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Unconventional gas reshapes the Geopolitics and Energy map

"A slight ripple was escaping from it, a little noise, like a whistling bird. - Put your hand, you feel the wind ... It is Grisou. "(Zola, Germinal). For the past two years, more than half of U.S. natural gas production comes from "unconventional" sources. "Grisou", one of the main obsessions of minors, and other unconventional gas become the new Eldorado for investors and energy companies.

Given the strong potential of these resources, the global gas market is being reshaped. Sia Partners gives an overview of the new American scene and explains the recent overhaul of the global gas market.

What's an unconventional gas?

Unconventional hydrocarbons are gas and oil resources that cannot be extracted by conventional drilling techniques and requiring innovative extraction approaches. Though, the extracted gas sample has the same characteristics as conventional natural gas and is used for the same purposes like electricity generation or home heating.

Two recent technological breakthrough in terms of drilling techniques are at the origin of this new craze in the production of natural gas, namely: the "horizontal guidance", which allows to maximize the drilling surface and thus improve returns, and the "hydraulic fracturing" consisting of breaking the deep layers of schist by injecting a mixture of water, sand and chemicals, which gives access to deep and little-permeable surfaces.

These major innovations have resulted in the extraction of gas from previously unusable gas fields. As illustrated in Figure 1, the natural gas production has evolved from 18% in the last three years, thanks to drilling of new unconventional gas wells.

Figure 1: Global resources and extraction costs

The main types of natural gas deposits are the following:

Coal Bed Methane, "Grisou" comes from methane vapors that are trapped in the coal mineral. It represents 50% of the unconventional gas production in the U.S. in 2008 (the remaining 50% are shale gas).

Tight gas sand is trapped in little-permeable structures (i.e. the gas does not circulate much). It is therefore necessary to crumble the rock before exploiting this gas. However, it is currently considered to be not very much or not profitable but could account for more than 50% of available stocks in the United States. The appeal for tight gas sands heavily depends on market prices and could become a great resource if the gas prices were to stabilize around a certain threshold. Four of the ten largest gas deposits found in the United States over the past 20 years were made of tight gas sands.

Shale gas, known since 1858, is considered to be a non-conventional gas resource with very high potential. It comes from fine-grained rocks such as clay, as opposed to limestone or sandstone cavity as for conventional natural gas. In the U.S., production of shale gas has tripled between 2004 and 2008 passing from 19.4 billion m3 per year to 57 billion m3 and probable stocks (not to be confused with proven stocks representing only 10% of total stocks) are constantly being reassessed upwards: they are actually estimated between 9.8 and 17.7 trillion m3.

Gas hydrates, also known as clathrate, are solids composed of methane and water lying at the bottom of the ocean. This type of gas is also found in very cold regions like Northern Canada. Although so far unexploited, the gas potential contained in these clathrates is colossal, more than twice the amount contained in all known fossils of the planet! Compared to other unconventional gases, operating costs, too high because of the fields' location, does not allow us to consider production at industrial scale yet.

Non-conventional gas should, according to Petroleum Economist, allow reassessing the global gas stocks from 60-250%. Inconceivable up until a few years ago, - at the time the United States considered even importing gas from Russia - the recent and numerous discoveries of additional resources as well as the systematic exploitation of gas fields are factors making the United States a net exporter of natural gas today. Consequently, the analysis agrees on a long lasting decline in prices on the U.S. gas market.

Figure 2: Evolution of natural gas production and drilling activity in the United States between 2004 and 2008

American Liquefied Natural Gas (LNG) imports are naturally the first impacted by the emergence of unconventional gas. Indeed, the methane carriers redirect their routes to Asia, well equipped with LNG regasification infrastructure and to Europe where LNG projects are rapidly growing.

These somewhat unexpected supplies challenge the rationality of some LNG projects not only in North America but also in Europe where the spot market prices are pulled down: the Russian giant Gazprom recently announced that it would delay of 3 years its gigantic Chtokman LNG project in the Barents Sea due to the vagueness of profitability of such an investment.

On the other hand, supply contracts in Europe differ from U.S. contracts because of the indexation of gas prices to oil prices. In the mean time, the price of oil keeps increasing, while the gas market fears excess supply. This would call into question the validity of energy companies' contracts.

Energy companies signed long term contracts (up to 30 years) with fixed drawing rights in order to cover the investments made to improve and develop the gas infrastructure (drilling, transport, distribute), fear that this new call will jeopardize their operational viability and profitability of their heavy investment.

Consequently, the companies have lodged claims in order to obtain a review of their contracts by their suppliers and in particular regarding the prices: last February, German E. ON Ruhrgas, agreed with Gazprom to review their contracts and obtained that a share of the supplied gas would be indexed on the spot price instead on the barrel price.

Hence, Europe could be the big winner against its suppliers: not only would the price of gas supply diminish, but also, its dream of having a spot market like in the U.S. will finally materialise in a significant volume and with price based on supply and demand. In parallel, the hypothesis of a real diversification of sources that would protect Western Europe from geopolitical uncertainties, such as the one of January 2009 in Ukraine become possible, and why not achieve a relative energy independence. Because the hegemony of Russian supplies is threatened, Russian officials acknowledge they are concerned over the events: Gazprom secures the loyalty of its customers (Eni, E. ON, Gasunie, electricity, etc...) and invite them to join in the long-term by taking stakes in major pipeline projects in Central Europe.

The specialists in new drilling techniques enter into the crosshairs of the majors, the great unknown remains the EU's potential

With this enthusiasm, both upstream and downstream of the gas sector, many new industrial players appear on the world energy scene such as IGAS, San Leon Energy or Green Dragon Gas. The big companies of exploration-production adjust themselves by quickly developing new skills by acquiring specialists of unconventional, lapped with the new extraction techniques. As illustrated by the acquisition of XTO Energy by ExxonMobil in December.

This huge deal of about 30 billion euros betrays the fact that the largest oil company wants to regain ground it has ceded to its non-conventional rivals, especially in terms of shale gas. This transaction is one of many where major oil companies have got hold of stakeholders or promising patches in terms of resources.

On the other hand, ExxonMobil, ConoccoPhillips can hardly hide their interests for the 1.36 trillion cubic meters potentially in reserve in the Polish soil. The governments of Central Europe applaude the specter of unilateral energy dependence to Russia evaporating. France, meanwhile, would benefit from probable reserves of shale gas in the south of the country, witnessing the recent acquisition of exploitation licences in Ardèche by GDF Suez. But the exploitation of gas in France is not quite relevant because, despite the strong industrial interest aroused by these resources, non-conventional gas have not only qualities and are questionable from the ecological perspective. Indeed, these new extraction techniques require carrying out many drill holes close to each other. In Europe, as illustrated by the example of the wind mills, population density is such that these new gas facilities near populated areas will not be socially acceptable for reasons of landscape preservation.

Finally, the extraction of non-conventional gas requires a lot of resources. The significant amounts of energy and water needed for the drilling phase deteriorate the environmental appraisal of non-conventional gas in comparison to the conventional gas. Finally, during drilling, many chemicals are used and the possibility of groundwater contamination has not yet been determined. New regulations are expected to determine the validity on the long-term of non-conventional gas, from a financial point of view but also an environmental view.

Sia Partners

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