Total’s investment a big step for the future of UK shale - but don't get too excited just yet

Mark Young
Evaluate Energy

On January 13th, 2014, French company Total confirmed that it had become the first global oil and gas major to invest in the burgeoning UK shale gas industry. This is a huge early milestone for the sector to have achieved, but Evaluate Energy argues that whilst this does bring the UK closer to widespread domestic onshore gas production, it will still be a long time before even the possibility of this becomes a reality. 

Of course, Total’s investment is rightly going to be seen as a huge vote of confidence into the sector, and the smaller UK shale companies will no doubt be rubbing their hands with glee at such an oil and gas powerhouse coming to their aid. Total will be investing a total of US$46.5 million on 2 exploration wells and pad construction to earn a 40% in 2 onshore licenses, joining Dart Energy, IGas and others in the quest to prove the commerciality of shale gas exploitation at these sites. These costs show just how imperative it was for small companies like Dart and IGas to get a partner like Total involved, as there are not many companies in the world that could afford such an outlay on an unproven sector. Total has an option to exit after the first vertical well, but its partners will need Total to stick around, if the well costs in the US are anything to go by.

Shale gas exploration is not cheap work. Shale gas’ short history has so far shown that it takes plays many years of production before costs fall into line with those of more conventional plays. Two examples of these mature plays are the Barnett in Texas, where a typical well will be costing Quicksilver Resources (NYSE:KWK) around US$3 million in 2014 according to the company’s December 2013 investor presentation, and the Fayetteville in Arkansas, where In its own December presentation, Southwestern Energy (NYSE:SWN) states it will only be spending US$2.3 million on each well in 2014. But these are shale plays that are mature in terms of the development work being done, so a look at one of the newer gas plays in the US will give a better idea of the costs to be experienced in the UK; the Utica play in Ohio is a good point of reference. Last year, approximately 2 years into the Utica’s development history, Gulfport Energy (NASDAQ:GPOR) budgeted for a cost of US$9.2 million per well, Halcón Resources (NYSE:HK) budgeted for US$9.5 million, and CONSOL Energy’s (NYSE:CNX) costs were just under US$15 million, to give some company-specific examples. This is approximately 2 years into the exploration stage of the play, and the average monthly rig count has been above 20 since May 2012, according to data from the EIA. If you assume one well per month being drilled by each rig, that would equate to hundreds of wells being drilled on the play in just over 18 months, and the well costs are still up at around US$10 million on average. Total has agreed to fund the drilling of 2 wells in the UK, so the UK still has an extremely long way to go before costs come down and the need for the presence an oil and gas major in the sector ends.

The profitability of UK shale gas will not be hampered as much by gas prices as the US has been, as prices in the UK are higher. So, assuming the high costs do not put Total off, the next step will be increasing production to the point where it fulfils the government’s promises over the last few months. Many figures have been cited in the press from various sources about percentages of UK gas demand that shale gas can satisfy and for how long, but for this we will just stick to a statement by Ed Davey, the UK Secretary of State, for Energy and Climate Change, when he said in a speech concerning potential shale gas exploration back in September 2013 that the UK is expecting to have to import 70% of its gas needs by 2025, as he predicts North Sea gas production will have lowered to around 19 million cubic metres per day by 2030. His speech suggests the UK will eventually be looking to get back to its net exporter status of 2003, and that shale gas is the answer. So we have to assume the plan is to, in fact, not import 70% of our gas needs, but produce it from the shale play. In 2012, the UK’s natural gas consumption was 7,554 million cubic feet per day (mmcf/d) according to BP. If we were to make even the simple assumption that consumption was to remain constant until 2025, shale gas would need to provide at least 5,288 mmcf/d of natural gas. Another look to EIA’s data for the US tells us that the gigantic Marcellus play (200 times bigger than the UK’s play according to Davey) in the Appalachian basin took around 4-5 years of widespread exploration and development work to reach this level of production in mid-2011, and the average rig count was over 100 for 2010 and 2011.  

 

Source: Evaluate Energy via the EIA & BP’s Statistical Review 2013.

This level of activity, i.e. the hundreds of wells needed, is something that is currently unimaginable in the UK. The government has released details of more incentives for local authorities to issue more shale permits; it will be allowing local authorities to recoup 100% of the business rates of these operations instead of the usual 50%. But this will do nothing to stop the environmental activism juggernaut that has plagued shale gas fracking operations across Europe so far. The UK’s only real fracking operation to date was carried out by private company Cuadrilla Resources, who began its own exploration work with one rig to drill one well in Balcombe, Lancashire in mid-2013. Its initial work at the site about a year earlier caused a minor earthquake and began to ring alarm bells for environmental activists across the country, and when the company tried to begin fresh work on the site last year, it was met with angry protests that lasted for the duration of its stay. The company had to postpone its work for a few days on the health and safety advice of police due to the nature of the protests, and according to commentators made little effort, or at least little effort that was successful, to assuage the concerns of the protestors at the site and convince them that its fracking operation was in fact safe and the protest was unnecessary. This undoubtedly added to the heated nature of the protest, and publicly-listed companies like the ones Total has invested with will no doubt make more of an effort to engage with the public about its operations, but it is hard to ignore how much of a debacle the drilling of one well has caused. If shale plays need hundreds of wells to start to reach their potential, as operations in the US have proved, then can the UK really consider any of its shale gas targets realistic with this level of widespread public animosity?

The need to import 70% of our gas needs in 2025 is a large financial burden, shale gas could or should play a part in alleviating the pressure, and the involvement of an experienced, world-renowned and wealthy company is necessary for any of this to happen. But while the deal with Total is a big step, and should be celebrated as such, the UK government and the companies involved have at least two more even bigger steps to take before UK shale gas can be successful. Firstly, public opinion needs to be dealt with to a point where the operations are at least accepted by a much wider audience. Secondly, intensive, expensive drilling work needs to take place over many years. Total’s involvement is definitely a good thing, but it’s only the beginning of a very long and bumpy road, and there is still no guarantee the UK will make it to the end of it.

Mark Young is a senior analyst at Evaluate Energy. Evaluate Energy provides data solutions for oil and gas company analysis.

 

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