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Fracking

Could shale gas be the answer to the UK's energy woes? Matthew Allan finds out whether it's worth investing in this controversial industry
February 15, 2013

You know fracking has made it big when Hollywood makes a film about it. Matt Damon's Promised Land - coming to a cinema near you on 19 April - is exactly what you would expect from America's infallible fount of knowledge: it dramatises the central arguments about fracking and depicts the destruction of a downtrodden rural community where, after the fracking industry came to town, "the land just turned brown and died".

Here in the UK, there has been just one shale gas well drilled and fracked. That's one eight-and-a-half-inch borehole in Lancashire - not exactly enough to make a movie about. True, the operation triggered two harmless earth tremors - a combination of unusual geology at the well site "coupled with the pressure exerted by water injection as part of operations", according to driller Cuadrilla Resources - but no death, destruction or poisoned water.

Regardless, fracking is making British headlines. That's because the UK government decided to give fracking the green light in December 2012 and allow companies to begin exploring shale gas basins - albeit under vastly increased regulatory scrutiny.

 

 

And while not everyone will agree with its decision, it's obvious why the government did so. The UK has gone from being a net gas exporter in 2003 to importing roughly 55 per cent of its gas today. Each year the UK uses about 3.3 trillion cubic feet (tcf) of natural gas; domestic production now only accounts for about 1.5 tcf.

Meanwhile, in the US, shale gas production currently accounts for 3-4 tcf per year - up from virtually nothing a decade ago. Given that it took 20,000 wells drilled and hundreds of thousands of fracking operations to achieve this in the US, large-scale success is unlikely to be replicated as quickly in densely populated Britain. But the potential is there. And Britain's nascent shale gas industry is worth looking at in terms of potential investment.

 

An illustration of hydraulic fracturing

Fracturing fluids are injected under pressure to stimulate fractures in the shale. The fractures are propped open by sand contained in the fracturing fluid so that shale gas can flow out of the shale into the well (source: AI Granberg/ProPublica).

 

Frack facts

First things first. Is fracking safe? The process of hydraulic fracturing - where water, sand and a small amount of chemicals are pumped deep underground at high pressure to shatter rock formations and release gas - has come under attack from environmentalists in recent years and is generally mistrusted, if not misunderstood, by a large part of our society.

Professor Mike Stephenson of the British Geological Survey told the Investors Chronicle that this probably poses the biggest threat to shale gas development in the UK. "We're a crowded island. People here have a close relationship with the countryside and they want assurances it will be done safely. I think most industry people think it can be done safely, but there's an amount of persuasion that needs to be done by the companies to make it work. They need to make sure they have a 'social licence' to operate, if you like."

To that end, new research by independent scientific experts at the Royal Society and the Royal Academy of Engineering has come out in support of fracking. Their joint report argues that it is just as safe as conventional oil and gas exploration, provided it is regulated properly: "The health, safety and environmental risks associated with hydraulic fracturing as a means to extract shale gas can be managed effectively in the UK, as long as operational best practices are implemented and enforced through regulation… The available evidence indicates that [these risks are] very low provided that shale gas extraction takes place at depths of many hundreds of metres or several kilometres."

True, poorly constructed wells or shabbily run operations pose a threat. But these risks can be close to nullified with proper regulation - something which the UK, with its strong history of oil and gas safety, should excel at.

 

 

Our crowded island

Still, the UK is 40 times smaller than its ex-colony to the west and about eight times more populated per square mile. Not only that, but the shale basins in the UK are tiny compared with their US counterparts. That could spell trouble for local shale gas development - a resource-intensive business that benefits greatly from economies of scale - despite the UK government's favourable attitude and attractive tax break proposals.

Prof. Stephenson isn't concerned about that just yet, though. "There's lots of shale here - it's the most common sedimentary rock, after all. It really depends on the age of the rock you're dealing with. In the United States, the famous shale gas that was exploited quite early was the Barnet shale in Texas. And the Barnet is very similar in age and character to what we have here in Britain in the Blackpool area, which is probably the reason why most of the interest is focused there."

