It depends on what you mean by “save.”

Recently The Financial Times ran a story (“Shale gas boosts US manufacturing“) discussing the fact that a number of companies, both American and non-American, were either re-opening chemical or fertilizer plants in the United States, or were building new plants. This trend has emerged as the result in the significant fall in the price of natural gas in the US as compared with other regions. As the FT noted,

Dow Chemical plans to open new US ethylene and propylene plants later this decade, and restart a Louisiana ethylene cracker closed in 2009. Royal Dutch Shell announced a chemical plant in the gas-rich Appalachian mountain region to make ethylene and petrochemicals. Sasol of South Africa last week unveiled a plan to convert gas into diesel fuel in Louisiana. In the fertiliser industry, Potash Corporation of Saskatchewan is investing $158m to restart a Louisiana anhydrous ammonia plant shut in 2003, when gas prices were climbing. Aluminium company Ormet is dusting off a nearby plant shuttered in 2006.

This is a turnaround from activity a decade ago, as the FT notes, when companies were closing plants and moving operations elsewhere. However, as one might expect, the story is somewhat more complicated, because the technology behind the drop in US natural gas prices—Hydraulic Fracturing, or “fracking”—comes with its own set of environmental and regulatory concerns. As the FT indicated,

The investments come as the US gas market faces regulatory challenges. Extracting gas from shale rocks involves injecting water, sand and chemicals at high pressures thousands of feet underground, raising concerns it will pollute drinking water. Some states have imposed moratoria or restrictions on the technology, while the Environmental Protection Agency is studying potential impacts. A government advisory panel last month urged disclosure of what is in fracturing fluid.

Nor are these concerns restricted to the US. Fracking is a controversial drilling technology, so much so that France has banned its use, and the states of New York and New Jersey have banned its use either in watershed areas or completely (although the New Jersey ban has been rejected by the state’s governor, who prefers a one-year moratorium). These concerns arise as Europe discovers its very own tracts of shale gas, which, as is the case in the US, offers the potential for overcoming what appeared to be declining natural gas supplies and rising natural gas prices, as well as the ability to reduce dependence on imports, a significant concern for Europe in general. The most recent shale gas discovery, in fact, has been here in the UK.

Fracking represents a technology that thus far has allowed the US to reap the benefits of significantly lower natural gas costs over the past several years, although this benefit may be temporary as other countries push to develop the use of this technology in their own regions. However, it’s not clear that other parts of the world have the infrastructure or expertise to develop shale gas reserves as broadly as has been done in the US. As a result, the US faces the prospect of potentially benefiting from lower natural gas prices for some period of time. Moody’s , for example, has opined that this benefit may last 5-10 years in the case of the chemical industry.

In addition, as intimated above, there are some interesting, and potentially significant, environmental issues associated with fracking. Not least of these is the fact that fracking technology uses very large quantities of water. Given that many recently posited shale gas reserves seem to occur in areas of water scarcity, this raises some questions as to how usefully some of these resources can be developed. In addition, concerns have been raised about possible groundwater contamination, although it’s not clear whether these objections can’t be addressed through better drilling practices.

However, should the environmental issues be resolved in a cost-effective manner (which is not at this point a certainty), there are several significant implications that follow. First, the prospects of somewhat cheaper energy costs, and a longer life for current gas reserves than envisioned just a few years ago, appear justified. This is likely to have broad macroeconomic impacts.

Second, there are clear implications for a number of industries—chemicals and fertilizers in particular—that are significant industrial users of NG, and these implications may have differential impacts on US and European chemical and fertilizer producers. These implications may be significant enough to affect business strategies, and even credit profiles, to the potential benefit of North American producers versus their European (and possibly Asian as well) counterparts. The US industries affected have been major employers in their regions, to the prospects of a resurgence in hiring has obvious appeal for policymakers.

Third, NG is attractive to industry and governments relative to other fossil fuel sources for another reason—it generates significantly lower levels of Greenhouse Gasses (particularly CO2). Thus, NG has been proffered by a number of governments and non-governmental organizations as a “transition fuel” for meeting greenhouse gas reduction and various climate targets (the latter in the EU, but not yet in the US). More readily available and less expensive NG would make it easier for governments, as well as industries and utilities, to meet such targets. It is therefore not surprising that the US government, for example, is enthusiastic about the increased utilization of shale gas as a positive development in dealing with global warming. However, given some of the medium term uncertainties associated with shale gas development, the potential promise of NG as a “transition fuel” may remain speculative for the near term.

