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Shale gas should make the world a cleaner, safer place

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ALONG the coast of China, six vast liquefied natural gas (LNG) terminals are under construction; by the end of 2015 they should have more than doubled the amount of LNG that the country can import. At the other end of the country, gas is flowing in along a new pipeline from Turkmenistan. In between the two, geologists and engineers are looking at all sorts of new wells that might boost the country’s already fast-growing domestic production. China will consume 260 billion cubic metres (260bcm, which is 9.2 trillion cubic feet) of gas a year by 2015, according to the country’s 12th five-year plan, more than tripling 2008’s 81bcm. The roots of this rapid growth, though, do not lie in China’s centralised planning. They are to be found in a piece of deregulation enacted decades ago on the other side of the world: America’s Natural Gas Policy Act of 1978.

America’s deregulation of its natural-gas market encouraged entrepreneurial energy companies to gamble on new technologies allowing them to extract the gas conventional drilling could not reach. Geologists had long known there was gas trapped in the country’s shale beds. Now the incentives for trying new ways of recovering it were greater, not least because, if it could be recovered, it could be got to market through pipelines newly obliged to offer “open access” to all comers.

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Decades of development later, the independent companies which embraced horizontal drilling and the use of high-pressure fluids to crack open the otherwise impermeable shales—a process known as “fracking”—have brought about a revolution. Shale now provides 23% of America’s natural gas, up from 4% in 2005. That upheaval in American gas markets has gone on to change the way gas is traded globally. A lot of LNG export capacity created with American markets in mind—global supply increased 58% over the past five years—is looking for new outlets.

To the extent that the shale-gas success is repeated elsewhere, a vital source of energy will become available from an ever more diverse and numerous set of suppliers in increasingly free markets. This means that, unlike the boom in oil in the decades following the second world war, this growth in gas may not hand a powerful political weapon to those countries with the biggest reserves. Shale gas could significantly diminish the political clout that Russia, Venezuela and Iran once saw as part and parcel of their gas revenues.

“The power of the shale-gas revolution has surprised everyone,” says Christof Rühl, chief economist at BP. In 2003 America’s National Petroleum Council estimated that North America (including Canada and Mexico) might have 1.1 trillion cubic metres (tcm) of recoverable shale gas. This year America’s Advanced Resources International reckoned there might be 50 times as much.

The shale-gas bounty is not confined to America. The country’s Energy Information Administration released a report in April that looked at 48 shale-gas basins in 32 countries (see map). It puts recoverable reserves at 190tcm, and that excludes possible finds in the former Soviet Union and the Middle East, where huge reserves of conventional gas will make investment in shale gas unlikely for years to come. In short order estimates of the Earth’s bounty of recoverable gas have expanded by about 40%. Improving extraction technologies and geological inquisitiveness are sure to raise that figure in the years to come.

Nor is shale gas the only new sort of reserve: “tight gas” in sandstones and coal-bed methane (the sort of gas that used to kill canaries down mines) are also promising. Farther in the future, and more speculatively, there’s the gas frozen into hydrates on the planet’s continental shelves, which might offer more than 1,000tcm if a way can be found to exploit it. The cornucopian belief that human ingenuity will always find ways to increase the availability of resources is not a sure bet (see article). With gas, though, the odds look pretty good for decades to come.

A scenario developed for the International Energy Agency’s forthcoming “World Energy Outlook” offers a sense of what may unfold. Called the “Golden age of gas”, it sees annual world production rising by 1.8tcm between now and 2035, when it reaches 5.1tcm. A fair bit of that is provided by unconventional sources (see chart). The growth is about 50% stronger than in the scenario used as a baseline; trade in gas between the world’s major regions doubles. Coal use declines from the late 2010s onwards, and by 2030 gas has surpassed it, providing a quarter of all the world’s energy.

The development of shale-gas reserves beyond North America is still at an early stage. Although widespread pollution of groundwater by fracking seems unlikely (shales that hold gas typically lie far deeper than groundwater supplies), such risks have raised a great deal of environmental concern about the technology. Coupled with a sensitivity to the rural charms of la France profonde, this has led to a moratorium on shale-gas exploration in France. But in Poland, which may have Europe’s largest reserves, companies are busily sinking test wells to see what is there.

