Q: What is fracking?
A: Fracking is the recovery of hydrocarbons in unconventional formations using hydraulic fracturing techniques. Most often, hydrocarbons (think oil) are found in permeable rock reservoirs. These formations are considered conventional. Unconventional formations (like shale) are composed of finer-grain rocks and are much less porous. Injecting a combination of water, sand and chemicals under pressure down wells and into targeted formations fractures the rock to effectively create the necessary porosity to release the oil or gas.
Q: Is fracking a real change in how we access gas and oil, or is it just a fad?
A: Fracking is very real and is, indeed, transforming the oil and gas industry. The development of fracking for natural gas in the United States really started to take off in 2005 and has been the product of market demand and price forces and technological innovation.
Henry Hub natural gas price, the U.S. reference price for natural gas named after a natural gas distribution hub in Louisiana, hit an all-time high in October 2005 at more than $13/MMBtu (millions of British thermal units). This price spike was a huge signal to the market that there were big returns to be made in natural gas.
Now, fracking itself is not a completely new phenomenon — in fact, the ability to drill horizontally and with greater precision had improved the ability to extract oil from shale through the 1980s and 1990s. But these drilling improvements and reduced costs, coupled with enhanced resource mapping, fracture reservoir simulations and new developments in the water-chemical mixture used in this process have now made the technique economic for shale gas (which on an energy-equivalent basis, sells for a much lower price than oil). You can think of the mapping and reservoir simulation software as a sort of MRI of natural resources, but at 1,000 to 14,000 feet below the earth’s surface.
Q. If there is so much money in fracking, why are some of the major oil companies reporting losses in North American shale?
A: It’s the perennial problem in the resource industries that when there are large returns everyone piles in in a huge lump, and after two to three years operations come on line and supply surges, in turn exerting downward pressure on prices. Natural gas prices, which I indicated had been higher than $13/MMBtu in 2005 are today just under $4. At the same time, the race for limited production resources, including land leases, has boosted costs. At $4, you are barely at — and possibly below — the current breakeven cost of shale natural gas.
Q: Has fracking caused us to redefine what recoverable reserves are? Has it created a whole new reserve base?
A: The short answer is yes. You can see on the chart (below) how conventional domestic U.S. gas production had been declining for many years. The only thing that stabilized production was the ability to use fracking to economically access “tight gas” — gas that is trapped in previously impermeable rock. Now, with fracking and the advent of the domestic shale gas boom over the past five years, natural gas production is rising substantially in absolute terms for the first time in decades.
Q: Does this mean that the United States is on the threshold of being energy independent — potentially even a major energy exporter?
A: We are still a ways away from energy independence. True, we have lots of natural gas — and shale oil — but it is largely in the places where the collection and distribution pipelines and export terminals are not.
As far as being a global leader in natural gas export, that is even further away, I think. There is no international market in natural gas — unlike, say, global oil, with the Brent benchmark. There are huge price differences in natural gas pricing among countries. The price of natural gas in Japan, for example, is currently over three times the U.S. price.
These differences reflect the fact that you cannot readily get the gas to the markets that will pay the most. The highest natural gas prices in the world are in Japan but virtually all of the liquefaction terminals are in the American East and Southeast. And the availability and charter costs of liquefied natural gas (LNG) tankers plays into this as well.
Finally, energy export involves important philosophical and policy issues. What happens if a non-Free Trade Agreement country wants to import natural gas? What are the license and environmental arrangements? There are a lot of regulatory and policy barriers to a truly international natural gas market with free movement of cargoes to highest bidder.
Q: How serious are environmental concerns? Could they derail fracking altogether?
A: Environmental concerns are material. They are a potentially large bump in the road, but I don’t see them derailing fracking. The dynamics behind fracking are too powerful. The one caveat to this might be some extensive, damaging and disruptive seismic event that is believed to be directly triggered by fracking operations.
It is important to recognize that we don’t fully understand what all the environmental issues are as of yet. The most likely scenario given the economic, climate and domestic energy security drivers for fracking is that the timeline for shale gas recovery will be extended from what projections show today. It will take longer and may end up costing more than currently estimated.
Q: Can you summarize these concerns for us?
A: Environmental issues can be grouped into three categories: water supply and quality, air and seismic. Each of these is a huge topic in itself.
Water is an issue both because of the quantities required for the fracking process and the potential for fracking to contaminate the water. To give you an idea of the volume here, the water required to launch a single well is equal to what the average American family will consume over 20 years. That is a lot of water.
Aside from the sheer magnitude of water required is the matter of where much of the shale is located. To the extent that shale deposits are in the Midwest and West where rainfall is infrequent — the water problem is that much greater.
The issue that has gotten the most media attention is the risk to drinking water. Fracking advocates point out that you are drilling thousands of feet beneath the water table, so there’s no issue. Environmentalists focus on what happens as you pass through aquifers on your way down. We may find out more on this when the EPA publishes a large study on fracking and drinking water next year.
A second issue is air quality. A fracking operation produces air emissions from various sources. You have drilling equipment and the transportation emissions (think engines combusting diesel). But you also create fugitive methane gas, which is released into the air during the fracking process. You have volatile organic compounds and various naturally occurring radioactive materials in the rock. We are just beginning to quantify these effects.
And then finally we have seismic issues. Water used in the fracking process is recycled as wastewater and generally disposed of by reinjection. This already happens with “produced water” in conventional oil and gas operations — so it’s not unique to fracking. But now the volume of liquids that are being re-injected is thought to act like a lubricant for the rocks deep down to slip and crack, depending on where you are.
Youngstown, Ohio, for example, experienced a preponderance of small but noteworthy earthquakes at the end of 2011 in what is otherwise thought to be a geologically stable area. Scientists at Columbia University concluded that there appears to be a correlation between injected waste water and these earthquakes.
Q: This is a hugely complex issue. Is there any way to sum up the outlook?
A: From my perspective, fracking and the U.S. natural gas boom are here to stay, but the full benefits are likely further off than the optimists predict. Technology will help reduce costs, but it will take a long time to make current prices profitable. Environmental concerns will constrain supply, so it will help raise prices — but it will also raise costs. Infrastructure issues will also postpone the big efficiencies and the big returns in distributing the gas.
Yet the marketplace is moving very fast to adopt natural gas in autos and trucks and in electricity generation. Simply put, fracking and the expansion of natural gas is a fundamental transformation in the global energy sector that will take years to realize but will have decades of long-term benefits.