There are, of course, differences between the "Texas stuff" and the "north of England stuff", notes Prof. Stephenson. "The basins are a bit more complex geologically in Britain - there's a bit more folding and faulting, for example. But generally it's the same stuff, it's just not found in very large areas in Britain."

More threatening to the UK's nascent shale gas industry is the dearth of onshore infrastructure and high-quality drilling equipment needed to quickly ramp up production. There are reportedly fewer than 75 onshore drilling rigs in the whole of Europe, compared with several thousand in the US alone. And the rigs that are here typically won't be best-in-class. As fund manager Angelos Damaskos of Junior Oils Trust puts it: "The big service operators in North America essentially ship their older equipment out to Europe to service the industry here. It is definitely a lot lower on their agenda as a business, and that might be an indication of their opinion of the prospectivity of Europe's shale gas industry."

Moreover, there's the powerful influence of environmental groups in the UK to contend with, and their demonstrated ability to delay controversial resource projects; the fact that the fracking process consumes a lot of water and water supply is tight in certain areas of the nation; the permitting process for new wells will take longer than in the US and drilling operations will need to be more carefully monitored, potentially causing delays; and last but not least, the rights to onshore oil and gas in the UK are owned and controlled by the government - as opposed to the US where private landholders typically own the rights to oil and gas beneath their land - which means gaining access to prospective acreage for shale gas development will be more difficult as landholders have less to gain.

Granted, it's still very early days. Geologists and companies don't even know for sure yet if shale gas resources in Britain can be successfully extracted at commercial rates. You only have to look toward Europe to see it's much easier said than done.

 

 

The continental experience

Given that many of the world's biggest and most experienced oil players - ExxonMobil, Chevron, ConocoPhillips, Statoil and Total, to name a few - have been drilling shale gas plays in Eastern Europe for years now, it's somewhat surprising that virtually no one is currently extracting shale gas on the continent at commercial rates. In fact, much of the early exploration and development work has been a financial and technical disaster - as exemplified by ExxonMobil's high-profile decision last year to pull out of Poland entirely.

According to fund manager Mr Damaskos: "What has become apparent to us through our involvement in looking at companies involved in shale gas in Europe is that the technical characteristics and the geology of Europe is completely different to that of the United States and North America. The fracking technology that has been applied so successfully in North America does not necessarily travel so well to the European context - as some widely publicised failures in Poland and Hungary have proven."

True, shale gas took several years to really take off in the US. It will need time to develop in Europe too. But the jury is still out regarding its wider potential, says Prof. Stephenson. "In Poland, for example, a lot of the shale is older - a lot older than the stuff they're looking at in the UK - and its character isn't known very well. It's not something they've drilled a lot before. So there's quite a lot of uncertainty over these different shales and they are quite varied over Europe and other parts of the world."

Yet the British geologist says the initial failures are all part of the exploration process. "Many companies are confident they're eventually going to get the gas out. But basically they're saying that they need time to work on it and experiment. This is exactly what they did in Texas; they didn't get gas out immediately, it took them time and lots of technological experimenting to actually get it working. They're pretty confident there's gas down there - it's just a matter of getting it out."

No doubt Europe's shale gas hopes will be boosted by Shell's well-publicised recent entry into the Ukraine. But while Ukrainian politicians are talking up a potential $10bn investment, Shell will be taking a more cautious approach. First, it will do some seismic testing and drill some test wells. If the results are disappointing it, too, could walk away - and leave Eastern Europe as reliant on Russia's gas pipelines as ever.

 

 

Frack to the future

The UK may have the good fortune of being able to rely on a number of international gas suppliers, but the fact remains that natural gas production from the North Sea has been in relentless decline for years. Could shale gas be the answer to the UK's energy woes? Possibly, in time. But how much time, exactly? BP's chief economist, Christof Rühl, boldly says shale gas is unlikely to be a "game-changer" for the UK over the next two decades. While it is likely to eventually play a small role here, the energy guru predicts that the UK will still need supplies from the Gulf and other regions to meet rising demand.

We're more optimistic, though. Twenty years ago, one of the main techniques to unlock shale gas reserves - horizontal drilling - hadn't even been developed yet. Today, the pace of technological change is only quickening. While it’s still too early to say whether shale gas will boom or bust in the UK, the next few years will be crucial. But it has to be said, the pace of any shale gas development here will be very slow compared with the US.