In South Africa, which may have the largest shale-gas reserves on the continent, the shales in the Karoo basin have attracted the attention of Shell, which is increasingly billing itself as a gas-focused company. Shell is also one of the companies looking at shale-gas reserves in China, which may be the largest on the planet. Chinese interest in shale gas is strong, with state companies buying up American expertise as they take stakes in established shale-gas producers. The country might be producing its first shale gas at scale before the current five-year plan is over.

Gas is currently bought and sold in three distinct global markets—North America, Europe and Asia—and prices differ widely between the three. In deregulated North America, with a competitive market and plenty of shale gas to augment conventional supplies, prices are low. In Asia, where gas is largely traded using a system of long-term contracts tied to the price of oil, prices are high. Europe sits in between: prices at the moment are around $4 per million btu in America, $8 in continental Europe and $11 in Asia (1m btu is about 300 kilowatt-hours).

The origins of long-term contracts and oil-linked pricing go back a long way. When gas first began to be used a lot in the 1960s it was a substitute for home heating oil, and so it made sense to tie its price to that of oil. Because big exploration, extraction and infrastructure investments required pots of capital, long-term contracts became an industry norm.

Today oil is generally no substitute for gas. Gas is used not to fill up cars and lorries—though there are gas-fired transport enthusiasts who would like to do something about that—but to fuel power stations and heat homes. Still, many gas producers are happy enough with the archaic pricing structure, particularly when oil prices are high. Customers with limited choices have had to put up with it. According to a recent study from the Massachusetts Institute of Technology, pipelines carry 80% of all gas traded between regions. The firms at the upstream end of those pipelines, such as Russia’s Gazprom, which supplies a quarter of all western Europe’s gas, thus have a strong hand in negotiations. Control of the pipelines meant that when Gazprom turned off the gas (as it did in 2009 in a dispute over trans-shipments through Ukraine), buyers had nowhere to turn for alternatives.

In the past couple of years, though, three factors—LNG from Qatar that was no longer needed in shale-gas-rich America, a little energy-market deregulation by the European Union and a drop in overall demand—have helped to loosen the grip of Gazprom. Power-sector reforms allowed smaller European utilities to compete more vigorously, buying LNG on the spot market at a price sometimes as low as half that of long-term contracts from Russia. Bigger utilities that were losing market share approached Gazprom, not known for sympathetic customer relations, for better terms. The normally intractable Russian company renegotiated contracts with European customers for a three-year “crisis period” to allow up to 15% of gas to be priced on cheaper spot terms. (Norway, also a big supplier to EU countries, had begun to sell gas on contracts that tied an even larger fraction to spot prices.)

Since then the European market has recovered. Prices rose after Libyan gas was cut off as a result of the country’s uprising and a lot of Qatari LNG has found a new destination in Japan, deprived of much of its nuclear power since the disaster at its Fukushima plant.

Unsurprisingly, further attempts to pressure Gazprom into revising its terms have faltered. In February it rebuffed appeals by Germany’s e.ON, one of its most important customers, to link its gas to spot prices. Gazprom’s boss, Alexei Miller, told shareholders at the end of June that oil-indexed long-term gas contracts were here to stay. In private the company is still talking to customers about changing the shape of future contracts, and appears more inclined nowadays to regard European utilities as potential partners rather than spineless adversaries.

Looking reasonable, say cynics, is a ruse to discourage investment in shale reserves and alternative pipelines. If an agreeable-seeming Gazprom, along with increased bullishness about LNG and shale gas, were to dampen European enthusiasm for Nabucco, a long-planned pipeline which might bring 30bcm of gas a year to Europe from the Caspian and the Middle East, that would suit Russia pretty well. But Russia’s new attitude could also spring from a realisation that the world really is changing. A study from the James Baker Institute at Rice University, published in July, reckons that, if shale-gas reserves are fully exploited, Gazprom’s share of the west European market might fall from 27% in 2009 to 13% by 2040.

And Gazprom is finding that China, with which it has been negotiating pipeline deals since 2005, is not interested in the sort of long-term locked contracts that have previously typified Asian markets; indeed it is not even willing to pay European prices. Its immense shale-gas potential might make it even less willing to pay up, inclining it to depend less on pipeline gas and to take the risk that it can smooth out ebbs and flows through spot markets. If the proportion of imported pipeline gas falls, so does the pricing power of conventional suppliers, even if the overall volume they supply goes up.

