, from an environmental perspective, natural gas may provide a bridge to a low carbon economy. Environmental concerns are among the factors that caused gas to account for 71% of new electrical generation capacity from 2005-07.
Conventional decline implications. The decline of conventional gas production over the past two decades has produced two key effects:
- Prices. Although price volatility is the norm in gas markets, and the rise over time was not linear, North American gas prices climbed steadily until recently. The Henry Hub price per million British Thermal Units (MMBtu) went from an average of 1.7 dollars per MMBtu in 1990, to 4.32 dollars in 2000, and to 8.83 dollars in 2005. After dropping to the upper range of 6 dollars/MMBtu for the next two years, prices averaged 8.86 dollars last year. The onset of the global financial crisis has, for now, reversed this trend. Prices recently hit their lowest point in almost eight years — so far, the 2009 average is 3.54 dollars/MMBtu.
- Unconventional production driver. Another consequence of the declining production/increasing consumption scenario was a push to develop unconventional gas reserves. The United States has 237.7 Tcf of proven gas reserves. However, this is just a small fraction of what the US Energy Information Administration classifies as ‘technically recoverable’ gas. The latter figure is a staggering 1,744 Tcf (considerably larger than proven Russian reserves), of which unconventional gas accounts for 60% of onshore recoverable resources. In fact, unconventional gas already accounts for almost half of the US current production of 19.4 Tcf. At this rate, available resources are enough to supply US demand for at least the next 90 years; other reliable estimates extend this potential to 116 years or more.
As conventional reserves continue to decline, increased dependence on unconventional sources is inevitable — and the technical challenges of producing unconventional gas are not trivial.
Unconventional gas. The term ‘unconventional’ natural gas does not refer to the composition of the fuel, which is the same mixture of methane and other gaseous hydrocarbon compounds as conventional gas. The difference is in the characteristics of reservoirs — usually of low permeability, making gas migration (or flow) extremely difficult. Extracting this gas requires applying advanced exploration and production techniques to particular sources:
- Shale gas. Shale gas is stored in shale formations — fine sedimentary rock with extremely low permeability. Deposits include the Barnett Shale in Texas — which accounts for 6% of all US gas production — Haynesville, Fayetteville, Marcellus, and Woodford Shales.
- Tight gas sands. This is gas stuck in a very tight formation trapped in unusually impermeable, hard rock, or in a sandstone or limestone impermeable and non-porous formation. It accounts for approximately 30% of US production, concentrated in the Rocky Mountains, Appalachians, and parts of Texas.
- Coalbed methane. Methane trapped in coal accounts for 9% of total gas production. Capturing coalbed methane could actually reduce GHG coal mining emissions, as the methane would otherwise be released into the atmosphere.
- Methane hydrates. These formations are made up of a lattice of frozen water, which forms a ‘cage’ around methane molecules, and were discovered in permafrost Arctic regions. The US Geological Survey estimates that methane hydrates may contain more hydrocarbons than the world’s coal, oil, and conventional gas combined.
Technological advances. High prices provided an incentive to develop unconventional sources, and shale gas has shown the greatest promise. Technological advances were crucial to the economic viability of this resource:
- Horizontal drilling. This followed advances made in directional drilling and allows for greater recovery at a lower cost and with a lesser environmental footprint.
- Hydraulic fracturing. This technique is used to increase production by creating fractures which open the reservoir surface. The fracture, which is kept open using a propant such as sand or ceramic beads, provides a conductive path connecting a larger area of the reservoir to the well, increasing the area from which fluids can be produced from the desired formation. Although this technology does improve recovery, its heavy usage of water and other fluids — and unknown impacts on underground water reservoirs — have prompted congressional leaders to study the imposition of regulations under the Safe Drinking Water Act. Producers and some state officials counter that this activity is already effectively regulated by states. The Environmental Protection Agency is conducting studies to determine if contamination in Pavillion, Wyoming was caused by hydraulic fracturing activities.
Boom, bust and boom? Despite these environmental challenges, 2008 was a boom year for the US gas industry. Consumption reached 23.2 Tcf — a near record — while net imports were at their lowest levels since 1997. Similar to the movements in oil prices, natural gas surged in July 2008, hitting a record 14.24 dollars/MMBtu.
However, this boom unraveled with the onset of the most acute phase of the financial and economic crisis last autumn, which was followed by a mild winter that drove prices down further. Yet while gas markets are experiencing difficult times, eventually prices will rise, making massive US unconventional reserves more economically viable.
CONCLUSION: Despite a number of potential obstacles, particularly the impact of possible environmental legislation, huge new US unconventional gas resources — driven by discoveries and advances in technology — will have a massive market impact. Over the long term they will continue to generate a larger share of US gas supply, displacing imports and changing the global liquefied natural gas market as well.