The IC guide to unconventionals

By their nature, unconventionals are more expensive to produce than conventional oil and gas, but with the industry looking to have shifted to a higher oil price environment, unconventionals look likely to play a growing role in global energy.

The best-known unconventional resource currently is shale gas, whose boom over the last year has transformed the North American energy sector. The US now has a glut of gas which was inconceivable just a few years ago, when it faced the unpalatable prospect of having to import gas from Russia. Shale gas has saved the US from that fate for many years to come.

The hunt for shale gas has now extended beyond North America to Europe, most notably in Poland and Germany. Shale gas prospects in Poland's Baltic Basin are geologically very similar to US shales, and can be evaluated and drilled using US analogues and existing technology. Efforts are also accelerating to exploit other unconventional resources such as coal-bed methane and shale oil.

Why are unconventionals important?

The greatest attraction of unconventional hydrocarbons is the fact that they are naturally found in huge quantities, explains Mr Gibson. "Once onstream, they provide a steady, almost endless flow – essentially a pipeline that goes on forever," he says. "If you are prepared to keep digging up Alberta and Venezuela, you can have as much of it as you want."

Oisin Fanning, chairman of San Leon Energy, which is developing both shale gas and shale oil projects, agrees that their sheer resource potential is the real attraction of unconventionals. "Unconventional hydrocarbons are typically found in huge quantities," he explains. "Once you've proved an area, you significantly lower the risk over potentially 30,000, 50,000 or even 100,000 acres, which offers quick reserve adds. You just need a minimum acreage of around 30,000 acres for a commercial project."

Andrew Austin, chief executive of IGas, a UK coal-bed methane operator that also has shale gas prospects, highlights another advantage of unconventional resources: better distribution. Being onshore, they are typically closer to market, which cuts transportation costs. He explains that from an economic point of view, it's not the comparison against conventional gas costs that's important but rather the cost relative to liquefied natural gas (LNG). Gas has traditionally been delivered by pipeline but with the evolution of LNG, gas (just like oil) can now be shipped anywhere in the world. The tipping point is the cost at which extracting unconventional gas is cheaper than importing LNG.

Mr Austin expects a lot of power generation demand to have to be satisfied by gas, probably unconventional gas. "Gas is cheaper and easier to get from your own resources, even if it's unconventional," he says.

Randeep Grewal, chairman and chief executive of China-focused coal-bed methane group Green Dragon Gas, agrees that unconventional gas can be cheaper to develop and is often close to market. He points to the new growth countries, in particular China and India, as being gaseous in nature. "Britain and the US are not going to change with unconventional gas, but China will – a significant part of its GDP growth is based on unconventional gas," he says.

What is driving unconventionals?

Two factors are driving the current race for shale gas and other unconventional resources. First, with the more accessible oil now gone, explorers are being forced to increasingly more hostile environments such as the Arctic, Falklands and deepwater Brazil. As they venture there, the marginal cost of new oil supplies rises. As the oil price stabilises at these higher levels, unconventional resources become more competitive and commercially viable.

Second, the oil and gas industry has made tremendous engineering and chemical advances over the past couple of decades, which has greatly increased the effectiveness of extracting unconventional hydrocarbons and made the process more economically attractive. Shale and tight gas production has been revolutionised by advances in horizontal well drilling and fracture stimulation technology, which have enabled much higher flow rates and productivity – and lower costs per well.

On the downside, unconventional resources can be very carbon-intensive to develop and often require building huge investment. Wood Mackenzie's Mr Gibson points to Shell's Pearl gas-to-liquids project in Qatar as a prime example: development costs there have ballooned to some $18bn-$19bn, against an estimate 10 years ago of just $6bn.

Unconventional oil and gas covers a wide range of resources. Some are already in commercial production; the development of others has proved more challenging and requires extraction technologies that aren't yet commercially available. Shale gas, coal-bed methane and coal-to-liquids/gas-to-liquids have already proved their commercial value. Oil (tar) sands have been commercially produced but face heavy opposition due to extraction techniques that have traditionally been very environmentally harmful.

Shale gas

Oil majors have been scrambling to secure shale gas resources more than any other unconventional. IGas's Mr Austin explains why: "Suddenly, people have realised what a game-changer unconventional gas has been in North America, where 50-60 per cent of consumption (up from just 10-15 per cent just three to four years ago) is now satisfied by unconventionals such as tight gas, shale gas and CBM."

However, the International Energy Agency (IEA), the inter-governmental energy policy adviser, warns that the extent to which the North American boom in unconventional gas production can be replicated elsewhere remains highly uncertain. "Outside North America, unconventional resources have not yet been appraised in detail and gas production is still small. Some regions, including China, India, Australia and Europe, are thought to hold large resources, but there are major potential obstacles to their development in some cases," the IEA says.

Mr Austin argues that the US boom has already had a global impact even if unconventional resources outside the US don't perform. That's because LNG cargoes that were previously expected to go to the US are now being directed elsewhere. "Unconventionals are going to be very significant," he says.

European shale gas

Having completely changed the energy landscape in North America, shale gas is poised to do the same in Europe; the IEA's caution hasn't deterred North American majors ConocoPhillips, Exxon, Marathon, Statoil and Talisman from a major land grab, although Mr Austin is surprised this has not yet extended to the UK. IGas is at the forefront of developing CBM in the UK and has recently identified shale gas potential that Mr Austin believes could offer comparable potential.