Natural gas (NG) provides an important source of energy, be it heating, a source of electricity, or a transportation fuel. It is also a fundamental feedstock for a number of major industries. This is particularly the case in many parts of the United States, where a substantial pipeline system now exists to provide natural gas as a fuel source to most parts of the country. This was helped by the large number of areas in the US that and substantial NG deposits, considerably more so than oil resources. Even with the creation of vast pipeline systems in the US (and more recently in Europe and Asia), NG remains predominantly a regional business. Gas is a bulky material, and to ship it requires either a pipeline, or a technology to convert it into another form—usually a liquid. As a result, over the past decade there has been substantial investment in NG processing and transmission facilities, either pipelines or facilities to convert NG into Liquefied Natural Gas.

NG is therefore one of the fundamental building blocks of the modern industrial economy. It is therefore of some concern that proven and probable reserves of NG have been in decline over the past two decades in parts of the world, such as the North Sea. However, improved technologies leading to more flexible drilling systems, including hydraulic fracturing, have altered the nature of this debate—if, indeed, it turns out that there is considerably more NG than previously supposed, as a result of this technology, then the often-made claim that shale gas is a “game-changer” seems justified.

Industrial production, currently about 27% of total US gas consumption, has been declining as a percentage of total NG consumption over the past few decades, for a number of reasons. First, overall industrial and manufacturing activity has declined in general over the past several decades as a percentage of US GDP. We have hollowed out our manufacturing base. Second, a number of US industrial enterprises have shifted production offshore, often to emerging markets to take advantage of lower labour and energy costs. Third, up until recently, higher NG costs put US costs (both fixed and variable) at a level comparable to those of Europe and Asia, since prices everywhere generally correlated with oil prices. As a result, industrial NG consumption in 2010 was substantially lower than in 1997, declining from 8.510.9 BCF to 6.599.9 BCF according to US Energy Information Administration data–the only category of end use that was lower over this period.

However, the US seems, for the moment, to have broken the relation between oil prices and NG prices, and it is plausible to speculate that industrial use of NG may begin to increase. Natural gas provides an important, indeed critical, feedstock to a number of important global industries. The most important of these are the Petrochemical, Fertilizer, Refining, Pulp & Paper, Metals and Mining industries. NG is also an important source of energy for the overall economic system, and its primary consumption is for heating (at all levels) and electricity generation, although its importance varies regionally. Energy production, in fact, has been a larger consumer of NG than Industrial sues since 2007, and this trend looks likely to continue. Moreover, in some quarters it is viewed as the fuel of choice as a “transition fuel” because of its lower CO2 generation characteristics than either oil or coal as countries, particularly in Europe, seek to meet greenhouse gas reduction targets.

In contrast to the US, the largest consumer of NG on a global basis. Europe consumes smaller amounts of NG, but is still in the aggregate the second largest consumer of NG. This is true even if Russia, the second largest country consumer of NG, is excluded. Only three European countries—the UK, German and Italy— are among the top ten consumers of NG in 2009. Only one European country—Norway—is among the top ten producers of NG (although the UK ranks number 15). Interestingly, the Netherlands, which has the largest gas field in Europe, is not among major NG exporters—the Dutch government maintains a rigorous production cap. And only Norway stands in the top twenty countries in terms of proven conventional reserves—and, in fact, Norway is the second largest NG exporter after the Russian Federation. Overall, OECD Europe consumed 19.2trillion cubic feet (tcf) of conventional NG in 2009, as compared with 22.7tcf in the US.

For most of the past century, NG prices tended to move in line with oil prices, since the two are often found together. NG was often treated as a by-product, albeit an occasionally useful one, of oil extraction. Over the past eighteen months, however, US NG prices have dropped well below those found in Europe or Asia, as shown in the following table:

Source: US Energy Information Administration

The EIA notes that “The relationship between North American and northwest European spot prices appears to have changed in the last 18 months. Before that time, they often followed similar paths; differences often reflected local conditions, such as storage, and tended to be temporary. However, in 2010 and 2011, the differences have grown and appear to be more lasting.”

The most common explanation put forward most recently is that this divergence reflects more aggressive drilling for and recovery of shale gas. In fact, shale gas has been being produced for decades in regions around the US (and elsewhere), but mostly in regions not economically reachable by pipelines. Until recently it has been a cumbersome process, and has generally been uncompetitive in terms of price with more readily available NG prices. Concerns that conventional production of NG was peaking, which arose from time to time, since NG is essentially a finite resource, have miraculously disappeared.

In the past, pricing of NG tended to be correlated with oil prices, which, of course, have been rising over the past decade. As a result, NG prices also rose, to the extent that energy costs involving NG tended to become non-competitive—or at least not a marginal factor in decisions on locating plant, unlike labour costs, which were often the significant decision in plant location decisions. And if NG derived from conventional sources was uncompetitive as an energy source, the additional costs associated with shale gas extraction made it even more uncompetitive at least until recently.

