July 14th 2012

S P E C I A L R E P O R T

N AT U R A L G A S

AN UNCONVENTIONAL

BONANZA

GAS.indd 1 02/07/2012 11:40

1

COLOURLESS, ODOURLESS, LIGHTER than air. Natural gas may nothave much impact on the senses, but as a source of heat and power it istransforming energy markets. Around 100AD Plutarch, a Graeco-Romanpoet, noted the �eternal �res� in what is now Iraq. They were probablymethane gas seeping out of the ground, ignited by lightning. Those eter-nal �res are now proliferating. An unexpected boom in shale gas that has

taken o� in America may wellspread elsewhere and will addmassively to global gas supplies.

Shale gas�an �unconven-tional� source of methane, likecoal-bed gas (in coal seams) andtight gas (trapped in rock forma-tions)�has rapidly transformedAmerica’s energy outlook. At thesame time discoveries of vast re-serves of conventional gas fromtraditional wells have pushed upknown reserves around theworld. Gas is the only fossil fuelset to increase its share of energydemand in the years to come.

For a long time it was regard-ed as oil’s poor relation. In thelate 18th century William Mur-doch, a Scottish engineer, used itto light his house, but it did notcatch on until some decades laterwhen it became popular for illu-minating homes and streets, re-placing �ickering candles. Com-mercial exploitation of gas andoil began around the same time,yet gas remained a niche productfor lighting. And despite its rapid

rise in recent years, it will still lag oil as a source of energy by 2035, accord-ing to the International Energy Agency (IEA), a rich-world energy club�and overtake coal by then only if the new gas reserves are fully exploited.

The trouble with gas is that it is di�cult and expensive to transport.That used to be true of oil too, but since the development of supertankersin the 1960s it can be shifted relatively cheaply to �nd a customer in theworld market. Gas needs a ready buyer and a way of delivering it.

A priceless commodity

Because of those hefty transport costs, gas does not behave like acommodity. Only one-third of all gas is traded across borders, comparedwith two-thirds of oil. Other commodities fetch roughly the same pricethe world over, but gas has no global price. In America, as well as in Brit-ain and Australia, it is traded freely and prices are set through competi-tion. In continental Europe traded gas markets are gaining a foothold, butmost gas is delivered through pipelines and sold on long-term contractslinked to the price of oil, for which it used to be seen as a substitute. Gas-poor Asia relies heavily on imports of lique�ed natural gas (LNG).�Stranded gas�, too far from its markets to go down a pipe, can be turnedinto a liquid by cooling it to -162°C, shipped in specialist tankers and

An unconventional bonanza

New sources of gas could transform the world’s energy markets,

says Simon Wright�but it won’t be quick or easy

A C K N O W L E D G M E N T S

CONTENT S

The author is grateful to the many

people who helped in the prep-

aration of this report. Particular

thanks go to Simon Blakey, Nathan

Calvert, Anne-Sophie Corbeau,

Richard Forrest, David Giles, Kurt

Glaubitz, Gregory Hild, Jan Willem

van Hoogstraten, Martin Houston,

Amy Myers Ja�e, George Kirkland,

Alex Krueger, Scott Nyquist, Marvin

Odum, Ed Osterwald, Kurt Oswald,

Gordon Pickering, Howard Rogers,

Philippe Sauquet, George Smith and

Wim Vandenberghe

A list of sources is at

Economist.com/specialreports

An audio interview with

the author is at

Economist.com/audiovideo/

specialreports

3 America’s bounty

Gas works

6 Fracking

Landscape with well

6 European worries

Sorting frack from �ction

8 Global reserves

A world of plenty

9 Gas pricing in Europe

Careful what you wish for

11 LNG

A liquid market

13 Energy policy

A better mix

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NATURAL G AS

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turned back into gas at its destination. But the huge plants need-ed to do the job at both ends are very costly.

Since gas prices in di�erent parts of the world are set byquite di�erent mechanisms, they vary wildly across the globe. InAmerica, where shale gas is whooshing out of the ground, theyrecently fell to a ten-year low. In Asia they can be ten times theAmerican level.

Gas all over

Global reserves have been steadily increasing for at least 30years. According to a report from the Massachusetts Institute ofTechnology (MIT), published last year, world production hasgrown signi�cantly too, rising by two-�fths between 1990 and2009, twice as fast as that of oil. Only half a decade ago it lookedas though the world might have only 50 or 60 years-worth of gas.Now shale and other unconventional as well as new conven-tional gas �nds have increased that period to 200 years or more,by some estimates.

The unconventional-gas bonanza has roughly doubled thegas resource base, a measure of the total gas in the ground ratherthan what might be economically recoverable. In 2009 the IEA

estimated the �long-term global recoverable gas resource base�at 850 trillion cubic metres (tcm), against 400tcm only a year ear-lier. The main reason for the rethink wasshale gas and other unconventionals. Notjust America but parts of Europe, China,Argentina, Brazil, Mexico, Canada andseveral African countries, among others,sit atop as yet unknown quantities of gasthat could transform their energy outlook.

Better technology has helped, and sohas the high oil price. The spiralling price of crude has caused oilcompanies to search even harder for it. But before a test well hasbeen drilled, it is near-impossible to be sure whether the geologi-cal idiosyncrasies that excite oilmen will yield either oil or gas (orsometimes both, and often nothing). Of late, big oil companieshave found plenty of gas.

Not only have breakthroughs in technology opened up

America’s shale beds, but advances in drilling in very deep wa-ter have dramatically changed exploration in the sea. Australiawill emerge as a gas superpower as it begins to deliver largequantities of LNG from o�shore �elds. And better technologyand global warming is unlocking the Arctic’s natural bounty.

But there are reservations. Last year the IEA published a re-port entitled, �Are We Entering a Golden Age of Gas?� The ques-tion mark re�ects the constraints that public disquiet about shalegas might put on its development. That is one reason why FatihBirol, the IEA’s chief economist, is far fromcertain that America’s shale boom can bereplicated elsewhere.

In the most promising scenario, ifshale development goes full steam ahead,the IEA reckons that the share of gas in theglobal energy mix will rise from 21% todayto 25% in 2035. That may not sound muchof an increase, but over that period totalglobal consumption will grow spectacu-larly. If the obstacles can be overcome,more gas and lower prices will mean a riseof 50% in global demand for gas between2010 and 2035, according to the IEA.

What has made gas so exciting is not just the steep rise insupply but also the wide range of uses for it. It is a �exible fuel, ca-pable of heating homes, fuelling industrial boilers and providingfeedstock for the petrochemicals industry, where it is turned intoplastics, fertiliser and other useful stu�. It is also making smallbut signi�cant progress as a fuel for lorries and buses.

But the biggest advances have been in power generation. A

Remaining recoverablenatural-gas resourcesEnd 2011

1970 1990 2010 2030

50

40

30

20

10

0

Coal Hydro Nuclear RenewablesOil Gas

By region Trn cubic metres

Top 15 countriesTrn cubic metres

World total752

Share of world primary energy, %

OECDEurope

45

LatinAmerica

71

Africa

74

OECDAmericas

122

Asia/Pacific

132

MiddleEast

137

East Europe/Eurasia

174

AUSTRALIA

QATAR

IRAN

NORWAY

ARGENTINA

UNITED STATES

MEXICO

ConventionalUnconventional

VENEZUELA NIGERIA

ALGERIA

SAUDIARABIA

CANADA

INDONESIA

RUSSIA

CHINA

2

35

9 9

7

22

2735

37

48

4

4

77

4

8

104

518

3737

920

3

11

7

1

106

23

F O R E C A S T

Sources: International Energy Agency; BP

Not just America but parts of Europe, China, Argentina,Brazil, Mexico, Canada and several African countries sitatop as yet unknown quantities of gas

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technological breakthrough, the combined-cycle gas turbine, aspin-o� from the aviation industy, has transformed the econom-ics of the industry. Not only has it made it cheaper to generateelectricity from gas, but the process releases up to 50% less car-bon dioxide than does coal. As governments strive to cut green-house-gas emissions, replacing coal with gas will bring fairlyswift results. Already the share of gas in the overall energy mix,which had remained at 16% from the late 1960s to the 1990s, hasrisen to 21%.

