RWGTM Presentation

The Global Implications of Shale:
Emerging Fundamentals
Based on the BIPP Center for Energy Studies publications:
“Panel Analysis of Barnett Shale Production”
“US LNG Exports: Truth and Consequence”
SENR Testimony Feb 12, 2013
Kenneth B Medlock III, PhD
James A Baker III and Susan G Baker Fellow in Energy and Resource Economics, and
Senior Director, Center for Energy Studies, James A Baker III Institute for Public Policy
Adjunct Professor, Department of Economics
Rice University
July 29, 2013
James A Baker III Institute for Public Policy
Rice University
The “50,000 Foot” view in 2000:
LNG is coming to North America
The difference a decade makes:
Over 6,600 tcf of technically recoverable shale*
Major North American
Shale Plays
(~1,930 tcf)
European, Latin American, African
and Pacific Shale Plays
(~4,670 tcf)
*Over 6,600 tcf of shale according to ARI report, 2011
Far-reaching implications of shale gas
Expansion of production from US shale plays has rendered the
utilization of LNG import capacity in the US very low.
It has had an impact on the relative price of oil and gas, and
… it has raised the possibility of US LNG exports.
Domestic price impacts have been a central concern.
This opportunity may be highly contingent on the value of the US dollar.
When weighing all demand responses, and thus market
impacts, the focus should not be on just exports.
Current and future expansion of shale gas in the US, Europe and
Asia makes the global gas supply curve more elastic.
This mitigates the potential for sustained long term increases in price.
Greater supply elasticity also pressures traditional pricing paradigms.
Modeling Well Decline in Shale Plays:
Assessing the Long Term Possibilities
“Panel Analysis of Well Production History
in the Barnett Shale”
Implications for Production Sustainability
Well-specific EURs can vary within a shale play substantially
Ultimately, profitability matters, as there is little debate about resource scale
Some wells are profitable at $2.65/mcf, others need $8.10… median is $4.85.
2.83 bcf
1.51 bcf
0.93 bcf
What does the global supply picture look like?
EURs in Shale Plays
EURs estimated using geologic data for active shale plays in North America and
econometrically fit for RoW shales.
– Average EUR is modeled as a function of porosity, TM, TOC, Clay Content, GIP
Concentration, Thickness, Depth... R2 = 0.875.
We “tier” the resources using a log normal distribution around the estimated mean
EUR. The distributions are fit using US analogs.
A snapshot of long run development costs
• In addition to EUR, we need estimates of drilling and
completion costs. These are econometrically fit to drilling depth
and reservoir pressure for known North American plays.
• Development costs in the following tables are long run costs.
- As such, the costs indicated are representative of costs when all short run
constraints on rig availability, frac’ing crews and equipment, qualified
personnel, etc. are relieved. As such, it should be noted that the first
entry cost in many regions may be considerably higher.
o A 10,500 ft well (TVD) with a 4,000 ft lateral in the Haynesville shale in the
US will typically cost around $8 million.
o The same well right now in Poland will cost in the $14-16 million range.
o Notice this changes the perception of commercial viability, but costs should
fall as activity ramps up due to the mobility of capital, labor and technology.
o The transition can be tricky and will in many cases depend on local policies.
So what about the foreign opportunities for
shale? Not as Fast. The US is Unique.
• Stable and conducive regulatory and institutional frameworks.
Resource Access – mineral rights ownership; acreage acquisition; resource
assessments; environmental opposition; etc.
Market Structure – transportation regulation (unbundled access vs.
incumbent monopolies) and bilateral take-or-pay obligations vs. marketable
rights; existence of infrastructure; pricing paradigms; etc.
• Many other issues face shale development.
Water – use in production; water rights and management; flowback options
(recycle and/or treatment and disposal) and native infrastructure; concerns
about watershed protection (casing failures and fracture migration); etc.
Other issues – earthquakes related to injection of produced and treated
water; long term effects of methane escape; concerns about contamination
from produced water; ecological concerns over land use and reclamation; etc.
• There are other supplies that may not face the same impediments
East Africa, Australia, Russia…
Margins of Demand Response and
The Prospect of US LNG Exports
Domestic Price Impacts of US LNG Exports
• Common claim: US price will increase substantially
– Only true if US domestic supply is highly inelastic (pictured below) and
foreign supply is highly elastic (not pictured). This claim is unlikely.
The Elasticity of Domestic Supply and the Impact of Exports on Price
increase due
to exports
due to
increase due
to exports
due to
Case 1: Supply elastic
Case 2: Supply inelastic
Impact of Shale on Henry Hub, 2011-2040
• The domestic supply curve is much more elastic as a result of shale gas
developments. Domestic long run elasticity*
- with shale = 1.52; without = 0.29.
* - Results derived from the Rice World Gas Trade Model (RWGTM). The RWGTM
was developed by Ken Medlock and Peter Hartley at Rice University using the
MarketBuilder software provided by Deloitte MarketPoint .
Price Impacts of US LNG Exports:
Introducing the Foreign Market Response
• When trade between two markets is introduced, price in each
adjusts. The adjustments will depend on the relative elasticities
Domestic and Foreign Market with Trade
of supply and demand.
