03/03/2011

Stepping on the Gas

New Drilling Technologies Shake Up Global Market

By Frank Dohmen, Alexander Jung and Jan Puhl


While the world fears a new oil priceshock, the entire energy market is on the verge of a revolution.Companies are using increasingly sophisticated technology to tap newsources of natural gas. Drilling is also underway in Germany, where boththe potential and the risks seem enormous.

It was May when globalization came to Lebien, a small town in Poland.The telephone rang and Elzbieta Religa answered. The caller said sherepresented Lane Energy, a subsidiary of a British company that investsin natural resources. She said her boss wanted to speak with Religa andtold her that the company had found something interesting in the earthbeneath Lebien's homes and farms.

ANZEIGE
Religa is a sturdy-looking farmer with three hectares (7.4 acres) ofland, 20 hogs and three dogs. Lebien is in the northern Polish region ofKashubia, some 90 kilometers (56 miles) from Gdansk. The town has 960inhabitants and only its main street is paved. Most of the houses werebuilt by Germans before World War II.

"The woman said there's gas here," says Religa. "Thousands of metersbelow the earth, locked into the rock, but somehow they can get it out."Religa is currently serving her third term as the Soltys, ormayor, of Lebien. She invited the people from Lane Energy to a meetingat town hall. They arrived in small buses, managers and engineers,Americans, Britons, Canadians and one Indian. The guests paid for alavish buffet.

The company built its first drilling rig a few months later. Oneevening, Religa saw a bright light on the other side of a forested area.Lane was burning off the first of the gas being pumped out of the well.The flames were as tall as houses.

Now the drill hole has been sealed with a head-high pipe and threevalve wheels. Thanks to the gas, thousands of new jobs will soon becreated in Poland -- and elsewhere.

Tapping Unconventional Sources

In many parts of the world, geologists are now testing the ground fornatural gastrapped in shale (shale gas), sandstone (tight gas) or coal seams, gasthat has been largely unreachable in the past. Using a new technologycalled hydraulic fracturing, or "fracking," a sort of controlledearthquake, companies are now bringing the gas to the surface all overthe globe, in Australia, China, India, Indonesia, Latin America andEurope. The entire planet is being resurveyed.

The authorities in Poland have awarded 70 concessions for exploratorydrilling in the last two years. The race for the best reserves is alsoin full swing in Canada, where the Chinese are leading the pack. TheChinese energy company PetroChina has just spent $5.4 billion (€3.9billion) on a Canadian project.

In the United States, however, the natural gas revolution is thefurthest along. Newly discovered reserves there are already beingexploited.

About half of the natural gas consumed in the United States now comesfrom so-called unconventional sources. The country has already replacedRussia as the world's leading natural gas producer. "We have twice asmuch gas as the Saudis have oil," boasts Texan investor T. BoonePickens.

The euphoria is being fueled all the more by current global fears ofnew oil price shocks. The crisis in the Middle East makes it painfullyclear, once again, how dependent the world's economy is on petroleumreserves in the Arab world -- and how sensitively prices and growthreact to any changes in the region.

When the unrest began in Libya, the international commodities marketsfell into a panic within hours. The oil price, which had hovered around$80 to $90 for months, broke through the magic $100-a-barrel (159liters) barrier within hours and peaked at about $117 on Friday.

This was not so much a factor of Libya being such an importantsupplier on world markets. What had traders and dealers so concerned andtriggered worldwide panic buys was the fear that the crisis couldspread to the United Arab Emirates (UAE) and Saudi Arabia.

Together, the UAE and Saudi Arabia are sitting on the world's largestoil reserves. Unrest with possible interruptions in delivery would drivethe price of oil to astronomic heights. The most recent upturn in theglobal economy would come to a precipitous end -- yet again.

Since the last oil price crisis in the 1970s, the industrializednations have been trying to reduce their dependency on oil from the OPECcountries, with moderate success.