Gas power stations are a �low-regret� option, according toMichael Stoppard of IHS CERA, a research �rm. They are relative-ly cheap to build, beating nuclear power hands down in terms ofcapital costs, and in most cases they are also less expensive thanrenewables. The EU hopes that by 2050 some 97% of power gen-eration will come from renewables, but gas power stations arelikely to be needed for decades yet to provide �exibility and se-curity. And if gas is cheap enough and techniques such as carboncapture and storage can be developed to make commercialsense, gas could thrive for much longer even in a world that hadradically cut carbon emissions.

Except in America, though, gas is currently expensive, andshifting it is likely to remain costly. Gas markets are regional. Thestu� is mainly delivered down pipelines that stretch acrosscountries and even continents, but not between them. Pipelinescost million of dollars a kilometre to build. The business modelof developing a gas�eld has been to �nd buyers and lock theminto long-term contracts to ensure that the costs of developingand delivering the gas will be paid back. The alternative is to shipthe gas in liquid form, as LNG. But projects to liquefy gas also re-quire huge investments, and often �nding long-term buyers too.

Well oiled

Historical factors have led to another anomaly: much of thegas traded across borders is sold at prices linked to those of crudeoil. When gas was �rst brought to market as a commercial fuel inthe 1960s, as an alternative to home heating oil, it made sense toprice it against a substitute. But there was also a more subtle rea-son. Oil was used as an independent price arbiter for Dutch gasin the 1960s and then for Algerian and Norwegian gas in the1970s because neither side could in�uence the supply and de-mand for it. The system persisted as Russian gas came to Europein the late 1970s. But the economics have changed, and valuingone commodity in terms of another now seems bizarre.

Britain has had competition based on supply and demandsince the deregulation of the energy industry in the 1990s. Thefuel is traded at the National Balancing Point, a virtual hub. Simi-lar arrangements are now spreading across north-western Eu-rope as the European Union is switching to hub-based gas trad-ing at the virtual Title Transfer Facility (TTF), as well as atZeebrugge in Belgium and NetConnect Germany (NCG) andGaspool in Germany. The model is America’s Henry Hub in Lou-isiana, where nine interstate gas pipelines meet and from wherethe gas is distributed to buyers, setting a benchmark for pricesacross America.

A more competitive market the world over would doubt-less make gas cheaper by breaking the link with oil, but that willbe di�cult to bring about. Gazprom, Russia’s huge state-run gasproducer and supplier of 25% of Europe’s gas, is strongly op-posed to dropping oil indexation. A tussle is under way betweenit and the continent’s big buyers. Some pundits say that gas musteventually become a global fungible product like oil, with re-gional price di�erences closing as more gas is shifted in the formof LNG, draining gluts and making up shortfalls in regional pro-duction in North America, Europe and Asia. But others reckon itwill never happen.

Gas producers are naturally happy with the high prices re-sulting from oil indexation, arguing that without them the eco-nomics of big gas projects would never work. But Rick Smead ofNavigant, a consultancy, thinks there are good reasons for allconcerned to want competitive gas prices. He points out thatthey would reduce regional price volatility and provide gas pro-ducers with a broad and �exible market instead of having to relyon a single consumer at the end of a pipeline. That should o�eran incentive to make the huge investments required.

If the �shale gale� blowing through America can be repli-cated worldwide, the huge surpluses it would bring could hastenthe advent of a global market. Just as the 20th century was theage of oil, the 21st could prove to be the century of gas. 7

PENNSYLVANIA, THE SITE of America’s �rst oil wells backin the 1850s, is now home to the world’s second-largest gas

�eld after South Pars, on the border between Qatar and Iran. Atthe turn of the millennium America’s conventional gas�eldswere in decline. The country was preparing to become a signif-icant importer: around $100 billion was invested in LNG importterminals that may now be redundant. Shale gas was known togeologists but had never been worth extracting. As recently as2000 hardly any of it was coming out of the ground.

Now shale contributes a third of America’s gas supplies. By2035 the country’s share of total supplies (which may by thenhave risen to 820 billion cubic metres a year) could be nearly half.The rise has been helped along by a variety of factors, such as theliberalisation of access to existing pipelines by third parties thatstarted in the 1970s, a deep and liquid gas market that allowedthe risks of drilling to be hedged, ready access to capital, Ameri-ca’s home-grown oil industry and the entrepreneurial zip thatprovided the men and equipment. But the biggest di�erence wasdown to the e�orts of one man: George Mitchell, the boss of an

America’s bounty

Gas works

Shale gas is giving a big boost to America’s economy

Barnett

Bakken

Haynesville

Marcellus

Utica

America’s hotspots2011

Sources: Energy Information Administration;International Energy Agency

Shale-gas production Basins

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oil-service company, who saw the poten-tial for improving a known technology,fracking, to get at the gas. Big oil and gascompanies were interested in shale gasbut could not make the breakthrough infracking to get the gas to �ow. Mr Mitchellspent ten years and $6m to crack the pro-blem (surely the best-spent developmentmoney in the history of gas). Everyone, hesaid, told him he was just wasting his timeand money.

The technology is in use in the Mar-cellus, Haynesville, Barnett, Utica and oth-er shale beds (see map, previous page), tostartling e�ect. It is also being used forshale oil, which can be extracted fromsome shale beds in the same way as gas.Some wells also render valuable natural-gas liquids (NGLs) such as butane and pro-pane along with the gas. Oily parts of theEagle Ford are giving up the black stu� inbig quantities. The Bakken shale in NorthDakota, a state with little else to boastabout, now contributes around half a mil-lion barrels a day (b/d) of oil. Some reckonthat in a few years the oily shale bedsmight produce as much as 3m b/d, arounda third of America’s current imports.

The cost of getting at the gas hascome tumbling down as techniques havebecome more e�cient. Drilling multiplewells from a single pad, up to six at a time,has made operations cheaper. Three-dimensional seismic imag-ing has made it easier to �nd sweet spots where gas might �ow inlarge quantities. Horizontal drilling sections have got longer.Break-even costs have plummeted.

Plenty for a century

Estimates of how much unconventional gas America has atits disposal vary. The Energy Information Administration (EIA)puts it at around 37tcm of recoverable reserves, two-thirds ofwhich is shale gas and the rest tight gas and coal-bed methane.Others say there is plenty more. Using the EIA numbers, Presi-dent Barack Obama, in his state-of-the-union speech in January,said that America now has nearly 100 years of gas supplies atcurrent consumption rates.

Earlier this year gas dipped below $2 per million Btu (Brit-ish thermal units, a measure of heating power), a price not seensince 2001. It now hovers around $2.20 and seems likely to staylow for a while. Lots of gas and falling prices sent many rigs

heading to oil-rich shales to take advantage of high prices forcrude. Such wells yield plenty of gas as a by-product. Wells pro-ducing only �dry� gas have been shut down where contracts al-low, but wells that produce NGLs, also pegged to oil prices, arestill producing too. Most analysts agree that gas prices will even-tually settle around $4-5 mBtu.

Between 2006 and 2012 gas went from providing 20% ofAmerica’s electricity to nearly 25%, mainly at the expense of coal.Cheap gas and environmental legislation under the Clean AirAct, aimed at emissions of sulphur dioxide, nitrous oxide andmercury (but not carbon dioxide) from dirty coal plants, acceler-ated a trend that is set to continue. For decades coal had providedwell over half America’s electricity. In 2011coal-generated powerwas down to 42%, its lowest level since at least 1949, when re-cords began. The EIA says the switch will speed up in 2012, withcoal falling to just 36% of the total.