We foresee just one or two British shale gas explorers drilling prospects and fracking them in 2013 – rising to a small handful of players successfully navigating the permitting process to do the same again in 2014. From there, though, much will depend on the technical characteristics of the specific shale basins targeted and the ability of the operators to extract shale gas at encouraging flow rates.

We would hope at least one, but possibly several, of the pioneering explorers will have had enough early success by then to begin a medium-sized drilling and fracking program to essentially prove that shale gas can be extracted en masse at a profit in the UK. With a bit of luck, that could happen within the next three to five years.

Admittedly, this timeline relies on the assumption that the maiden few operators don't have any slip-ups along the way: that means no more earth tremors, good community relations and definitely no methane leakage from wells.

The government has laid the groundwork; the geological potential is apparent. Now, Britain's shale gas industry has to work to ensure this emerging sector doesn't run out of gas before getting out of the driveway. As for whether it's worth investing in, we recommend heeding Mr Damaskos' counsel: "Over the medium term, I think it's a very attractive sector to look into - and we intend to do so, carefully."

 

  

Ways to play shale gas in the UK

Cuadrilla Resources (Private UK-based exploration company)

The only company to have actually drilled for shale gas in the UK. Its Lancashire-based project could hold up to 200 tcf of 'gas in place', of which only a small fraction could be recoverable. It plans to restart drilling and fracking operations later in 2013, after completing the new permitting process put in place by the government in December 2012. Cuadrilla is also reportedly in talks with several major energy companies to farm out an interest in its UK shale gas assets. Private equity group Riverstone Holdings holds a 41 per cent interest in Cuadrilla.

AJ Lucas (Australian engineering group listed on the ASX, ticker: AJL)

AJ Lucas holds a 42 per cent equity interest in Cuadrilla. It also owns a direct 25 per cent interest in two of Cuadrilla's UK exploration permits, PEDL 165 in the Bowland basin and PEDL 244 in the Weald basin. It has invested A$73.6m in Cuadrilla and its direct exploration interests since Cuadrilla began operations in 2007.

Dart Energy (Australian unconventional energy group listed on the ASX, ticker DTE)

Dart acquired Greenpark Energy for $42m (£26m) in late 2011, which included coal-bed methane licences and shale gas prospects throughout the UK and Europe. Now it holds over a dozen licences in the UK and says it has "established material shale gas potential at PEDL 133". Current status of shale gas exploration is unclear.

Alkane Energy (The UK's leading coal mine methane producer and power generator. Listed on Aim, ticker ALK)

Alkane has a 100 per cent interest in more than 800 square km of acreage in the UK under various onshore exploration and production licences. The company previously considered its shale gas assets non-core to its operations, but now the board "is evaluating the options open to the group in relation to potential shale gas resources within its licensed portfolio".

Reach Coal Seam Gas (Private UK company)

Reach is focused on coal-bed methane, and is also looking for shale gas.

Celtique Energie (Private UK company)

Celtique holds 10 licences in Southern England, Cheshire and the East Midlands. It is currently trying to secure local planning consents from the relevant authorities before exploratory drilling. The company is looking for both conventional and unconventional sources of oil and gas, including shale gas.

Europa Oil & Gas (Aim oil and gas explorer with a focus on Europe, ticker EOG)

Europa holds licences covering an area of over 600 square km in the UK's Humber basin that might have potential to hold "significant shale gas resources held in Carboniferous basinal black marine shales known to be 120m thick in the region". Current exploration status unknown.

UK Methane Ltd (Private UK company)

Current activity unknown.

Coastal Oil & Gas (Private Welsh company)

Coastal claims its licences in South Wales could hold up to 50 tcf of shale gas, or £120bn-worth of gas.