In fact, natural gas prices in the US over the past decade have been hugely volatile, rising from an average of $1.92 per thousand cubic feet during the 1990s to an average of $7.33 in 2005, and driven to over $12 after Hurricane Katrina knocked out several gas production facilities in 2005. Since the newer technologies allowed for profitable extraction of NG at $7 per tcf, a “shale gas rush” ensued, which has driven the price down even further.

At present, after several years of aggressive development of shale gas, prices are currently in the $3.50-$4 region, and in all likelihood look set to decline modestly over time as more supply comes on stream. While this puts margin pressure on utilities and Independent Power Providers, it makes feedstock and energy costs for the chemical industry (not to mention other industries) very attractive. On the other hand, NBP (National Balancing Point) prices in the UK, the proxy for European pricing, have remained tied to oil prices, which, while declining over the past several months, remain high relative to historical norms, and look set to remain that way.

The American Chemistry Council, the US chemical industry’s trade organization, has noted that the cheaper ethane derived from shale gas is currently giving US chemical manufacturers a cost advantage over non-US manufacturers. Moody’s has suggested that this cost advantage may last for up to a decade, depending on whether this advantage is sustainable given environmental considerations, and how long it may take European and Chinese shale gas resources to be developed–if they are. As we’ll see, there are particular issues in both regions that suggest development, if it occurs at all, will be a lengthy process.

So just what is shale gas? All natural gas is found in sedimentary rock formations, as a result of the condition under which it (and oil and coal) were created. Some formations, however, are more troublesome to recover petroleum products from, and shale is a particular problem, for a variety of reasons. Depth isn’t necessarily the problem, although shale deposits are often deep, as much as two miles below surface. The problem is that shale itself has a potentially problematic porosity and hardness that makes normal drilling processes unsuitable—it’s too thick and hard. Shale gas is an unconventional gas, like coal bed methane and tight gas, which means, essentially, very low permeability. As a result, over the past decades shale gas has not figured prominently in recoverable reserves estimated by energy companies and government agencies.

Recent changes in drilling technologies, however, have opened up the possibility of significant recoveries of gas from shale, in quantities that alter the reserve estimates of the US and a number of other countries, particularly in Europe, and in China. Shale is the most common sedimentary rock, and on a global basis contains a possible 5.760 trillion cubic feet (tcf) of NG reserves, according to a recent EIA report, World Shale Gas Resources: An Initial Assessment of 14 Regions Outside the United States. This is a significantly larger figure than previous worldwide estimates of proved NG reserves.

Significant shale gas opportunities are known to exist in the US, as shown in the map below:

Identified shale gas deposits in the United States

What has opened up potential shale gas production has been the significant and rapid development, particularly over the past decade, of a set of technologies in two areas: (1) horizontal drilling, and (2) hydraulic fracturing, the technique of exploding shale under pressure by “blasting” it with significant amounts of water, sand and chemicals. Once “fractured”, gas seeps out from the shale and can be collected. However, the combination of heavy use of water, and the possible effects of chemical contaminants on groundwater supplies, have raised issues about the relative utility and safety of fracking.

Recent shale gas developments have been successful enough such that shale gas is bearing the weight of substantial hopes in the US government and in the US NG industry, both of which expect shale gas to take up an increasing percentage of US NG production and consumption over the next several decades. The following graph, from the Energy Information Agency of the US department of Energy, gives a flavour of the hopes now resting on Shale Gas, in a graph that would have likely been inconceivable just four years ago

A growing dependence on shale gas in the US



Nearly all the improvement in the recent growth of estimated NG reserves in the US is accounted for by shale gas, in fact.

The effective result of these recent developments has been to make the US largely self-sufficient in NG in a surprisingly short period of time, as opposed to being a net importer of NG as was expected just a few years ago. These developments have also, as mentioned previously, caused NG prices in the US to disconnect from global oil prices to a potentially significant extent. Should this disconnect become permanent, it is difficult to avoid the conclusion that companies in the US that rely on NG for feedstock or for significant energy consumption may garner a competitive advantage relative to competitors relying on NG derived from conventional sources, where pricing remains linked to oil prices.

