Kemp: Shale Plays Reduce Political Risk
But once the initial investment is in place and the project enters the production phase, there is a strong incentive to revise the terms of the project to increase government revenues and reduce the share remaining for investors.
The problem of changing fiscal terms and obsolescing bargains has been well explained by Daniel Johnson ("International petroleum fiscal systems" 1994) and Peter Nolan ("The state's choice of oil company: risk management and the frontier of the petroleum industry" 2012).
The bigger the project, and the more lumpy the upfront capital investment required, the greater the temptation to revise the terms subsequently. But shale plays require continuous investment in the drilling of new wells, so the terms need to remain favourable or drilling will stop.
Shale plays therefore align the financial interests of the drilling firms and host government more closely than a conventional field or a megaproject.
Shale investments are not entirely without risk. There are still upfront capital costs for seismic surveying and acquiring experience with drilling in the play. Drilling firms must bore dozens or even hundreds of wells before they acquire the necessary know-how to exploit the play efficiently, which represents a sunk investment.
But the upfront costs associated with developing a shale play can be measured in the hundreds of millions of dollars, not the billions associated with many frontier conventional projects, or the tens of billions spent on Kashagan.
For a large international oil company like Chevron, which is active in Neuquen and able to spread investment risks across a broad portfolio of projects, shale offers an attractive balance of risk and reward.
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