Gas has wrought some remarkable changes. Over the past�ve years America has recorded a decline in greenhouse-gas

Dream pipes

Iran

1,262

2.86

Pakistan

856

2.85

Argentina

1,086

2.08

Brazil

950

1.70

India

1,519

1.10

Italy

867

0.78

China

227

0.61

Colombia

561

0.36

Uzbek-istan

1,378

0.31

Thailand

649

0.30

UnitedStates

102

0.11

1A slow roll-outNatural-gas vehicles, 2012, m

Number of vehicles perrefuelling station*

*Including those under constructionSource: GAS Vehicle Report

Empire StateBuilding

381m

DRILLING RIG(removed after3-4 months)

30m 0

-100

-1,000

-1,500

-500

-2,500

-3,500

-2,000

WELLBORE

-3,000

-4,000

Metres

GR OUND LEVEL

Coa

l-bed

meth

an

e (CBM

)

SH

AL

E G

AS

Groundwater aquifer

Source: ExxonMobil

The Economist July 14th 2012 5

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emissions of 450m tonnes, the biggestanywhere in the world. Ironically, givenits far greater e�ort to tackle climatechange, the European Union has seen itsemissions rise, partly because its highergas prices (linked to oil) have led to an in-crease in coal-�red power generation.

Cheap gas is also helping other partsof America’s economy. The country’s in-dustry uses around a third of its gas out-put. The biggest winner might be thepetrochemicals industry. It gobbles up gasas feedstock to make chemicals such asmethanol and ammonia, a vital ingredi-ent of fertiliser. Switching feedstock fromnaphtha, derived from oil, to ethane, de-rived from gas, has kept petrochemicalscheap even as oil prices have peaked.These chemicals in turn provide cheaperraw materials for carmakers, agriculture,household goods and builders, or go forexport at prices to compete with theworld’s lowest-cost producers, the state-owned petrochemicals �rms in the Mid-dle East.

Dow Chemical and others have an-nounced a raft of new investments inAmerica to take advantage of low gasprices. Methanex, the world’s biggestmethanol producer, is considering dis-mantling a huge ethylene cracker in Chileand rebuilding it on America’s Gulf coast.

The United States might export fewer cheap raw materials tocountries with low labour costs to be made into goods to exportback to America. The country could do the job itself, shorteningthe supply chain and returning manufacturing jobs to Americain industries where petrochemicals are a large part of the costbase. PricewaterhouseCoopers, a large accountancy �rm, reck-ons that lower feedstock and energy costs could result in 1mmore American factory jobs by 2025.

There are non-industrial bene�ts too. According to MIT, res-idential and commercial buildings account for over 40% ofAmerica’s total energy consumption, in the form of electricity orgas, making up over half the country’s demand for gas. Low gasprices have meant that the cost of heating schools and other gov-ernment buildings, often itemised on local tax bills, is falling.

What’s in your tank?

The place where gas might have the biggest impact, thoughperhaps not for a while yet, is in American petrol tanks. Trans-port is responsible for around a third of all American carbonemissions. Gas produces around 25% less carbon dioxide thanpetrol. Gas at $2.50 mBtu is the equivalent of a barrel of oil at $15rather than $100. For the moment cars, buses and lorries are al-most entirely dependent on re�ned crude oil. But gas can be usedto propel vehicles in a number of ways: directly either as com-pressed natural gas (CNG) or LNG, or indirectly by converting gasinto liquid fuel or power for electric vehicles. So far only 3% ofAmerica’s gas production is �nding its way into vehicles.

America’s �eet of natural-gas vehicles (NGV) doubled be-tween 2003 and 2009, though at 110,000 it still makes up only0.1% of all vehicles on the road. Dallas-Fort Worth airport runs500 maintenance vehicles on gas (and has allowed fracking be-neath one of its runways). AT&T, a telecoms company, is set tobuy 8,000 CNG vehicles over �ve years, giving it the largest com-

mercial NGV �eet in thecountry. School buses, refuselorries and other municipalvehicles are switching fast.

There are drawbacks toCNG. It has to be stored athigh pressure, which makes itbulky. An average-sized fueltank will give only a quarterthe range of its petrol-�lledequivalent. Retro�tting theequipment to standard vehi-cles is expensive and refuell-ing infrastructure is in its in-fancy. There are only 500public CNG stations in thecountry, compared with115,000 regular �lling sta-tions. Still, CNG is good for�eet-delivery vehicles andbuses. Some 20% of local bus-es already run on CNG orLNG. Mr Stoppard of IHS

CERA, the research �rm, reck-ons that by 2030 a third of theworld’s shipping �eet will berunning on LNG. Early con-verts include the Staten Is-land ferry.

Another way to �ll thetanks is through gas-to-li-quids (GTL) technology,which uses heat and chemis-try to convert gas into liquidfuel. The technology uses cat-alysts to turn gas into longer-chained hydrocarbons likediesel and kerosene, as wellas various petrochemicals.

There was little devel-opment until the 2000s, but abundant gasand high oil prices have worked in GTL’sfavour. Several plants around the worldare now in operation. The biggest by far,Shell’s Pearl facility in Qatar, jointlyowned and run with the Qataris, cost awhopping $19 billion. Shell is consideringa similar outlet on the Gulf of Mexico.

The fossil-fuel industry is only asmall slice of America’s economy, but therelative drop in gas prices is so dramaticthat it could boost a manufacturing re-naissance. That might add 0.5% a year toGDP over the next �ve years, says UBS, aSwiss bank. Meanwhile low gas prices arealready fattening American wallets. Ac-cording to IHS Global Insight, a researchout�t, they are saving the average Ameri-can household $926 a year.

Not everyone will win. Some coal-miners, for instance, will have to �nd newwork. But Mr Obama says that frackingmight support 600,000 jobs by the end ofthis decade. Not bad for a business thatbarely existed ten years ago. 7

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IN FOLKLORE THE will-o’-the-wisp, a mysterious light thatlures travellers away from paths into dangerous marsh-

lands, was thought to be the embodiment of evil spirits. The lightwas probably methane, given o� by rotting vegetation, that hadspontaneously ignited. The atavistic fear of gas lives on in publicanxiety over fracking. The IEA’s report �Golden Rules for a Gold-en Age of Gas�, published in May, says that if shale extractiongoes ahead at full speed worldwide, gas could make up around25% of primary energy demand by 2035, against 21% in 2010. Butif public resistance holds back its development, its share may riseto only 22%.

Why does fracking provoke so much opposition? Some callit the �GasLand� e�ect, after a 2010 �lm byJosh Fox about America’s shale-gas indus-try in which an old man puts a match tohis water tap (a popular party trick inshale-gas areas) and then reels back fromthe dramatic gas explosion. The �lm

blames fracking for such incidents. In reality a host of regula-tions are in place to prevent gas from getting into the groundwa-ter, and it very rarely does. But the damage has been done.

New York, Maryland and New Jersey have imposed tem-porary bans on fracking and Vermont may follow, but every-where else in America the gas �ows unimpeded (see box). Eu-rope is a tougher nut to crack. The most ardent opponents toshale-gas exploitation are in France, which, along with Bulgaria,has declared a moratorium. About three-quarters of the electric-ity there is generated by nuclear plants,and there has been some lobbying againstshale gas by the nuclear industry, but thefear goes much deeper. In Europe as awhole, many of the objections to shalehave to do with green issues, though thereare plenty of other obstacles too.

However, most of the complaintscentre on fracking. There are three mainconcerns: that it could set o� earthquakesor play havoc with water supplies; andthat methane could escape into the atmo-sphere and exacerbate global warming.

