by Fabio Herrero

In the past years there has been a lot of noise about LNG export from the US. On March 25, 2014, Senate Energy Committee Chairwoman Mary Landrieu spoke about replacing Ukraine Russian gas imports with US gas. The indirect reply by Cheniere CEO Mr. Souki “It’s flattering to be talked about like this, but it’s all nonsense. It’s so much nonsense that I can’t believe anybody really believes it”. Cheniere will be the first to start exporting LNG from the US, in Q4, 2015. At the same time the son of the actual US Vice President, Hunter Biden is a director of Burisma, a company holding shale gas licenses in eastern Ukraine, indicating a strong support for shale gas inside the US administration. This article will demonstrate that exporting LNG gas doesn’t make sense from an economic point of view and that it will hurt the US public by increasing domestic gas prices.

This article will demonstrate that exporting LNG gas doesn’t make sense from an economic point of view and that it will hurt the US public by increasing domestic gas prices.

1. The US is a net importer of natural gas

The US is a natural gas importer, and has been for many years: in 2013 domestic production covered 89% of consumption. The EIA is forecasting that by 2017, the US will finally be able to meet its natural gas needs. Canada is the main exporter to the US and is losing ground as a major player in North American natural gas production, the Conference Board of Canada said in a report released in September of 2013. The report forecasts that production is expected to ratchet down over the next five years, led by declines in Alberta, where production is expected to slide by 20%. Mexican conventional oil and gas production is also in decline. The last move by the Mexico government to liberalize the oil and gas sector, breaking PEMEX’s monopoly, shows how the desperate the situation if the state has to seek help from private companies. Mexico used to have the second biggest oil field in the world, Cantarell, but Cantarell is now in decline.

2. The US wants to reduce the production of electricity from coal and oil, and is not replacing its nuclear facilities.

Natural gas is the only energy source whose production is significantly growing, from 31% of total energy production in 2012 to 38% of total US forecasted energy production in 2040. Renewables are expected to grow from 11% to 12% of total US energy production. All of the others fuels, including oil, whose total production in the US has risen by 60% in the last five years, are expected to shrink as percentages of total energy production between 2012 and 2040. And there is the possibility that this or a future administration will overturn the ban on US crude oil export that has existed since the 1970s, as suggested by the Council on Foreign Relations and by others.

Using EIA data, US natural gas needs are expected to grow by only 12% between 2013 and 2030. By 2040, natural gas consumption is expected to be 23% higher than in 2013. It is the opinion of the author that this forecast is wrong. For one, because of pollution and the global warming (climate change) threat, the Obama administration is talking about scaling back coal use for electricity production, and the US uses almost as much coal as natural gas. Natural gas is an alternative to coal for this purpose. Furthermore, the EIA expects US oil production to start dropping by 2020, my assessment here is that it means that more natural gas will be needed to substitute the oil, without even introducing the eventuality of using natural gas in transportation. Many US nuclear plants in service will need to be replaced in the next 20 years. If the US substitutes natural gas in this area as well, it will further send US natural gas usage up.

3. Shale gas requires an enormous amount of rigs just to maintain output

According to Austin, Texas-based Drillinginfo Inc, the output of shale wells drops faster than conventional ones, falling by 60 to 70 percent in the first year alone. Traditional wells take two years to fall by about 55 percent before flattening out. This forces companies to keep drilling new wells to make up for lost productivity. It will take 2500 wells a year just to sustain the 1mil barrels of actual production in North Dakota.

“The seemingly inevitable outcome for the US shale industry is that, once investors wise up, and once the drilling sweet spots have been used, production will slump, probably peaking in 2017-18 and falling precipitously after that.”

We now have more than enough data to know what has really happened in America. If a huge number of wells come on stream in a short time, you get a lot of initial production. This is exactly what has happened in the US, says Tim Morgan, former global head of research at Tullett Prebon. Mr. Morgan elaborated in an article he wrote for the Telegraph in 2014:

“The key word here, though, is initial. The big snag with shale wells is that output falls away very quickly indeed after production begins. Compared with “normal” oil and gas wells, where output typically decreases by 7-10 percent annually, rates of decline for shale wells are dramatically worse. It is by no means unusual for production from each well to fall by 60 percent or more in the first 12 months of operations alone. Faced with such rates of decline, the only way to keep production rates up (and to keep investors on side) is to drill yet more wells. This puts operators on a “drilling treadmill”, which should worry local residents just as much as investors. Net cash flow from US shale has been negative year after year, and some of the industry’s biggest names have already walked away. The seemingly inevitable outcome for the US shale industry is that, once investors wise up, and once the drilling sweet spots have been used, production will slump, probably peaking in 2017-18 and falling precipitously after that. The US is already littered with wells that have been abandoned, often without the site being cleaned up.”

Extracting shale gas is a sign of desperation, it means that you have already extracted all easier gas and you are going after that which is hardest to extract and most expensive.