The world's thirst for energy is massive, and there are fewalternatives to oil. This could make the exploitation of the new naturalgas reserves all the more important.

Part 2:Will Shift to Natural Gas Undermind Renewable Energies?

A revolution has gotten underway at a rate that has even surprisedexperts. US energy expert Daniel Yergin calls it "the biggest energyinnovation of the decade." Today's estimates of the volume of gasreserves considered exploitable are several times higher than a fewyears ago, with prognoses ranging from two to six times as high asearlier estimates.

So far, though, engineers have not pumped a single cubic meter of gasout of the earth in most places, except in the United States. And evenif the prospects are promising, there is always the risk that instead ofencountering so-called "sweet spots," or locations with highconcentrations of natural gas, engineers will hit "dry holes."

Nevertheless, the expectation is that the energy mix will soon shiftsignificantly toward natural gas. In its latest global energy forecast,ExxonMobil predicts that natural gas will replace coal as the mostimportant source of electricity by 2030.

A Cascade of Effects

And because only half as much CO2 is emitted during gas combustion asin coal combustion, the new boom will also have consequences for theworld's climate, and for prices in the emissions trading market. Thebusiness of trading pollution rights will likely come under pressure,which in turn will affect renewable forms of energy. The cheaper CO2rights become, the harder it is for electricity produced with wind poweror solar energy to compete in the market.

Hence, the new global gas rush is also triggering a cascade ofeffects that will change the world energy market and radically changecompanies. Corporations like Exxon, BP and Shell, which have seenthemselves primarily as oil producers for generations, are now investingbillions in the gas industry.

Electric utilities like Germany's RWE have to consider whether itwill even be economically viable to use coal to generate electricity inthe future. And gas distributors like Germany's E.on Ruhrgas are askingthemselves whether their old business models are still viable and whatthey should do to prepare for the new gas age.

A few weeks ago E.on Ruhrgas moved into its new headquarters buildingon the outskirts of the western German city of Essen: two glass towersconnected by a glittering steel bridge. Maps are provided at the mainentrance to help the roughly 2,000 employees find their way around. Thecompany's strategists could use similar guidance, as Europe's largestgas distributor tries to find a way out of the crisis it faces as aresult of the boom in unconventional sources of gas.

Excess supply is depressing prices, allowing Ruhrgas's competitors toundercut the German distributor. It costs Ruhrgas more money just tokeep up. "The more cubic meters of gas we buy, the more we have to payat the moment," says CEO Klaus Schäfer. The company recently lost €500million ($690 million) -- in only two quarters.

Shakeup Expected in European Market

Schäfer has been at the head of Ruhrgas for only a few months. He wasbrought in to revive the business, but everyone knows that the days aregone when producers and distributors divided up the European market.Things will also change for consumers.

This is how the system has worked until now: The big Europeanplayers, like Gazprom in Russia and Statoil in Norway, exploit theirreserves and then transport the gas through thousands of kilometers ofpipelines to deliver it to the border of Germany or other Europeannations. From there, distributors like Ruhrgas or Wintershall feed thegas into their networks and sell it to municipal utilities or industrialcustomers. It was a profitable business for everyone involved.

Prices were not even negotiated -- they were dictated. Long-termagreements were in place with terms of up to 40 years, and they werebased on the so-called gas-oil price link, which means that gas pricesfollow oil prices, only with a few months' delay. The distributors addeda healthy margin of up to 30 percent for the distribution, storage andsale of the gas. For a company like Ruhrgas, this meant that with itsroughly €2 billion in annual profits, it was the most importantsubsidiary within the E.on group.

But ever since efforts began to tap the new gas reserves, suchastronomical profits have been a thing of the past. For the first time,something resembling competition has developed in the gas industry.

The volumes being traded on the spot markets are getting bigger andbigger. New competitors are buying up gas at favorable terms, whichbenefits consumers, who can now choose from among an average of 31 gasproviders, as compared with only eight providers two years ago. "It's arapid development that's nothing short of a revolution for theinternational gas markets," says Ruhrgas CEO Schäfer.

