Karoo Shale Gas Economics Part 2

This the second part of an exclusive interview with Saliem Fakir on the WWF-SA report he authored on the economics of Karoo shale gas.

The first part of the Fakir interview can be found here.

Fakir here focuses on the differences between the US shale experience and South Africa’s and the difficulties facing this high-cost, low-margin industry.

He also mentions the worrying levels of ignorance among so-called experts and in Government on shale gas economics…

Julienne du Toit: What are the key differences between SA and the USA when it comes to shale gas economics?

SALIEM FAKIR: There are many differences. We don’t really have an oil and gas industry to speak of, for starters.

This does alter things. People think this is just about the geology and getting rigs to dig holes. They do not see the importance of history, institutions and culture that play a role in creating the enabling conditions for the oil and gas business to succeed.

The US has close to 150 years of experience in exploiting oil and gas.

There is a lot of knowledge of how to drill, how to design wells, manufacture equipment. They have an education system feeding technical experts into the industry every year, and they have also developed infrastructure linked into the oil and gas industry.

There is a sort of network between industry, finance, academia and the public sector. This network creates the intellectual and supportive environment for the oil and gas industry.

You cannot put this in money terms. It is a form of social capital that South Africa does not have.

This makes a massive difference for how the oil and gas business works because it creates an enabling environment for the transmission of ideas or knowledge.

Nonetheless, even in the US with its extensive infrastructure, some of the shale-plays do not have adequate midstream infrastructure to for shale oil or gas.

So, this remains a challenge especially for shale-oil from North Dakota and getting this crude oil to refineries on the east coast. Also, huge quantities of shale gas from North Dakota are being flared off because there are no available gas pipelines yet.

The US oil and gas industry culture is enabled by the US politics and regulation. It allows mavericks, wild-catters and high-risk entrepreneurs to function.

In addition, Wall Street is prepared to fund this anarchy.

States also have autonomy and so try to out-compete each other for oil and gas investments because every governor wants to be re-elected.

You can see that where there is this level of unruliness, lack of co-ordination and management of production, you can be hit by shifts in oil and gas prices.

In the next five years, I predict the US shale industry is going to go through a bloodbath and massive restructuring.

More than $500 billion has already been invested in the industry with a huge debt load hanging over poorly performing companies.

Such incentives for the unruly sort of exploitation of the resource has limited scope in South Africa even though we have a big push by the State and industry.

It is a lot tamer here but we have watch they do not get start to play fast and loose with environmental issues and management of water resources.

The industry in the US is able to take on litigation and because the land is privately owned it can enter into agreements that also prevent property owners from talking in public.

The ‘bribe’ is big enough because royalty rates are high. That will not necessarily be the case here, and we need to be mindful of the poverty and race divide in South Africa.

In the end this is not just an environmental issue. It is also about who gets to exploit the resource, what their intentions are, and how benefits from such a resource can truly uplift South Africans.

There is a lot of upbeat talk but the track record in mining is not great.

So how can they say it will be different for shale-gas?

JdT: What has been the response of industry to this report?

SALIEM FAKIR: I think we have been pretty surprised at how well it has been received from both sides.

The general response has been it is a balanced, sound and draws sensible conclusions.

I do believe the report will be a reference report that people will use for a developing their own work in the future.

But I have to tell you when we went around presenting our findings before we wrote the report we were surprised at how little was known of the complexity of the economics.

I mean people in the investment world and even in the oil and gas industry were a little clueless.

People were making remarkable claims about shale-gas that had no basis in reality.

It made me realise we often give the so-called experts too much credit.

I was also surprised at the degree to which the Government was not on top of the economics.

They had no economic model to speak of.

Partly it has got to do with the fact that this is all new in South Africa, but also people have  not really investigated the detail.

I must confess we were also guilty of this. I hope this report contributes to changing all of that.

 JdT: The Karoo Basin is the only ‘shale play’ in the world with dolerite (ironstone).  How much influence do you think Karoo Geology will have on economics?

Look, this is still something we need to understand. There is a need for more research. But I would say the following based on my own research. Several things can influence the technically recoverable resource estimates:

• The interconnectivity of the groundwater sources and their sensitivity to drilling. Those that are vulnerable will be subject to either no-go areas or there should be buffers to avoid accidental connectivity between shale wells and water sources. This will reduce the land area that can be drilled. The exact size is unknown;

• From some discussions with experts the dolerite intrusions can make it hard to drill and so this will also limit the scope to drill in these areas. The dolerites can also act as preferential pathways for water at various depths. This adds risks and there is a high likelihood it will also force the creation of buffer zones and also reduce the land area for intense drilling activity;

• Then there could be more factors, like the potential for rock displacements and the triggering of seismic events which needs to be understood as a result of drilling and fracking. Certain areas may be more vulnerable than others. If, so, then these areas would also have to be excluded if trigger events are deemed to be a significant risk.
  I think this is an area we know little about and we need to do much more work on this. Originally, it was thought of as not being a big issue but some people are of the view we need to look at this more closely. I think the recent findings in Netherlands over the Groningen gas field (the largest gas field in Europe) may reignite this interest and a closer look at this issue;

• The fourth factor could be the depths at which we drill for different areas. Some drilling costs could be higher than others and depth of drilling costs with other costs can push out the economics and these areas will simply become economically unviable even if the technology learning rates are high or gas prices are reasonable.

