Sunday, October 05, 2008

Aubrey McClendon's natural gas smoke screen

It would be lovely to think that the United States and even the entire world could transition from oil to natural gas as its major energy source. Natural gas is inarguably cleaner when it burns than oil or coal; it produces less carbon dioxide per unit of heat delivered, a plus for those concerned about global warming; and there is already a large infrastructure in place to deliver it, one that could be expanded as new supplies increase.

It is these positive sentiments which Aubrey McClendon, the chief executive officer of Chesapeake Energy Corp., exploits in his new push to use compressed natural gas for transportation fuel. The company McClendon heads purports to produce 4 percent of all U. S. natural gas and drill 9 percent of all new gas wells. (We'll come back to the curious difference between these two percentages later and what it tells us about McClendon's claims.) He funds a nonprofit called American Clean Skies Foundation and a website called CNG Now to push his agenda. A set of television ads currently playing in my area (and I suspect across the country) can be viewed on the CNG Now site. It all adds up to a natural gas smoke screen that makes it harder for people to understand the real natural gas situation in North America.

Not surprisingly, Chesapeake and along with it McClendon have prospered as natural gas prices have risen fourfold in this decade. That price rise has made it profitable to drill deep into known deposits of shale gas. The resource was virtually ignored for many years because it is deep--a mile and a half down in the Barnett Shale in Texas, for example--and difficult to produce. The permeability of shale is quite low and that has meant low flow rates in the past. Typically, only wells encountering rare natural fractures in the shale (which provided increased permeability) proved to be profitable.

But advances in fracturing technology--i.e., creating artificial fractures in the shale--and in drilling along with high prices have made shale gas economical to produce, and a drilling boom has emerged in areas previously almost untouched. The future for shale gas does seem promising. And, in the last year it has almost singlehandedly been responsible for the first major uptick in the rate of U. S. natural gas production in a decade. But does that mean that total natural gas supplies can grow to meet the proposed additional transportation demand along with all other demands?

Three participants at the recent ASPO-USA conference in Sacramento are skeptical. David Hughes, now retired from the Geological Survey of Canada and a keen student of North American gas supplies, told me that the jury is still out on whether shale gas supplies can grow at high rates in the long term. That shale resources cover seemingly large areas is deceptive. The permeability of the shales is highly variable changing over relatively short distances. There are "sweet spots" which are worth drilling, but those "sweet spots" often turn out not to extend very far, according the Hughes. That means the number of wells drilled when compared to conventional gas exploration is significantly higher.

I asked Hughes if he puts any faith in geologist Jean Laherrère's work on North American natural gas which predicts a plunge in production in the coming years as older conventional fields deplete. Hughes responded affirmatively. LaHerrère believes that conventional production is now mirroring conventional discovery with a 23-year lag and that conventional production could be down by one-half by the end of 2010, mimicking the cliff in conventional discovery which occurred 23 years prior.

Oilman Jeffrey Brown, originator of the Export Land Model, also talked with me at the conference at length about shale gas. His take: Shale gas wells deplete rapidly, dropping some 65 percent on average in the first year alone in the Barnett Shale. The wells then deplete completely by the fourth year. The number of wells drilled will have to grow geometrically in order to replace depleting shale gas wells and increase overall natural gas production. This may explain why although Chesapeake Energy produces only 4 percent of America's natural gas, it must drill 9 percent of the country's new wells.

To increase natural gas production in North America, new shale gas production will also have to overcome, in part, the depletion of conventional wells which are declining at the rate of about 5 percent a year. Brown's conclusion: Production growth will stop in shale gas at some point because of constraints on manpower and drilling rigs. Shale gas won't even be able to sustain its own growth in production beyond three more years, let alone make up for the depletion among conventional wells.

Finally, Andy Weissman, publisher of Energy Business Watch, suggested in a presentation at the ASPO conference that increasing demand for natural gas from new electric power plants combined with a poor outlook for natural gas supply growth could mean a major crisis at the beginning of the next decade for both natural gas and electricity. He said that if something isn't done to change North America's energy trajectory, marginal supplies of liquefied natural gas (LNG) which now sells for about $20 per mcf in Japan and around $12 to $14 per mcf in Italy will dictate prices for North American gas. That, of course, could lead to a lot of unpleasant demand destruction as businesses and power plants dependent on natural gas shut down.

