Shale gas: The dotcom bubble of our times

5 08 2014

Comment: output from shale wells declines so quickly that they will never be profitable – when investors realise this, the industry will collapse, writes Tim Morgan

Workers exploring a potential shale field in Pennsylvania.

Workers exploring a potential shale field in Pennsylvania.  Photo: AFP

On the one hand, many environmental and conservation groups are bitterly opposed to shale development. Ranged against them are those within and beyond the energy industry who believe that the exploitation of shale gas can prove not only vital but hugely positive for the British economy.

Rather oddly, hardly anyone seems to have asked the one question which is surely fundamental: does shale development make economic sense?

My conclusion is that it does not.

That Britain needs new energy sources is surely beyond dispute. Between 2003 and 2013, domestic production of oil and gas slumped by 62pc and 65pc respectively, while coal output decreased by 55pc. Despite sharp increases in the output of renewables, overall energy production has fallen by more than half. A net exporter of energy as recently as 2003, Britain now buys almost half of its energy from abroad, and this gap seems certain to widen.

The policies of successive governments have worsened this situation. The “dash for gas” in the Nineties accelerated depletion of our gas reserves. Labour’s dithering over nuclear power put replacement of our ageing reactors at least a decade behind schedule, and a premature abandonment of coal has taken place alongside an inconsistent, scattergun approach to renewables.

Those who claim that Britain faces an energy squeeze are right, then. But those who claim that the answer is using fracking to extract gas from shale formations are guilty of putting hope ahead of reality.

The example held up by the pro-fracking lobby is, of course, the United States, where fracking has produced so much gas that the market has been oversupplied, forcing gas prices sharply downwards.

The trouble with this parallel is that it is based on a fundamental misunderstanding of the US shale story.

We now have more than enough data to know what has really happened in America. Shale has been hyped (“Saudi America”) and investors have poured hundreds of billions of dollars into the shale sector. If you invest this much, you get a lot of wells, even though shale wells cost about twice as much as ordinary ones.

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.

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 7pc-10pc annually, rates of decline for shale wells are dramatically worse. It is by no means unusual for production from each well to fall by 60pc 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.

Meanwhile, recoverable reserves estimates for the Monterey shale – supposedly the biggest shale liquids play in the US – have been revised downwards by 96pc. In Poland, drilling 30-40 wells has so far produced virtually no worthwhile production.

In the future, shale will be recognised as this decade’s version of the dotcom bubble. In the shorter term, it’s a counsel of despair as an energy supply squeeze draws ever nearer. While policymakers and investors should favour solar, waste conversion and conservation over the chimera of shale riches, opponents would be well advised to promote the economic case against the shale fad.

Tim Morgan was global head of research at Tullett Prebon 2009-13 and is the author of ‘Life After Growth’

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One response

5 08 2014
Charles Aulds

Maybe it’s simply because I’m tuned into it, but suddenly it seems everyone’s talking about the untapped riches of natural gas that lie, literally, beneath our feet; which the technological miracle of hydraulic fracturing has placed right at our fingertips. Ripe, succulent, low-hanging fruit, just waiting to be plucked.

It’s a pyramid. They aren’t selling the product; they’re selling the business. The pyramid. Investors are encouraged to 1) get in early (on the “ground floor”) and 2) get others involved.

I know there’s natural gas underground. I also believe that it will prove expensive and difficult to extract. I don’t believe the natural gas is the scam. The scam is that it’s easy to extract. It isn’t. This is an example of “too good to be true,” a very strong marker for a scam.

The goal is not to get the natural gas; it’s to get investors for the exploration and extraction. To bring in more people at the bottom of this pyramid.

It’s a scam. And it’s gone global, have you noticed? This low-hanging fruit is just waiting to picked in just about everybody’s backyard.

They aren’t selling the natural gas; they’re selling the pyramid. That’s a hallmark of every pyramid scheme. Learn to recognize it.

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