 JdT: All three current applicants (Shell, Falcon and Bundu) have recently been talking down their chances of success. Why do you think that is?

[Click here for Shell interview; see this for what Falcon’s CEO thinks; and here for Bundu and SRK’s take on Karoo shale gas economics.)

SALIEM FAKIR: Since shale gas extraction in new countries is a high-cost low-margin activity, the economic factors that are core to the commercial viability can play big role in the success of fracking.

Key to overcoming this is to design effective fracks that allow for high recovery rates and being able to have cost-effective mitigation of environmental and water costs.

It can work if you have a significant percentage of high-producing wells with lower drilling costs.

Drilling is a bit of a lottery. If you can get a substantial number of high-producing wells – your so-called ‘sweet-spots’ – then this pushes up the average production rate for your shale play or field.

This is the crux: you can never predict these beforehand – you can only do so after you have drilled and fracked.

We also think water costs could be high but we are still doing more work to explore this. A lot depends on where the water comes from.

Deep brine water requires drilling. Then the brine will probably have to be treated. If the brine has a chemical composition that interferes with the frack fluid chemistry then this water cannot be used or may have to be treated with better technologies.

But this requires a lot more work before we can draw any proper conclusions for now on what it means for the economics of shale-gas.

The industry wants to do exploration because if there is a recoverable resource – even if the economics do not work in the first drills – they may well push for concessions to improve the internal rate of return of each well that is drilled.

There is all the possibility they will do so if the commercial success looks marginal without assistance.

JdT: German geologist Dr Stefan Cramer (currently based in Graaff-Reinet) recently wrote an article called “Six Reasons the Karoo Will Not Be Fracked”.  Do you agree with him?

(Cramer’s six reasons were: Karoo Geology, No Water, No Infrastructure, US Shale Experience Not Applicable, Problematic Legal Framework and Poor Investment Climate.)

SALIEM FAKIR: I agree with some aspects Stefan’s thesis but I have a different take on some of what he says.

The geology needs to be still understood. Even if complicated areas were excluded as an option for drilling some areas could still have a reasonable resource that makes fracking viable. Even 10-20 TCFs could justify exploitation.

So, you have to be careful to make firm conclusions based on limited knowledge because we have not fully appraised the geology at present.

Water can be an issue. Water can also be imported but then it will be a cost issue.

But we should not think that in ten years’ time there could not be new ways to frack as a result of technology innovation. Never say never.

Increasingly, the US shale gas industry is going for the re-use of flow-back water. The big thing here is cost of recycling and treating this water. If these cost curves come down then water may not totally throw out the economics.

But from what we know now based on our current knowledge it could be a significant cost barrier depending on how other cost variables go as well. You have to look at it in relation to other cost variables rather than in isolation.

On the question of infrastructure that is also raised in Stefan’s presentation: it depends. At present domestic beneficiation from shale-gas can be limited if infrastructure development takes time.

But it may not be an insurmountable problem for the frackers. You could build gas turbines close to gas sites. But again, this depends on whether the resource has reasonable certainty that production rates can be sustained over the life-span of the plants themselves.

Therefore these investments will not happen unless you drill for some time and there is some certainty that sufficient production rates can be sustained to justify investments in gas turbines.

With shale-gas this may prove to be difficult given the patterns of production each well displays and every new well has unpredictable production rates.

In the future it is possible that there will be technologies making it feasible to exploit gas in remote or isolated areas where large-scale infrastructure would be expensive and take a long time to build.

But to add to Stefan’s assessment, the one dimension people may not have understood as being important and significant is gaining access to the land for the drill rigs, equipment, workers and trucks.

This sort of invasion without a payback to the farmers that is sufficiently rewarding will lead to the possibility of endless litigation and legal challenges.

This is something that can hold up the drilling pace. And, if the drilling intensity is at risk it will throw out the economics.

In the US this is taken care of through a significant ‘bribe’ – I mean the royalty fees to farmers or land-owners has been generous.

I do not think the legal framework will have a significant impact in the future although in the interim it is a stumbling block.

What will matter more is what goes on at the grassroots and the action communities and landowners will take.

I happen to think this will be one of the biggest problems for shale-gas in South Africa because unlike minerals you really need a vast tract of land to ensure reasonable and good average rates of gas production to sustain the economics.

If you want to succeed, land-owners will have to have a high incentive to risk damage to their land. The money has to be good.

With so much financial interest from State royalties and Black Economic Empowerment stakes and everybody trying to extract something from the constrained cash-flows from shale-gas, I can’t see how it will work, especially if the economics are already so marginal.

In short, you must be crazy to drill in South Africa.

• The first part of the Saliem Fakir interview can be found here.
• Fakir’s full report, called Framework to Assess the Economic Reality of Shale Gas in South Africa, can be found here.
• Saliem Fakir is head of WWF-SA’s Living Planet Unit. He is also a regular contributor to the South African Civil Society Information Service. Saliem Fakir’s profile and other contributions to SACSIS can be found here.

Related posts:

Karoo Fracking: A Perfect Storm over Pearston Karoo Shale Gas Economics: Q & A with Saliem Fakir, Part I Bundu, Falcon and Karoo Shale Gas Karoo Parliament: The Second Sitting The Farce of Fracking Consultation Popular Fracking Opposition in the Karoo Fracking U-Turn Professor Gerrit van Tonder Dies Dolerite, the Karoo’s Fracking Game-Changer