So, how can it be that Aubrey McClendon believes that North America needs to find a new user for natural gas, namely, transportation? I can only take McClendon at his word. He must believe that the vast resource of shale gas is going to be tapped in a way that most experts discount. McClendon's American Clean Skies Foundation commissioned a report from an energy consulting firm that concluded that available natural gas resources in the United States, especially from shale, are far larger than previously thought. (Lousy is the consultant who fails to come up with the conclusion that his client wants.) But a look at the report reveals a number of holes.

The report writers assume straight-line trend growth for shale gas production. They use numbers that include "unproven technically recoverable resource" to conclude that we have 118 years of natural gas left at current rates of consumption. The words "unproven" and "technically recoverable" should give us pause. We ought not to be making policy based on extravagant claims of unproven resources. We should be even more cautious when these resources are categorized as technically recoverable since they may never be economically recoverable.

We should also keep in mind that little phrase "at current rates of consumption." Proposing a vast new use for natural gas means perforce that rates of consumption will rise dramatically and therefore shorten not only the life of the resource, but also bring the peak in production much, much closer. So even if we accept the consultants' numbers (which I don't), they are misleading us about the longevity of supplies and not even mentioning the time to peak production. Even more concerning, the report writers don't even deal with the stocks versus flows problem. The gas may be there, but it's going to be awfully hard to get it out of the ground at the rate we would like, and the rate is the key variable in determining what will be available to us in any one year. To repeat an analogy I've used before: If you inherit a million dollars with the stipulation that you can only draw it out at $500 a month, you may be a millionaire, but you will never be able to live like one.

I don't question McClendon's motives. If he believes vast supplies of natural gas are about to come onto the North American market, it's his job to figure out whom to sell them to. The idea of running much of our transportation system on domestic natural gas as an bridge to future liquid fuels is a good idea in theory if not in practice. And, McClendon must be thinking that he's right for now since plummeting prices for natural gas have led him to cut back spending on drilling for the time being.

But if Weismann and others are right, any dip in the natural gas price will only be temporary and therefore other measures including stringent conservation ought to be part of any overall energy policy.

As for McClendon's natural gas smoke screen, I'm inclined to believe that some of the smoke is actually getting into his eyes and making it a little difficult for him to see the true long-term picture. Anyone who drills for natural gas for a living wants to believe that there is a lot out there ready to be harvested by a clever, experienced risktaker.

But the key questions about the actual size of North America's natural gas resource remain unresolved. And, concerns about the possible rate of production from unconventional sources such as shale gas loom large. Until these are addressed more convincingly, North American policymakers would be advised to look upon McClendon's proposals with skepticism and to plan prudently for a less than rosy natural gas future.


Farwest99 said...

>Oilman Jeffrey Brown, originator of the Export Land Model, also talked with me at the conference at length about shale gas. His take: Shale gas wells deplete rapidly, dropping some 65 percent on average in the first year alone in the Barnett Shale. The wells then deplete completely by the fourth year.

Brown is dead wrong about the complete depletion of Barnet wells after four years. While they do drop off substantially the first two years, the wells produce much longer than four years. A call to IR at any of the public companies drilling the Barnet will confirm this.................

Kurt Cobb said...

Farwest99 is correct that many wells produce longer than four years. But their economic viability is questionable since most of those that operate longer than this don't even cover lease costs. Yes, they can produce but for many it's hardly a winning proposition. That still means that an ever expanding number of new wells is needed to grow production. At some point this becomes physically impossible even if the gas is there.

sv koho said...

Kurt, you must know by now that Aubrey's world has collapsed, at least financially. He got a margin call for 30 million shares of his stock which when CHK was $72 this year was worth over 2 billion dollars. CHK had dropped to $12 at one point this week, had already cut its budget and could be caught in its own margin call of sorts if gas prices slide further. Who knows what price is break even for shale drilling but it sure isn't current prices. easy come easy go Aubrey. Matt Simmons had thought that CHK was one of the best companies in the business. The NG press lately has been full of hype and hyperbole. Who to believe? doomsters or promoters? If Matt can be wrong I'm worried. YOYO. Keep at Kurt. You are needed and held in affection.

Unknown said...

I too am deeply suspicious of Aubrey McClendon, and posted earlier on my blog about how he has managed to co-opt the AWEA in an effort, also pushed by T. Boone Pickens, to tie the wind energy industry to his gas interests. His activities merit ongoing scrutiny.

Kurt, I have only recently discovered your blog and am greatly enjoying working my way through older posts. Keep up the fine work; you set an exemplary standard of scholarship and clarity of exposition. Thanks!