It’s everywhere

Increasingly, it looks as if today’s significant regional price differences will be arbitraged away, and that gas could become as fungible and as widely traded as oil. LNG’s growth (23% by volume in 2010) shows no sign of slowing. European LNG import capacity has more than doubled since 2000; the costs of building an import terminal have plunged. So far this year twice as many LNG vessels have been ordered from the world’s shipyards as in the whole of 2010. Qatar, which along with Iran and Russia holds the world’s most impressive conventional gas reserves, is adding new liquefaction plants. Other countries are also busily constructing export terminals; while Australia leads the way, Indonesia, Papua New Guinea and others are all set to bring more LNG to the world markets. There’s even work on liquefaction plants in America.

One consequence of a global gas market supplied from widely distributed conventional and unconventional sources is that this diversity will reduce the power of big suppliers to set prices and bully buyers. There has been occasional talk of a “gas OPEC”, most audibly when, just before the end of 2008, a dozen or so gas producers met in Moscow under the chairmanship of Russia’s prime minister, Vladimir Putin. Despite the rattling of sabres on pipelines, though, something analogous to OPEC looks near impossible under current conditions. For one thing, utilities mostly have spare capacity and can thus adjust their fuel mix in a way that car drivers confronted with an oil shortage cannot. What is more, managing the supply of gas month by month, as the oil cartel seeks to do, would be near impossible when most gas continues to be supplied on long-term contracts that are difficult to break.

And the new technologies are widening the production base all the time, weakening the strategic importance of conventional reserves and the power of those who hold them. Before shale gas, it was thought that Venezuela might soon become an important gas source for America, and that Iran’s vast gas reserves would motivate potential customers to break the sanctions imposed on it as a result of its nuclear programme. Both things are now less likely; the Baker Institute study suggests that while both countries will grow in importance—it foresees 26% of the world’s LNG coming from Venezuela, Iran and Nigeria by 2040—they will do so much more slowly than they would have in a world of constrained supplies.

The growth of the gas market will not be untroubled. Large projects will be delayed sometimes, leading to periods of tight supply; there may also be overcapacity at times, as there has been recently. America’s shale-gas success—a matter not just of helpful geology and Yankee ingenuity, but also of various legal and regulatory positions such as those of the 1978 act—may prove hard to replicate in some other countries. Environmental worries could stop shale gas dead in places. But although the pace may slow and the road may have bumps, for the moment the revolution looks set to roll on.

Original Article

Shifting Sands: Saudi Arabia’s Oil Moves East to China

Published April 05, 2011 in Arabic Knowledge@Wharton

The pivotal year was 2009, according to the Paris-based International Energy Agency (IEA). It was then that China consumed more energy than any other country in the world, even the U.S., prompting an expert at the IEA expert to proclaim “the start of a new age in the history of energy.”

For Saudi Arabia, which has the world’s largest oil reserves and is the world’s largest oil exporter, that new age couldn’t begin fast enough. Over the past 10 years or so, the Kingdom had been forging closer trade ties with China, becoming its key source of oil. In 2009, Saudi oil exports to China reached one million barrels per day (bpd), or 20% of its total oil imports and nearly double the number of barrels it exported the previous year; in contrast, U.S. imports of Saudi oil fell to less than one million bpd in 2009 for the first time in over two decades.

According to Tim Niblock, professor of Arab Gulf studies at the University of Exeter in the U.K., the growing Sino-Saudi oil trade is a reflection of the two countries’ “mutually dependent relationship that has advanced fairly steadily since 2000.” The Chinese need Saudi Arabia as a stable, established oil producer — all the more so today as turmoil across the Middle East continues, pushing the price of Brent crude to as high as US$116 a barrel in early March, and the Kingdom calms markets with pledges to increase production to fill any shortfall in supply. The Saudis need China’s burgeoning demand for oil in light of flat, or even decreasing, demand among consumers in developed markets. Even with the Chinese government lowering the official target earlier this year for average GDP growth over the next five years to 7% from 7.5%, the country’s thirst for oil looks unlikely to abate.

But are those ties now being tested? As unrest sweeps across the Middle East and North Africa, the entire region is on the cusp of change in ways that will affect the geopolitics of oil. “The whole political situation is different than what it was a couple of months ago, and it will stay different for a long time,” says Niblock. “It is a major turning point. Inevitably, that will have foreign policy effects. But it is very difficult at this stage to know what the nature of those effects will be, because we’re really only at the beginning of a process.” Equally unclear, then, is where the Sino-Saudi oil relationship goes from here.

