The impact of the shale gas revolution By Eli Wærum Rognerud, Office of the Auditor General of Norway, August PDF

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The impact of the shale gas revolution By Eli Wærum Rognerud, Office of the Auditor General of Norway, August 2015 Note: This paper was submitted as part of an assig nment of the Norwegian BI Executive

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The impact of the shale gas revolution By Eli Wærum Rognerud, Office of the Auditor General of Norway, August 2015 Note: This paper was submitted as part of an assig nment of the Norwegian BI Executive MBA Programme Table of content Introduction... 2 Executive summary... 2 What is the shale gas revolution Energy markets and prices Developments in existing petroleum producing regions and nations Energy policy in consuming countries The geopolitics of energy Energy companies' strategies Renewable energy production The environment Conclusion References Introduction Shale gas has been described as a revolution , our bridge to a low carbon future and indeed the biggest thing that happened to America (shale pioneer Harold Hamm, quoted in The Guardian 2015), yet others have branded it an environmental disaster . There is little dispute however that the commercial exploitation of shale gas has been, and continues to be, a major game changer in the global energy sector. Following this introduction and an executive summary, the opening chapter of this paper briefly describes what is meant by the shale gas revolution and what technological developments brought it about. The following seven chapters discuss the impact of the shale gas revolution on various aspects of the energy sector. Executive summary Chapter one examines the immediate and potential longer term impact of shale gas on global petroleum markets and prices, illustrating how the North American supply boom has brought a dramatic reduction in gas prices in the US. It has also broken the traditional link between energy prices in the global energy market, resulting in a geographically divided, three-tier gas pricing structure in the global gas markets. The chapter further explains how changes in supply and prices have influenced energy demand, especially in the US, and shifted the global trading patterns of gas. Notwithstanding these major changes, the chapter points to the uncertainty still associated with volume forecasts in the shale industry, and the multitude of additional factors at play in global energy markets. Chapter two goes on to discuss in some more detail the way shale gas has influenced developments in existing petroleum producing regions and nations. The chapter focuses on developments in the USA, as the home of the revolution , and Qatar, as the world's leading LNG exporter and a key player in global gas markets. Apart from levelling the American energy trade balance, it is argued that the availability of higher quantity gas at lower prices has helped boost American economy; increasing employment, stimulating activity in gas-demanding industries especially and improving the competitiveness of many American exports goods. For Qatar, the emergence of American shale gas has weakened its global pricing power and may, at least in the medium term, challenge its position as a global swing supplier . Finally, this chapter makes reference to how the shale boom is sought replicated by other reserve holders; in Europe in particular. 2 Chapter three takes a closer look at the impact of the shale gas revolution on energy policy of consuming countries. This issue is closely related to the previous chapter, as main producers are also consumers. Energy policy is further a matter of geopolitics, which is treated in chapter four. This chapter thus gives a few examples only of policy considerations and changes that are likely motivated by developments in gas price- and supply structures, in Europe and Asia in particular: efforts to reduce energy dependency, increase self-sufficiency and diversify energy sources. Chapter four discusses how the shale gas revolution is changing the geopolitics of energy; including US' outlook on energy security and thereby the Middle East as a major sphere of interest ; OPEC's response to the supply shock and Russia's concern over weakening negotiating power in Europe. It is also briefly described how energy-exporting countries may face domestic instability as a result of falling revenues, especially in autocracies. Chapter five examines how a few, selected energy companies have approached the new opportunities presented by shale gas. In the US, the shale gas revolution has given rise to a number of small companies venturing in production. A few larger players are positioning themselves to convert US LNG import facilities to export terminals. To yet others, shale represent a strategic area of long-term investment. Chapter six briefly reviews the possible impact of shale gas developments on renewable energy production. Though it is virtually impossible to demonstrate any direct and linear relationship between supply and price of one energy source vs another, abundant, cheap gas undoubtedly threatens to slow investment in renewable projects and reduces the competitiveness of eg wind and solar vis-à-vis fossil fuelss for electricity generation. Finally, chapter seven discusses various aspects of environmental impact of the shale gas revolution, focusing on the actual extraction and production itself, possible results of changes in energy consumption patterns, and the general issue of public environmental concern. Arguably, shale gas remains a controversial energy source, and by no means the answer to a low-carbon future. The conclusion summarizes the key arguments above, and reiterates how the seven key issues discussed are mutually interdependent. 