4. Shale gas is not profitable

In an excellent study by Ivan Sandrea entitled, “US shale gas and tight oil industry performance: challenges and opportunities” from the Oxford Institute Energy Studies in March 2014, he demonstrates that the very economic viability of shale gas depends on low interest rates. Financial problems of operators in US shale gas and tight oil plays might hold production growth below current expectations, according to Sandrea. “What is not clear is if the industry (both large players and independents) can run a cash flow-positive business in both top-quality and in more marginal plays and whether the positive cash flow could be maintained when the industry scales up its operations.” Sandrea cites asset write-downs approaching $35 billion since the shale boom began among fifteen of the main operators. “While most of the companies that have made write-downs are not quitting, many players in this industry have already noted that the revolution is not as technically and financially attractive as they expected.” Sandrea also cites an Oil & Gas Journal 2012 analysis by Energy Aspects, showing six years of progressively worsening financial performance by 35 independent companies focused on shale gas and tight oil plays in the US. “This is despite showing production growth and shifting a large portion of their activity to oil since 2010, presumably to chase a higher-margin business,” he adds. Oil and gas production by the companies represented 40% of output in unconventional plays in last year’s third quarter.

Shale debt has almost doubled over the last four years while revenue has gained just 5.6 percent, according to a Bloomberg News analysis of 61 shale drillers. A dozen of those wildcatters are spending at least 10 percent of their sales on interest compared with Exxon Mobil Corp.’s 0.1 percent. “Interest expenses are rising,” said Virendra Chauhan, an oil analyst with Energy Aspects in London. “The risk for shale producers is that because of the production decline rates, you constantly have elevated capital expenditures.”

Shale debt has almost doubled over the last four years while revenue has gained just 5.6 percent, according to a Bloomberg News analysis of 61 shale drillers.

According to the Energy Aspects analysis, total capital expenditure nearly matches total revenue every year, and net cash flow is becoming negative as debt rises. Other financial indicators “add to concerns about the sustainability of the business,” Sandrea says. Still, shale-gas and tight-oil development remains “a fledgling industry” with hope for “a positive inflection point for cash flow and a full-cycle risk-adjusted return.” But how can we get a positive inflection point when we know that the exploitation of any resource always starts with the richest portion and goes down to the less economic part? Sandrea says “above-ground reasons” include the need to constantly acquire and drill leases, infrastructure needs, transportation costs, increasing costs to manage environmental considerations as operations grow, and “the fact that drilling and hydraulic fracturing costs respond to fluctuations in gas and oil prices as well as demand, leaving little excess profit for long.” Below ground, rapid production declines and low recovery rates remain problems in many plays and might worsen as operators move into increasingly challenging acreage. Unless financial performances improve, capital markets won’t support the continuous drilling needed to sustain production from unconventional resource plays, Sandrea suggests, asking, “Who can or will want to fund the drilling of millions of acres and hundreds of thousands of wells at an ongoing loss?” Keep in mind that today interest rates are the lowest in recorded history with the Federal Reserve policy being to keep them low till 2015 at least. Per a Bloomberg article in 2014 independent producers will spend $1.50 drilling this year for every dollar they get back. Shell’s new boss, Ben van Beurden, said bets on U.S. shale plays haven’t worked out for his company. “Some of our exploration bets have simply not worked out,” Shell’s Chief Executive Officer Ben van Beurden was quoted in Reuters as saying. It was bad management policy to commit close to $80 billion in capital on its North American portfolio and still lose money. Now, he said, it’s time to cut the loss and slash exploration and production investments by 20 percent for 2014.

When the oil business started, for every hundred barrels of oil produced you had to consume just one. Now one barrel is needed to extract just five barrels of oil or gas.

5. Low EROI for shale extraction

The energy return on investment, or EROI, in the shale gas (and oil) business is very low. When the business in oil started, for every hundred barrels of oil produced you had to consume just one. Now one barrel is needed to extract just five barrels of oil or gas. The massive quantity of steel, water, frack chemicals, and electricity that is needed to extract shale oil and gas is unprecedented in the business, just slightly better than Tar Sands. Keep in mind that if the ratio becomes 1:1 it does not make sense anymore to extract at all.

6. The US is building too many LNG export terminals

The US economy has been enjoying extraordinarily low gas prices for many years now, and this is bringing gas intensive industries back home (with associated consumption). The consequence of gas exports will be to increase the prices shale gas producers can get for their gas. This comes partly by engineering higher US prices (by shipping an excessive portion overseas) and partly by trying to take advantage of higher prices in Europe and Japan. Dumping huge amounts of natural gas on world export markets is likely to sink the selling price of natural gas overseas, just as dumping shale gas on US markets sank US natural gas prices there (and misled some people, by making it look as if shale gas production is cheap). The amount of natural gas export capacity that is in the process of being approved is huge: 42 bcf per day per the author’s calculations in May 2014. The Obama administration is constantly approving new facilities and this number will grow. The European Union imports only about 30 bcf a day from all sources. This amount hasn’t increased since 2005, even though EU natural gas production has dropped. Japan’s imports amounted to 12 bcf of natural gas a day in 2012; China’s amounted to about 4 bcf. The US oil and gas sector wants to export almost the same amount imported by these three combined. The countries that are importing huge amounts of high-priced natural gas are not doing well financially. They aren’t going to be able to afford to import much more high-priced natural gas. If the US has to pay these high prices for natural gas the US economy will also take a hit.

