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« Climategate and HADCRUT | Main | YouTube stills »
Monday
May282012

Frackonomics

Doug Proctor points me to this article about the economics of shale gas. Considering it is on a website called Smartplanet, it's argued in a pretty sane and sensible manner, concluding that $2/mcf is a function of oversupply rather than the true cost of shale gas.

I don't have a problem with this argument actually. Figures in the range of $5-7/mcf are often quoted for the range in which fracking operations become economic, perhaps more outside the US where the shales are more readily exploited than in the UK. This would still be much cheaper than the kinds of prices we pay for gas now and there are energy security considerations in favour of shale too.

But at the end of the day, the economics of shale are not relevant to the government's decision about whether to let fracking commence. Arguments over what is cost effective and what is not are just so much hot air. We have markets to settle the bickering.

(Of course, it goes without saying that the energy market is so rigged and distorted by subsidies, obligations, surcharges and price floors that it is impossible for it to function properly, but that's another argument).

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Reader Comments (31)

Had a quick look but didn't see any discussion of the economics of electricity production. IMO the investment case for CCGT vs wind/barrarage/nuclear needs to be explored in the context of uk energy supply.

May 28, 2012 at 8:18 AM | Unregistered Commenternot banned yet


But what if the business isn’t actually profitable? What if it’s really based on accounting trickery and overstated claims?

What, like wind power?

May 28, 2012 at 8:22 AM | Registered CommenterLord Beaverbrook

It does not matter what the break even price is, if you have bought and paid for the capital equipment, the minerial rights etc you are commited to drill and produce whatever the price is. The US has too many drilling rigs and until some go bust and stop drilling they will have to sell at below cost. One way would be to move the rigs outside of the US hint hint.

May 28, 2012 at 8:27 AM | Registered CommenterBreath of Fresh Air

It is a good and interesting article, but nowhere in it can I see an argument against letting shale gas be exploited in the UK.
However, doubtless the Royal Society's forthcoming report will announce that the process is uneconomic therefore we should not be allowed to try!
I would be surprised if anyone here had ever thought that shale gas was going to be an all-singing all-dancing perfumed solution to UK energy needs...but it looks very promising as an additional, potentially large, part of our energy mix.
There may still be a lot of fossil fuels about to secure the immediate future, but a TOTAL reliance on the market to keep bringing us affordable energy might be a bit misplaced.
I would like to see more research money put into all forms of nuclear, which is where the mathematics and the physics indicate our long term energy needs can be satisfied.
The country that can produce and export a safe,modular we-can-build-it-anywhere nuclear power plant will be exporting them as fast as they can build them for decades.

A mass produced, safer, bigger version of these?

http://en.wikipedia.org/wiki/Russian_floating_nuclear_power_station

May 28, 2012 at 9:04 AM | Unregistered CommenterJack Savage

Who puts the value on "Security of Supply"?

When a significant volume of our gas is sourced from Russia (via their sqabbling neighbour the Ukraine - until Nord Stream via the Baltic is operational), the fact that we have our 'own' gas from beneath Blackpool aids our negotiating position to drive their price down.

May 28, 2012 at 9:37 AM | Unregistered CommenterJoe Public

Exactly, Joe Public, well said. One wonders whether anybody in the current government has any business acumen to have spotted this opportunity. Just think, if we had cheaper energy we might all have more cash in our pockets which we might all go and spend, thus giving the economy a kickstart that wallpaper heir, little G Osborne, has been hoping for so desperately. And just think of all that extra 20% VAT that might flow into the Treasury (assuming that Vat on energy is still at 8% - is it? I'm a bit out of touch. All I know is that I am grossly overcharged by Eon on monthly direct debit who owe me £700. And that's after them having to refund me £2000 last year through overcharging, but I digress).

May 28, 2012 at 10:12 AM | Unregistered CommenterBiddyb

The focus on the price of gas hides another key aspect: in some areas it is a by-product of oil production by the same techniques. Oil is,of course, far more valuable so the gas gets dumped or even flared - when allowed.
In the same vein, there are "wet" plays where the condensates are worth much more than the gas.
This surplus by-product gas may keep prices low unless the price of oil crashes and/or demand catches up with supply.