Growing Interest

Though diplomatic relations between the two countries were established in 1990, it wasn’t until 2006, when Saudi Arabia’s King Abdullah made China the first destination for his early state visits after succeeding his half-brother to the throne the previous year, that the bilateral relationship began to gel. As a result, “the Sino-Saudi relationship is expanding across all levels,” says Paul Gamble, head of research at Riyadh-based Jadwa Investments. He cites 2009 data showing that China was the source of 11.3% of the Kingdom’s imports, including textiles and heavy machinery, compared with 6.6% in 2004, while Saudi Arabia’s share of China’s imports rose to 11.2% from 4.8% over that time, thanks mostly to oil. In 2010, bilateral trade reached a record high of US$43 billion, a year-on-year increase of 33%, scooting the countries closer to their goal of having their trade reach $60 billion by 2015.

As for oil, Saudi Arabia shipped 36.7 million metric tons of oil to China in the first 10 months of 2010, about 19% of its foreign purchases, according to Chinese government data. Angola, the second-biggest source, sent 33.7 million tons and Iran 17.2 million tons.

It’s not just about trade, however. “One needs to take into account the significant contracts coming China’s way in Saudi Arabia,” says Niblock. Those contracts involve Chinese companies getting a slice of the US$385 billion that the Saudi government is investing in infrastructure, such as highways and railways, under its five-year development plan launched in 2009.

In reverse, Saudi companies are also investing in China. Saudi Aramco, the world’s largest oil company, has two refineries in China, one in Qingdao province that is fully owned and another in Fujian province run as a joint venture with Sinopec, a Chinese petroleum giant, and ExxonMobil of the U.S. Then there’s the US$32 billion oil-processing joint venture in Tianjin in northern China between two other Saudi-Sino giants — Sabic and Sinopec — which went into operation last year to produce 3.2 million tons a year of ethylene derivatives. More such partnerships could be on the way. During the Tianjin venture’s first quarter results announcement, Sabic’s chief executive, Mohammed al-Mady, cited lower labor and materials costs is a big reason why his company is open to making further investments in China.

An Insatiable Appetite

In other parts of the world besides Saudi Arabia, China has deployed a relatively straightforward strategy to secure access to natural resources — it simply opens its check book and uses a combination of inward investments and trade deals. In Brazil, for example, China lent US$10 billion to national oil company Petrobrás to secure future oil supplies. China’s oil giant Sinopec, meanwhile, bought a 40% stake in Brazil’s other major oil company RepsolBrazil for US$7.1 billion. By August last year, China was Brazil’s top foreign investor, with a finger in everything from iron ore and mineral processing to telecoms and electricity grids.

Though China is driven by an overwhelming need for secure oil supplies via the likes of Saudi Arabia, it’s not afraid of also tapping high-risk countries. Iraq is one example. Precarious political stability aside, Iraq has abundant oil reserves and underdeveloped oil fields. In 2009, China National Petroleum Corporation (CNPC) and BP entered into a 20-year service contract with Iraq’s State Oil Marketing Company to develop the war-ravaged country’s Rumaila oil field. Reports in China’s state press from earlier this year say that daily output from Rumaila, currently the world’s fourth-largest oilfield, is 1.03 million barrels and rising. “The scale and the dynamics of this contract have no precedent,” observes David Butter, head of Middle East research at the Economist Intelligence Unit (EIU) in London. “It provides an interesting paradigm in terms of the working relationship between an increasingly confident Chinese oil company and an old-school Western major.”

China is also banking on oil-rich Russia. “China’s oil production is pretty much maxed out and it needs Russian oil,” Laban Yu, an energy analyst at Macquarie Hong Kong, told Bloomberg in September. “In fact, it needs oil full stop and Russia is close and convenient. As part of agreements to supply oil, Russia wants to have stakes inside China in ventures,” including a venture being discussed between CNPC and Russia’s state-owned Rosneft to build a US$5 billion refinery in Tianjin. And to increase exports from Russia, the first oil pipeline between the two countries was opened earlier this year, financed by a US$25 billion loan from China to Russia.

And it’s not only China’s sizeable check book that has made it such an attractive business partner. Its policy of refusing to meddle in the politics of the countries in which it invests has also opened doors in parts of the world shunned by other governments. While such policy “agnosticism” might be a welcome counterweight in some oil-producing markets to what’s seen as meddling U.S. foreign policy, it has been drawing increasing criticism from other trading partners.Iran, which has the world’s second-largest oil and gas reserves, is a case in point. Despite several rounds of arms and financial sanctions by the United Nations Security Council, the U.S. and the European Union over Iran’s contentious nuclear program, China has continued to sign oil deals with it.