European worries

Sorting frack from

�ction

Shale gas’s poor image in Europe is largely unjusti�ed

The European Commission has concluded that no new lawsare needed to cover shale gas beyond those already inpace for the extractive industries

DEEP IN THE rolling tree-clad hills of Penn-sylvania, on a hilltop close to a group ofbarns and farmhouses, Chevron’s Kikta wellpad can be found at the end of a narrowcountry lane. This is part of the Marcellusshale, 250,000 sq km (96,500 square miles)of gas�elds stretching across Pennsylvania,West Virginia and New York state. The drill-ing rig is 30 metres high, so large that it ishard to imagine how it could have got to thesite, but it comes apart and the components�t onto lorries. It sits on an acre of �attenedhilltop, along with a million-gallon reservoirto provide the huge quantities of waterneeded for extracting shale gas. Vehiclesand machines are poised for action. Fourwells will be drilled from this one pad. Thedrill will �rst bore 2,300-2,600 metres(7,500- 8,500 feet) downwards; then thedrill bit is coaxed to the horizontal and thedrilling continues outwards. Gas will startrising to the wellheads, just a few metresapart, after the next task is performed:hydraulic fracturing, or fracking.

Shale is a hard rock made up of sedi-ments deposited on sea and lake beds hun-dreds of millions of years ago. To make it giveup the gas held within, it needs to be broken

up. Along up to 2km of horizontal pipes14cm wide, holes open out onto the shale.Along small sections, water, �ne sand (the�proppant�) and fracking �uid are injectedunder high pressure.

The fracking �uid, which makes upabout 1% of the brew, is a combination ofgelling polymers of the sort found in foodand cosmetics, to keep the sand suspendedin the �uid as it is pumped into the well;chelants (like kettle descaler) to break downthe polymer and release the sand when itarrives in the fractured shale; friction reduc-er (as found in nappies) to keep the �owsmooth; and biocide, a disinfectant thatstops bacteria gumming up the well.

On reaching the shale, the mixture ofwater and fracking �uid bursts open the rockand the sand keeps the fractures open,allowing the gas to �ow to the surface. Thepower for the operation is supplied by theengines of a �eet of trucks, so this stage ofthe process can be noisy. But it takes only�ve days to complete, and then the shale gasbegins to �ow and the trucks, portableo�ces and hoppers are taken to another siteto start all over again.

After a little over a year of activity, at

Landscape with well

Despite its poor image, fracking causes little mess or disruption

least half of which is taken up with planningand obtaining permits, most of the land isreclaimed, apart from a little pipework and awater tank on a small section of the originalsite. At Elias, a completed Chevron oper-ation, the only sound to disturb the replant-ed clover meadow is a faint whooshing as gaspasses to an underground pipe network. It isthe sound of dollars clocking up, and it couldgo on for 30-50 years. The gas rushes outrapidly in the �rst year or so before tailingo� quite fast to a third of the original �owand gradually declining thereafter.

The remarkable thing about extractingshale gas, says Bruce Niemeyer, Chevron’sregional boss, is �the absence of anythingremarkable going on� above the ground. TheMarcellus is not what you might expect agas�eld to look like: the views can be spec-tacularly beautiful. And not only is it good tolook at, its gas is also cheap to develop andcheap to produce. The average cost per wellis $6m-7m, against $7m-11m in the Haynes-ville shale, spread across parts of Arkansas,Louisiana and Texas. Moreover, the Marcellusis close to the big markets of the Atlanticcoast, so the gas is cheap to transport too. Ifonly every gas�eld were like that.

ROMANIAF R A N C E

GERMANY

NETHER-LANDS

CZECH REP.

POLAND

U K R A I N E

R U S S I A

BRITAIN

SWEDEN

Boon or curse?

Source: International Energy Agency

Shale-gas basins

There was a ripple of fear in Britainwhen test-drilling for shale gas in north-west England set o� small earth tremors,but the evidence so far suggests that earth-quakes should not be a worry. Frackinghas been used in conventional wells for atleast 50 years. A report from America’sNational Research Council on energy andseismic activity, due to be published laterthis year, records only two incidents of mi-nor tremors associated with fracking�theone in Britain and just one in America, de-pite the scale of activity there.

Water is a more serious problem,both because a lot of it is needed to frackwells and because local groundwater isseen to be at risk of pollution. A recent re-port from MIT says that in America shalegas has a good environmental record.With over 20,000 wells drilled in the pastdecade there have been only a few in-stances of groundwater contamination, all of them due tobreaches of existing regulations. There does not appear to be anysystemic risk. Fracking takes place thousands of feet below thewater table, and fracking zones are typically separated fromgroundwater by fairly impermeable rocks.

A shale well does use a lot of water�an average of up to22m litres (5m gallons) over its lifetime�but this is no more than agolf course in Florida consumes in three weeks, according to oneestimate. Most of that water stays in the well, but 20% returns tothe surface as �ow-back in the days and weeks after fracking.This must be stored and disposed of or recycled safely. Still, theMIT report points out that shale-gas extraction uses less waterthan other industries, and indeed than other sources of energy.In America’s big shale �elds it gets through much less water thanlocal mines or local livestock.

Most studies to date suggest that shale-gas wells may leadto slightly higher carbon-dioxide emissions than conventional-gas ones because more wells are needed and fracking requireslots of power from diesel motors. But a bigger worry is that thegas itself may leak. Methane is a particularly pernicious green-house gas. It can escape accidentally, through broken pipes,valves or other equipment, or be let out on purpose, when it isvented or not fully burnt during �aring.

Methane emissions are hard to measure; estimates vary be-tween 1% and 8% of the total amount of gas produced. If the real�gure proved to be near the top end of the range, it would chal-lenge the fuel’s claim to relative cleanliness. A study from Cor-nell University last year calculated that from production to end-user some 7.9% of total shale-gas output �nds its way into the at-mosphere, up to twice as much as for conventional gas wells. Ifso, it would make shale gas dirtier than coal or oil. But the analy-sis has been heavily criticised. Research published by America’sEnvironmental Protection Agency (EPA) around the same timeput the �gure at 2.2%, only a little more than conventional gas.And methane emissions are probably falling because of �greencompletion�, a method used on most new wells that avoidsventing or �aring methane. The EPA is now conducting the big-gest study ever into all aspects of shale exploration, likely to bepublished next year, which might help allay public fears.

The European Commission, in a rare display of good sense,has concluded that no new laws are needed to cover shale gas be-yond those already in pace for the extractive industries. The IEA

says that if the industry wants to gain public acceptance therewill have to be more disclosures, engagement with local commu-

nities, e�ective monitoring of wells, tough rules on well design,fracking and surface spills, careful water management and a stopon methane emissions. It reckons that all this would add onlyabout 7% to total well costs�and might go a long way towardspacifying the environmentalists.

A tale of two continents

Geologically, the chances of �nding shale gas in Europe areevery bit as good as in America. France, Poland, Britain and Uk-raine look promising, and decent quantities may yet be found inother countries. America’s EIA puts Europe’s recoverable re-serves on a par with America’s. But there the similarities end.

Perhaps the most important di�erence is in property rights.In America individuals generally own the minerals under theirproperty. Since a gas strike will make them rich, they will gener-ally be enthusiastic about extracting the stu�. In Europe mineral

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Not in Europe’s backyard

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EXACTLY HOW MUCH unconventional gas lurks outsideAmerica is a matter for conjecture, but the list of countries

with potentially large reserves grows steadily. Canada and Mexi-co are known to have lots. Australia already produces coal-bedmethane and has plenty of shale and tight gas too. South Africaalso has big deposits, though a fracking moratorium was an-nounced last year. Argentina and India could join the shale club,and so could countries that already export conventional gas,such as Algeria and Libya. Even Russia and Saudi Arabia, the larg-est conventional oil producers, have the stu�.

But the biggest shale-gas reserves may be lurking in China.At the end of last year the IEA estimated the country’s total recov-erable resources at 50tcm, over 70% of it in shale beds, most ofthe rest coal-bed methane. China already extracts prodigiousquantities of the latter�some 10bcm last year. Only a handful oftest wells for shale gas have been sunk, and it looks as though thegeology may make it harder to get at than America’s.

