Economic Overview and Geography of the Shale Gas Revolution

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IPAN Research Brief No.05/2014 by Julien Terragnolo

Economic Overview and Geography of the Shale

Gas Revolution

By

Julien Terragnolo IPAN Senior Fellow

NOTE: This paper forms a part of IPAN Research Briefs. International Policy Analysis Network holds

exclusive rights over its publication, use and distribution. Unauthorised use of this document in any form is

strictly prohibited. The views expressed here are of the Author and don’t reflect those of International Policy

Analysis Network (IPAN).

Disclaimer by the Author: The author owns a mutual fund portfolio invested in bonds from emerging

markets including from the BRICs.


Economic Overview and Geography of the Shale Gas

Revolution

The exploitation of shale gas is transforming the energy and utilities industry,

with numerous positive externalities in the United States, whereas the rest of the

world has overall adopted a wait-and-see approach with respect to fracking. As a

result of the ongoing shale gas revolution, British Petroleum anticipates that the

proportion of oil, coal and gas in the global energy mix each will converge to 27

percent each by 2035. In this process, oil, whose demand is expected to be the

slowest growing among the three types of fossil fuels, at 0.8 percent per year,

would lose its dominance.

Through the exploitation of shale oil and shale gas, the United States will have

moved fast forward, within no more than 10 years, from the status of net energy

importer to the rank of first global gas producer displacing Russia, and of first

hydrocarbon producer in general ahead of Saudi Arabia by 2018-2020. In 2012,

approximately half the US current account deficit was ascribable to fossil fuel

imports. Consequently, as the US becomes a net fossil fuel exporter by 2018-2020,

its current account deficit, so far a major manifestation of global macroeconomic

imbalances, is going to be cut by half by the direct impact alone of the shale gas

revolution, in isolation from indirect effects on the US current account such as

lower energy costs resulting in a competitive advantage for other sectors.

Outside the United States, the potential of shale gas is generally not well known.

Since energy costs are one driver of competitiveness, no actor of global trade can

ignore the shale gas revolution. More clarity is however needed on existing shale

gas reserves, on extraction costs, and on direct economic externalities, such as tax

revenues, job creation, trade balance, as well as on indirect externalities, which

may include productivity gains and the competitive advantage for other sectors

resulting from a lower cost of energy.

Oil and gas importers lagging the US shale gas revolution, including the

European Union, India and China, depend on two groups with agendas of their

own: US oil and gas companies on the one hand, which are intent to export gas

and dictate to prospective buyers the terms of gas exploitation under their

technology, and Russian conventional gas exporters, which seek to preserve their

market shares.


The exploitation of shale gas leads to a lower cost of energy

The United States has been pioneering the exploitation of shale gas. As far back

as the 1980s, Government funded research explored drilling, the results of which

were widely disseminated to private industry. Since 2007-08, the exploration and

exploitation of very large shale gas deposits spanning underground on hundreds of

square miles spanning the North-East and the Middle West of the United States

allowed it to become the first gas producer worldwide by 2010. Although shale gas

extraction amounts to only a fifth of US gas output and still is in development

phase, it allowed the cost of gas to drop from 13 to 1-2 US dollars per unit (million

British thermal units (mmBTU)) in 2012: the exploitation of shale gas allowed

dividing the cost of gas by 6. A lower cost of gas impacts the cost of electricity,

which is one item in the make-up of production costs. The cost of US electricity is

about a quarter of that of Italy and half that of Chile, Mexico, or France,

notwithstanding the regional competitive advantage drawn by the latter from its

reliance on comparatively inexpensive nuclear energy. The estimate of Natixis, a

French investment bank, is that the lower cost of energy resulting from the

exploitation of shale gas amounts to 6 percent of the difference in labor costs

between the United States and Europe.

Environmental challenges and civil protest

Fracking, the shale gas extraction technology developed by US oil groups

(Chevron, Texaco, Williams, etc.), continues to be the only one available. Fracking

consists of perforating very deep rock layers by projecting a mixture of water and

sand horizontally (see (C) in the below chart). High pressure water mixed with

sand and small amounts of chemicals is then shot through the wells to fracture

the sandstone and free up gas. Several millions of gallons of fresh water

containing different chemical products, some of which are toxic according to

environmentalists, are injected into each well. Around 80 percent of this mixture

remains underground. Environmentalists believe that the 20 percent rising to the

surface are not always disposed of safely, that aquifers have been contaminated by

leaks, and that methane leaking from the casing of the well is released into the

atmosphere. Oil and gas companies dispute these arguments vigorously.