May 28, 2012 at 10:34 AM | Unregistered CommenterMikeH

Bish.

Your update on the subject of Myles Allen's poor self-image appears to have been appended to the wrong post.

May 28, 2012 at 10:38 AM | Unregistered Commenterjerrym

The best thing we could do with that gas is to be ready to exploit it, and willing, but leave it in the ground if we can. It will come in handy when the other gas is gone or gets expensive. Of course we do need to know how much there is and where.

May 28, 2012 at 11:40 AM | Unregistered CommenterRhoda

As long as the Conservatives think that "carbon" is toxic to their image and as long as the Liberals think they can "save the planet" there is not much chance of the coalition government giving anything more than lukewarm backing to exploration for shale gas and even less chance of them actually backing extraction of shale gas on a large scale.

May 28, 2012 at 12:09 PM | Unregistered CommenterRoy

Roy,

It was Labour that led the charge into thinking Co2 was a toxic substance do lets not play the sane petty political games MP's play. The simple fact is labour ABD the Tories only difference is the colour used to represent them on a map.

Mailman

May 28, 2012 at 1:14 PM | Unregistered CommenterMailman

It is difficult to estimate just how much of the reduction in North American natural gas prices is down to oversupply, how much to it being treated as a by-product of more valuable oil and how much is down to improvements in productivity and efficiency. In analysing strategic options on energy for countries I have been using $5.50 to $6 as a medium rerm conservative figure.

May 28, 2012 at 1:30 PM | Unregistered Commenterjheath

The problem for the pro-shale gas voices is the lack of evidence of profitability during periods where gas prices were higher. Everything depends on the assumptions made about ultimate returns but little is done to reconcile those assumptions with reality because new activity keeps kicking the can down the road. While the income statement can hide the problems the balance sheet and cash flow statements cannot. So what we see is a huge explosion of debt and very large negative cash flows. The real problem is the very low energy return on the energy invested. If it is so tiny in the core areas of the best formations how negative will it turn out to be in non-core areas?

May 28, 2012 at 1:58 PM | Unregistered CommenterVangelV

Geothermal Energy is being looked at again by DECC
http://www.decc.gov.uk/en/content/cms/meeting_energy/renewable_ener/re_roadmap/re_roadmap.aspx
http://www.decc.gov.uk/en/content/cms/meeting_energy/geothermal/geothermal.aspx

Unfortunately they don't appear to know that extraction of such energy involves "fracking" and pumping water into radioactive rocks.

Why aren't the Watermelons up in arms about this latest threat?

May 28, 2012 at 2:39 PM | Unregistered CommenterDon Keiller

The problem with the cost vs prices is that the gas you are paying for right now is cheaper than the gas you will be paying for later. Whatever the source. Shale gas is a relative problem source: that is why it has not been accessed to-date. Plus the way the government and companies determine both the total supply and the individual well supply is misleading. There is in practical terms less of it both as a producile resource and as a well cummulative production number.

The USGS just downgraded the Barnett shale, the initial excitement by 70%. That is, the recoverable estimates by 70%. The same happened to coalbed methane. In Alberta I worked CBM. One government report said there would be 1200 wells in a particular ranching valley. Of course the locals were upset! How many are there? None. Why? Because the coals aren't producible. Period. There is no inherent permeability for a frac to connect to.

I stress this because the Euro-UK is being told that shale-gas is a good thing. Cheap and plentiful. It is not. It is necessarily more expensive than conventional gas and this will show up on your energy bills. It is a much more limited resource, but if you allow the self-interest groups to advise you, you will have gaswells drilled all over the country, to your personal cost because the majority won't pay enough: you will subsidize stupid drilling.

Of course the gas companies will make money: they'll get it from you.

Market forces will join with government desires. Yes, market forces will work. But they will work to get your energy bills higher than today. This is my story: cheap gas from shale gas is a fraud.

