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Shale gas bubble about to burst Japanese energy sector facing a self-inflicted crisis ：English JBpress
March 04, 2014 Kazuhiko Fuji
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This article first appeared in Japanese on JBpress on January 17 and 31.
Shale gas has been heralded in recent years as a savior of the U.S. economy, and has been welcomed in Japan too as the rise of shale gas led to a subsequent decline in prices. However, overproduction and declining per rig output are portending price rises at the very time Japan is having to import record quantities of natural gas. Kazuhiko Fuji, a former energy policy advisor for the Japanese government, examines the problems and suggests how Japan can solve this growing problem.
"Osaka Gas loses 29 billion yen from the unexpected absence of shale gas."
Such was the headline in the prominent Nikkei daily on December 21, 2013, reporting the first time that a Japanese company had taken a heavy loss in its shale gas investment in North America.
Osaka Gas had acquired a working interest in shale gas drilling area in Texas for 33 billion yen, however issues with the geological layer deeper than 3300 meters made it impossible for the company to secure economically viable volumes with current technology.
In June 2012 Osaka Gas became the first Japanese company to make a direct equity investment in the shale gas industry, and has been at the heart of Japan's shale gas development industry. Although Osaka Gas plans to continue producing and selling shale gas, in Japan concerns about development risk are likely to grow.
Shale gas business not breaking even
Shale gas rig in Waynesburg, Pennsylvania〔AFPBB News〕
Japanese companies aren't the only ones having trouble. In October 2013, Royal Dutch Shell admitted that its 24 billion dollar shale gas business in the U.S. had ended in failure. With BP also recording an impairment loss of 2.1 billion dollars, the shale gas craze is rapidly cooling among the overseas oil giants who were allocated poor drilling areas.
The reason behind these outcomes is quite simple: shale gas is not a cheap fossil fuel.
Shale gas is a natural gas present in a sedimentary rock called shale. The elements that comprise shale gas are the same as those in conventional natural gases, but difficulty in its extraction has caused even global oil companies to hesitate over the development cost.
But after the year 2000 new extraction technologies were established and shale gas became widely publicized, which saw venture companies flush with capital from investors compete for shale gas development and production, leading to a large oversupply of natural gas in the U.S.
This caused prices on the Henry Hub price index to plunge from 12.17 dollars (June 2008) to 2.68 dollars (May 2012), giving Japan the misconception that shale gas is a cheap resource.
It's been eight years since large-scale development of shale gas began, and it has become clear that the rate of gas output declines quicker for shale gas than for gas from conventional gas fields. It turns out that shale gas production declines more than 75 percent after the first three years of production on many fields. In other words, in order to maintain production volume, new wells need to be drilled continuously.
The minimum cost to maintain the shale gas operations in the U.S. was 42 billion dollars in 2012. However, with total sales of shale gas of 32.5 billion dollars, shale gas development is running 10 billion dollars in the red at the present.
Developers facing bankruptcy due to natural gas price collapse
Shale gas production volume has been off course since 2012. The number of drilling rigs in operation is less than 1/4 of the 2008 peak. In the U.S., despite the strong demand for natural gas, supply is sluggish.
U.S. natural gas prices collapsed due to the sudden rise of shale gas. Through 2013 the price was in a slump at three to four dollars and many of the shale gas fields will probably not be able to make a profit unless the price recovers to eight dollars. Some companies have already taken the next step, such as GMX Resources Inc. in Oklahoma, which filed for Chapter 11 bankruptcy protection in April 2013 after carrying eight consecutive quarterly losses due to the collapse in gas prices.
Will this be the beginning of the end?
There is growing concern that U.S. shale gas developers have been portraying the future of the industry in excessively optimistic terms and selling drilling rights at inflated prices to major U.S. and foreign companies, and then running off.
How should Japan respond to a rise in natural gas prices?