The US National Development and Reform Commission and the National Energy

Commission believe that the possibility of contamination is small since shale

rocks are generally located much deeper than aquifers and there are many non-

permeable rock layers between aquifers and shale rock formations. However,

leaks, on which US extracting companies release little transparent data, are

estimated to amount to 1 to 8 percent of output. In 2010, the US Congress tasked

the Environmental Protection Agency (EPA) to investigate the potential impacts

of fracking on drinking water and groundwater. The report having been delayed

several times, its release is now due in 2014.

Other side effects are not well known, but it is certain that damages to geological

layers are irreversible. Worst case scenarios must include earthquakes, which

happened on a British extraction site. The SPT Energy Group, a Chinese firm

advising PetroChina on the construction and drilling of wells, believes that

fracking is not so powerful to the point of provoking earthquakes, but admits,

when questioned, that it is not aware of any scientific study on this topic.

The reluctance of extracting companies to share data owes to onsite activism. The

example of flames coming out of a tap in the US documentary Gasland is an


example of inconvenience to nearby inhabitants. Civil mobilization makes it

difficult to exploit shale gas close to urban centers without risking organized

protests locally, or even legal action. Remarkably, lawmakers in densely

populated jurisdictions adopted moratoria or even bans on the exploitation of

shale gas (Bulgaria, France, New York State, etc.). In addition, in civil law

countries (unlike in the US), landowners do no possess ownership rights on the

underground and would therefore not collect royalties from drilling on their land.

In those jurisdictions, underground and mineral resources belong to the

Government under a provision of civil law dating back to Napoleon, and nearby

inhabitants have little incentives to welcome extracting companies in their yards.

Indirect externalities of lower energy costs in the United States

In the United States, it is estimated that one job is created for every two drilling

wells. The positive fallouts of lower energy costs do not only comprise higher tax

revenues and jobs directly created by exploitation, but also new employment from

the onshoring of manufacturing businesses, which had been relocating to lower

wage countries, in particular to China. The competitive advantage resulting from

lower energy costs is one determinant among others in the onshoring decision.

The latter is also motivated by the tightening gap in labor costs between the US

and China, proximity to consumers in view of transportation costs and the

preservation of intellectual property rights. Whereas US industrialists have saved

23 percent on gas and electricity expenses since the first shale gas exploitation

sites became operational in 2008, on average this gain only amounts to 0.8 percent

of payroll. The latter is however material enough in energy intensive industries to

the point of constituting a decisive competitive advantage for refineries, the

production of oil based products, chemicals, plastic materials, rubber, tooling,

transport equipment and the steel industry, where gas covers 35 to 60 percent of

energy needs and where energy related expenses may amount to 60 percent of

added value (added value intended as corporate sales minus cost of external

services and procurement). According to the American Chemistry Council, another

million jobs can be created in the United States if shale gas output continues to

grow. Moreover, lower energy costs enable American manufacturers in the above

mentioned industries to expand their market shares in foreign export markets,

where local competitors do not enjoy the same advantage on the cost of their

inputs. Some US industrialists are therefore not just relocating from China, but


also closing production sites in Europe. In short, the exploitation of shale gas has

deeper economic ramifications than energy independence, royalties to land

owners, and the reduction in trade deficit by 10 percent (USD 70 billion in 2012)

associated to the mere decrease in energy imports in isolation of other

externalities on industrial products deriving from hydrocarbon.

Lesser benefits expected outside the United States

For a combination of reasons explained hereinafter, mostly related to the relative

advantage of the United States as regards both technology, existing infrastructure and

financial capital to expand the former, the Energy Information Administration of the

United States expects it to remain by far the global shale gas leader, even far ahead of

those countries with larger natural reserves such as China. US companies contemplate

exporting shale oil and gas overseas by cargo. Indeed, British Petroleum’s Outlook

projects that 80 percent of energy import growth through 2035 will come from Asia,

whereas the US will become a net energy exporter around 2018-2020.


The benefits of the exploitation of shale gas outside the United States, in particular in

Europe, are not well known, but will most likely be lesser than in the United States.

Because of their historical presence in crude extraction and their dominant position

both inside and outside the United States, American oil companies control shale gas

extraction technology. Those Governments wishing to exploit their underground

resources must negotiate extraction licenses with American companies. The latter have

sizable fields to develop domestically, where costs are low (and notably much lower

than in Europe) because of their location in much less densely populated areas, that is

in areas where it is possible to avoid costs resulting from environmental obligations and

controls, including as regards leaks.

Because of environmental and regulatory/political risks under public pressure, shale

gas remains a high risk business. Due to the rational risk-aversion of economic agents

and investors, financial capital for risky business is traditionally scarce. In this regard

as well, the United States has the unmatched advantage of the breadth and depth of its

capital markets, i.e. more investors (domestic and foreign alike) seeking to provide

venture type capital at formative or expansion stage than in other financial markets,

including the European Union. As a matter of fact, Chinese national oil companies have

acquired over 10 billion dollars of upstream assets in the US, mostly on unconventional

oil and gas projects with the intent to import know-how.