The Euro-Brit needs cheap energy. All societies need cheap energy. Shale gas is a stopgap that is not cheap. If developed prudently, it is valuable and can be reasonably inexpensive - in the core. Taken as a false "industrial" process, it will drive up your bills, taking money from better things.

Nuclear? Something.

Have at it. Just let your pensioners-to-be know what they are in for.

May 28, 2012 at 1:58 PM | VangelV
said in fewer words.
May 28, 2012 at 8:27 AM | Breath of Fresh Air
uses the "spilt milk" analogy. Unfortunately, someone has to pay for that spilit milk. If it is previous profits, then you know futuure equipment costs etc. will not allow the projects to continue.

You cannot pay less than it costs unless you take money from someone else. Or increase prices to the consumer. The USSR did the former, the UK will do the later.

May 28, 2012 at 3:34 PM | Unregistered CommenterDoug Proctor

@Doug.
Shale gas may well end up being more expensive than conventional gas. We will just have to wait and see. However that is not the point here.

It is the relative expense of shale gas v "renewables" such as wind and solar.

To say nothing about the unfathomable cost of "energy security".

May 28, 2012 at 3:41 PM | Unregistered CommenterDon Keiller

The main problem shale gas has in the UK is that it is being pre-judged as impractical by a bunch of ecoloons who are willing it to fail. They are running scared as the last thing they want is for shale gas to pull the rug from under their ridiculous renewable energy schemes.
I find it strange that the government won't take an impartial stance and, barring ensuring the necessary safeguards are in place, let the drilling companies go ahead. What have they got to lose?

May 28, 2012 at 4:11 PM | Unregistered CommenterSteve Jones

Steve Jones: exactly right! Allow some prospecting by private firms. If it is not viable, they will be out of pocket. On the other hand, if it works we all benefit.

Maybe someone can shed some light....I saw a programme recently on drilling for gas in the Norwegian sector of the North Sea. It described horizontal drilling followed by fracking. It seemed to be a routine operation. If it is economic to frack offshore with all the cost adders, why would'nt it work onshore?

May 28, 2012 at 6:09 PM | Unregistered CommenterMikeH

The problem with the cost vs prices is that the gas you are paying for right now is cheaper than the gas you will be paying for later. Whatever the source.

The real issue is still the energy return on the energy invested. When it is said and done the energy in the tight oil/gas found in shale do not justify the energy spent to extract it, except in the core areas of the best formations.

Shale gas is a relative problem source: that is why it has not been accessed to-date. Plus the way the government and companies determine both the total supply and the individual well supply is misleading. There is in practical terms less of it both as a producile resource and as a well cummulative production number.

As you know, the problem still comes down to how much you have to spend in energy to get the energy out. What is worse is the confusion among people who should know better but still manage to confuse tight oil in shale formations with shale oil, which is kerogen that has to be upgraded before it can be made useful.

The USGS just downgraded the Barnett shale, the initial excitement by 70%. That is, the recoverable estimates by 70%. The same happened to coalbed methane. In Alberta I worked CBM. One government report said there would be 1200 wells in a particular ranching valley. Of course the locals were upset! How many are there? None. Why? Because the coals aren't producible. Period. There is no inherent permeability for a frac to connect to.

It is funny how people forget all of the CBM excitement. Or forget to look to actual fields like the Elm Coulee in the Montana portion of the Bakken. The field was one of the Bakken 'core areas'. It was the first commercial success in the entire Williston Basin. Development began in 2000 and by 2005/2006 the Elm Coulee become the highest producing onshore field in the Lower 48 states. The trouble is that the field peaked in 2006 and has been in decline every since. Montana production is now way down from its peak and falling by approximately 1 per cent a month. The optimists can talk up shale oil and gas but history shows that they have no clue what is really going on.

May 28, 2012 at 6:46 PM | Unregistered CommenterVangelV

It is the relative expense of shale gas v "renewables" such as wind and solar.

We can't fall into a trap of choosing between two uneconomic options. Prudence demands that we pay attention to what is going on in the real world.

May 28, 2012 at 6:47 PM | Unregistered CommenterVangelV

The main problem shale gas has in the UK is that it is being pre-judged as impractical by a bunch of ecoloons who are willing it to fail. They are running scared as the last thing they want is for shale gas to pull the rug from under their ridiculous renewable energy schemes.

