The U.S. Energy Information Administration (EIA) released its Annual Energy Outlook 2011 (AEO2011) Early Release Overview last week that dramatically increased its estimate of technically recoverable unproved shale gas resources and raised its forecast of the amount of natural gas to be consumed in the future. Neither of these changes to their annual forecast is a great surprise given ongoing industry trends, but what may be somewhat of a surprise is the smaller increase in gas shale resources compared to the 2009 forecast from the Potential Gas Committee at the Colorado School of Mines.
Exhibit 1. Potential Gas Committee Gas Resource Forecast
According to the release, the EIA believes there is 827 trillion cubic feet (Tcf) of technically recoverable unproved shale gas resources as of January 1, 2009, more than double what it had previously estimated. The prior estimate of 353 Tcf of shale gas resources has been increased by some 474 Tcf in the new assessment. An article in the Financial Times discussing the new EIA energy outlook and shale gas resource estimate makes the classic mistake of confusing proven shale gas reserves with shale gas resources. In the latter case, we only know the likelihood of a volume of gas trapped in the shale rocks and not that it can be extracted in an economical manner, which is the critical variable in defining proven reserves.
What does this new estimate mean? According to the AEO2010 report, the 2008 year-end estimate of total proven dry natural gas reserves in the United States was 239 Tcf. This means that the ratio of shale gas resource in the AEO2010 report (353 Tcf) to total proven gas reserves was nearly one and half times. In contrast, as Art Berman has estimated, the Potential Gas Committee estimated total technically recoverable natural gas resources of 1,836 Tcf, of which he suggests roughly a third, or about 616 Tcf, is from shale gas. When he assesses the probable reserve category, Mr. Berman suggests that there is a total of 441 Tcf of probable gas reserves with about 147 Tcf coming from shale gas. We are hesitant suggesting that shale gas accounted for one-third of the EIA’s proven gas reserve estimate as the boom is of recent vintage. Unfortunately, the EIA’s release does not provide proven gas reserve estimates so we don’t know what role shale gas plays given the agency’s more than doubling of its estimate of the resource.
The confusion in the media over resources versus reserves, and even among E&P company executives who are drilling shale gas wells, creates some serious misperceptions about exactly how much gas is readily available for consumption. Proven reserves is the only supply category that can be appropriately compared with current production in order to determine how many years worth of supply actually exists today. While all the technically recoverable resource may ultimately become proven and economic over time, that isn’t the case now. So to say that we now have 36 years worth of gas supply is incorrect. However, even if wrongly calculated, the Financial Times estimate is lower than EOG Resources (EOG-NYSE) CEO Mark Papas’ 50-years of supply statement in a speech recently, and the often repeated 100-years of supply statement that is derived from using the Potential Gas Committee’s estimate of the gas shale resource potential. What we do know, however, is that over time potential hydrocarbon resources tend to become proven and thus developed, but that is not a given.
Many people are excited about the dramatic increase in shale gas resources, just as they were in 2009 when the Potential Gas Committee boosted its estimate of the resource’s potential. What is interesting, however, given the revised resource estimate is to see how actual reserves fit into the equation. Unfortunately, the AEO2011 early release doesn’t contain any tables showing the EIA’s estimate of proved reserves. The AEO2010 report showed an estimate of total dry natural gas proved reserves in 2009 of 239 Tcf. In that year, the EIA estimated that total natural gas consumption was 23.3 Tcf. That means there are sufficient proved reserves to supply 10 years of total gas consumption at 2009’s consumption rate. This ratio of proved reserves to consumption is about where the long-term average has been, although it is probably up slightly from the prior few years given the increase in shale gas reserves becoming proven and the drop in natural gas consumption due to the recession. Note, however, that this 10-year supply ratio is nowhere near the 36, 50 or 100 year supply figures being tossed around amidst the shale gas boom.
In the AEO2010 report, total proved dry natural gas reserves are projected to increase steadily from 2009 until hitting a peak in 2020 of 260 Tcf. Then the reserve estimate begins dropping for a few years, bottoming out at 258 Tcf in 2023 before resuming its long-term climb toward the 2035 total of 268 Tcf. The developing shale gas boom was partially behind the projected growth in total proven gas reserves. We will be interested to see the role of shale gas reserves in the growth in total dry gas reserves and its future growth presented in the AEO2011 forecast. In other words, will we see a one-time jump in proven reserves and then a similar growth rate to 2035 as in the AEO2010 forecast?
Comparing the outlooks for the supply of natural gas and the role of shale gas in the future mix is enlightening for understanding how mainstream shale gas has become in our predicted energy future. The AEO2010 and the AEO2011 natural gas supply outlooks and mix are depicted in nearby graphs. The EIA’s caption on their projection for gas supply sources in AEO2011 captures their view that it is all about an expanded role for shale gas. Between the AEO2010 and AEO2011 forecasts, the shale gas contribution to total supply more than doubles from 6.0 Tcf to 12.2 Tcf by 2035. As a percentage of total supply, shale gas production accounts for 45% in AEO2011, which is up from 26% in AEO2010. You should also note that in AEO2011, natural gas imports are almost totally eliminated by 2035.
Exhibit 2. 2011 Shale Gas Market Share Up Rapidly
Exhibit 3. 2010 Shale Gas Forecast – More Modest
As we said in our last Musings, it is now official: Unconventional gas has become conventional. If one looks at the AEO2011 chart and adds together the contributions of shale gas and tight gas to total supply in 2035, two-thirds will come from these unconventional categories. An aspect of shale gas supply growth is its impact on natural gas prices. EIA Administrator Richard Newell said in a press release, “Our Reference case projection shows the growing importance of natural gas from domestic shale gas resources in meeting U.S. energy demand and lowering natural gas prices.” In fact, the AEO2011 projections show that the wellhead price for natural gas that was $3.71 per thousand cubic feet (Mcf) in 2009 will only grow in constant dollars to $6.53/Mcf by 2035. Significantly, the wellhead price fails to rise above $5/Mcf until 2023.
Given the economics of most of the shale gas plays in the United States, having to wait until 2023 in order for wellhead prices to make them economic may be too long for many producers to survive. The prospect of more than a decade of sub-$5/Mcf natural gas prices suggests considerable pain and suffering for the industry and its investors. Investment bankers have to be licking their chops at the possibility of an explosion in M&A transactions of shale gas producers being on the horizon. Quite possibly, though, many of the M&A deals will be born in bankruptcy courtrooms.
G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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