There is an increasingly widely held opinion in the U.S. that the shale gas boom is a short-term bubble. It is possible that U.S. domestic natural gas prices will rise dramatically if the assumption held for the past five years, that the rapid expansion of shale gas production will continue, is revised.
Although the U.S. currently has the lowest natural gas prices in the world, in the wake of Hurricane Katrina natural gas prices reached 10 dollars, and spiked to 18 dollars in the severe winter of late 2003. Clearly, a strategy predicated on shale gas exports to Japan bringing down the price of natural gas is unrealistic.
So what should Japan do?
Since the accident at the Fukushima Daiichi nuclear power plant Japan's electrical power industry has been undergoing an upheaval. LNG use has skyrocketed, generating 43 percent of Japan's electric power in fiscal 2012, compensating for a decline in nuclear to a mere 2 percent. The power companies are trying to overcome electric power shortages by running their LNG thermal power plants at full capacity when they had hitherto only been running at 50 percent.
Japan lagging in pipelines
The reason that natural gas hasn't played a major role in power generation in Japan is that nearly 100 percent of Japan's natural gas imports rely on costly maritime transport of LNG.
With its substantial pipeline network the U.S. has established markets where natural gas is traded at distribution centers (e.g. Henry Hub), but with no pipeline network Japan has no open markets where suppliers and buyers can gather to set prices. Because of this, the price of LNG imports is determined by linkage to the perennially high price of crude oil. For Japan, building a pipeline network such as exists in the West is an urgent matter.
Resistance to pipeline construction from Japan's electrical power industry
On the seafloor in the shallow waters off Sakhalin, an island just 40 kilometers north of Wakkanai in the northern extreme of Japan, there are rich natural gas fields. With 2.11 trillion cubic meters in verifiable reserves at present, there is enough natural gas to cover Japan's total consumption for approximately 20 years.
Sakhalin's natural gas was discovered in the 1980s and a Japanese-Russian collaboration began, which also saw big oil companies such as Exxon-Mobil join. Although Exxon-Mobil had proposed the construction of a pipeline from Sakhalin to Tokyo via Hokkaido around the year 2000, it never happened. According to the insider source, Japan's electric power industry seems to have thought that building international pipelines would lead to pressure to deregulate the industry and that the industry would subsequently be pressured to lower prices.
However, today thermal power plants' demand for natural gas is exploding. Add to this buyers' urgent desire to diversify means of supply and you see that the situation is completely different from 10 years ago. The leadership of Japan's Agency for Natural Resources and Energy are promoting new policies different from 10 years ago and clearly expect to see forward-looking initiatives from private business.
Lowering Japan's annual import bill for LNG from six trillion to 3.6 trillion yen
This project is also attractive for the Russian side in that it pioneers a new market to export natural gas to. This will almost certainly bring cross-border prices to Japan to the same level as that for natural gas sold to Europe. If natural gas can be sourced from Russia on these terms, Japan will have an effective card in negotiations for lowering the price of LNG from other sources.
If we assume the price of LNG in Japan becomes the price of pipeline gas from Sakhalin, the 6 trillion yen annual LNG import bill (2012) will drop to 3.6 trillion yen. As the pipeline project would cost around 500-600 billion yen the initial investment would be recouped very quickly.
Japan accounts for just under four percent of global natural gas consumption, which is low when compared to its five percent shares of electricity and crude oil consumption. It is possible that this international pipeline could become the trigger for proceeding to create a pipeline network in Japan, and for rapidly reducing dependence on Middle Eastern crude oil if the adoption of natural gas is accelerated. And from the perspective of Japan's energy security the value of Sakhalin's natural gas is immeasurable. Both the public and private sectors need to move quickly on pipeline construction.
The author, formerly with the Ministry of Economy, Trade and Industry on policy for sectors including energy, trade and SMEs until 2003, when he began working at the Cabinet Intelligence Agency. Since 2011 he has been a Senior Research Fellow at the Institute for International Policy Studies.