I find it strange that the government won't take an impartial stance and, barring ensuring the necessary safeguards are in place, let the drilling companies go ahead. What have they got to lose?

Private investors should be allowed to take all of the risks that they want to take. And they should be allowed to take advantage of all of the regulatory rules that allow them to hide from their investors the reality of the economics of their operations. If the investors fail to do their homework and pay attention they deserve to lose their investment. I only hope that those that are busy cheering on the mountebanks who are promoting shale as a solution will keep their traps shut and not claim that they were mislead after the bubble pops.

May 28, 2012 at 6:50 PM | Unregistered CommenterVangelV

@VangelV
"We can't fall into a trap of choosing between two uneconomic options. Prudence demands that we pay attention to what is going on in the real world."

You're right we can't. Thanks to shale gas US energy prices are considerably lower than ours.
That's why their economy is recovering and ours isn't.

By all means go and grow your organic food and enjoy your "sustainable" lifestyle in your Yurt.
Just don't count me in on your ecodream.

May 28, 2012 at 9:26 PM | Unregistered CommenterDon Keiller

You're right we can't. Thanks to shale gas US energy prices are considerably lower than ours.

That is not exactly true. The US is enjoying lower gas prices due to a number of factors. First, there was a collapse in demand thanks to a considerable contraction in the real economy and a very warm winter. Second, US producers are trapped and have to destroy capital in order to keep the game going. If management actually chose to stop taking losses and write down leases most companies would be insolvent and would have to be liquidated. It is a far better option to keep adding debt and produce gas at a cost for as long the game can continue. After all, those salaries and bonuses would keep shale producer executives comfortable for years into the future

That's why their economy is recovering and ours isn't.

The US is not recovering. What you see is a flood of liquidity by the Federal Reserve at a time when the Euro is imploding. US unfunded liabilities stand at more than $100 trillion and the GAAP deficit is running at a third of GDP. If you count the people who have given up work or are underemployed you are looking at an unemployment rate as measured pre-Boskin at more than 20% and if you use the proper GDP deflator you see negative GDP for almost a decade. If we do the pension accounting properly we find that most US states are bankrupt. So are most cities and counties. Lower gas prices are not really helping as much as you think because part of the strategy by the shale drillers is to get the EPA to ensure that many of the coal plants are shut down. This is why the long term futures contracts are showing that electricity rates are about to explode in the next three years. With drilling rigs down by 50% a cold winter could cause US gas rates to spike to over $10 per Mcf. Of course, we could get 'lucky' and see another economic collapse that kills demand and drives the last nail into the long term future of the shale sector but that is a subject for another posting.

By all means go and grow your organic food and enjoy your "sustainable" lifestyle in your Yurt.
Just don't count me in on your ecodream.

I am basically as much of a free market advocate as you can imagine. I believe that governments have no business in the creation of money and should not interfere in any voluntary transactions between individuals. I believe that all services, including policing and courts can be provided better and cheaper than government and consider government the enemy of a free society. I have no problem with the econuts pursuing their goals as long as they do it with their money and as long as they cannot force others to live in ways that they do not wish to. And as I said, I have no problem with foolish investors pursuing their dreams of energy riches by investing their money because as someone who invests a great deal in energy such stupidity gives me the opportunity to make a potload of cash by betting against them. Of course, they would not be able to use the force of government to stop competing nuclear, hydro, or coal projects and that would be to the great advantage of rational investors as it punishes the fools who chose renewables and uneconomic shale or ultra-deep-water plays. .

May 28, 2012 at 10:08 PM | Unregistered CommenterVangelV

Monbiot is back on the job with a rant against gas and coal. This excellent investigative journalist has turned up all sorts of evidence that the government, beneath its green exterior, is secretly being sensible.
As usual, comments and recommends show Guardian readers to be in total disagreement with the paper’s insanity.
Commenter absitreverentiavero:
“Shale gas technology offers us the chance of clean, green, vast reserves of energy that will keep us going for several decades to come”. [27 recommends]
Monbiot’s reply: [6 recommends]
Monbiot also achieves the remarkable feat of replying to a critic before his comment appears.