And it turns out that shale gas deposits are found worldwide (as are, of course, oil and NG deposits), but it has only been with the development of the drilling technologies and methods described above that interest in developing these resources has recently emerged. As a result, we are already seeing some countries increase their reserve estimates. At present, 32 countries have estimable potentially recoverable reserves, according to the EIA study mentioned above. As shown in the following map, shale gas reserves occur worldwide:

Worldwide distribution of Shale Gas reserves



The US is actually the number two in terms of potential reserves, after China. Only three European countries—Poland, France and the UK—show up in the top ten. However, this is slightly misleading, since Europe as a whole does in fact have significant shale gas deposits, although not nearly to the extent of the US. The IEA has estimated that of the 6.622 trillion cubic feet of worldwide shale gas deposits, about 640 tcf are to be found in Europe, which would place “Europe” as number five in terms of potentially recoverable shale gas. Nonetheless, this offers enough of a prospect that development efforts are under way in a number of countries, especially Poland, as discussed further below.

Europe is already the world’s second largest NG market, but the supply differential between the US and Europe is significantly different—while the US generally is self-sufficient in gas, Europe is currently reliant on imports, largely from Russia and North Africa, and at current trends the import portion of Europe’s supply is expected to grow. Moreover, NG production in Europe continues to decline overall, particularly as North Sea gas fields continue to run down, reinforcing the prospects of increased imports going forward.

Europe and much of the rest of the world also gets its NG from more diverse sources than the US, which gets its NG directly from NG deposits in the ground. Europe, on the other hand, derives much of its NG from naphtha, a by-product of petroleum refining. In fact, prior to the discovery of significant gas fields in the North Sea in the 1970s (which continue to be discovered, although in smaller quantities), NG was not a major energy source within Europe, which tended to rely on coal and oil. Industrial users of ethylene, which is derived from gas, relied on gas derived initially from naphtha rather than straight natural gas, simply because there was more of the former than the latter.

However, over the past several decades this dynamic changed materially with several developments: the discovery of large NG fields in the North Sea, and the construction of various pipelines to get the gas to Europe; the expansion of export markets from NG sources such as North Africa; and the emergence of Russia as a major supplier of gas to Europe. Nonetheless, the North Sea gas fields are running down (the UK became a gas importer in 2005), and both North Africa and Russia as sources of NG carry some degree of geopolitical risk.

As a result of the above, there has been considerable interest in those areas where shale gas reserves have been estimated in Europe. Work is already under way in Poland, which has had mixed success to date, and has proved politically controversial. Austrian oil company OMV is currently drilling in an area of potential shale gas in Austria. Exploratory drilling is currently taking place in Denmark and is beginning in Sweden, beneath which runs the Alum Shale deposit. Significant shale gas deposits elsewhere in Europe have not yet been developed to any extent.

However, a number of European governments are actively reviewing the process, a necessary step given the potential environmental issues associated with shale gas. France, for example, has banned fracking, and has cancelled the exploratory drilling permits of companies who indicated they would rely on fracking technologies. However, France’s major energy company, Total, has objected that this will limit the potential for developing alternative energy supplies to supplement France’s well-known dependence on nuclear power. The UK government, following recent shale gas discoveries, has indicated it will not ban fracking, although it remains under pressure to do so. Rather, it appears as if there may be some confusion over who is directly responsible for whatever regulations may be required. There are signs that the UK government seemed to find the idea of shale gas development appealing earlier this year. However, this was before the earthquakes which forced the company developing some test wells to suspend operations (which have not yet been resumed, as of time of writing, although they may be shortly).

Unlike the US, Europe has been relatively late in developing shale gas resources. However, the fact that there are significant political benefits to reducing Europe’s dependence on gas imports has not gone unremarked among policy circles. There is currently a debate both at the country and at the EC level concerning how best to proceed with shale gas development in Europe, and we expect this debate will remain lively over the near term. However, we also expect that, pending resolution of some of the environmental concerns associated with shale gas, development will proceed in the near future. However, this is speculation on our part, admittedly, and we cannot really say how and indeed whether Europe will develop these deposits sufficiently to potentially close the widening gap between gas prices in the US and gas prices in Europe. If this gap does not close, it may disadvantage European production facilities with a high NG dependence.

It is not just Europe that is seeking to develop shale gas reserves. As the EIA study cited above suggest, Argentina has the world’s third largest shale gas reserves, followed by Mexico. We would expect development effort to accelerate in all areas where shale gas reserves are sufficiently large and potentially exploitable. However, even in areas where there appear to be large recoverable reserves of shale gas, there is often sufficient government concern about the potential risks to result in temporary slowdowns in development. Quebec, for example, instituted a year-long ban on shale gas development in March 2011 pending further study. Also in March 2011, India deferred shale gas auctions until 2012-2013 pending the development of suitable regulatory regimens.

