Daniel Lacalle

The Revolution of Shale Gas

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As I expected in my predictions for 2010, the process of mergers and acquisitions in the energy sector is not waiting. Total surprised us last week following on the footsteps of Exxon and embarking on the adventure of shale gas, through a joint venture with Chesapeake. The benefits of shale gas for oil companies are many and varied. Let me try to explain the environment as concisely as possible.

The technologies that allow the extraction of gas have proven to be much more competitive than it was initially estimated. We will not expand in technical terms, but basically through a process of fracturing the rock with water injection or horizontal extraction companies can stimulate the production of a gas that otherwise would not be economically produced. In fact, large companies are extracting gas at costs of $1.8 to $3/MMBTU compared with previous estimates of $ 5.5-$ 7. This cost levels allow very attractive returns, over 30% ROCE, even at current gas prices in the U.S., despite how much these have fallen from levels near $12 to $6/MMBTU today.

Moreover, the geological differences between areas of the United States that have shale gas (Haynesville, Marcellus, Barnett, and others) have proved to be lower than estimated, which allows a more comfortable environment for investment, as the potential economies of scale are very important. This is why the companies are buying large areas of land, as the shale gas production grows very fast but declines quickly once reached plateu. After this abrupt decline, production can be sustained for a long time at economical levels.

Furthermore, for companies like BP, Exxon, or Total it is an excellent opportunity to access abundant reserves of gas in a country with almost no risk (United States). Not to mention that it is a platform to learn and explore opportunities in shale gas in Europe, mainly in the North Sea and some Eastern European countries.

Matt Simmons and his team expect that by mid 2020 half of the US gas production will comes from U.S. shale gas, and the estimated reserves of unconventional gas in the most conservative scenario would cover 65 years of production, c1.35 billion cubic feet.

Total has paid the equivalent of $30,000 per acre of land in its joint venture with Chesapeake in Haynesville. In 2008, BP paid an average of $19,400 in Woodford. 2007 saw how Shell paid for Duvernay $13,100 per acre. Meanwhile, Statoil paid for their participation in the Marcellus area c$7,000 per acre. The price has jumped fourfold in just over two years. Not surprisingly, therefore, that US independent exploration and production stocks with shale gas exposure have soared, even though gas prices continue to be low.

Interestingly, amid all this, the financial market assumes that the oil majors are kind of large NGOs, which will exploit the reserves purchased in an indiscriminate manner, flooding the market and accepting gas prices well below the current ones. I can not believe that companies which operate under a strict target of return on capital employed will accumulate reserves to lose money monetizing the production at suboptimal prices. Meanwhile, the six big oil companies control more than 25% of the reserves of U.S. shale gas. What do you think are going to do? The consolidation process will continue and we will see that the profits will be very substantial in the medium term.

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