May 28, 2012 at 10:34 PM | Registered Commentergeoffchambers

VangelV's statement that Montana's oil production is way down from its peak is not relevant to what is really happening in the US.

http://www.masterresource.org/wp-content/uploads/2012/05/image.png

The oil production from fracturing shale formations is rising in both North Dakota and Texas, and is expected to rise significantly during the next several years.

May 29, 2012 at 12:30 AM | Unregistered CommenterDon B

There seem to be two separate threads of discussion here. One is the economics of shale gas, and the other is the desirability of exploiting shale gas for other than economic reasons.

The economics of shale gas can be left to the market, but as the Bish and others have pointed out, the real issue is the lack of a level playing field for different energy sources. Nobbling of unfashionable energy sources and targeted interventions like the RS study (when in history has a 'learned' academy's views on energy markets meant diddley squat in the real world?) are obstacles to cheaper and more reliable energy, and should be deplored and relentlessly attacked from a policy perspective.

From a national interest perspective, it makes sense to maximise the chances of home-grown energy which is economically viable coming on stream. So, it actually aligns quite well with the economic arguments. The way to do that is to actively identify policy and regulatory impediments to that happening, and address them. Having been involved a a couple of 'identifying the obstacles' exercises in other policy areas, I know that it is very worthwhile. It is often surprising what is uncovered. Impediments which are archaic, based on unrelated objectives (which may be much less important) or are simply there for reasons no-one is quite able to justify, abound. Repealing regulatory impediments is almost cost-free, except for the squealing of interest groups that have been benefiting from them. But, the rewards can be orders of magnitude greater for the larger policy objective - in this case, cheap, reliable energy which is less subject to events over which a country has no control.

May 29, 2012 at 2:58 AM | Unregistered Commenterjohanna

I posted the following on "Unthreaded" but then realized that these two articles have relevance to the wider (energy) context of this thread.

Most intriguing to think about how some aspects of politics, economics, and energy are changing right before our eyes:


Monbiot is in a tizzy about this, but (therefore) I like it:

Britain's climate change policy is going up in smoke

The phrase "center of gravity" would seem to be journalistic carelessness not justified by the numbers, but still, changes in the western hemisphere do seem "interesting" for debates about energy sources:


Center of gravity in oil world shifts to Americas

May 29, 2012 at 3:48 AM | Registered CommenterSkiphil

If the shales beneath the UK are rich in gas then they must be exploited. The UK problem is the government who regards the oil/gas industry as cash cows, overtax them so full removal of these resources is reduced so as to lower tax payments. This is happening in the North Sea.

Geothermal power is very costly as the Salton Sea station in California will affirm. It does entail fracking to ensure the water pumped down the hole circulates into the hot rock. Holes need to be deep, depending on the local temperature gradient in the rock but the average is 30C/Km so a 10Km deep hole will produce 300C water laden with salts which at that temperature eats steel so some exotic material pipework and turbines are required. Geothermal was tried in the Cornish granite but failed due to lack of funds and heat.

May 29, 2012 at 11:37 AM | Unregistered CommenterJohn Marshall

VangelV's statement that Montana's oil production is way down from its peak is not relevant to what is really happening in the US.

http://www.masterresource.org/wp-content/uploads/2012/05/image.png

The oil production from fracturing shale formations is rising in both North Dakota and Texas, and is expected to rise significantly during the next several years.

That is what happened in Montana. Production exploded as more and more drills began to turn into one of the most prolific areas of the Bakken. The problem was depletion. Those $5-$7 million wells are down to less than 100 bpd within two years. And that is in the core areas of the best formations. Such a well in a typical conventional reservoir would have yielded more than 10,000 bpd. We understand the geology and understand the math. Given the massive depletion rates you need a great deal of drilling activity just to keep production flat. The growth comes from additional drilling but that runs into the math problem because a higher production rate means even more depletion that needs to be made up by additional drilling.