But China has ambitious targets for getting its hands on it allthe same. It wants to use a lot more gas to generate electricity andto fuel its expanding �eet of cars. Since 2000 its appetite for gashas grown by around 15% a year as the lights have come on innew towns and cities and the country’s breakneck economic ex-pansion continues. At present gas makes up just 4% of the coun-try’s primary-energy consumption. The latest �ve-year plan en-visages an increase in that share to 8% by 2016. Even then, Chinawill still lag far behind most rich countries, where gas generallymakes up a quarter or more of the total energy mix.

Because of China’s vast size, what sounds like a small shiftcould have massive implications for the global gas market. An in-

Global reserves

A world of plenty

Of all the countries now looking for shale gas, China

has the most potential

The start of something big

rights mostly belong to the state. Another big di�erence is that in America most of the shale

gas occurs in easily accessible �elds far from houses and schools.Europe is far more densely populated, and the more people thatlive near shale-gas operations, the more objections there will beto �eets of tankers carrying the huge quantities of sand and wa-ter needed for fracking. A single shale well could require be-tween 890 and 1,340 truck journeys from drilling to completion.

But sensible rules can go a long way to mitigating the e�ect.In the Marcellus there are agreements that tra�c will be sus-pended at weekends and on holidays, or even when the schoolbus is running. Moreover, operators are obliged to upgrade pot-holed roads and rickety bridges that otherwise might wait yearsfor repair. And if necessary, water could be piped in at additionalcost to cut down on the tra�c. Tra�c, in any case, is a concomi-tant of modern life. As the European Parliament notes, a padwith eight wells may need 4,000-6,000 lorry journeys over sixmonths to get the well up and running; but a typical shoppingcentre will require 15,000-25,000 lorry journeys year in, year out.

Now you see it, now you don’t

Shale wells also do little to spoil the local landscape whenin production. The only thing that shows is a wire fence enclos-ing a small area of valves and pipes. The �ow of gas is virtuallysilent. And once wells are decommissioned, they leave hardlyany trace at all. Moreover, America has served as a test bed forthe most e�cient techniques, which means that more wells cannow be drilled from a single source and well counts are fallingeven as production is increasing. So the impact on local commu-nities in Europe might be less than in America from the start, andwill become even smaller over time.

America’s long history of hydrocarbon extraction and avast oil-services industry on its doorstep gives it an edge over Eu-rope. It has many hundreds of drill rigs available to go after shalegas, compared with Europe’s mere handful at present. And inAmerica pipeline owners are obliged to allow anyone to pay touse them to move gas from the well to the buyer, whereas in Eu-rope there is no obligation to allow third-party access.

In a continent where shale development is in its infancy, Po-land has made the biggest strides. Keen to break its dependenceon Russian supplies, it has awarded over 100 exploration li-cences to state-backed �rms as well as to oil giants such as Chev-ron and ExxonMobil, Eni and Marathon. So far the results havebeen disappointing, and Exxon has now pulled out. Poland’s ge-ology is di�erent from America’s and new techniques may beneeded to winkle out the gas.

Ukraine has recently granted exploration licences to Chev-ron and Shell, and Romania has also awarded a few. Britain,which relies more heavily on gas than its European neighbours,appears set to go ahead with shale. Cuadrilla, the American com-pany that had been exploring for gas in the north-west of thecountry, has been allowed to continue, on condition that it keepsthe ground-shaking to a minimum.

But for every two steps forward in Europe, there is a back-ward one. The Czech Republic is currently considering joiningFrance and Bulgaria in imposing a moratorium on fracking. Ad-ditions to Sweden’s few test wells have been held up by publicobjections. Germany’s good shale potential is marred by a vocif-erous opposition.

In America shale gas was seen as an overnight sensation,but in reality it took two decades of research and tentative drill-ing before it began to reshape the energy landscape. For its part,Europe could well take a decade before it gets fracking in earnest.And like the traveller following the will-o’-the-wisp, it could stilltake a few wrong turns in the next few years. 7

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crease of one percentage point in China’s consumption is reck-oned to equate to 25bcm a year, roughly half of what Qatar, theworld’s biggest exporter of LNG, puts on the market annually.

To meet this enormous demand, China will need imports.Pipelines from neighbouring countries (including one of 1,100miles from gas-rich Turkmenistan) and LNG regasi�cation termi-nals have proliferated. At the same time China is making big ef-forts to step up domestic production of both conventional andunconventional gas.

The country’s eventual capacity to produce gas is hard togauge. It has been seriously tapping its domestic conventional re-serves for only a decade, and what gas it has is in inland prov-inces far from the economic powerhouses on the coast. But o�-shore deepwater exploration could yet produce considerable�nds more handily placed in the South China Sea.

China is pushing exploration of shale gas by encouragingdomestic producers to form partnerships with foreign oil andgas companies. BP, Chevron and others are involved in explora-tion joint ventures with Chinese partners. In the past couple ofyears Chinese state energy �rms have struck multi-billion-dollarshale deals in America with Chesapeake Energy, mainly forshale oil, and with Devon Energy Corp for gas. The deals gavethem an opportunity to learn about shale technology fromAmerican operators. Yet shale gas is unlikely to make a seriousdi�erence to the country’s supplies for several years yet.

In March China set production targets of 6.5bcm by 2015and up to 100bcm by 2020, and announced measures to encour-age competition, along with various �nancial inducements. Butthese incentives may not outweigh the drawbacks of state-con-trolled gas prices. China has said that shale-gas pricing will bemarket-based, which is vague but suggests that producers cancharge higher prices than the state-controlled system currentlyallows. Jingzhou Tao of Dechert, a law �rm, says drawing up pro-duction agreements that will satisfy regional and central govern-ment, owners and operators alike will be tricky.

Give it time

As in Europe, there is still a question mark over how easilyAmerican technology can be applied to China’s shale beds. LikeEuropeans, the Chinese are tightly packed in some parts of thecountry, and as they become more resistant to centrally wieldedpower they may object to drilling on their doorstep. China alsolacks gas infrastructure to serve shale �elds. Much of what it haswas built to connect conventional �elds to markets. The countryhas a record of building infrastructure at lightning speed: theTurkmenistan pipeline, for instance, went up much faster than itwould have done in the West. Yet coal-bed methane, although indevelopment in China for ten years, in many places still lackssuitable pipelines linking it to markets. And two of China’s bigshale �elds are in the parched far north-west of the country, farfrom the water needed for fracking.

Sinopec extracted gas from test wells in Sichuan in March,but it could be years before the gas starts �owing in earnest. Still,if all goes well there may be plenty. The IEA says that total gasproduction could increase �vefold by 2035, to 475bcm, of which390bcm would come from unconventionals, over half of thatfrom shale.

India hopes to map its shale resources and have explora-tion rules in place by December 2013. But it is short of water, andlocals are often chary of drillers and miners. Argentina’s hopesof getting at its shale probably took a blow when its governmentrecently took control of YPF, a formerly state-owned oil and gascompany that had been sold to Spain’s Repsol. All in all, it is like-ly to be a decade or more before shale has much of an e�ect onglobal gas markets and pricing systems outside America. 7

EUROPEAN ENERGY COMPANIES threw lavish partieswhen they signed new 20-30-year contracts with Russia’s

Gazprom around the middle of the past decade. Ensuring securi-ty of gas supply for many years ahead seemed cause for celebra-tion. The hangover was to come.

Europe is the main battleground for gas pricing. In Americagas prices are set by the fundamentals of supply and demand(known as gas-on-gas competition), which means they are cur-rently low. In Asia gas is mainly bought and sold at prices set bycontracts linked directly to (currently high) oil prices. Europe issomewhere in the middle.

The long-term take-or-pay contracts that guarantee mini-mum purchases of gas indexed to oil prices�the customarymethod for buying and selling gas in Europe�are coming underenormous pressure. This is upsetting Russia’s Gazprom and Nor-way’s Statoil, which between them supply 40% of the conti-nent’s gas, mainly on those terms. Even Vladimir Putin, Russia’spresident, acknowledged in a speech in March that competitionfrom shale gas would have a big impact on Russia’s gas suppliers.Gazprom is having to gauge ever more carefully how much it cancharge its European customers without putting them o�. Gas ac-counts for 10% of Russia’s GDP and makes a handsome contribu-tion to the state’s co�ers, so Mr Putin is right to be worried.