7. Shale gas is more expensive to extract than Russian or Middle Eastern gas

The US is the high cost producer. “To sustain in the short term, the US needs prices at $65 a barrel,” Leonardo Maugeri, a former manager at Rome-based energy company Eni SpA who’s researching the geopolitics of energy at Harvard University’s Belfer Center for Science and International Affairs, was quoted as saying in Bloomberg. “That’s a critical level. Below that level, many opportunities will vanish.” There is a lot of natural gas production around the world, particularly in the Middle East, that is cheaper. If we add the high cost of shale gas to the high cost of shipping LNG long-distance across the Atlantic or Pacific, the US will most definitely be the high cost producer. The US can even pretend to offer help to the Ukraine. Reality is, Europe won’t get its independence from Russian gas, but US consumers will pay more.

Last year the United States produced 24.28 tcf of natural gas, an all-time record amount. However, the US still imported 2.5 tcf of gas (11 percent of total consumption). The trend in US gas increasing production rates has leveled off and is likely to begin declining in the next few years, just about the time new liquefied natural gas (LNG) export terminals will be ready for business.

If we add the high cost of shale gas to the high cost of shipping LNG long-distance across the Atlantic or Pacific, the US will most definitely be the high cost producer.

Finally, an examination of previous government forecasts reveals that they invariably overestimate production.

Conclusion

In fact, talk of oil and gas exports is being driven not by excess production capacity or geopolitical acumen, but rather by old-fashioned profit seeking.

As for the notion of making Vladimir Putin shiver in fear of a tsunami of American crude and natural gas, forget it.

The US natural gas industry is suffering under low domestic gas prices. During the last few years, shale gas companies over-produced in order to upgrade the value of their assets (millions of acres of drilling leases), thereby driving prices down below actual costs of production (in fact per US legislation they have to drill, or often lose their licence). If some US natural gas could be exported via LNG terminals now under construction, that would tend to raise domestic prices. However, this would also under-cut promises of continuing low prices that the industry has repeatedly made, promises that have lured the chemicals industry to rebuild domestic production facilities and that have enticed electric utilities to switch from burning coal to natural gas.

A lifting of legal constraints on exporting US oil and physical constraints in the case of gas, would help refiners and producers sort out this temporary mismatch. This is what all the oil and gas export fuss is really about, helping the domestic oil, gas and LNG achieve higher prices and hence profits at the expense of the American public. As for the notion of making Vladimir Putin shiver in fear of a tsunami of American crude and natural gas, forget it.

Fabio Herrero is a student in the ENERPO program at European University at St. Petersburg.

Sources

Reuters, 2014

http://www.reuters.com/article/2014/03/25/us-usa-lng-congress-idUSBREA2O08Z20140325

Reuters, 2014b

http://www.reuters.com/article/2014/03/13/us-shell-strategy-idUSBREA2C0NE20140313

Sandrea, Ivan, 2014, US shale gas and tight oil industry performance: challenges and opportunities, Oxfort Institute Energy Studies, March 2014 http://www.oxfordenergy.org/wpcms/wp-content/uploads/2014/03/US-shale-gas-and-tight-oil-industry-performance-challenges-and-opportunities.pdf

Canada, 2013

http://www.arcticgas.gov/canadian-natural-gas-production-continues-to-decline

CFR, 2013

http://www.cfr.org/oil/case-allowing-us-crude-oil-exports/p31005

Bloomberg, 2014

http://www.bloomberg.com/news/2014-02-27/dream-of-u-s-oil-independence-slams-against-shale-costs.html

Bloomberg, 2014b

http://www.bloomberg.com/news/2014-05-26/shakeout-threatens-shale-patch-as-frackers-go-for-broke.html

Oil & Gas Journal Vol. 110.12, December 3, 2012 http://www.ipc66.com/publications/EvaluatingProductionPotentialShaleGas&Oil_2012.pdf

Financial Times, 2014

http://www.ft.com/intl/cms/s/0/96f9e220-c0cb-11e3-bd6b-00144feabdc0.html?siteedition=intl#axzz3Dbn41PSj

Telegraph, 2014

http://www.telegraph.co.uk/finance/personalfinance/investing/11006723/fracking-for-Shale-gas-the-dotcom-bubble-of-our-times.html