Peter Bassett, an oil and gas analyst at broker Westhouse, highlights major economic advantages of European shale gas over US shale gas. First, in contrast to the US, where gas and oil prices move largely independently of each other, European gas prices are more linked to oil prices, and are thus likely to drift higher over time.

Second, many Eastern European countries are seeking to reduce their reliance on Russian gas in light of serious supply disruptions that have followed recent disputes between Russia and Ukraine. This will tend to drive up European gas prices, as will the phasing out of subsidies as Eastern European prices converge with Western European levels.

Coal-bed methane

Coal-bed methane (CBM) is natural gas – mostly methane – created during the formation of coal that is trapped within coal seams by water pressure. CBM is extracted by drilling wells into the coal seams to pump out the water and allow the gas that was previously compressed onto the seams to flow to the surface. Seams used in its production need to be shallow to avoid the pressure of overlying rocks from impeding gas flow, which means CBM fields have inherently lower reservoir pressures than conventional gas fields. This requires operators to drill more wells, which makes production more expensive compared with conventional gas, although drilling wells horizontally can access more of a seam with a single well and makes the process more efficient.

The US and Australia have been the most prolific developers of CBM projects. CBM provides 10-15 per cent of the US's domestic gas production and almost two-thirds of supply in Queensland, Australia. These successes have prompted other countries to examine their CBM potential, including Russia, which has the largest global reserves, Canada, China, India and the UK. Australian CBM has now evolved into a material supplier to the global LNG market. Royal Dutch Shell's recent A$3.5bn (£2.1bn) acquisition, with PetroChina, of Australia's Arrow Energy illustrates the value of applying LNG technology to Australia's vast CBM reserves.

Coal-to-liquids and gas-to-liquids

Coal-to-liquids (CTL) and gas-to-liquids (GTL) processes use similar long-established technologies to produce synthetic liquid fuels such as petrol, diesel and rocket fuel.

CTL converts mined coal into gas, which is then synthesised into liquid fuels. Sulphur and carbon dioxide produced during the gasification of coal can be removed and stored, which allows the production of clean fuels. GTL is potentially even cleaner, as it avoids the initial mining stage, which also makes it simpler and slightly cheaper than CTL.

The major downsides to CTL and GTL projects are the vast capital requirements and long lead times involved. To be commercial, projects need huge volumes of low-cost input gas or coal, for example the plentiful, cheap Qatari gas that will fuel Shell's Pearl GTL project. First production is targeted for late 2010, and by late 2011 Pearl could be delivering 140,000 barrels per day of high-quality oil products with low sulphur content, making it the world's largest GTL plant by quite some margin.

Oil (tar) sands

Also called tar sands, oil sands comprise bitumen (very heavy oil) and tar mixed with sand in a solid or semi-solid form. Oil sands are an established fuel, although the scale of their extraction has only boomed in recent years. Around 80 per cent of the world's extractable oil sands are found in Canada, and its attractive location close to the US (and nowhere near the Middle East) adds to its appeal.

Despite becoming big business over the past few years, oil sands have a poor public image due to extraction techniques that have involved open-cast mining and landscape dredging on vast scales. The process has been so expensive it potentially consumed more energy than it produced, and released more than three times the carbon dioxide released in extracting conventional oil.

The new steam-assisted gravity drainage (SAGD) technology could transform both the economics and public image of oil sands. SAGD uses two horizontal wells: an upper well continuously injects high-pressure steam to soften the bitumen so that it flows into a lower production well that pumps it to the surface. Vastly improved horizontal drilling capability allows SAGD wells to be drilled accurately and efficiently, thereby lowering oil sands recovery costs and removing the need to scar the landscape.

SAGD technology is transforming oil sands recovery, although problems remain. The oil produced is of low quality and requires substantial refining, and the volume of steam needed to extract the oil diverts large amounts of fresh water, which can cause environmental harm. Nevertheless, SAGD has already been applied to several oil sands projects.

Shale oil

Not to be confused with oil sands, shale oil is a form of 'immature oil'. It is extracted from sedimentary rocks containing a high concentration of kerogen, which is organic matter that hasn't been subjected to sufficient temperature and pressure for full conversion into hydrocarbons.

Wood Mackenzie's Mr Gibson describes shale oil as having the largest volumetric potential of any unconventional resource; analysts estimate Jordan alone could hold billions of barrels of shale oil resources. However, Mr Gibson adds that viable extraction techniques have not yet been developed and there are currently no commercial shale oil projects.

Shale oil recovery is proving even more difficult and expensive than extracting oil sands. Major firms such as ConocoPhillips and Chevron have invested billions of dollars trying to commercialise the process. Methods tried have included mining, crushing and boiling the shales, which leaves environmentally-unfriendly piles of residue rock. Other novel techniques have included inserting electrodes into the ground to heat shales to very high temperatures to distil the oil to the surface, although such processes involve high greenhouse gas emissions. Yet another technology being tested involves freezing the outside of a shale patch and then baking it to release the oil.

Attempts are being made to produce shale oil through wells, in a similar fashion to the use of SAGD technology for oil sands, although Mr Gibson describes shale oil as technologically the most unproven unconventional resource by a long margin. "I don't see it as having much of an influence on oil supplies for the next 20 years," he concludes.

Global resources and extraction costs