But even close partnerships that eschew politics cannot guarantee oil supplies, according to Ben Simpfendorfer, an economist and editor of China Insider web site. “The best security [for supply] Chinese companies can hope for is to buy oil at the highest possible price,” he noted in his 2009 book, The New Silk Road: How a Rising Arab World Is Turning Away from the West and Rediscovering China, citing examples of China’s state-owned oil companies with deep pockets paying above market rates for oil imports around the world.

Drilling Down

Meanwhile, in cash-rich Saudi Arabia, China has needed a different deal-making strategy. “With one of the world’s most developed energy sectors in terms of infrastructure and operating efficiency, Saudi Arabia is not desperate to attract foreign investment to help expand its capacity to produce and export oil,” a blog on the Saudi-U.S. Relations Service web site notes.  Instead, Saudi Arabia wants to find new sources of steady, long-term demand as Western countries decrease their oil consumption of oil.

“Chinese investment in the Saudi energy sector is relatively modest at present, owing to limited opportunities in the upstream segment and Saudi Arabia’s historical preference for tying up with Western firms offering advanced technology,” says David Butter, head of Middle East research at the Economist Intelligence Unit (EIU) in London. “What is interesting is the building of partnerships and joint ventures between Chinese and Saudi companies. That’s as close as the Chinese can get to owning any oil assets,” he adds.

Those partnerships and joint ventures mark an important recalibration of the Kingdom’s oil policy. “Saudi’s economic relationship is certainly shifting,” says Niblock. “Most Saudi oil is going eastward than westward. Its relationship with the East is becoming more important, and probably more so in the future. It’s not just China. Japan and South Korea are importing a lot of Saudi oil, too.” And as more Saudi oil goes eastward than westward, there’s a new layer of complexity in the geopolitics of oil, involving one of Saudi Arabia’s closest ally, the U.S.

In a bid to diversify its energy sources, the U.S. has been reducing its oil imports from Saudi Arabia, now its fourth-largest supplier of oil, behind Canada, Mexico and Venezuela. But Saudi Arabia and the U.S. are tethered together in ways that go beyond oil. That includes interlocking defence and security strategies in the region. The U.S. State Department also confirmed last autumn that it plans to sell as much as US$60 billion in advanced military aircraft, the largest-ever U.S. overseas arms deal. “Neither China nor Saudi Arabia want to politicize their relations because each of them have good reason not to,” says Niblock. “Saudi Arabia because it remains strategically dependent on the U.S. in weaponry and some other key ways; and in conversations I have had with Chinese officials, they say they are worried about the relationship with the U.S. — they realize the Gulf is very important to the United States, and they don’t want to undermine this.”

But other observers wonder whether tensions might be mounting. In a 2008 report titled, “The Vital Triangle: China, the United States and the Middle East,” Washington, D.C.-based Center for Strategic and International Studies (CSIS) noted that China military buildup around the “vital” sea lanes for shipping oil out of the Middle East, for which the U.S. has long provided security is causing unease. “Analysts wonder about the purpose of the Chinese-built deep-sea port in Gwadar, Pakistan, and its implications for a Chinese military presence far beyond the Pacific Ocean. Gwadar is only 45 miles from the Iranian border and 250 miles from the Strait of Hormuz, making it close to the region’s most vital waterways,” the report noted. Nonetheless, the report’s authors conceded that the China’s “capacity to regulate and dominate the 7,000 miles of ocean between Shanghai and the Strait of Hormuz lies, by generous estimate, half a century down the road. In addition, at present, the Chinese have expressed satisfaction with simply ‘free-riding’ off of U.S. control of the aforementioned supply lines.”

In a radio interview shortly before a China-Arab trade forum last September, Yang Guang, director of the Institute of West Asia and African Studies at the Chinese Academy of Social Sciences in Beijing, said he sees no real sign of a geopolitical rebalancing, even though China is increasingly important for Saudi Arabia and its Middle Eastern neighbors. “If you look at the proportion of trade and investment in the Arab world, China still accounts for a very, very limited proportion. The lion’s share of the business is done with U.S. and Europe,” said Yang.

( Original Aritcle )

http://knowledge.wharton.upenn.edu/arabic/printer_friendly.cfm?articleid=2649

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