Musings: Gas Shales Face Conflicting Future

A good friend and student of the energy business, and especially the ongoing shale revolution, cautions that there should be warnings about gas shale resources, much like the tobacco industry places on packs of cigarettes. Since we address potential U.S. natural gas resources in the following article, we felt a warning appropriate.

Caution: The term "resources" refers to hydrocarbons that cannot be produced commercially now, and maybe never, at any price. Also, the resource hydrocarbons may not exist, or are sequestered in such a way that they may never be located. Placing any reliance on this number to meaningfully add to our national energy sources during your lifetime could be hazardous to your financial health.

On April 27, the Potential Gas Committee (PGC) based at the Colorado School of Mines, issued its 2011 report on the state of natural gas resources in the United States as of the end of 2010. The good news for the country contained in the 2009 report is that the PGC found greater gas resources than they had estimated at the end of 2008. In that earlier report, the PGC highlighted the impact of gas shales on its estimate of potential gas resources showing that the entire growth between 2006 and 2008 in its estimate of the amount of technically recoverable natural gas resources was due to this asset class. It was this report and the estimated size of the gas shale potential resource - 615.9 trillion cubic feet (Tcf) of gas - that gave rise to the belief this country has 100+ years of supply. While the momentum behind the gas shale revolution had been building since Mitchell Energy, and its eventual owner, Devon Energy (DVN-NYSE), began proving the commerciality of this resource in the late 1990s, industry, investment and media focus truly heated up following the 2009 PGC report.

Despite the best efforts of the PGC and serious analysts of the economics of natural gas resources, the claims of decades of increased supply due to gas shales have become a driving force behind the push in this country to use more gas in electric power generation and in our transportation system. The effort to tame somewhat the claims about the gas revolution continued in the recent PGC press release announcing its 2010 resource estimates. Dr. John B. Curtis, Professor of Geology and Geological Engineering at the Colorado School of Mines and the Director of the Potential Gas Agency, was quoted as saying, "Assessments of the Potential Gas Committee are "base-line estimates' in that they attempt to provide a reasonable appraisal of what we consider to be the "technically recoverable' gas resource potential of the United States." This means the PGC did not assume either a timetable or a specific gas price that would lead to the discovery and production of these potential resources.

The PGC report estimates that the U.S. has potential gas resources of 1,898 Tcf, which includes 1,739 Tcf of gas attributable to traditional resources (conventional, tight sands and carbonates, and shales) and 159 Tcf of gas in coalbed reservoirs. This is the highest estimate of potential gas resources in the PGC's 46-year history. Compared to the 2008 report, the increase in resource potential was a net change of 61.4 Tcf, or 3.3%, which is comprised of a 4%, or 67 Tcf, increase in traditional resources and a 2.7%, or 4 Tcf, decline in coalbed resources. When the PGC estimated resource potential is combined with the Energy Information Administration's (EIA) estimate of 273 Tcf of proved dry natural gas reserves as of year-end 2009, the United States has an estimated total available future supply of 2,170 Tcf, an increase of 89 Tcf over the previous assessment.


The PGC's estimate of total natural gas potential resources compared quite favorably with the estimate made late last year by the EIA. Its estimate was that the United States in 2010 had a total of about 2,125 Tcf of reserves and resource potential. The EIA's 2011 estimate has been increased significantly to 2,550 Tcf due to an increase in the amount of shale gas resource potential. Unfortunately, the EIA has adopted the myth that resource potential equates to proven reserves. That view was demonstrated when in 2010 the EIA determined that based on its forecast of domestic gas consumption for the year and the total estimated natural gas resource base, the U.S. could meet its demand for 110 years.


An interesting aspect of the PGC report, however, was the regional breakdown of potential gas supply and the changes by region from the committee's prior estimate. In the traditional gas potential, the Gulf Coast total increased by 50.8 Tcf, or about 11.2%. That increase reflects the growth of the Eagle Ford Shale formation, which has only recently blossomed. On the other hand, the Marcellus Shale, supposedly the largest U.S. gas deposit and certainly the largest in the Atlantic region, displayed a two-year increase of only 0.1 Tcf, or essentially flat. Interestingly, several of the other regions showed declines from 2008. The decline was greatest for the Rocky Mountain region at -30.4 Tcf, followed by -2.6 Tcf and -2.4 Tcf declines for the Mid-Continent and North Central regions, respectively. The Pacific region increased by 2.7 Tcf, while Alaska showed no change, although this supply has no impact on the domestic natural gas market. Coalbed gas resources were down 4.4 Tcf between the two surveys.