3 What is the shale gas revolution Shale gas, along with tight sands and coalbed methane constitutes so-called unconventional gas resources. These are natural gas resources trapped in deep, underground rocks such as shale rock or coal beds (Carbonbrief 2015). The resources are harder and more expensive to access than for example conventional gas, but can be extracted using hydraulic fracturing, or fracking , a method whereby a mixture of water, sand and chemicals are injected into the rock formation under high pressure, fracturing the low-permeability shale to release natural gas. The method has been used in the industry since the nineteenth century and in the US since the mid twentieth century, but has recently become much easier and much cheaper as a result of improved techniques and technologies. Most significant has been the development of horizontal drilling: Having drilled a vertical well of several hundred meters, the drill can turn 90 degrees and pierce the rock horizontally for another several hundred meters. This gives producers access to a large sub-surface area from a single mother drill hole and greatly increases the reach of the drilling rig. (Marey and Koopman 2013, 2; Carbonbrief 2015) Shale rock is common in many parts of the world, and makes up an estimated 35% of the world's surface rocks. As illustrated in Figure 1, technically recoverable shale gas resources exist in a number of countries, however it is the USA that has piloted the revolution and today by far dominates the industry. US shale gas production in 2012 stood at some 460 billion cubic meters (bcm) gas, followed by Canada (80 bcm), Poland (0,66 bcm) and China (13,4 bcm) (IEA 2015b). Figure 1. Source US EIA 2013, cited in OPEC The development has been rapid. Between 2007 and 2014, US shale gas production grew more than 50 percent, with a five-fold increase in proven national reserves in the same period. Though not the main focus of this paper, it should also be noted that oil production from shale deposits, so-called tight oil is growing even faster than shale gas, bringing US oil production to a level not experienced since Of total marketed gas production in the US, 60% are now unconventional gas resources. (IEA 2014; Nyquist and Lund 2014; Statoil 2015). Though there is considerable uncertainty still surrounding production forecasts, the IAE estimates that global natural gas reserves, including shale gas, will last 250 years with current consumption levels, compared with 120 years when only including conventional recoverable resources (IEA 2011, 7). This vast increase in global gas supply has significant impact on the energy sector at large, as will be discussed in subsequent chapters. 1. Energy markets and prices When launching the IEA Energy Outlook Report in 2012, Executive Director Maria van der Hoeven left little doubt about the significance of the shale gas revolution: North America is at the forefront of a sweeping transformation in oil and gas production that will affect all regions of the world, she stated to the press (IEA 2012 a). The key to this transformation is first and foremost the sheer volume of gas production, but also the -at least longer term - possible flexibility with which US gas can be traded. Natural gas made up 21% of the world's energy supply in 2011 (IEA 2014), and demand is rising. According to the IEA, gas is especially attractive to developing regions in Asia, most notably China and India, and the Middle East, which face rapid urbanization and growing energy demand. In its special report on gas in 2011, The golden age of gas? IEA outlines a scenario where the share of natural gas in the global energy mix rises to 25% by This assumes a gas demand of 5,1 trillion cubic meters (tcm), 1,8 tcm more than current levels. Unconventional natural gas resources are now estimated to be as large as conventional ones (IEA 2011), and the portion of shale gas of total production is expected to grow significantly, as illustrated in figure two. 5 Figure 2 : Projections for increased shale gas production. Source: IEA 2013; Marey & Koopmann 2013 Despite vast increase in demand, EIA's 2035 scenario further assumes that average prices will remain relatively stable, mainly due to the emergence of unconventional sources. In this perspective, the shale gas revolution indeed has an impact on global