Now he and his counterparts in the industry have little choice but torenegotiate the terms of their agreements with the producing companiesin Moscow and Stavanger, Norway, in the hope of at least making up forsome of their losses retroactively. This is no easy task. "There is noreason for price adjustments," says Gazprom Germania CEO VladimirKotenev, who points out that the excitement over the new reserves istemporary. The partners have made a lot of money together in the past,says the former Russian ambassador to Germany, and now they'll just haveto "endure a dry spell" together.

Geologists have long known that much larger reserves existed inaddition to the known, easily exploitable gas wells. The problem wasthat there were no technologies to extract the gas from the porous rockat a reasonable cost.

Part 3:Bad News for Russia

That has since changed. Today drilling companies can drive theirwells thousands of meters beneath the surface, divert the drill headsand even continue drilling horizontally. The engineers can control theirhigh-tech moles with such great precision that they can reach a targetlocation, down to the last meter, even when it's eight kilometers (aboutfive miles) away. Once the target has been reached, an armada ofvehicles, the "frack trucks," is dispatched to the well site.

The trucks bring giant 2,400 horsepower pumps to the site, whereabout a dozen of these monsters are connected. They force a fluidmixture into the gas deposit at a pressure of about 1,000 bar. Themixture consists of millions of liters of water, special sand andchemicals, including toxic substances. Some of the chemicals aredesigned to kill bacteria that inhibit the flow of gas. The processproduces enough pressure underground to fracture the rock.

This creates fine cracks, some of them hundreds of meters long. Thesand keeps the fractures open, hence the term "fracking," or fracturing.The fluid is pumped out of the well and the gas escapes like carbondioxide from a soft-drink bottle: powerfully at first, and then moreslowly for several months until the pressure is so low that the frackingprocedure has to be repeated.

It wasn't major corporations like Exxon, Shell and BP that developedthis method, but small drilling companies funded by venture capitalcompanies that believed in the revolution. They began drilling in Texasin the 1990s, in a formation called the Barnett Shale, now one of thelargest natural gas fields in the world.

Today fracking is being used to pump natural gas out of about 3,000wells in the United States, with 120 to 150 wells being added everymonth. "It's become (normal) manufacturing," says Andrew Ross, managingdirector of Elixir Petroleum. The actual procedure lasts only about aweek, and then the fracking team moves on to the next on a long list ofwells.

Production using this new method is generally more expensive thanwith a conventional gas well, but there has been some progress inbringing down costs. The drilling engineers at Talisman Energy, forexample, managed to cut costs in half in the Marcellus Shale field inthe northeastern United States.

Pressure Will 'Help Keep Prices Down'

With each new project, more and more gas floods into the market,which is already saturated today, as evidenced by price trends in theUnited States. Almost every other commodity has become more expensive inthe last year, while the price of natural gas has dropped by 27percent. And the pricing pressure could continue if the gas supply keepsgrowing, says John Corben of the International Energy Agency in Paris."It will help keep prices down."

This is bad news for Russia. The Kremlin derives a large share of itsnational budget from the exploitation of mineral resources. TheRussians have invested billions in the infrastructure needed to developkey markets in Europe for the long term. That infrastructure includesthe Nord Stream pipeline through the Baltic Sea, which is slated to gointo operation later this year.

The final preparations are now underway at the construction site inLubmin on Germany's Baltic Sea coast. This is where the pipes emergefrom the waters of the Bay of Greifswald, marking the end of the two1,224-kilometer (765-mile) pipelines that were installed on the seafloor using special ships. Just past the beach in Lubmin, workers arebuilding giant valves, each as tall as a two-story building. The valveswill regulate the flow of gas in the future. Nord Stream is expected tosupply about 26 million households with electricity and heat.