S’+ m
Imports, m
Exports, x
Domestic Market
Foreign Market
The Impact of US LNG Exports
• Lots of attention given to current international spot price, but
several factors are often ignored, such as
- short term capacity constraints, which are important when
considering where we are today,
- domestic market interactions with markets abroad, and
- a weak US dollar.
• “Spot” price of natural gas in Asia changed after Fukushima.
• US LNG exports could put significant downward pressure on
international price.
- In 2011, LNG trade was about 32 bcfd. Current filings exceed 30 bcfd.
• Effects of international trade are contingent on both domestic
and foreign elasticities of supply and demand.
International Prices
• Will the change in regional gas price relationships since March 2011 persist?
Unexpected demand shocks have had an influence.
It is reasonable to expect that US price will rise to reflect marginal cost and
JKM premium will subside with relief of deliverability constraint
Price data from Platts; LNG Oil-Index author’s calculation
A Longer Term View of Prices
• The recent divergence is new… but can it persist? Or, is it a result of short
term constraints?
Interest in
LNG exports
Interest in
LNG imports
Sources: Compiled from Platts, IEA, EIA
Contracts and Liquidity
• Absent storage and physical
The Supply Curve Effect of Shale and Implications for Price
liquidity, oil indexation
provides an element of price
Implied additional rents
associated with existing
• Oil indexation is a form of price
(1) Firm must be able to
distinguish consumers and
prevent resale.
(2) Different consumers have
different elasticity of demand.
• Increased ability to trade
between suppliers and
consumers (physical liquidity)
violates condition (1).
This will happen in a liberalized
market, or as LNG trade grows,
or as hubs emerge in end-use
Effect of shale on the
supply curve
Oil Indexed
Total Volume
Contracts and Flows
• Atlantic Basin LNG diverted…
short term volumes expand
• … Pacific Basin LNG expands.
short term volumes expand
Data Sourced from the International Group of Liquefied
Natural Gas Importers (GIIGNL)
Exchange Rate Effects
• Another factor that is important to the export issue is the
exchange rate. In fact, this matters for US industrial sector
competitiveness as well.
- Exchange rate impacts: PUS  PUK  XR  HR  arb value
Trade-Weighted Value of US $, Major Currencies (Daily, Jan 1973 – Jan 2013)
Source: US Federal Reserve Bank
Final Comments on US LNG Exports
• Export capacity will be built on the expectation that current
rents from arbitrage will “pay” for the upfront fixed cost.
- But, once the fixed cost is sunk, operation no longer hinges on the
payment to capital. It is possible that some terminals will not earn the
ex-ante required rate of return, contingent on the off-take agreement.
- Project success is contingent on where the contractual risk falls.
• US LNG export capacity could be used for seasonal arbitrage.
While the annual load factor would be lower in this
circumstance, if seasonal price differences among the regional
markets are sufficient, US exports could be profitable.
• LNG exports from the US, even in small volumes, will link
global markets to storage in the US. By providing this link,
liquidity benefits could spill over and contribute to very
different market paradigm.
What about other domestic demands?
• What are the end-uses where demand could change?
Power generation
Industrial uses as an energy source and feedstock
Automotive transportation – personal and commercial
Marine transportation – EPA forcing out heavy fuel oil and diesel
LNG and pipeline exports (foreign demand for US gas)
• Incremental demand responses (by 2020
35 bcfd)
LNG exports (12 bcfd)
Power generation (10 bcfd)
Industrial uses (7 bcfd)
Automotive transportation (2 bcfd)
Marine transportation (2 bcfd)
Pipeline exports (2 bcfd)
What about other domestic demands?
• What are the end-uses where demand could change?
Power generation
Industrial uses as an energy source and feedstock
Automotive transportation – personal and commercial
Marine transportation – EPA forcing out heavy fuel oil and diesel
LNG and pipeline exports (foreign demand for US gas)
• Incremental demand responses (by 2020
LNG exports (12 bcfd)
< 4 bcfd – market
Power generation (10 bcfd)
< 5 bcfd – policy and market
Industrial uses (7 bcfd)
< 3 bcfd – market
Automotive transportation (2 bcfd)
< 0.25 bcfd – market
Marine transportation (2 bcfd)
< 2 bcfd – policy
Pipeline exports (2 bcfd)
< 2 bcfd – market
• Scale of demand increase
35 bcfd)
< 16 bcfd – RWGTM modeled outcomes
… or up to 25% of current demand. (Note: Res/Comm falls by >1.5 bcfd)
A Fully Integrated Modeling Outcome
Henry Hub remains below the relationship that persisted historically, although the
Asia price and NBP grow slightly closer. Notice the margin for profitable US exports
grow very thin…
Sources: Compiled from Platts, IEA, EIA and RWGTM
What about Price Volatility?
Common claim: If we allow LNG exports we will import oil price volatility.
The premise here is that crude oil is more volatile than natural gas. Is it?
Economic theory predicts this. The more fungible (or tradable) a
commodity is, the lower its price volatility, all else equal.
Is the term being misused? (Volatility vs. forecast accuracy?)

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