Those countries that banned the exploitation of shale gas and exploration, such as

France due to the proximity of major urban centers, might subsequently benefit from

technology transfer and the learning curve of other countries as environmental risks

are not yet well checked. It is certain that exploitation costs will be higher in countries

where shale gas reserves are situated near urban centers than in the United States

because of the necessity of tighter environmental standards on CO2 emissions. When

fields are smaller, like in Europe, economies of scale will also be less. For these reasons,

it is estimated that exploitation costs would range from 6 to 8 US dollars per unit in

China (million of British thermal units), from 1 to 2 US dollars in the United States

and amount to approximately 11 dollars in Europe. According to British Petroleum’s

World Energy Outlook 2035, shale gas is predicted to make for only 6 percent of

Europe’s demand for gas by 2035.

Although shale gas could be an alternative to policies mainly based on uncompetitive

renewable energy sources such as in Germany, and although it is relatively clean in

terms of CO2 emissions, all current scenarios considered by the French Oil and New


Energy Institute forecast that Europe and Asia will remain net hydrocarbon importers,

as opposed to the United States.

Since the environmental consequences of fracking are not fully understood, the

transposition of the American model into more densely populated territories, such as

India, Eastern/Northern China or Europe, where extraction costs may also be penalized

by the relative size of fields, is by and large unlikely.

Consequently, American companies do not need to exploit foreign shale gas fields and

enjoy a strong negotiating position vis-à-vis prospective sovereign clients. American

companies can propose unfavorable revenue sharing terms, as illustrated by the failure

of such negotiations in Poland. However, the United States is very far from having the

global monopoly of shale gas. The US Energy Information Administration studied the

reserves of 41 countries (out of a global total of 193) and concluded that the reserves of

China (31,500 gm3), or Argentina (22,600 gm3) and of Algeria (20,000 gm3) clearly

exceed those of the United States (18,800 gm3).

The above map only shows assessed basins and is not exhaustive. There also are large

basins to be fully assessed in Italy, Greece, and Cyprus. The reserves of exploitable

shale oil of Russia are likely to exceed those of the United States. However, Russia’s

policy is to exploit conventional gas at this stage.


All countries seeking to exploit shale gas face structural bottlenecks as regards not only

drilling technology but also transportation. In the US, the rapid growth of oil

production (up to 64 percent between 2009 and 2012 in some states) has outstripped

pipeline capacity, and is being mitigated by rail transportation from extraction sites in

the Middle West to the refineries of the East and the West Coast. Crude oil and

petroleum products shipments by rail averaged 1.37 million barrels per day during the

first half of 2013, up 48 percent from the first half of 2012, according to the Association

of American Railroads. The US not only has the advantage of a favorable geology, but

far more developed infrastructure than all other potential producers (pipelines, freight,

trading hubs, futures markets).

Aspiring shale gas producers, in particular emerging economies such as India and

China, are limited by their relative lack of infrastructure. China is addressing it by

building pipelines to Central Asia as a significant part of its shale gas resources are

situated in arid regions in Western China. The infrastructure gap with the United

States is one reason why China, in spite of its large estimated reserves (1.5 times the

US) continues to explore purchase and transportation of oil and gas from Russia.

Because of the geopolitical rivalry between China and the United States and their

diverging views and practice in intellectual property rights, a transfer of fracking


technology from American oil companies to China cannot be taken for granted,

although discussions and competitive bids are clearly ongoing. Aside of the US oil and

gas giant Shell, PetroChina invited Total (France) to extract gas from Northern China

in a joint venture. To curb the ever rising CO2 emissions that come along economic and

industrial development, China is eager to quickly reduce the share of coal in its energy

mix and replace it with gas, a cleaner energy source.

The closest shale gas fields to Chinese industrial and population centers are in disputed

areas near Taiwan and Japan under the seabed, which is easier to fracture than

continental shale. For China, alternatives to asserting sovereignty over these disputed

areas are to exploit far-flung basins in water scarce Western China, or near densely

populated centers in northern China, and/or export gas from Russia. The matter is all

the more strategic to China as 75 percent of its imported oil transits through the Strait

of Malacca (Singapore), which is under indirect ÙS control.

In Argentina, whose estimated shale gas resources are comparable in size to those of

the United States, the lack of financial capital to build up infrastructure is an

additional hurdle, aside of technology. Argentina has capital controls in place, and

nationalized YPF in 2012, the Argentinian arm of the Spanish oil and gas company

Repsol, which claims 10.5 billion US dollars in compensation for the confiscation of its


assets. In 2012, an Argentinian court also ordered the seizure of Chevron’s deposits and

of 40 percent of its cash flows from sales in Argentina towards the payment in full of 19

billion US dollars of penalties for the pollution of the Amazon area in Ecuador between

1964 and 1992, in a recourse against Chevron’s Argentinian assets by Ecuadorean

plaintiffs who could not collect these penalties in the absence of assets in Ecuador.

