By Saliem Fakir · 17 Jun 2014
The local hype over shale gas continues as the ANC’s National Executive Committee recently announced that shale gas is a “game-changer” and must be exploited for the benefit of the country.
How much gas there truly is below the Karoo’s surface is anybody’s guess. The original U.S. estimate of the South African resource was put at 480 trillion cubic feet (TCF). Separate resource estimates by the Petroleum Agency of South Africa and the Geological Sciences Council put estimates much lower at anywhere between 40-72 TCF -- and this is only for the resource. We don’t know enough to have a view on the final economic reserve. Water could be a pivotal factor in Karoo shale gas extraction, possibly throwing the economics out.
This has not tamed the propaganda from both sides. Nevertheless, it is science and hard-nosed economics that will ultimately determine what is viable.
Shale gas is not just a mineral product; it is also a good that will come up against the tension of whether it is best privatized or its rewards socialised as much as possible. The real economic viability and benefit of the resource will rest on settling this tension.
Unfortunately, as current debates in the mining sector go, the economics of shale gas will undoubtedly fall prey to the same resource nationalism dynamics as other natural resources, i.e., pursuing fracking simply because it is assumed that there is a compelling story for the future, beyond the current hopeless narrative soiling the promise of our mining sector, that persuades us that private benefit is always the same as public benefit.
Two immediate issues highlight a serious concern about the real motives driving shale gas exploration in South Africa. Firstly, there is the absence of a proper gas infrastructure network in South Africa. Secondly, and related to the first problem, gas is not used pervasively in the country. This situation is likely to become an incentive for exporting gas out of the country. Shell is already gearing itself for this eventuality, as it is developing new technology, such as a mobile liquefaction plant, that can be placed directly at shale gas boreholes. Once the gas is extracted and liquefied, it will be quickly transported out of the Karoo and shipped out of the country.
This scenario is the least beneficial for South Africa.
So where do we turn to learn more about the benefits of shale gas exploration for South Africa? The U.S. is the leading example, but is it replicable and is their model appropriate for South Africa?
The late George Mitchell, one of the early pioneers of hydraulic fracking, succeeded in productively extracting gas from impermeable shale-rock in the nick of time, as his company, Mitchell Energy, desperately needed new sources of gas and oil to keep going in the 1990s.
Gas and oil is stored in difficult to reach ‘source’ rock that has to be fractured artificially to get gas and oil to gush to the surface. After many years of trial and error, Mitchell, a Greek immigrant, got the right technology mix - combined horizontal and vertical drilling with a mixture of chemicals and water - to remove high rates of gas from deep within the earth’s bosom.
Mitchell’s desperation was a powerful force for innovation. Today, the U.S. has moved from producing 11% of gas from shale in 2008 to more than 20% in 2010 and if current assumptions still hold, may approach 50% by 2035.
It was this technological revolution in the oil and gas industry combined with unique above ground U.S. characteristics that produced the current boom from unconventional sources since hydraulic fracking was first commercialised in 2004.
Since then, thousands upon thousands of fracking wells have been drilled across close to 48 shale gas and oil fields.
Ironically, these new technological innovations will facilitate the expansion of conventional sources of oil and gas from existing wells that have been economically unrecoverable, keeping the fossil fuel economy going for a few more decades.
America’s drilling pace is driven primarily by firms started by maverick, never say die entrepreneurs, eager to risk all in the new ‘gold rush’. Many of these companies, like Chesapeake, are willing to bet everything on the continuous flow of gas and oil. They use their friends on Wall Street to borrow to the hilt and come up with financialised products like volumetric production payments (VPPs) or forward contracts to advance payments for the promise that they can deliver the hydrocarbon product at some future date.
But some analysts are sceptical that this gold rush will last without a major crash and restructuring of the U.S. industry. In some cases the rate of capital and operational expenditure far exceeds the amount of revenue generated.
There are a few reasons why the U.S. experience is unlikely to be repeated in other parts of the world, including here in South Africa.
One of the key reasons the American model won’t work here is the lack of an economic framework to support shale gas exploration. A few pointers can be drawn from the recent comments and work of Leonard Maugeri who has written about the economic infrastructure of the American oil and gas industry. Maugeri is a proponent of the oil and gas industry and a familiar global expert.
Firstly, the U.S. economy was built on oil and gas. Think of Rockefeller and you slowly begin to see the relevance of railroads, pipelines and the first T-model automobile that Ford built going back more than a hundred years. All of these were supported by the discovery of rich oil fields in the U.S.