Eden Energy (Australian alternative energy company, listed on ASX, ticker EDE)

Eden reportedly owns a large interest in Coastal Oil & Gas through its UK subsidiary, Adamo Energy. Adamo is also reportedly partnered with UK Methane. Independent consultant RPS estimated the unrisked (P90) resource volumes of shale gas in the Numurian Measures on 7 licences in South Wales in which Eden holds a 50 per cent interest as: volume of gas initially in place, 34 tcf (Eden's share,17 tcf ); recoverable volume, 12.8 tcf (Eden's share, 6.3tcf ). The total area of the 17 UK joint venture exploration licences in which Eden holds an interest is approximately 500,000 acres, "all of which is considered prospective for coal-bed methane, conventional natural gas and/or shale gas".

Egdon Resources (Aim oil and gas producer and explorer, ticker EDR)

Egdon owns 13.5 per cent interests in two licences in the East Midlands prospective for shale gas. Based on analogous plays in the US, consultant RPS Energy estimates the licence area could contain 1.76 tcf of gas in place (net to Egdon). The basin is the Gainsborough Trough, which contains a 125m thick sequence of Carboniferous-age Pendleian shale at a depth of over 2km. Egdon plans on drilling a deep exploration well to evaluate the area's potential during 2014, subject to obtaining all necessary permits and approvals. The company's costs are carried through the work programme. The other licence holders reportedly include: eCorp Oil and Gas UK, 60.0 per cent; Greenpark Energy, 16.5 per cent; and Star Energy Oil and Gas (taken over by IGas in 2011), 10.0 per cent. Egdon is also evaluating the unconventional resource potential in some of its other East Midlands licences.

eCorp Oil & Gas (Private US company with offices in Houston and London)

eCorp reportedly holds a 60 per cent interest in Egdon's PEDL 139 and PEDL 140 licences in the East Midlands. It is also exploring and developing shale gas assets in the US and Europe.

Igas Energy (Aim oil and gas producer and explorer, ticker IGAS)

IGas recently raised £23m, mainly to advance its early stage shale gas prospects in the UK. The company produces unconventional and conventional oil and gas onshore, and only recently turned toward shale gas when its Ince Marshes coal-bed methane well intersected a significant shale structure of at least 1,000 feet, with gas indications observed. It is apparently the same Bowland structure Cuadrilla intersected. IGas initially tried to farm out an interest in the prospect, but either couldn't find a partner on attractive enough terms or realised there is a lot of investor interest in it and has consequently decided to go it alone. In addition to the main Bowland basin, IGas says it has identified "prospective shale horizons across all of its UK acreage in both the East Midlands (Bowland extension) and the Weald Basin (Kimmeridge/Lias)". Plans to drill a two-well shale appraisal programme, including a subsequent flow test of a well, after going through the permitting process. The program is expected to cost up to £15m. The company could also hold a 10 per cent interest in Egdon's licences (see above).

Enegi Oil (Aim oil and gas explorer with a focus on Atlantic Canada and the UK, ticker ENEG)

Enegi holds a 100 per cent interest in a licence covering 495 square km of the Clare basin onshore western Ireland. Initial studies suggest the basin has the potential to contain shale gas, with Fugro estimating Enegi's licence contains between 5 and 13 tcf of gas in place. Total recoverable resources could be between 1.5 and 3.9 tcf. It is applying for an extension to the licence, which expires in February 2013.

BG Group (Global oil major headquartered in UK, ticker BG)

Current UK shale gas activity unknown. The company is very active in the US shale space and is thought to be looking into it in the UK, too. However, BG's chief has said the company doesn't expect the UK to be a significant shale producer like the US.

Drillers, engineering companies and oil services groups (Mainly listed in London and New York)

Investors can choose to adopt a 'picks and shovels' approach to UK shale gas, but it's too broad an exposure for us given the huge uncertainties and long timelines involved. Nevertheless, groups such as Hunting (HTG), Petrofac (PFC), Amec (AMEC), John Wood Group (WG) and Schlumberger (SLB.N) could offer some exposure with lower risk.

Oxford Catalyst Group (Oil and gas technology company listed on Aim, ticker OCG)

This company has developed a revolutionary new technology to turn natural gas into transportable liquids. Stranded gas assets and small to medium-sized fields are their target market. This technology should help shale gas producers in the US, where the price for gas is low but the price for liquids is still high, and could do the same for shale gas plays throughout the world where affordable infrastructure isn't already in place. It recently raised £30.6m and hopes to sign up its first few customers this year.