energy markets and prices. So far however, the most important effects are observed in the US, where a positive supply shock has fuelled demand and at the same time a significant downward pressure on natural gas prices (Fatouh, Rogers and Stewart, 2015, 24; IEA 2015, EAI 2015a). US gas prices are quoted by the Henry Hub 1 index, reflecting the pricing point of natural gas futures contracts traded on the NY Mercantile Exchange, NYMEX. Spot prices are given in USD/MMBtu, or million British thermal units. From peaks well above 10USD/MMBtu in , prices on the Henry Hub for a period dropped below USD2/MMbtu when suppliers rushed to drill the easiest reachable shale plays (Maroy and Koopman 2013, 3). Prices have now stabilized between USD3 and USD4/Mmbtu. The developments on the Henry Hub are illustrated in figure 3. Figure 3: Henry Hub Natural Spot Price. Source: EIA Henry Hub is a distribution point on the gas pipeline in Louisiana and lends its name to the index 6 The US domestic effects of the supply shock will be described in more detail in chapter two, but in terms of market position, it has moved the US from a major gas importer to a position of energy selfsufficiency and potential net export within few years (IEA, 2012a). The US supply boom has further broken the historically stable relationship between the price of oil and Henry Hub Natural gas. Most importantly, it has increased price differential or spread of gas prices between the US on the one hand and Europe and Asia and Japan on the other, resulting in geographically divided, three-tier gas pricing structure. This means Henry Hub is selling at a fourth of European prices and a fifth of Japanese, as illustrated in Figure 4 (Maroy and Koopman 2013, 2). Figure 4: Broken link between energy sources. Source: WB, EIA, presented in Maroy and Koopman 2013, 2 These developments have in turn has affected the global trading pattern of gas, and to some extent the energy mix in different regions. As indicated above, virtually all US gas is currently traded in the domestic market as there are no natural gas export facilities in operation yet, though several are underway. Overseas export is expensive, requiring either a gas pipeline or LNG production facilities. As a result, LNG imports that had been expected to reach 70 Bcm in 2010, were in fact reduced from 18 Bcm in 2005 to 4,2 Bcm in This has meant that volumes from other gas producers originally intended for the US market has had to find new buyers. Qatar, as the world's largest LNG exporter, whose record-size LNG compressors (megatrains) launched in 2009 expanded capacity in a low-demand period, were able to divert volumes to both Europe and Asia. Declining demand in Europe and readily available Qatari LNG led to a drop in pipeline imports in Europe, mainly from Russia. Russia in the period proved itself as a shock absorber of an increasingly integrated market, reducing its pipeline exports (Fattouh, 7 Rogers and Stewart 2015, 22). Asian demand had suffered from the financial crisis of 2008, but rapidly recovered and soared in the , partly due to the Fukushima disaster, after which Japan used gas to replace its nuclear power (BP, 2014; OPEC 2014a). The Asian demand was then in part met by the Gulf surplus created in the wake of increasing US self-sufficiency. Notwithstanding these important supply shifts, the perhaps most important impact is possibly still to be seen, if and when the US position itself as an exporter. Whilst the US prohibits exports of crude oil and condensate, there are much fewer restrictions on natural gas. Export are already approved to countries with which US has a free trade agreement (Irwin 2013), and in May this year, US president Obama gave green light for another milestone LGN export project. Cheniere Energy's proposed liquefaction terminal in Corpus Christie bay, Texas, became the sixth LNG to win approval for global gas export. Over the next 20 years, Cheniere will be allowed to export up to 2.1 billion cubic feet of LNG per day to countries with which the United States does not have free trade agreements (Dlouhy, 2015). With more than half a dozen such terminals planned, Cheniere is positioned to become one of the world's most important gas exporters in the global energy market. The impact we re having on the rest of the world sometimes surprises us, the company CEO Charif Souki told Bloomberg (2015) earlier this year. We re going to represent 25 percent of the gas sold to Spain. We re going to feed enough gas to England to heat 1.8 million homes, he said. Many more investors have sought approval for similar export projects as federal policy on the issue is expected to relax further. License to export unrestrictive of destination and a strategic geographic position means that not only export volume, but flexibility, may pave the way for the US as the new global swing supplier in gas. However, uncertainty surrounding the technical as well as financial viability of many of these projects, political resistance and industry lobby fighting to keep the cheap gas at home leaves forecasts uncertain (Blackwill and O'Sullivan 2014). Since oil, gas and coal are to some extent substitutes, shale supply also has also had an impact on the market of other energy sources. In the US, low gas prices has made it competitive to coal and helped reduce consumption, though the US also has the world's largest reserves of coal. US Coal output dropped from some 160 million MWh in 2002 to nearly 120 million MWh in Coal exports soared in the same period, from a quarterly figure of just over 20 million MWh on 2002, to a peak over 160 million MWh in 2012 (IAE, 2013). The US shift from coal to gas is further helped by government policy to reduce coal, and increasing shares of renewable source in electricity generation (OPEC 2014b). Consequently, according to OPEC (2014a, 8) US coal has found its way into European markets, where its relative low price coupled with low carbon prices has made it more competitive in power generation than gas. In fact, 50% of US coal exports was absorbed by Europe in 2012 (Maroy and Koopman 2013, 3). Also in Asia, coal is still far cheaper than natural gas, and demand outlook 8 depends as much on Co2 prices and government policies as the volume of shale gas on the global market. Analysts at Rabobank also found a strong negative price relationship between oil and gas prices when relative supply of gas over oil increased (IEA 2014; Maroy and Koopman 2013). Finally, it must be noted that both shale gas production forecasts and assumptions about the impacts on market flows comes with much uncertainty. Despite the fact that shale gas holds huge global potential, there are still uncertainties surrounding the shale gas development in other regions, such as Asia, Oceania and Latin-America, which can impact the global gas market outlook OPEC (2014a) announced. Last autumn, a joint IEA-IEF-OPEC symposium discussed the prospect of natural gas and shale gas in particular as compared with other energy sources. It concluded that natural gas will remain competitive only if the gas price is maintained below USD 4/MBtu , and pointed to growth outlooks in Asia as the main point of attention in coming years (OPEC 2014a). 2. Developments in existing petroleum producing regions and nations It is beyond the scope of this paper to review the potential effects of the shale gas revolution on all actors in the energy market, and the multitude of factors at interplay with increased gas supply. This chapter therefore focuses mainly on developments in the USA, as the home of the revolution , and Qatar, as the world's leading LNG exporter and a key player in global gas markets. For a country that imported 40-50% of its energy only few years ago (Ridder and de Yong, 2013), the abundance of cheap natural gas has most obviously levelled the US American energy trade balance. More importantly, the availability of cheap gas has significantly helped boost American economy. It is estimated that the shale boom has already helped generate an additional 135,000 high-wage jobs in the energy sector from The development of infrastructure, drilling and rig facilities, pipelines and rail networks could generate a total 1,7 million jobs, according to analysts at the McKinsey Global Institute (Nyquist and Lund, 2014). For gas-intensive industries such as petrochemicals, transportation, metals (especially iron and steel), and fertilizer, the boom has been a game changer , bringing about what an IHS report (Fullenbaum and Larsen 2013) termed A manufacturing renaissance . US has now become the world lowest-cost chemical producers outside the Middle East (Barteau and Kota 2014, 8), and production cost on a number of goods from the gasfed industry is nearing that of China, improving the competitiveness of many American exports goods. Construction, infrastructure and services are also benefitting. Looking at tax revenues, IHS 9 suggests that government revenue from the unconventional sector will exceed $1.6 trillion from 2012 through 2025 (Fullenbaum and Larsen 2013). All in all, it is estimated that by 2020, unconventional oil and gas production could boost the United States annual GDP by between two and four percent (Nyquist and Lund, 2014). Marey and Koopman (2013) at Rabobank liken the development to the ICT revolution some 20 year ago, and the boost provided for the services sector. Tough plunging oil prices have taken a toll on profits also in the shale industry, the downturn is to some extent spent improving production techniques and cost saving measure. This has already brought higher production efficiency on several rigs, which can reinforce outfit and profits later (Loveless 2015 and Harlan 2015). Shale gas also takes a prominent place on the US political and policy agenda, as will be discussed more in chapter 4; spurring debate about which economic, political and security priorities should inform energy strategy. Quatar's proven oil and gas reserves comprise more than 13% of global reserves, making it the world's third largest holder after Iran and Russia. As illustrated in Figure 6, US
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