But whether the investment will pay off is still unclear. The oldcalculations, from the days when the gas-oil price link was still fullyapplicable, are now obsolete. Even less clear is the outlook for the twoother major European projects: South Stream, which will link Russiawith Europe farther south, and, most of all, for Nabucco, the EuropeanUnion alternative, which will transport gas from non-Russian suppliersand is intended to make Europe less dependent on Russia. Companieswithin the Nabucco consortium are already in exploratory talks with theEU, with the goal of bringing together segments of the Nabucco and SouthStream projects, currently competitors.

Will Poland Become Next Norway?

In addition to changing worldwide energy markets, the emergence ofnew gas sources is leading to shifts in the global balance of power.Indeed, the dominant position of classic production countries,especially Russia, could soon erode strongly. Poland, on the other hand,could become a relevant player in the global market. Polish ForeignMinister Radoslav Sikorski already envisions transforming his countryinto the "next Norway" -- rich, important and independent --particularly of its giant neighbor Russia.

The United States, for its part, is on a sure path to becoming aself-provider and even exporter instead of a gas importer. The newdevelopments will "significantly improve the energy security of theUnited States," raves President Barack Obama.

The world market is expanding, the selection is broadening and theconsuming countries are becoming less dependent on the producingcountries. Germany still gets 40 percent of its natural gas from Russia,but it is quite possible that more and more gas will be coming from theUnited States in the future. A gas rush has even erupted in Germany, acountry with few natural resources.

About a dozen companies have already staked claims in the westernstates of North Rhine-Westphalia and Lower Saxony, where they aresearching for economically viable deposits. The most promising site todate is in a field near Lünne, a town with a population of 1,900 in theElmsland region.

Exxon has erected a massive drilling rig in a field where corn wasgrowing a year ago. The energy company is pumping rock samples thesurface from a depth of about 1,500 meters (4,920 feet). Its goal is tofind out whether it is worthwhile to produce natural gas, using the newmethods, in this region about 40 kilometers from the Dutch border.


Part 4:Is Drilling a Threat to Idyllic Landscape?

Workers in orange overalls are puttering around with the drillpipes. The men are engineers with a Scottish specialty company Exxonhired to sink the well, as the work is referred to in the industry. Theteams work day and night. Floodlights keep the Lünne 1 site bathed inbright light.

"It looks like a football field here," says Markus Rolink. He and hiswife and their three children live only a field away from the drillingsite. The 37-year-old teacher at a special needs school, sporting anearring and a five-day beard, says that he hadn't planned to becomepolitically involved again, ever since campaigning for the Green Partyas a university student. But he changed his mind when he heard about thedrilling plans.

Rolink is worried that this idyllic rural landscape could soon bedestroyed, especially when trucks carrying chemicals start rumbling downthe road to the drill site. He is also concerned about the possibilityof future accidents. "Then we'll have plenty of energy, but no water,"he says sarcastically.

'Who Will Want to Live Here Anymore?'

Rolink and his neighbors have joined forces and formed the SchönesLünne (Beautiful Lünne) initiative. About 80 Lünne residents have cometogether for an evening meeting at a local farm, where they are sittingon wooden benches in a barn heated with a woodstove. They are watching aTV report about fracking in the United States that aired on Germanpublic broadcaster ARD. The film portrays people who could no longersell their houses, polluted water and elevated cancer rates.

"Who will want to live here anymore?" a woman asks, breaking thesilence after the film ends. A farmer says she is worried about hercrops and wants to know what will happen if the fracking fluid leaksinto the topsoil. "Who will liable?" The more the local residentsdiscuss the issue, the more anxious and determined to resist gasdrilling they become. "We have to think about ways to fight this," saysone man. "All I can say is: Gorleben." He's referring to thecontroversial experimental storage site for nuclear waste in Germany.