As a result, today’s frackers had something to build on, including industry knowledge, technology, vast amounts of drilling logs, a financial sector that understands the business and a dense network of oil and gas pipelines that supply energy to major centres within America, mainly in the North East and South. The already paid costs of old investments - soft and hard - allowed a rapid revival of their oil and gas sector. This ‘plug-and-play’ characteristic has been the most important factor in America’s ability to scale gas and oil production from unconventional sources.
South Africa does not have this advantage and this does influence the economics of shale gas exploration, for a start.
The key to the success of U.S. shale gas drilling is that the pace of drilling is done rapidly with quick turn-around periods. We are talking days as opposed to months. There is a good reason for this. If gas prices are low, overall production rates can only be kept at high levels if companies drill as many wells as they can.
Shale gas wells on an individual basis have high decline rates – as much as 80% or more within the first two years. Companies find themselves on a rapid death treadmill if they are just drilling for gas. With low gas prices as well as high capital expenditure and debt, companies can do nothing but drill as much as they can, creating paradoxical overproduction with gas prices too low compared to production costs.
In the end, the U.S. model may not be appropriate for South Africa. Even their cheap gas scenario, largely due to the nature of their gas market, is unlikely to last in forthcoming decades as cheap gas is already inhibiting further exploration and development of dry gas fields.
Geography and depth also matter. The most productive U.S. wells are at depths that are easy to drill and in hospitable terrain. The deeper you have to dig and the rougher the terrain, like Chinese shale gas, the costlier it is to extract the gas. Geographic hospitability includes generous availability of water – something that our Karoo simply does not have in any form of abundance.
Poland’s recent foray into shale gas also turned out to be a damp squib. Blame was put on their government for wanting too many royalties. But in truth, this was not the foremost reason fracking was abandoned. The real reason behind the decision to withdraw is that Poland’s wells proved not to be as economical viable as originally anticipated.
The sheer weight of the economics - because it is going to be tough for South Africa - will merely force us to leave the gas in the ground, which would be preferable given the ecological sensitivity of the Karoo and the lack of any evident social benefits for South Africans other than lots of talk. Alternatively, selfish interests could push us towards extraction through false promises and taxpayers might be persuaded to socialise the cost and privatize the benefits.
Mining sector should be a learning curve for SA on strategic economic sector in relation with social investment and investors
Thank you Saliem for bringing up such fruitful discussion. I think, you have laid it very well and perhaps, it is always be my concerned that if these kind of project(s) will ever have social investment? The wildcat strike in the mining sector is a result of failure in social investment or social benefits. It is evident that, if these companies fails to internalize their externalities such causalities as it is happening in the mining sector will be experienced by other economic strategic sectors if socio-economic benefits are not on the top of agenda i.e Platinum mines. Fracking in Karoo has received huge criticisms from environmentalist based organisations and contrary, got go-head by government, this then in real terms suggested that the project is going ahead. It then, prepares people of South Africa to voice out and ensure oil and gas companies play vital role in addressing social illness from poverty, education, enterprise development, skills transfer programmes and etc. The social-economic plans must be inline or aligned with tough environmental and other mitigation measures, this will then need intensive monitoring processes from all stakeholders involved. This also draws lessons for REIPPP for social-economic plans and how this programme will benefit socially and address some challenges faced by the country. Yes, agree with you and other scientific findings that the amount of oil/gas available in the Karoo is uncertain, this is making very hard to do economic/financial conclusions. But this also indicates high alarming risk of this project and lessons should be learnt out of it. â€œInternalize externalitiesâ€ â€œsocial welfare as priorityâ€ â€œintense compliance and monitoringâ€ â€œenvironmental, social and economic benefitsâ€
No State Can Afford to Subsidies Extraction
>>"Alternatively, selfish interests could push us towards extraction through false promises and taxpayers might be persuaded to socialise the cost and privatize the benefits."
Example - ineffective mining companies that already pay slave wages need to be subsidized by government (read overburdened taxpayers) to fulfill their housing obligations. The private sector is sometimes very irresponsible/opportunistic.
Criminally Negligent Loans
"They use their friends on Wall Street to borrow to the hilt and come up with financialised products like volumetric production payments (VPPs) or forward contracts to advance payments for the promise that they can deliver the hydrocarbon product at some future date."
Shale gas is about scraping the bottom of the barrel. Borrowing vast sums of money against even more vastly exaggerated promises of returns should be treated as criminal negligence. Didn't the American financial institutions learn anything from the housing mortgage collapse? Imagine if the fracking loans were being invested in renewable energy instead? Now that would be a 'game changer'!
Perfect point again - not much different to what has happened to our other resources actually. Taxpayers pay the costs and capital gets the rewards.
Investments which yield long term benefits for the community are wise ones. Investments which leave an aftermath of problems for the community to cope with are definitely unwise. They might appear to be wise for those who hope to make money from them in the short to medium term. Fracking is definitely unwise.