March 04, 2014 Kazuhiko Fuji
Tweet
This article first appeared in Japanese on JBpress on January 17 and 31.
Shale gas has been heralded in recent years as a savior of the U.S. economy, and has been welcomed in Japan too as the rise of shale gas led to a subsequent decline in prices. However, overproduction and declining per rig output are portending price rises at the very time Japan is having to import record quantities of natural gas. Kazuhiko Fuji, a former energy policy advisor for the Japanese government, examines the problems and suggests how Japan can solve this growing problem.
"Osaka Gas loses 29 billion yen from the unexpected absence of shale gas."
Such was the headline in the prominent Nikkei daily on December 21, 2013, reporting the first time that a Japanese company had taken a heavy loss in its shale gas investment in North America.
Osaka Gas had acquired a working interest in shale gas drilling area in Texas for 33 billion yen, however issues with the geological layer deeper than 3300 meters made it impossible for the company to secure economically viable volumes with current technology.
In June 2012 Osaka Gas became the first Japanese company to make a direct equity investment in the shale gas industry, and has been at the heart of Japan's shale gas development industry. Although Osaka Gas plans to continue producing and selling shale gas, in Japan concerns about development risk are likely to grow.
Shale gas business not breaking even
Shale gas rig in Waynesburg, Pennsylvania〔AFPBB News〕
Japanese companies aren't the only ones having trouble. In October 2013, Royal Dutch Shell admitted that its 24 billion dollar shale gas business in the U.S. had ended in failure. With BP also recording an impairment loss of 2.1 billion dollars, the shale gas craze is rapidly cooling among the overseas oil giants who were allocated poor drilling areas.
The reason behind these outcomes is quite simple: shale gas is not a cheap fossil fuel.
Shale gas is a natural gas present in a sedimentary rock called shale. The elements that comprise shale gas are the same as those in conventional natural gases, but difficulty in its extraction has caused even global oil companies to hesitate over the development cost.
But after the year 2000 new extraction technologies were established and shale gas became widely publicized, which saw venture companies flush with capital from investors compete for shale gas development and production, leading to a large oversupply of natural gas in the U.S.
This caused prices on the Henry Hub price index to plunge from 12.17 dollars (June 2008) to 2.68 dollars (May 2012), giving Japan the misconception that shale gas is a cheap resource.
It's been eight years since large-scale development of shale gas began, and it has become clear that the rate of gas output declines quicker for shale gas than for gas from conventional gas fields. It turns out that shale gas production declines more than 75 percent after the first three years of production on many fields. In other words, in order to maintain production volume, new wells need to be drilled continuously.
The minimum cost to maintain the shale gas operations in the U.S. was 42 billion dollars in 2012. However, with total sales of shale gas of 32.5 billion dollars, shale gas development is running 10 billion dollars in the red at the present.
Developers facing bankruptcy due to natural gas price collapse
Shale gas production volume has been off course since 2012. The number of drilling rigs in operation is less than 1/4 of the 2008 peak. In the U.S., despite the strong demand for natural gas, supply is sluggish.
U.S. natural gas prices collapsed due to the sudden rise of shale gas. Through 2013 the price was in a slump at three to four dollars and many of the shale gas fields will probably not be able to make a profit unless the price recovers to eight dollars. Some companies have already taken the next step, such as GMX Resources Inc. in Oklahoma, which filed for Chapter 11 bankruptcy protection in April 2013 after carrying eight consecutive quarterly losses due to the collapse in gas prices.
Will this be the beginning of the end?
There is growing concern that U.S. shale gas developers have been portraying the future of the industry in excessively optimistic terms and selling drilling rights at inflated prices to major U.S. and foreign companies, and then running off.
How should Japan respond to a rise in natural gas prices?