Although YPF is promising 15 to 20 percent return to prospective joint-venture

partners to enable it to exploit Argentina’s huge shale gas basins, the legal

environment and political risk appear to be obstacles for the development of shale gas

extraction and transportation infrastructure.

In 2012, Indian scientists 28 identified shale gas basins which could cover the needs of

the country for 200 years. Indian scientists assessed reserves to be 13 times as large as

the estimate made by the US Energy Information Administration in 2011, which would


make it the fifth largest hoard worldwide, behind China, the United States, Argentina

and Russia.

More so than China or Argentina, India’s recent policy decisions are mindful of the goal

to keep national assets and resources in domestic hands. Aside of the need for

immediate financial capital to develop oil and gas transportation infrastructure and the

usual technological challenges to shale gas extraction, water scarcity is for now an

obstacle to domestic extraction. In February 2014, two national oil companies, the

state-run Oil and Natural Gas Corp (ONGC) and Oil India Ltd were allowed to explore

blocks allotted to them by the New Exploration Licensing Policy in 1999. According to

the Cabinet Committee on Economic Affair, “this policy will allow national oil

companies (NOCs) to carry out exploration and exploitation of unconventional

hydrocarbon resources particularly shale gas and oil in their already awarded onland

Petroleum Exploration License/Petroleum Mining Lease (PEL/PML) acreages under the

nomination regime.” Production is expected to start after an initial 5-year exploration

phase.

Regardless of whether exploration is assigned to domestic or foreign importers, India is

predictably going to face inherent capacity constraints. The website Indiawaterportal

points out that in the next 12 to 15 years, while the consumption of water will increase

by over 50 percent due to irrigation, population growth, industrial development, rising

standards of living, etc., water supply will increase by only 5 to 10 percent. Potential

shale gas fields, such as Cambay, Gondwana, Krishna-Godavari, and the Indo-Gangetic

plains are expected to experience severe water stress by 2030.

The Northern Indus basin overlaps both Indian and Pakistan territories, which might

aggravate tensions between New Delhi and Islamabad. The latter will depend on

whether either country feels a need to exploit the resources of its neighbor. There have

been precedents in history where geopolitical rivalry, fueled by disputes over mineral-

reach territories, led to armed conflicts. Such was the case of France and Germany

ahead of World War I. Upon its victory at the Franco-Prussian war of 1870-71,

Germany annexed coal and iron-rich German-speaking territories so far under French

control at the border, which entertained French resentment until 1918. After World

War II, Germany had to allow France to exploit coal in extensions of its mines in the

German underground.


Source: TERI Policy Brief, “Shale Gas in India: Look Before You Leap”, June 2013

Conclusion

Shale gas could be an alternative to energy policies mainly based on less competitive

renewable sources, while still allowing to curb (but not eliminate) CO2 emissions. All

current scenarios anticipate that Europe and Asia will remain net hydrocarbon

importers, as opposed to the United States. Shale gas exploitation is a boon for the

latter, which has an opportunity to rebalance its trade deficit by reducing oil and gast

imports and exporting its own, as well as by onshoring manufacturing activities that

benefit from a lower cost of energy at home. The environmental consequences of

fracking are not fully understood and give rise to significant controversies and civil

opposition. This precludes the transposition of the American model into more densely

populated territories, such as China, India and Europe, where the relative size of fields

also weights on unit costs.


Shale gas carries the potential of energy independence for emerging economies, which

have been contributing to half the growth in energy demand over the past two decades

– nearly all of which from India and China in particular. In spite of large assessed

reserves, energy independence should not to be taken for granted due to important

capacity constraints everywhere but in the United States.

References

Adam Sieminski, Administrator of the US Energy Information Administration,

Testimony before the Committee on Energy and Natural Resources of the US Senate,

July 16th, 2013

Alistair Osborne, Emily Gosden, The Daily Telegraph, “US shale revolution will

transform global economy”, January 15th, 2014

Anne Feitz, “Gaz de schiste, déception en série en Pologne”, Les Échos, May 26th,

2013

Bloomberg News, “China’s 2013 Shale Gas Output Rises to 200 Million Cubic Meters”,

January 8th, 2014

Cécile Boutelet, “En Allemagne, les effets pervers d’une révolution énergétique”,

Le Monde, May 16th, 2013

Counter Currents, “Chevron Fined $19 Billion for Polluting The Amazon Basin”,

November 9th, 2012, http://www.countercurrents.org/cc091112A.htm

Dominique Pialot, “Énergie: l’industrie française inquiète pour sa compétivité”, Le

Monde, May 16th, 2013

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Documents

Economic Overview and Geography of the Shale Gas Revolution