This is why each of the shale formations should see a similar profile as Montana. The problem for the optimists is that the current areas are not as prolific on average as the Elm Coulee field was. As such the economics should not be nearly as good as projected and the production growth should not last as long as Montana's.

For the UK and other European locations the type of formation matters. There should be a profit to be made by the producers in prolific core areas but that profit will be limited by expansion into areas that should never be developed. If the lease terms are as they are in the US the producers could have a major problem surviving.

May 29, 2012 at 1:46 PM | Unregistered CommenterVangelV

"BISMARCK, N.D. (AP) -- A typical well drilled in North Dakota's rich Bakken and Three Forks formations will produce about 540,000 barrels of oil during its 29-year lifespan and will generate more than $20 million in net profit, according to state Department of Mineral Resources data.

Over its lifetime, an average Bakken or Three Forks well will pay more than $4.5 million in taxes and about $7.5 million in royalties to its mineral owners, agency data show.

Drilling horizontally into the formations, which lie two miles underground in western North Dakota, costs companies about $7.9 million; each well will pay more than $2 million in salaries and wages over its lifetime, the agency said."

http://finance.yahoo.com/news/nd-bakken-wells-pump-nearly-170254013.html

The results of fracked horizontal shale wells in the US demonstrates the irrationality of the opponents' arguments in the UK. Greenies must strongly wish to harm the economy.

May 29, 2012 at 7:53 PM | Unregistered CommenterDon B

BISMARCK, N.D. (AP) -- A typical well drilled in North Dakota's rich Bakken and Three Forks formations will produce about 540,000 barrels of oil during its 29-year lifespan and will generate more than $20 million in net profit, ACCORDING TO STATE DEPARTMENT OF MINERAL RESOURCES DATA.

Data? What data shows that? After all the typical well being drilled is horizontal and there were no horizontal wells drilled in ND until recently. And the Elm Coulee wells in Montana, which were drilled in a prolific area, did not last 29 years and are showing a decline of 1% per month.

And let us note that the typical well is not drilled in, "North Dakota's RICH Bakken and Three Forks formations," but in the typical ND Bakken and Three Forks formations, which are not rich. We cannot project the returns from wells in the best parts of the core areas with the TYPICAL return from the formation.

Over its lifetime, an average Bakken or Three Forks well will pay more than $4.5 million in taxes and about $7.5 million in royalties to its mineral owners, agency data show.

If the 29 year lifetime is correct and the EURs are sound. But there is no production data that I have seen that shows that this is true.

Drilling horizontally into the formations, which lie two miles underground in western North Dakota, costs companies about $7.9 million; each well will pay more than $2 million in salaries and wages over its lifetime, the agency said.

Now these are pretty good estimates. We know what it costs to drill a well. We know the salaries paid to the drillers. The trouble can be seen from the data in the chart below. See all that massive drilling? That means decent IP numbers as all wells produce a decent amount of oil in the first month. But the average production per well has stalled even though all that drilling has been going on. This means that the huge depletion is taking its toll and the massive drilling program is needed to keep the average per well around 150 bpd. So what we have are huge upfront costs doing nothing to boost average production levels. This means that the companies are not self financing in their shale operations and will have to add debt to keep going forward unless they have a conventional source with positive cash flows that can keep them afloat. I am sorry but that is not a positive.

http://i.bnet.com/blogs/laherrere-n_dakota_bakken-only-production.jpg

The results of fracked horizontal shale wells in the US demonstrates the irrationality of the opponents' arguments in the UK. Greenies must strongly wish to harm the economy.

The UK should be free to pursue any strategy it wishes. But the problem is that it cannot escape the consequences of economic reality. Given the lack of service sector infrastructure a typical UK well would cost far more than $7.9 million to complete. How much oil is produced depends on the quality of the formations. It is possible that companies can find the core areas of a few formations very profitable. But it is a certainty that most of the formations will remain uneconomic. Of course, that is not the government's business. Investors should be free to speculate with their own money on whatever scheme they wish as long as those schemes do not harm other people directly.

May 30, 2012 at 12:56 PM | Unregistered CommenterVangelV

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