Alice In Shale Gas Wonderland

This article was written as a Guest Commentary for The Oil Depletion Analysis Centre (ODAC) of which I am a trustee.

It is hard to know where to begin regarding Ambrose Evans-Pritchard's article entitled "Energy crisis is postponed as new gas rescues the world." But since the speculative world he invokes has more to do with Alice In Wonderland than the hard reality of engineering and science, let us begin - at the end.

Evans-Pritchard caps his evangelistic encomium with this: "I am not qualified to judge where gas excitement crosses into hyperbole. I pass on the story because the claims of BP and Statoil are so extraordinary that we may need to rewrite the geo-strategy textbooks for the next half century."

He admits his lack of gas qualifications but surely he is enough of a journalist - and an economist - to ask some basic fact-checking questions. If he had, he would have discovered that people like Aubrey McClendon, CEO of Chesapeake Energy, have been brazenly hyping shale gas - even employing well known gas expert Tommy Lee Jones to promote the stuff - in the hope of making a fortune. Given that Mr McClendon is reputed to have lost around $2bn in the recent financial debacle, his keenness is perhaps understandable (though he still managed to earn more than $100m last year).

As for BP saying anything earth shattering, according to geologist David Hughes, "(Chief Executive) Hayward said nothing that wasn't in the latest BP report, which wasn't much different from previous BP reports (ie. 60 year Reserves/Production where it has been in past BP reports)."

What none of the boosters want to talk about is the reality of shale gas. It is true that there is most likely a lot of shale gas around, especially in the United States, but after this, the story goes down a rabbit hole. Shale gas is not like the conventional gas finds that gave the US vast supplies of cheap methane. Shale gas is locked in until the rocks holding it are fractured in a process known as hydro-fracing. This requires a lot of work, a lot of wells, a lot of water (2 - 5 million gallons per well), and some rather unpleasant chemicals. Having made all this effort, the production decline rates look like the cliffs at Beachy Head. Within two years production has typcally dropped by 80%.

Not surprisingly therefore, these expensive wells have an average commercial life of less than eight years. Worse still, in August of this year, World Oil pointed out that total production of many wells was only a third of what operators had predicted. Furthermore, of the two dozen or so shale plays in the US, Barnett appears to have the best geological profile and is responsible for 80% of current shale gas. Many of the other plays have much lower gas content density, which would likely mean yet more wells and more fracing for less gas.

But you ask, unlike Evans-Pritchard, if these wells are expensive, what happens if either the price of gas falls or drilling declines precipitously (the former of course being a likely trigger for the latter)? Very good question, because US natural gas has now sunk to roughly half the price of the median break-even price of shale gas. In a nice moment of symmetry, gas drilling has also fallen by half. Of course, drilling can and will increase, but only when the economics justify it. For the moment, it looks like US gas production may decline by up to 14% this year (according to Bernstein Research), which would actually leave the US supply a few percent short, though it will be easy to fill the gap with gas in storage or imports.

There are least two key missing points which make the article so misleading. The first is that shale gas flow rates are always much lower than conventional gas, which in practical terms makes it an expensive and unlikely replacement either for conventional gas or for oil. The second and far more profound omission is that the geology of gas shale varies widely across both America and the world, so that to extrapolate from the best - Texas Barnett shale - to the world is like saying we should be able to grow bananas in Norway just because they grow in India.

Natural gas is a very useful energy source and it emits less carbon than any other fossil fuel. If large, new, easy-flowing sources of it were found, it could relieve some short-term energy worries and reduce geopolitical tensions. However, shale gas, though possibly a useful crutch, is not going to rescue the world, for the reasons outlined above. Alice was finally woken from her dreamworld and brought back to reality by a hot cup of tea. That may not be enough to get us to face the disappointing reality of shale gas.

My thanks to Dave Hughes for his recent presentation: 'Natural Gas in North America: A Panacea to Replace Imported Oil?'

China Enters A New And 'Interesting' Phase

Making observations about geopolitics is often hazardous even for the seasoned analyst - events have a way of intervening in the most embarrassing ways. As we have seen with the economic crisis, a small number of economists did accurately warn about the coming meltdown and were roundly ignored by those in power, who universally said that there was no chance of a recession until the economy was already capsizing.

This is not to blame anyone for this state of affairs. Hindsight is a splendid thing, and when trying to operate in real time, one has to deal with human systems which are (too) complex and inter-dependent, wherein any move is usually met by a quick and often unexpected counter-move or a gambit to exploit an inadvertent opening. Natural eco-systems are not very different most of the time.

The above preamble is a kind of disclaimer. Despite the likelihood of being wrong in prognosis, there are some big picture items that we just have to try to diagnose and discuss even if we don't have the complete picture or anywhere near. One of these is the situation in China. There are several nations that have a disproportionate effect on the world, and China has become one of them. China has been a famous enigma for a few thousand years and it doesn't look as if that will be changing any time soon.

Until recently, it has become the done thing to say that the Chinese economic miracle will carry it through to being the largest economy in the world, and that along with the rising India and a possibly resurgent Japan, the centre of the world will keep shifting towards the East and South Asia. It is possible that this is what will play out, but it might happen in unexpected ways or not all.

The economic crash has taken China by surprise, as it has every other country. The reduction in economic activity is causing a huge increase in unemployment, which is not easy to cope with in any country (neither for those without jobs nor those trying to govern), but in China the situation is rather more tricky, because every year it has to absorb six to eight million new migrant rural workers into the eastern industrial and heavily urbanised part of China.