Non-OECD countries will comprise the bulk of demand for oil and gas over the next several decades, according to the International Energy Agency’s (IEA) Medium Term Oil and Gas Markets 2011 report. While many of these countries—particularly some in Latin America like Brazil, and some in central Asia such as those surrounding the Caspian Sea—are likely to be energy self-sufficient, many are not. This latter category includes a number of significantly growing economic powers, such as India, Korea and China. China, in fact, is expected to account for about one-third of the total growth of incremental gas demand through 2016, through both pipeline gas and LNG.

We note that China has by far the largest potential shale gas reserves. China may have a particular interest in developing its own shale gas reserves. It is the world’s largest producer and consumer of energy. And it is moving from a net oil and gas exporter to a net oil and gas importer. Moreover, China is aggressively developing a number of industries, including a chemicals industry, which have a heavy reliance on NG as feedstock. China has recently embarked on a number of arrangements to ensure its oil and gas supplies, including many with former Soviet Union countries, including Russia, through various pipeline arrangements. However, the prospect of developing what may be the world’s largest shale gas reserves will undoubtedly be tempting to a government that has indicated its desire for energy independence, and whose most recent five-year plan has targeted a substantial increase in gas production in its primary energy mix by 2015—to 8.3% of total energy generated, from 3.8% in 2008 . China has taken a number of steps the past several years to encourage gas production of NG in general, and shale gas production in particular. In June 2010 the government lifted price controls on the price of gas at the wellhead in an effort to spur investment. More recently, China signed up to the US-sponsored Global Shale Gas Initiative, a forum for technology sharing among countries seeking to develop their unconventional reserves (and, one assumes, also to allow US-based oil and gas service companies to participate). As it turns out, the severe water intensity of the fracking process may raise some interesting resource allocation conflicts in China, a country where water resources are already under significant pressure from competing interests driven by agriculture and urbanization and its consequent energy demand.

There is a difference in identifying potentially recoverable reserves, however, and having the means to recover them. In contrast to the US, Europe in general has substantially fewer drillers, particularly drillers with shale gas expertise. In fact, Europe in general has far fewer gas rigs for conventional gas as well, and the oil and gas service industry is smaller than that in the US. In addition, Europe is more densely populated than the US, which in and of itself may raise concerns about extensive shale gas development. This suggests that development of European shale gas reserves may take longer than the recent learning curve in the US might suggest. For the time being, and barring significant curtailment of shale gas drilling in the US, it would appear as if the competitive NG cost advantage offered by rapid shale gas development in the US can be sustained for several years, at least.

All of the above has created a very tantalizing prospect for journalists, at least, who are now waxing eloquent about an industrial renaissance in the US, on the back of cheaper energy. This is certainly a plausible scenario should the conditions that allow cheaper NG than elsewhere in the world be sustained. There are some clear industrial beneficiaries if this is the case:

1. The chemical industry: since NG is a basic feedstock for the ethylene chain, on which so much of the industry depends, this offers the prospect of permanently cheaper feedstock costs (not to mention cheaper energy costs) going forward. Should the price differential between US NG and prices in Europe and Asia persist, this may create a competitive advantage for plants located in the US. While we would expect these to be plants largely owned by US companies, it’s worth noting that most major European chemical companies have substantial plant exposure in the US;

2. Fertilizer producers: NG is the principle feedstock for nitrogen fertilizer, which remains the major category of fertilizer products (Potassium-based fertilizer uses potash, which is mined). A number of fertilizer companies are expanding their plant capacity in the US and Canada at present;

3. US Energy and Power companies—should the cost advantage currently accruing to NG be sustained versus coal, the ongoing move by many utilities to NG from coal is likely to accelerate;

4. Oilfield Equipment and Service companies. These companies have already benefited considerably in the US, and shale gas expertise and equipment that looks set to be in increasing demand in Europe and China.

And above and beyond individual industrial sectors, there has already been a general shift away from coal towards natural gas for power generation, again particularly in the US, but also in countries with a high coal dependency such as Germany. In the US, this is not simply because of more attractive gar pricing for utilities—coal is a serious greenhouse gas generator relative to NG, as well as a generator of other substances (such as mercury) likely to subject to increased regulatory pressure over time. Gas turbine manufacturers are all seeing increased levels of inquiry demand in the US.

In general, these developments would seem to have a number of potential implications. For the US economy, and a number of US industries, these implications seem uniformly positive—cheaper energy and feedstock translate into a lower cost of business than European and/or Asian competitors, and, in the case of parts of the chemical industry, perhaps even Mideast producers as well. Moreover, the US looks set to become an exporter of LNG—several companies have received US government permission to export LNG from existing LNG terminals in the Gulf region. While it seems likely that there may be broader macroeconomic benefits as well, consideration of most of these potential benefits is beyond the scope of this report.