There is an increasingly widely held opinion in the U.S. that the shale gas boom is a short-term bubble. It is possible that U.S. domestic natural gas prices will rise dramatically if the assumption held for the past five years, that the rapid expansion of shale gas production will continue, is revised.
Although the U.S. currently has the lowest natural gas prices in the world, in the wake of Hurricane Katrina natural gas prices reached 10 dollars, and spiked to 18 dollars in the severe winter of late 2003. Clearly, a strategy predicated on shale gas exports to Japan bringing down the price of natural gas is unrealistic.
So what should Japan do?
Since the accident at the Fukushima Daiichi nuclear power plant Japan's electrical power industry has been undergoing an upheaval. LNG use has skyrocketed, generating 43 percent of Japan's electric power in fiscal 2012, compensating for a decline in nuclear to a mere 2 percent. The power companies are trying to overcome electric power shortages by running their LNG thermal power plants at full capacity when they had hitherto only been running at 50 percent.
Japan lagging in pipelines
The reason that natural gas hasn't played a major role in power generation in Japan is that nearly 100 percent of Japan's natural gas imports rely on costly maritime transport of LNG.
With its substantial pipeline network the U.S. has established markets where natural gas is traded at distribution centers (e.g. Henry Hub), but with no pipeline network Japan has no open markets where suppliers and buyers can gather to set prices. Because of this, the price of LNG imports is determined by linkage to the perennially high price of crude oil. For Japan, building a pipeline network such as exists in the West is an urgent matter.
Resistance to pipeline construction from Japan's electrical power industry
On the seafloor in the shallow waters off Sakhalin, an island just 40 kilometers north of Wakkanai in the northern extreme of Japan, there are rich natural gas fields. With 2.11 trillion cubic meters in verifiable reserves at present, there is enough natural gas to cover Japan's total consumption for approximately 20 years.
Sakhalin's natural gas was discovered in the 1980s and a Japanese-Russian collaboration began, which also saw big oil companies such as Exxon-Mobil join. Although Exxon-Mobil had proposed the construction of a pipeline from Sakhalin to Tokyo via Hokkaido around the year 2000, it never happened. According to the insider source, Japan's electric power industry seems to have thought that building international pipelines would lead to pressure to deregulate the industry and that the industry would subsequently be pressured to lower prices.
However, today thermal power plants' demand for natural gas is exploding. Add to this buyers' urgent desire to diversify means of supply and you see that the situation is completely different from 10 years ago. The leadership of Japan's Agency for Natural Resources and Energy are promoting new policies different from 10 years ago and clearly expect to see forward-looking initiatives from private business.
Lowering Japan's annual import bill for LNG from six trillion to 3.6 trillion yen
This project is also attractive for the Russian side in that it pioneers a new market to export natural gas to. This will almost certainly bring cross-border prices to Japan to the same level as that for natural gas sold to Europe. If natural gas can be sourced from Russia on these terms, Japan will have an effective card in negotiations for lowering the price of LNG from other sources.
If we assume the price of LNG in Japan becomes the price of pipeline gas from Sakhalin, the 6 trillion yen annual LNG import bill (2012) will drop to 3.6 trillion yen. As the pipeline project would cost around 500-600 billion yen the initial investment would be recouped very quickly.
Japan accounts for just under four percent of global natural gas consumption, which is low when compared to its five percent shares of electricity and crude oil consumption. It is possible that this international pipeline could become the trigger for proceeding to create a pipeline network in Japan, and for rapidly reducing dependence on Middle Eastern crude oil if the adoption of natural gas is accelerated. And from the perspective of Japan's energy security the value of Sakhalin's natural gas is immeasurable. Both the public and private sectors need to move quickly on pipeline construction.
The author, formerly with the Ministry of Economy, Trade and Industry on policy for sectors including energy, trade and SMEs until 2003, when he began working at the Cabinet Intelligence Agency. Since 2011 he has been a Senior Research Fellow at the Institute for International Policy Studies.