The claims about how large the gas resource potential is in the United States continue to mushroom, pushed by long-time supporters of using greater volumes of natural gas to reduce the country's energy import needs and other promoters with vested interests in a growing role for natural gas. On the same day that the PGC report was released, T. Boone Pickens, the former and long-time oil and gas company executive and now energy hedge fund manager, appeared on CNBC's "Squawk On the Street" early morning investment show and discussed his push for legislation that would enhance the government's support for increased use of natural gas, especially in the transportation sector. His pitch is that by converting all the heavy-duty trucks in the U.S. from diesel to natural gas fuel we would cut the county's need for imported oil from OPEC in half.

In his presentation, Mr. Pickens said that the public analysts were willing to concede that the country has at least 2,000 Tcf of gas reserves, which he calculates is the equivalent of 350 billion barrels of oil equivalent, or more than the estimated crude oil reserves attributed to Saudi Arabia. He said he believes the U.S. actually has gas reserves in the range of 4,000 Tcf, or 700 billion barrels of oil, or twice what the public analysts believe. The natural gas legislation Mr. Pickens has been pushing has nearly 200 co-sponsors in the House of Representatives, including both Democrats and Republicans, he said. He is sure the bill will be approved by the House and also anticipates it will be passed by the U.S. Senate and then signed by the president. A report issued by Washington Analysis a few weeks ago suggested they did not see the legislation being passed by the Senate due to certain provisions attached to the bill. I guess we will have to wait and see when Congress returns from its Easter vacation.

In the meantime, the gas shale business got a black eye two weeks ago when a well Chesapeake Energy Corp. (CHK-NYSE) was drilling in Leroy Township, Bradford County, Pennsylvania, had a discharge of fracturing fluid flowback that spilled across the neighboring farm fields and into Towanda Creek and an adjacent tributary. The spill occurred on the one-year anniversary of the Deepwater Horizon accident and resulting oil spill from BP Ltd.'s (BP-NYSE) Macondo well in the Gulf of Mexico. Fortunately there were no injuries or fire caused by the spill, and according to media reports, little or no environmental damage. The accident, however, caused Chesapeake to elect to shut down all its hydraulic fracturing activity in Pennsylvania and West Virginia until the cause of the accident has been determined.


The well site has a bucolic look from a distance, but up close it resembles what many of us associated with the oil and gas industry picture as an active well site - lots of equipment, dirt/mud depending on the weather, and hard working people. This spill achieved a high profile because it is in the heart of the region most opposed to hydraulic fracturing. The reportedly 13-hour response time needed for well-control specialists, Boots & Coots, to arrive on the scene has created a minor media fury., the investigative news web site, reported that Chesapeake well lost control at about 11:45 pm on April 19th and the team from Boots & Coots didn't arrive until 1:25 pm the next day. The well was totally controlled on April 25. Chesapeake reported that a company well-control specialist arrived at the well site within 30 minutes from the well control loss and that three additional company specialists arrived within eight hours. Chesapeake reported its internal team had shut down 70% of the well's flow before the Boots & Coots team arrived.


The reason why this situation has received such attention is because the Pennsylvania Department of Environmental Protection (DEP) has an arrangement with CUDD Pressure Control, which has an office with staff and equipment in Pennsylvania specifically to be able to provide rapid response to well control events. The agreement with the DEP was put in place in response to long delays on previous well accidents. This past January, the CUDD team responded to a well incident and had it under control within four hours, demonstrating the value of the contract. Chesapeake declined the help from the DEP because it already had an arrangement with Boots & Coots.

One could almost describe the events of the past two weeks as the manifestation of Charles Dickens' opening line from his novel, A Tale of Two Cities: "It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only." How these two tales play out remains to be seen, and much like Dickens novel, there likely will be many twists and turns on the way to a conclusion.