European competitors, on the other hand, may face higher feedstock and energy costs, which may place hem at a competitive disadvantage in some cases. This is particularly true in the chemical and fertilizer industries, where feedstock cost differentials and energy costs differentials, respectively, may be material in terms of profit margins.

This would explain why shale gas deposits in Europe have received recent attention. While such deposits are not as extensive as in the US and China, they are certainly present, and do afford European NG extractors the opportunity for bringing less expensive feedstock to the European chemical industry, and less expensive NG into the European energy mix. They also afford European governments and companies an opportunity to shift away from coal more rapidly, thus allowing the region greater opportunity to hit its self-imposed GHG reduction targets.

This all sounds great. What could possibly go wrong here? For all the potentially positive implications of shale gas development in North America (and elsewhere), there are also some concerns. Whether these concerns will become significant enough to curtail or even stall shale gas development completely remains unclear. However, they are at present significant enough for a number of municipalities and states in the US to have either imposed limited restrictions on fracking, or outright (but at present probably temporary) bans. On an international scale, similar issues have arisen at the sovereign level, such that France, (for example) has banned shale gas development, as mentioned previously. In the following discussion, we tend to concentrate on developments in the US, but this is largely because shale gas drilling has been occurring in the US for some period now, and there is a well-advanced regulatory infrastructure at both the state and federal levels which have been devoting considerable attention to some of these issues.

The main concerns to date concern the following:

1. Water use: Fracking uses significant amounts of water. Most oil and/or gas drilling involves pumping water into wells when the natural underground pressure becomes insufficient to move oil or gas up the well so that it can be recovered. However, shale oil and shale gas require significant amounts of water above and beyond normal the normal requirements of the industry. A “typical” well, for example, may involve 3-10 million gallons of water, and 1.5 million pounds of sand. Even by the standards of the water-hungry natural gas industry, these are prodigious amounts. In upstate New York, companies developing the Marcellus shale (the largest shale gas region in the US) have resorted to bringing in water by the truckload, in an area not noted for its water scarcity.

Were water in abundant supply everywhere, this would not necessarily be a problem. However, water is not in abundant supply everywhere. In fact, in many parts of the world water is in short supply, and there is already intense competition for water resources between agriculture, energy resources and urban development in areas such as parts of China. We would not expect this competition to get easier over time. Since the amount of water on the planet is finite, it’s not as if more can be discovered.

Parts of Texas, for example, have recently imposed water use restrictions on fracking drillers as a result of the severe drought the state has been experiencing. Texas is not the only area of the US with active shale gas drilling and limited water sup plies—much of the far west region, particularly the shale gas drilling areas of Wyoming, Colorado and Utah, are areas of increasingly constrained water resources.

Water Scarcity–Physical



Source: International Water Management Institute

The above map simply shows area of physical and economic water scarcity. A comparison with the global map of potential shale gas resources presented earlier suggests that there are several areas of overlap—the western US, parts of northern and southern Africa, and western China in particular. However, a more revealing picture derives from looking at potential shale gas reserves against a map of Environmental Water Requirements—the withdrawal of water from groundwater or river sources for human use—suggests a more challenging picture:

Water Scarcity—Taking environmental water requirements into account



Source: International Water Management Institute

Taking existing human water consumption patterns into consideration suggests that there will be increased competition for water resources in some areas where there is little physical scarcity—the scarcity will come from competing economic interests. Given the level of water intensity involved in fracking, it is difficult to see how such competition for water resources will not increase over time, especially in regions such as the north-eastern US and Eastern Europe, and particularly China, where there may be considerable economic weight put on the development of shale gas resources.

2. Potential chemical contamination of water supplies: As described earlier, fracking involves blasting shale material with water, sand and chemicals. However, at present few companies have actually disclosed what chemicals are involved, a number of companies indicating that the chemical compositions are proprietary. While the chemical content of a drilling operation may represent only 0.5% of the total liquids involved, as industry sources have indicated, for a typical well involving 3 million gallons of water still translates into a meaningful amount of water. This has raised concerns concerning contamination of water supplies, including deep aquifers, from leakage. These concerns aren’t fanciful—spills are common occurrences in the drilling industry, and a number of potential contaminations of local water supplies have been reported to regulatory authorities. Not only are spills not uncommon, but accidents occur as well that can result in the release of contaminated liquids and water, and increased pressure for identification of the chemicals involved. In addition, at least one study has found evidence of methane contamination of water supplies in Pennsylvania from fracking, although the broader implications of this study, if replicated, aren’t completely clear yet.