Oil-indexed gas prices are being squeezed by a combina-tion of factors, chie�y the aftermath of the 2008 �nancial crisis,the deregulation of European electricity prices, the liberalisationof British energy markets and the arrival of shale gas. Deregula-tion in Britain in 1986 had brought gas-on-gas competition to thecountry. Trading at spot prices took place at the National Balanc-ing Point, a virtual trading hub. In 1998 a pipe linking Norfolkwith the Belgian coast, known as the Bacton-Zeebrugge inter-connector, made it possible to send spot-market gas to northernEurope when it was cheaper than oil-indexed gas.

Just as energy demand in Europe was collapsing in thewake of the �nancial crisis, a glut of Qatari LNG appeared on thespot market. Qatar had developed a mammoth LNG capacity to

Gas pricing in Europe

Careful what you wish

for

The pros and cons of a more competitive gas market

in Europe

2The great divergence

Sources: BP; ICIS Heren *European spot price

Gas prices, $ per million Btu

0

5

10

15

20

2000 01 02 03 04 05 06 07 08 09 10 11 12

LNG Japan cif Average Germanimport price

Heren NBPindex*

Henry Hub

supply America, but the gas was no longerneeded because by then that intendedcustomer was awash with shale gas, so theQataris needed new buyers. Qatar’s LNG

undercut the price of oil-indexed gas fromRussia and Norway and brought new li-quidity to northern European gas marketsthat had been used to gas bought mainlyon long-term contracts. All this meant thatin 2008 there were large quantities ofcheap gas and plenty of buyers who couldget access to spot-market gas from north-ern European LNG terminals or fromacross the English Channel.

The upheaval sent big European en-ergy �rms to Gazprom’s door begging forbetter terms. Collapsing demand left themwith potential bills for gas they had to takeor pay for but did not need. Competitorswith access to spot markets stole their cus-tomers. And all the while oil prices, towhich gas prices were indexed, were ris-ing steeply.

Gazprom was uncharacteristicallyreceptive to its customers’ laments. Alongwith Statoil, it agreed to introduce an ele-ment of spot pricing in contracts, partly tostop sales to European customers fromfalling further. In the same way that a glutof gas led to the development of the Hen-ry Hub in America, European hubs such as the Netherlands’ TitleTransfer Facility developed to sell the spot gas. Gas-on-gas com-petition now sets the price for over half the European market,against only about 20% in 2005.

Further progress may be slower. The gas glut has dried upfor now and the European Union, intent on creating a fully liber-alised gas market, is still well short of its aim. The deregulationintroduced in the 2000s was slow and tortuous, and future liber-alisation is unlikely to be any easier.

A nuclear disaster half-way across the world put the brakeson the natural expansion of Europe’s liquidity. Japan’s devastat-ing tsunami last year caused the country to shut down its nuclearpower plants and turn to other power sources, particularly gas.The delighted Qataris reset the compasses of their LNG tankers,diverting spare gas to the Paci�c. European spot prices climbed.But they still remain below contract prices, and German utilitiessuch as RWE and E.ON are still losing billions on contracted gas.German and other European utilities have entered into arbitra-tion with Gazprom in an e�ort to get better terms.

Spot on?

The system certainly needs an overhaul. Setting the price ofone commodity against that of another, largely unrelated one isodd. Peter Hughes of Ricardo Strategic Consulting points out thatif gas becomes a �normal commodity market�, prices will ap-proach the long-run marginal cost of supply, which is well belowthe oil-indexation price. But oil indexation might persist all thesame. The contracts are convenient and can be more �exiblethan they seem at �rst. Besides, liberalisation and hub tradingcould have consequences that Europe may wish to avoid.

A liberalised market hands power to big suppliers. Relyingon spot markets rather than long-tem contracts would allow Rus-sia, which supplies a quarter of all Europe’s gas, to manipulatevolumes to manage prices. Gazprom is said to be split internallybetween those who want to defend oil indexation at all costs

and those who reckon that it has had its day. High oil-indexedprices threaten to cut Gazprom’s market share, by encouragingthe building of more LNG import terminals and the develop-ment of European shale gas. The question is what price-volumetrade-o� Russia might settle for.

As one gas-industry insider puts it, oil-indexed long-termtake-or-pay contracts are really �licences to renegotiate�. Eachside may reopen the contract once every three years if market cir-cumstances change �materially�. And Gazprom is open totweaks. On July 3rd it settled a dispute with E.ON and agreed toprice cuts that could save the utility �1billion a year. Settlementswith other energy companies may follow.

Creating a market for gas in Europe is a tough ask. In Ameri-ca it took a gas glut and lots of deregulation over many years.Though hubs are emerging, deep and liquid markets are still along way o�. One huge obstacle is that given Europe’s economicwoes, demand for gas there is not currently growing, though thelong-term trend is upward. And as energy consumption is close-ly linked to economic growth, the euro crisis is making gas an un-attractive investment for the moment.

To make such a market work, shifting gas around the conti-nent would have to be easy. But Europe’s long-distance pipelinesystem is �dysfunctional�, say Pierre Noël of Judge BusinessSchool in Cambridge. The patchwork of state-owned pipelinemonopolies bears no resemblance to America’s system of openaccess to interstate gas transport and its decentralised invest-ment, which allowed it to adjust rapidly to the shale-gas boom.

Meanwhile coal is still the cheapest way to produce power,and governments in Spain and eastern Europe openly protectcoalmining. The near-collapse of Europe’s emissions-tradingscheme means there is no realistic carbon price to reward thegreen advantage of gas over coal in power generation. And re-newables are having large subsidies lavished on them. Add pub-lic fears over shale to the mix, and the picture looks less and lesspromising. The golden age of gas could just pass Europe by. 7

Putin is a fan

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THE TOPOGRAPHY OF the Gulf of Mexico’s coastlinemight have been designed for the hydrocarbons business.

In a �at landscape, a shoreline punctuated with bayous and oth-er watery inlets o�ers havens for big ships to load and unloadcargoes of oil, gas and petrochemicals. No wonder the coastlinesof Texas and Louisiana are one long string of soaring smoke-stacks, vast valves and tangles of pipes. Only the company logoson the huge tanks distinguish one facility from the next.

On the Louisiana side of Johnson Bayou, at the boundarywith Texas, stands Cheniere’s Sabine Pass LNG facility. In thisswampland (the plant has a resident alligator called Snap) an-other huge construction job will shortly get under way that willexemplify the astonishing changes in America’s gas business.

Sabine Pass was designed as a regasi�cation plant for a timewhen domestic gas would decline and America would need toimport LNG. Giant refrigerated vessels would unload LNG intothe maze of pipes that turn it back into gas. And Sabine Pass is nota one-o�: a dozen more American �rms have invested a total of$100 billion in similar �regas� facilities.

But when the shale-gas boom got under way, Cheniere’sboss, Charif Souki, quickly started to turn Sabine Pass into aplace that could export gas too. In June the permits were grantedat last. Installation of the liquefaction equipment�essentiallyrow upon row of expensive fridges that cool the gas to -162°C�will soon begin.

Building a liquefaction facility is highly capital-intensive.Chevron’s Wheatstone LNG project in Australia, approved lastSeptember, will cost A$29 billion ($29.7 billion) for a capacity of8.9m tonnes per annum (tpa)�the equivalent of 12bcm, morethan a quarter of the country’s total gas production. At least Che-niere, like other brown�eld sites that want to change direction, isable to use the pipeline infrastructure, loading facilities and oth-er bits of the previous import terminal at Sabine Pass to exportgas. If all goes well the �rst cargoes should start to ship from therein 2015, at a cost of some $5 billion for a capacity of 8m tpa.