It is said that every percentage point of Chinese growth (per year) creates about a million jobs. One can readily see why it is necessary for China to grow at a rate in excess of 8% per year. Anything less risks social destabilisation. However, China's growth is showing signs of falling below this number (leaving aside the question of whether the growth figure may be exaggerated).

Signalling that all is definitely not well with the Chinese industrial machine, some 20 million of the roughly 130 million migrant workers are now reported unemployed. This number does not show up in official unemployment statistics because migrant workers are not counted. There is little question that such a huge number of displaced unemployed people showing up in the poverty-stricken villages of China has the potential to cause trouble.

The Chinese leadership is only too painfully aware of the situation and is trying to introduce policies to stabilize and reverse the economic decline. They are doing this for a number of reasons including the fact that they don't want to see social order break down (which government does?) and they also see signs that the economic miracle has promoted the regions too much leading to an age-old problem of local and potentially uncontrollable power bases developing.

It is therefore imperative that the Chinese economic stimulus, now underway for two months, work quickly and effectively. Specifically in response to the rural migrant worker problem, the measures include subsidies and training programmes, and encouraging the formation of new small businesses, though there is little optimism that the latter will have much traction in the poorest, most cash-starved areas, at least in the short term.

Rural health care systems are being proposed, and much more boldly, China has just announced that it will spend $123 billion to provide universal health care within two years instead of eleven. This in itself could relieve a lot of potential social and economic tension (as it might in America, were it ever to be tried).

The economic stimulus package is also going to spend massively on constructing new inter-city rail lines - $88 billion is proposed, with $44 billion having already been spent last year. If China were able to power these trains with renewable electricity instead of coal or imported diesel, it would have moved a long way to having a sustainable transport system. Given Chinese expansion in wind and solar PV, such an idea cannot be ruled out.

The Chinese leadership knows there is plenty of trouble with the country, but they are certainly taking vigorous action. There are signs of incoherence and conflicting policy aims, but China has weathered these before. With the petroleum price now fallen so far from last year, however temporarily, and waning industrial activity, China is importing less oil even as it builds its own new strategic petroleum reserves.

There are many other problems besides those mentioned here and the stimulus and other policies may not all work as intended. But for the world, the consequences of China's new path may be easier to grasp, however unwelcome in some quarters, because whether China succeeds or not, it looks like it will start pulling back from the heavy emphasis on global export trade as it concentrates on domestic development. It should be noted that it is unlikely to pull back from its need to import oil, especially if the domestic stimulus works.

A withdrawing China would have some interesting effects to put it mildly, and one of the most interesting would be if China starts liquidating its holdings of US treasuries just when America needs China - and anyone else - to start buying even more. China has withdrawn from the world before, but this does not appear to be what China is planning now, rather a refocusing on domestic issues and infrastructure, not least because it does not wish to emulate the kinds of collapse that the economies of Japan or the Asian Tigers underwent after growing too fast.

It is a trite and now cliched saying, but China really does look as if it is heading into 'interesting times', with both danger and opportunity in its own future and in its relations with the rest of the world. As a broad brush stroke, that much at least is not too hazardous an observation. The unfolding details may be another matter.

Sources: NYT, WSJ, Reuters, FT, Stratfor: Baker Friedman, CIA, P&C

Getting To The 'Deeper Why'

A friend of mine said to me today that if Wall Street bankers were surgeons he wouldn't want any of them to operate on him. Yet almost no-one has been seriously taken to task and the banking system and the bankers who helped create the disaster look like they are about to get another 350 billion dollars - apparently with slightly more oversight this time.

I find all this quite mind-boggling. The amounts of money are staggering and the amount of planning and oversight seems to be absolutely minimal. I don't have any special access to Wall Street or Washington DC but I do know from former lives that what you read in the media is the acceptable face of some of the truth. The blogosphere helps, and things leak out onto the web that can shed more light on what is going on. But the thing that is missing - and which is so vital - is that so often we don't know really know why something is happening.

The 'deeper why' is hard to get at for all kinds of reasons. One might take the example of the Russia-Ukraine natural gas dispute. I am not favouring one side or the other, but on the one hand, the Ukraine has been paying a really low price for the gas that it takes - or rather, it has not even been paying a low price, because it is badly in debt to Russia for what it has used. On the other hand, why did Russia wait till a viciously cold winter period to shut off gas, since the debt had been building up for a long time.

The matter is not just about natural gas and being a bad payer. Although Ukraine has few energy resources compared to its huge neighbour, it has one thing that Russia really needs - well located ice-free access to the sea. The Ukraine is also an important transit route from Russia to Europe for many things besides energy. Russia is therefore very alarmed by Ukraine's moves into western arms - if such a move were completed, it would have serious security implications for Russia, not least because the home port of Russia’s Black Sea Fleet is at Sevastopol on Ukraine’s Crimean Peninsula.

The above analysis is all gleaned from public sources. I hope it gives a slightly better and more balanced picture than some media reports, but the 'deeper why', the real motivations and machinations will likely be hidden for decades or eternity. And so it goes for almost every other important issue in every nation on the planet.

Does not knowing the deeper why matter? For the serious historian, the answer is surely yes, but if one asks the question in a different way, I think the answer would be yes for all of us, at least in the future: does all of this covert manoeuvring lead to an efficient use of resources - especially money and energy - and good macro planning?

Surely the answer is no. What we need is a lot more transparency and the ability to ask more and deeper why questions. The next question is how to do this in such a complex society with so much at stake, and thus so much to hide. It would be so much easier if the surgeons of Wall Street were genuinely interested in the wider economy and society and would use their diagnostic skills to help the body politic. Since that is not the case, we need some new surgeons and some new approaches to anatomy that actually treat the body as precious instead of disposable.