The industry has responded with greater disclosure over the past two years, and some industry trade groups such as the Marcellus Shale Coalition continue to call for greater transparency (although not mandatory disclosure) on this issue. Some jurisdictions, including the State of New York, have issued outright bans on fracking operations in watershed areas. In other areas, including Wyoming, regulatory bodies have issued requirement to divulge what chemicals are used in the fracking process. By and large, the industry continues to resist these efforts. Federal Legislation, embodied in the Fair Power Act, would require disclosure of these chemicals, but this legislation is stalled in the current Congress. A number of states, including Wyoming and Pennsylvania, both centers of active fracking activity, have passed legislation requiring the disclosure of the chemicals used in the fracking process. However, these requirements often include exemptions for “proprietary” products, allowing drillers to block disclosure, as is the case in Wyoming. Moreover, they vary significantly from state to state.

A report from the Department of Energy earlier in 2011 called for substantially greater disclosure of chemicals used in fracking. The Environmental Protection Agency in the US is considering whether to assume a federal regulatory role in this regard, which the drilling industry is opposing. We expect this issue to remain contentious. The EPA has asked drilling companies to voluntarily disclose the identity of chemicals used in the fracking process, and some companies have responded affirmatively, but not all.

3. Fracking produces significant amounts of wastewater: Given the still-uncertain composition of the chemical mixes used in fracking, this in and of itself raises some concerns for public interest groups. Coupled with the significant amount of water used, concerns have been raised about what regulations will be required to ensure the safe disposal of wastewater. Typically, anywhere from 10%-40% of water injected in wells using fracking technology gets returned, and must be disposed of in some manner. One proposal has been to pump the water into the ground. However objections have been raised over concerns of possible groundwater contamination. Another tactic has been to simply dump the wastewater into local waterways. This process also has some significant drawbacks. However, the Environmental Protection Agency determined local wastewater facilities could not process fracking wastewater, and ordered the drilling companies to develop a more systematic plan for wastewater disposal. A number of proposals for recycling fracking wastewater have emerged, but these may have their own set of problems.

The more general issue is that for decades, as pointed out in a paper from the Environmental Working Group (Free Pass for Oil and Gas: Environmental Protections Rolled Back as Western Drilling Surges), the oil and gas industry has been able to garner a significant number of exemptions from a variety of federal environmental legislation, including

(a) the Safe Water and Drinking Act of 1974;

(b) the Resource Conservation and Recove5y Act of 1976, which requires cradle-to-grave management of materials used in drilling, including disposal of hazardous materials;

(c) The Emergency Planning and Community right to Know Act of 1986;

(d) The Clean Water Act (1987 amendments)

(e) The Clean Air Act.

The Environmental Protection agency in 2004 took the position that hydraulic fracturing was exempt from the requirements of these acts, which is the main federal legislation governing water quality and use in the US, including clean-up standards and requirements. However, as discussed in the next paragraph, the EPA is now considering applying several of these acts to hydraulic fracturing. And at the state level, we may see more proposals such as that recently put forward by the Governor of Pennsylvania, which would allow counties to impose fees for drilling using fracking technology to pay for environmental remediation efforts.

All of this remains in a state of flux at present, and we would expect a vigorous debate over the treatment and disposal of wastewater to be sustained for some time. At present, both the ACC and the American Natural Gas Alliance (the US Natural gas producer trade group) are actively opposing further federal regulation of fracking activities, preferring that such regulations remain at the state level.

4. Likely increased government regulation: Regulation, by its very nature, adds costs. It is in fact likely that given the concerns mentioned above that there will be increased regulation. What remains uncertain at present is whether any increased regulation will be at the federal or state level, the potential scope of these regulations, and therefore their potential costs. While there are pressures for an outright ban on fracking, such as is the case in France, we suspect such a ban is unlikely in the US, unless the evidence for groundwater contamination becomes unequivocal, which at present it is not. The US government may issue federal guidelines for fracking within the next month, and several states, including New York and New Jersey, are currently reviewing or developing guidelines to ensure groundwater safety. Given the relative recency of much current gas shale development, however, we would expect the regulatory environment to be a shifting one over the next several years. The Natural Gas industry trade group, along with related organizations such as the American Chemical Council, have indicated the preference for continuing with the present policy of leaving most drilling regulations to States.

We note that this is a situation that is likely to only exist in the US, where there can be a variety of regulations, and regulatory oversight agencies, at both the state and federal level. Most countries, however, have only a single set of regulations governing such issues as drilling and water use, and these are generally national regulations.

