The unconventional oil and gas industry was once at the margins of the energy sector, but now barely a month passes without news of another oil 'major' boosting its stake in this corner of the market. This is simply because long-term supply/demand dynamics dictate that unconventional energy – whether derived from shale, tight gas, oil sands, or gas-to-liquids – has become an increasingly viable commercial option, and one that will form part of the investment landscape for years to come.
Figures published last year by the International Energy Agency (IEA) suggested that global crude oil production peaked in 2006 at 70m barrels per day, and should plateau at just below that level by 2015. The same IEA report concluded that daily global oil demand will reach about 100m barrels just 20 years later. Every year, we eat up between 4 and 6 per cent of existing reserves. Then there's always the possibility that Saudi Arabia has overstated its oil reserves. It's not hard to understand why the doomsayers tend to hold sway in the debate about 'peak oil'.
Scarcity driving incentives
Despite crude oil's status as the world's chief commodity, there is still surprisingly little consensus about how extensive the world's existing reserves are. In any case, the goal posts are constantly moving because technology improves recovery rates and so increases reserves.
Nevertheless, oil majors such as Exxon Mobil and Royal Dutch Shell have effectively been hedging their bets by pouring billions of dollars into unconventional oil and gas projects. These companies appreciate that most new sources of conventional oil are locked deep beneath the ocean floor, or are located in relatively inaccessible locations that necessitate substantial investment in plant and infrastructure, which, conversely, reinforces the economic incentives for accessing unconventional sources of energy.
Born in the USA
Shale gas is a great example of what a game-changer unconventional energy can be. The first commercial extraction of natural gases trapped within shale rock formations was carried out over 20 years ago by Mitchell Energy in the Barnett Shale in North Central Texas. But the widespread use of horizontal drilling has turned it into a major component of the US energy mix.
US companies have remained ahead of the curve. According to figures published by the US Department of Energy, yearly shale gas production in the US increased from 0.39 trillion cubic feet (tcf) at the start of the millennium to 4.87 tcf by the end of last year, and it now represents nearly a quarter of current US dry gas production. While US shale gas reserves only amount to around 61 tcf, the EIA estimates that the country has 862 tcf of 'technically recoverable' shale gas – enough to last 160 years at the current rate of consumption.
Pricing remains a cause for concern
Of course, the shale gas industry in the US – though firmly established – still has to contend with ongoing environmental and technical issues; including the sharp decline in production rates that rendered some previously profitable gas projects uneconomic within a relatively short time-frame. This has prompted some industry analysts to question whether current US prices achieved for shale gas are high enough to warrant further industry investment. However, long-term support for US prices could be provided by a Congressional Bill currently doing the rounds in Washington which, if passed, would offer substantial tax breaks for manufacturers that produce commercial vehicles powered by natural gas.
Covering global demand
From a wider perspective, shale gas deposits could conceivably supply over 40 per cent of global gas demand, so it's easy to understand why this industry is developing so rapidly as a substantial global energy deficit looms into view. For example, a fast-growing economy such as Brazil's – although resource rich – still needs to import 55 per cent of its natural gas requirements; but if it chose to exploit its prospective resource of 226 tcf it could fuel its own energy requirements for decades, or turn it into yet another potentially lucrative global export market.
Of the European nations, France and Poland are best-placed to benefit from the expansion of the shale gas industry; both are largely reliant on imports to meet existing gas needs, but are sitting on potential reserves in excess of 180 tcf. To put this into perspective, Norway – western Europe's biggest gas producer – currently boasts proved conventional natural gas reserves of 72 tcf. Of course, the whole issue of European gas supplies has taken on a political dimension, given the increasing reliance of EU member states on Russia's Gazprom.
Existing energy giants have woken up to alternative energy. Last year, Royal Dutch Shell paid $4.7bn (£2.88bn) to buy privately held East Resources Inc, which not only boosted the Anglo-Dutch giant's North American production by around 7.5 per cent, but also provided access to the Marcellus Shale in the US – a crucial source of future gas production. Other companies, such as South African petrochemicals group Sasol and resource giant BHP Billiton, have also secured footholds in North America's shale gas resources. In fact, you would be hard-pressed to find a major player in energy markets that hasn't secured a stake in the industry, so you could argue that shale gas has the most advanced commercial base of the current sources of unconventional oil and gas, although advocates of coal-bed methane might beg to differ.
Old king coal
Coal-bed methane (CBM) is another form of natural gas derived from unconventional sources that is fast gathering favour with industry. It is extracted from deposits locked in coal seams – the same gas that frequently proved fatal to both coal miners and canaries alike. Again, the industry was initially established to service North American markets, but the technology developed there has spread to other locations – most notably in Australia, where approximately 20 per cent of natural gas currently being used comes from coal seams.
Queensland's Surat and Bowen basins are among the world’s most productive areas for CBM, and companies such as BG Group and Australia's Santos have initiated projects that would allow CBM to be transformed into liquefied natural gas (LNG) for export to energy-hungry Asian markets by 2014, although these companies could be trumped by an Indonesian consortium headed up by state oil and gas producer PT Pertamina.
BP got on board with Pertamina earlier this month as part of four new production sharing contracts with Indonesian partners in the region, while Coal India plans to open up its CBM resources to experienced overseas operators in a bid to close the country's widening energy gap. CBM is also seen as an increasingly important component of China's future energy mix, and UK-listed entities such as Green Dragon Gas and Greka Drilling have already established a presence in what promises to be a highly lucrative industry, given that China has estimated reserves of 90 tcf-115 tcf.
|The Bakken wakes|
|Perhaps one of the more interesting unconventional oil resources is locked within the oil shale deposits that make up the Bakken Formation, a huge area in North America straddling Montana, North Dakota and Saskatchewan. The US Geological Survey recently increased an earlier assessment it made of the Bakken resources by a factor of 25, to 4.3bn barrels of undiscovered, technically recoverable oil, although the total Bakken resource is estimated to run up to 80 times this figure. Hydraulic fracturing and horizontal drilling are gradually unlocking Bakken's oil deposits, which are relatively light when compared with many other shale oils, but are located two miles subsurface. Investors interested in gaining early exposure to this resource could do so through Samson Oil & Gas (NYSE: SSN) – a dual-listed Australian oil and gas explorer with significant interests in the region|
The heavy oil of Athabasca
Aside from gas markets, energy companies have also been devising methods of extracting oil from heavy deposits of bitumen, or oil sands, the most notable of which is located near the Athabasca River in the Alberta Province of Canada. This prospect could profitably yield upwards of 180bn barrels of crude assuming an oil price of $85 a barrel, which is just 11 per cent of the oil sands that are technically recoverable. The higher oil prices climb, the higher the proportion of oil sands that could theoretically turn a profit.
The way in which tar sands are extracted has attracted widespread criticism from the environmental lobby, particularly when it became known that BP had earmarked $2.5bn for further development of its oil sand project in Alberta barely a few months after its Gulf of Mexico spill. But that’s not stopped development: 2.5 per cent of Shell’s total oil production is now derived from sands, while Exxon Mobil recently confirmed that the lion’s share of its $34bn capital expenditure for this year was destined for its unconventional oil sources, including sands.
2009 natural gas market (trillion cubic feet)
|Current production||Consumption||Imports (exports)||Proved natural reserves||Technically recoverable shale gas resources|