Plans are in hand to remodel other redundant terminals forexport as well as to capitalise on the staggering di�erentials ingas prices between regions. Whereas American gas currentlycosts about $2.50 mBtu, European oil-indexed pipeline gas goesfor around $12 mBtu, and in Asia LNG can fetch $16 mBtu or more.Some 90% of gas trade is regional, through pipelines; LNG con-nects the bits where the pipelines do not reach.

The LNG glut after 2008 that led to Europe’s row over oil in-dexation between the big energy �rms and Gazprom showshow events in other parts of the world can put pressure on re-gional price mechanisms. The same is true of the boom in shalegas in America, the recession in Europe and the accident at theFukushima nuclear-power plant in Japan. As the trade in LNG

grows, it will bring more price competition between America,Europe and Asia and so loosen the tie of gas to oil prices.

Oil, too, used to be bought and sold largely in regional mar-kets in the 1950s and 1960s, but the development of supertankershas since made it a global product. Paul Stevens of ChathamHouse points out that in the early 1950s transport accounted for athird of the cost of Persian Gulf oil shipped to America. Only 20

years later that share had dropped to a mere 5%. The industryhad been convinced that the world would become ever thirstierfor oil, so it made huge investments in re�ning capacity, infra-structure and tankers. The oil shock of 1973 made a big dent in de-mand, but it also left a large �eet of tankers ready to move oil atmuch lower prices.

A similarly dramatic change in the economics of shiftinggas is much less likely. Pipelines remain costly to build, and abuyer has to be found and a price (generally linked to that of oil)agreed on before construction can start. Much of this applies toLNG too.

The technology for LNG was not developed until the 1960s,and even now only 19 countries export liquid gas. Global tradewent from 3bcm in 1970 to 331bcm in 2011. The technology al-lowed �stranded� gas, too far from its markets to travel downpipelines, to get to customers. Costs became less steep as tech-nology improved. By the early 2000s LNG had at last establisheditself as a mainstream transport technology. Qatar, a tiny coun-try with enormous gas�elds, now leads the way. Its �rst LNG car-go left port in 1997. By 2006 it had become the world’s largest ex-porter, overtaking Indonesia, Malaysia and Algeria. It nowaccounts for a quarter of the world’s LNG exports.

It won’t come cheap

But the economics of LNG still resemble those of pipelines.Big LNG projects need customers in order to secure �nance forbuilding the liquefaction and regas terminals and the specialisttankers that shuttle between them. And costs have been increas-ing steeply, making it ever harder to raise the money. In the 1980sbuilding a liquefaction plant cost around $350 per tonne of LNG

a year. By the 2000s the �gure, in current terms, had fallen to$200 as technology improved. Now some facilities cost as muchas $1,000 a tonne. One reason is that steel, which LNG projectsuse in large quantities, has shot up in price. And LNG terminalsare now being built in Australia, which is set to become a biggerproducer than Qatar within a few years, rather than in low-wagedeveloping countries. Australian workers do not come cheap,and wages make up a big part of the total cost. Tankers to tote theLNG round the world are pricey too, at around $200m apiece.Liquefying the gas, carrying it to its destination and regasifying itcan cost between $4 and $7 mBtu, a lot more than the $2.50 mBtuthat the gas itself currently sells for in America.

But global LNG trade has been growing fast all the same, farfaster than the gas market as a whole. Countries with gas that arefar from their customers have no choice but to liquefy. Je�eries, abank, says that LNG demand has doubled over the past decade.

LNG

A liquid market

Thanks to LNG, spare gas can now be sold

the world over

3Going swimmingly

Sources: Waterborne LNG; Oxford Institute for Energy Studies

LNG imports, bn cubic metres

0

100

200

300

400

2008 09 10 11 12 13 14 15

Japan

South Korea

China

Europe

North AmericaOther

F O R E C A S T

Spreading it around

Source: Eurasia Group, GIINL

Top ten LNG exporters2011, bn cubic metres

4

0 20 40

Qatar

Malaysia

Indonesia

Australia

Nigeria

Trinidad &TobagoAlgeria

Russia

Oman

BruneiStagnatingDeclining

Growing

103

Eurasia Group, a consultancy,expects global LNG capacityroughly to double again by2020, from 278m tpa in 2011 to526m tpa. Some gas-marketpundits reckon that the growthin LNG and its ability to link re-gional markets will cause amore global and competitivemarket to emerge.

Cheniere’s export deal isground-breaking in one respect.The company has agreed to sellAmerican gas to a number ofshippers, including BG Groupand Fenosa, at Henry Hubprices with a 15% mark-up andliquefaction fees of $2.15 mBtu.Its destination is likely to beAsia, explicitly linking prices inthe two markets. After trans-port and regas costs, the price

will probably be around $10 mBtu, still signi�cantly lower thanthe $16 for oil-indexed gas. Even if American gas prices were to goup to $4-5, there would still be money to be made.

Cheniere has managed to get an export licence, but it is notclear how many other LNG plants in America will be permittedto send cheap gas abroad. Some think that it will be political sui-cide for any president to allow large-scale exports, which couldpush up prices at home. But Mr Souki says the abundance of gasin America will make it more di�cult not to export, and the 30states which bene�t from taxes and royal-ties on hydrocarbons will want to keep thegas �owing.

Transport costs remain uncertain.The Panama canal authorities have yet todecide whether they will charge a specialpremium for LNG tankers heading fromthe Gulf of Mexico to Japan, South Koreaor China. If they do, the United Statesmight become a modest exporter of gasrather than a big one.

But there are other suppliers of LNG

aside from the United States, and theycould be exporting a lot more of it in a fewyears’ time. Luis Barallat of Boston Con-sulting Group expects a supply surge inLNG during 2015-16. Canada has largequantities of shale gas that it could send toAsia, and shipping costs from its westcoast will be far lower than from the Gulfof Mexico. Exporting westwards will getCanada out of a bind. Its energy infra-structure is tied to that of the UnitedStates, where gas is cheap. Canada wouldget a lot more in Asian markets. Shale gasfrom the Horn River or Montney �eld inthe far north is expected to get to the Pacif-ic coast through pipelines. According tosome estimates, Canada could end up ex-porting 30m tpa by 2020, almost half asmuch as export-happy Qatar.

LNG will also start shipping fromeast Africa, the eastern Mediterraneanand other newly discovered basins as well

as from more obvious sources. Russia’s Gazprom and its partners,Total and Statoil, have been delaying a �nal investment decisionon Shtokman, a big gas�eld in the Barents Sea. Its Arctic locationmakes it technologically tricky, but the main problem is market-ing the gas. It was originally intended to produce LNG for Ameri-ca, but if and when it gets the go-ahead its output is now likely tobe destined for Asia.

Thanks to advances in technology, more LNG is becomingavailable all the time. One innovation is ��oating LNG�, vast ves-sels that can process gas from smaller o�shore �elds and thenmove on when the �elds are exhausted. Shell’s Prelude, a hugegas-liquefaction project, will be the world’s biggest �oating vesselwhen it takes to the ocean waves. Construction began in May andthe facility is set to start producing in 2017. Some smaller �oatingLNG vessels are also in the works.

Squeeze harder

�De-bottlenecking� of LNG liquefaction plants�upgradingor replacing bits of equipment over time�will also add to gas sup-plies. This usually increases output by 5-10%, says Pascal Mengesof Lombard Odier, an investment �rm. This gas will not be undercontract and should �nd its way onto the spot market.