5. Uncertainty surrounding the long term estimates and productivity of shale gas wells: The EIA (and others) have noted that most shale gas wells are relatively new. Not only are they new, but their drilling lives may be considerably shorter than those of conventional gas drills. The more general concern here is that, just as is the case with other NG resources, not all shale gas is equal. Some deposits are easier to get to than others; some deposits are easier to drill than others. Not all areas of the Barnet shale in Texas, which currently has about 15,000 wells in various stages of drilling life, or the Marcellus shale in West Virginia, Pennsylvania and New York, which has a number approaching that, are equally easy to recover shale gas from. The EIA, in fact, in its Annual Energy Outlook 2011, specifically cautions:

Estimates of technically recoverable shale gas are certain to change over time as new information is gained through drilling and production, and through development of shale gas recovery technology. Over the past decade, as more shale formations have been explored and used for commercial production, estimates of technically and economically recoverable shale gas resources have skyrocketed. However, the estimates embody many assumptions that might prove to be untrue in the long term.

More generally, it is also the case that estimates of reserves are often in early stages of refinement. The most dramatic example of this recently was the announcement by the U.S. Geological Survey that initial estimates of recoverable gas from the Marcellus shale area were overstated by as much as 80%. According to the USGS report, the Marcellus shale area contains about 84tcf of recoverable shale resources, as compared with previous estimates of 410tcf. While 84tcf is still a large number, this does point up the fact that in many cases the early estimates of recoverable shale resources may be significantly overstated or understated.

6. The utility of shale gas as a candidate for a “transition fuel” may be unsupported. In fact, using shale gas may run counter to meeting greenhouse gas reduction goals. A recent study has suggested, in fact, that shale gas may a very bad source for NG if the latter is to serve as a transition fuel with a lower carbon content than what it is replacing. This is because the amount of methane, itself a greenhouse gas, released during shale gas drilling may more than offset the benefits derived from using the natural gas recovered from fracking technologies, rendering the aggregate GHG contribution to one comparable to coal. According to the authors of the study,

Natural gas is composed largely of methane, and 3.6% to 7.9% of the methane from shale-gas production escapes to the atmosphere in venting and leaks over the life- time of a well. These methane emissions are at least 30% more than and perhaps more than twice as great as those from conventional gas. The higher emissions from shale gas occur at the time wells are “hydraulically fractured”as methane escapes from “flow-back return fluids”and during drill out following the fracturing. Methane is a powerful greenhouse gas, with a global warming potential that is far greater than that of carbon dioxide, particularly over the time horizon of the first few decades following emission.

Thus, the notion that using shale gas may be used as a transition fuel to reduce GHG generation may be misplaced.

There are a number of competing interests here, as there usually are, and in this case the stakes are unusually high. On the one hand, there appear to be some significant concerns about water use and quality, and even availability, that may conflict with the drive to get at all that shale gas—and this may vary by region. We have already seen at least one instance of this conflict not going the drillers way in Texas, where the recent (and record in a number of respects) drought has forced the introduction of significant water use restrictions, including on shale drilling. We would expect to see more if evidence emerges that water supplies for agriculture and drinking water are being compromised.

It is worth noting that some, indeed many, of the above concerns may be amenable to technological solutions, although in many cases it’s early days yet. A company named GasFrac is experimenting with a liquefied petroleum gas gel as a substitute for water in the drilling stage, a development that would likely deal with a number of the above issues (depending on what’s in the gel material, of course). It seems likely that at least some of the incidents of groundwater contamination, and indeed the methane contamination study referred to above, derive from poor well construction, rather than fracking technology itself—this is an issue that can be addressed in a straightforward manner by enforcing stronger well casing standards.

On the other hand, the positive economic benefits of cheap energy are clear, especially in industries in the US and Europe that have been slowly decimated by foreign competition with access to cheaper labour and, indeed, cheaper energy in some cases. In addition, the prospect of reducing gas imports will remain increasingly appealing to European policy makers and governments. Moreover, it may very well be the case that cheap energy is becoming the marginal factor in decisions on plant placement globally, rather than cheap labour—we have recently seen examples of companies moving plant from China for countries where energy supplies are less expensive and, perhaps more importantly, more dependable. More to the point, however, is the fact that regions of the US and where that have seen their industrial core hollowed out over the past several decades now seem to be in a situation where the apparent cheap energy from shale gas would allow for a general level of economic improvement. As core industries such as energy and chemicals rebuild manufacturing capacity in core product areas in the US, ancillary growth will follow.

All of this bears close watching. If the drilling industry is able to satisfy what appear to be potentially important environmental issues at a relatively modest cost, than shale gas appears likely to live up to the often-repeated claim that it is a “game-changer.” However, the hurdles here may be high. There’s also the issue of whether it’s actually a wise idea to let the US continue on its current road of energy profligacy, considering what the costs have already been.