Opposition to the gas industry's plans is taking shape, and not justin the Emsland region. In the neighboring state of NorthRhine-Westphalia, where drilling companies are perforating coal seams tosearch for gas, citizens are organizing against the efforts. Many haveseen "Gasland," the film by US director Josh Fox, who uses a suggestivestyle similar to that of filmmaker Michael Moore ("Fahrenheit 9/11") inhis indictment of the industry.

In the most powerful scene in the film, Fox shows a man using alighter to set the water coming from a faucet on fire. Fox claims thatfracking has contaminated groundwater with toxic gas. It's acontroversial charge, with US authorities insisting that the drillingcannot be blamed, at least not in this case. But despite itscontradictions, Fox has made an impact with such images. He has alarmedcitizens -- and the industry, now that "Gasland" was nominated for anOscar in the Best Documentary Feature category.

Elixir Petroleum's Ross calls the nomination incomprehensible andsays that the film really belongs in the comedy category. Energy inDepth, an industry association, even warned against awarding the Oscarto a film filled with such "mistakes, inconsistencies and lies."

'We Have to Answer Questions'

It's up to the industry to take the initiative and explain thetechnology, says Bruno Courme, managing director of Gas Shales Europe, asubsidiary of French energy conglomerate Total. "We have to answerquestions," he says. And there are many of them.

One is about the ingredients of the fracking fluid that's injectedinto the rock. Even more important: How contaminated is the sludge thatshoots back up to the surface? And how is it properly disposed of? Thewastewater contains large amounts of salt, and it often containsbenzene, xylene and toluene, all highly toxic substances that couldcontaminate groundwater.

The gas industry's engineers insist that contact with groundwater ishighly unlikely, because the layers of rock containing the gas are somuch deeper. But they do admit to other potential weak points, forinstance, when the steel pipes in the borehole are not properly cementedtogether. The US environmental authorities have documented a number ofsuch accidents, in which wastewater has harmed the environment.

Not everything is going swimmingly in the German gas productionindustry, either. In Söhlingen, where Exxon is producing natural gas,wastewater containing toxic chemicals was leaked from the site aboutthree years ago. Citizens' initiatives have since demanded that theauthorities tighten their inspection regimens. Many regulations ofGermany's outdated mining law are not relevant to the new technologies.

Green Party members of the German parliament, the Bundestag, want tochange this. "Citizens need to be more involved," says Oliver Krischer,the party's energy policy expert. The North Rhine-Westphalia stategovernment is also pushing for a revision of the law and plans to launchan initiative in the Bundesrat, the upper legislative chamber thatrepresents Germany's states.

One way or another, it will take years before the data from theexploratory drilling have been analyzed and producers have decidedwhether the German sites are worth exploiting. Only one thing is clear,namely that gas's share of the energy mix worldwide will keep on growingand the fuel will become more important, which will also haveconsequences for the gas supply in Germany. "Precisely this circumstanceopens up new possibilities," says RWE executive board member LeonhardBirnbaum.

In all likelihood, gas-fired power plants will become increasinglycommon, replacing old coal plants. They would be the ideal supplement toa fluctuating flow of energy from renewable sources. Gas also offersnew prospects as a fuel. Logistics companies in the United States arealready thinking about converting their fleets to natural gas. The oldpostulate that natural gas is too valuable to burn is no longer true.

"A lot of things that didn't make much sense a few years ago" saysRuhrgas CEO Schäfer, now have to be "reevaluated." Apparently, this alsoholds true for thenational energy planthe German government unveiled last fall. Natural gas plays only asecondary role in the document, because the experts had based theirassumptions on higher prices and smaller reserves.

In the end, issues of geology are probably not as likely to hold upthe gas revolution. The biggest obstacle, says London antitrust expertAlan Riley, lies in the question of whether society will acceptunconventional drilling for natural gas --- and, of course, whether thegas price will decouple itself from the oil price in the long term.

Ruhrgas CEO Schäfer, at any rate, is convinced that the trend "isunstoppable, especially given the current price developments in the oilmarkets."

Translated from the German by Christopher Sultan