But that market is still small. Mr Barallat reckons that, al-though the LNG spot market is growing fast, in 2011 the industrydelivered only three cargoes a day under spot or short-term con-tracts, about a quarter of total LNG traded volumes. Still, there aresigns that LNG markets are getting more �exible, partly becauseEurope, unwilling to let Gazprom dominate supplies, is addingmore LNG import capacity. Asian buyers, for their part, are gettingmore reluctant to sign 20-year oil-indexed contracts in current ne-gotiations with Canadian suppliers. In future LNG contracts may

Almost as good as a pipeline

In 20 years’time gasaround theworld willprobably besold underan array ofcontractualarrange-mentsbased on asingle price,set bysupply anddemand

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be drawn up for just two or three years rather than decades, ac-cording to Holman Fenwick Willan, a law �rm that specialises inoil and gas.

Japan is still the world’s biggest LNG importer, and its util-ities can pass high oil-linked gas prices onto consumers. But Che-niere has done deals with Mitsui and Mitsubishi linked to HenryHub prices.

Much of the global growth in demand will come from Chi-na. It is building LNG import terminals fast, with four up and run-ning, �ve under construction and a dozen more at the planningstage. And Shanghai is vying with Singapore to become a region-al hub to develop spot markets based on competition betweenLNG, pipeline gas and domestic production. China has been innegotiations about a pipeline deal with Russia’s Gazprom for adecade but has so far refused to sign. Meanwhile it has securedcompeting gas supplies by building both LNG terminals andpipelines from Myanmar and from Turkmenistan.

A question of price

Plans for the Russian pipeline remain on the drawingboard. Gazprom wants to sell gas to China in order to becomeless reliant on exports to Europe, and China is sure to need Rus-sian gas in the future. The most recent set of talks broke up be-cause China will not pay Asian oil-indexed prices, as Russia de-mands, or even European oil-indexed prices. It wants somethingcloser to European spot prices, which Russia will not entertain.But a deal may eventually be struck.

In the longer term, as shale gas becomes more widespreadoutside America, some countries will no longer need to importLNG, freeing up more supplies for the spot market. Yet it will takea lot of spot LNG to create a big, liquid global market. Mr Stop-

pard of IHS thinks this will happen only if America takes to ex-porting LNG on a large scale.

Nevertheless the LNG trade will put pressure on oil indexa-tion in Asia. Mr Stoppard reckons that in 20 years’ time gasaround the world will probably be sold under an array of con-tractual arrangements based on a single price, set by supply anddemand. When deep, liquid markets with credible prices devel-op, supply is assured and long-term contracts become unneces-sary. MIT’s bo�ns believe that integrated global markets wouldincrease gas supplies, raise demand and bring down prices. Itmay be a long way o�, but the foundations for such a market arestarting to be built. 7

ENERGY DOES A splendid job of raising the temperature.That is as it should be when it drives the turbines of a pow-

er station or runs a boiler on a winter’s day. But it can also stokepolitical tensions, both domestically and internationally, andturn up the heat of the planet.

The usual villain is oil. The oil crises of the 1970s broughtpower cuts and motorists queuing at the pumps. Oil politicsplayed a part in Iran’s nuclear ambitions, and the country’sthreat to close the Strait of Hormuz helped to send oil above $125a barrel in March. Had the strait been closed, gas supplies wouldhave been hit too. Nearly 30% of the world’s LNG is currently be-ing shipped from Qatar and must navigate the narrow seaway.New supplies from Africa, Australia and the eastern Mediterra-nean would not face the same threat.

Some argue that more gas means more opportunities fortensions. Russia has already shown that it is prepared to wieldgas as a weapon to keep eastern Europe in check. Disputes withUkraine in the winters of 2006 and 2009 had Europeans worriedthat Russia might turn o� the heating. Only a handful of coun-tries in eastern Europe were a�ected, but the sense of insecurityspread right across the continent.

More generally, there are worries that gas is being evenmore tightly controlled than oil. Before shale gas appeared on thescene, about 60% of the world’s total reserves were thought to bein Russia, Iran and Qatar, suggesting that gas suppliers mightwell form a cartel similar to OPEC, which for decades has doneits utmost to steer global oil prices. Russia and its colleagues inthe Gas Exporting Countries Forum have regularly discussed theidea in private even as they dismissed it in public.

OPEC is able to function because its members have most ofthe oil and the market is global and fungible. The cartel can rapid-ly add to supplies or remove them from global markets, sendingprices up or down. Gas is di�erent. Exports are supplied on long-term contracts that guarantee delivery many years ahead. Such asystem o�ers no scope for the manipulation of short-term sup-plies, the cornerstone of OPEC’s control of oil markets.

Shale, along with new �nds of conventional gas, will allowmany more countries to produce their own gas and make avail-able gas for export from a lot more places, many of which are lessdi�cult to deal with than some oil-producing countries. With-out shale gas, Russia and Iran would dominate the global mar-

Energy policy

A better mix

Shale gas will improve global security of energy

supplies

ket. With it, Iran will �nd it much harder to exploit its huge re-serves, denying it a market and a tool of energy diplomacy.

America’s shale-oil production, together with the potentialfor gas to replace oil for use in transport, will also help to reduceAmerican dependence on oil imports. A global gas market withprices lower than those of oil should provide a bigger incentiveto develop the use of gas in vehicles.

New pipelines, such as the planned �Southern Corridor�one to bring Caspian gas to Europe, along with shale gas andLNG terminals, will also reduce Europe’s dependence on Russia.According to a paper from the James Baker Institute at Rice Uni-versity, the growth in shale production could bring down Rus-sia’s share of the western European gas market from around aquarter now to 13% by 2040.

More secure energy supplies for China might reduce localtensions in the South China Sea and other contested sea beds inthe region, where territorial disputes with neighbours over ascattering of islands have been partly prompted by the search for

reserves beneath the waves.And if both America and China,the biggest energy consumers,become less dependent on theMiddle East for gas, they are lesslikely to fall out over securing re-sources from the region.

The shale-gas boom inAmerica, and the potential forsimilar bonanzas around theworld, is turning a seller’s mar-ket into a buyer’s paradise, pro-mising deep and liquid marketswith a growing diversity of sup-plies that improves security forbuyers. The danger is that newlarge consumers like China andIndia will make bilateral ar-rangements for large supplies ofgas with big producers, whichcould set back the developmentof a global market.

Gas is a hydrocarbon, al-beit the cleanest, so burning gasreleases carbon dioxide into theatmosphere. According to theIEA, if its �golden rules� forshale-gas development are fol-lowed, emissions in 2035, atabout 36.8 gigatonnes, will be20% higher than in 2010. Lowergas prices will increase energy consumption and displace somelower-carbon nuclear power and renewables, but will alsosqueeze out some dirty coal and oil. In net terms, emissions arelikely to be much the same as they would have been without asigni�cant shift to gas, provided that goverments stand by all thecommitments they have made to curb carbon emissions.

Power switch

The biggest potential cuts in emission would come from amuch more rapid switch from coal to gas in power generation. BP

forecasts that even in 2030 some 30% of the world’s energy willstill come from coal. With plenty of gas and tumbling prices, thetime scale could well be compressed. And some analysts suggestthat the IEA is underestimating future gas supplies and demand.If that proved to be true, the gas age could look more golden still.Cheap gas could replace more polluting petrol in cars as well asdirty coal in power stations.

Moreover, there is always the possibility of another techno-logical breakthrough. Many a gasman talks excitedly of methanehydrates, �ice that burns�. MIT calls it �tomorrow’s unconven-tional resource�. The icy white material, found in seabed sedi-ments around the globe and in frozen Arctic sandstone reser-voirs, contains lots of gas.

A Japanese company sunk a test well in the Canadian per-mafrost in 2008 and Japan is now preparing for test-drilling o�its own coast. America’s government is also backing the devel-opment of technology to extract methane hydrates. Thoughtricky to get at, and dangerously explosive, methane hydratescould be a massive energy source. By some estimates the gaslocked up in methane hydrates amounts to twice the global re-serves of all conventional gas, oil and coal put together�thoughonly a small part of this may be recoverable, even with whizzynew technology. Still, until just a few years ago much the samewas said about shale gas. 7

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14 The Economist July 14th 2012

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NATURAL G AS

You’d hardly notice it