Opinionista Saliem Fakir & Manisha Gulati 1 July 2014

Frackonomics: game-changer or just unfounded hype?

In his State of the Nation Address, President Jacob Zuma spoke of shale gas in the context of the path to energy security. He echoed what many in the country have been claiming: shale gas is a game changer for the economy.

Our view is that we do not know if shale will really be a game-changer and secondly, basing arguments on the US example tells us even less. There is simply no rigorous economic evidence for South African conditions.

One way to settle some of the outlandish claims is to develop a base case economic model for shale-gas under South African conditions rather than a superficial borrowing of selective evidence from the US experience.

Such a model will go a long way to introducing some realism into the debate. Such a model will take into account royalty fees, drilling costs, specialised labour cost, cost of water and other costs that will determine what the price of gas will likely be at the well-head and so too  the long-term economic viability of drilling for shale-gas .

So, here are some samplings of factors that could influence shale-gas economics in South Africa as we understand it and should be included in such a model?

The wellhead costs of shale gas are sensitive to the geology of the shale play, required technology (soft and hard), and well production rates. Each well in a shale play can have different requirements.

For instance the depth of the shale-gas resource, its organic content and mineraology will not only influence the number and type of fracks but also the rate of gas production. These in turn will define whether a particular shale-field is mostly dry-gas, wet-gas or oil producing.

The US’s great advantage is that it has more than a hundred year old oil and gas industry. Industry tacit knowledge and expertise makes a big difference and should not be underestimated in the way it influences the final outcome of shale-gas economics as much of this expertise will have to be imported into South Africa.

We have too little data for the Karoo to know which types of hydrocarbons will be predominant. The assumption is that it will be mostly dry-gas. Since, there is no gas market in South Africa shale-gas prices will have to be regulated. At what prices will largely be determined by what it costs to produce a million cubic feet/day of gas at a specific drilled well.

A base case economic model will give some sense of these costs and whether the price is competitive with conventional gas prices, other energy sources or not. Since we have no model or good economic data we cannot tell whether gas prices will be cheap or expensive. All base case scenarios help us to do is build realistic models for different conditions. They help us to understand the challenges of shale-gas economics in a more rigorous manner than the current plethora of guesses.

Since a gas field can have many wells each well will have unique characteristics in terms of lifespan, how much gas a well can produce and its break-even cost. Unlike, conventional gas wells shale-gas wells have high decline rates within the first eighteen months of production – sometimes as high as 80% – dramatically influencing the productivity and economic limit of the well.

You need to then drill as many wells as you can to optimise total gas production for a shale-gas producing area or field. Drilling more wells cost more and so managing the environmental challenges, especially the management of water resources.

Breakeven prices for shale gas production at the wellhead, in the US context, vary but should be on average lower than the range of USD 5-8/Mcf. At present most dry gas wells in the US underperform as far as well-head cost go given the prices they receive for gas in the US markets

This is why most US companies are moving into the wet-gas and oil shale windows until dry-gas prices go up. Once again, pointing to the fact that while US shale-gas is cheap, because of the way its gas markets work, they bear no resemblance to the true cost of extracting the gas. At present the US has an overproduction problem and too low a gas price to make dry-gas drilling a viable economic option. But conditions can change for the better in the future.

Then there is the bit on energy affordability and how it could boost the competitiveness of our manufacturing and benefit the common person alike. Again, over-statements belie the true nature of competitiveness and the way energy pricing works.

Infrastructure availability is crucial to wider beneficiation from gas for the domestic economy. This all depends on the pace at which the infrastructure is built and high levels of co-ordination that link beneficiation with gas extraction.

Our track record with other mineral resources already tells us sober story of the challenges involved in getting this right. Nonetheless, an infrastructure bill will have to be footed by the taxpayer or consumer and not the gas companies. For this to be achievable gas prices have to be competitive with other energy sources.

The big advantage the US has had is that it has both a huge gas infrastructure pipeline network and in the 1990s built as many 200 GW’s of gas power plants that were underutilised. When gas prices fell it’s was easy to bring these power plants into production again at very low cost.

Gas infrastructure is expensive. Even if shale-gas costs at the well-head were low in South Africa it is unlikely to be cheap in terms of its overall bill either to industry or to the common person as one would have to add other costs.

The game changing tag of shale gas needs closer scrutiny. We need tangible economic facts and figures tailored for our conditions to have an intelligent discussion on whether the proposition of shale gas is a game-changer or not.

It would be good if the government leads an independent process to develop a base case economic model for shale-gas in South Africa rather than be a participant in the hype. This will bring sobriety to a debate riddled with misinformation and misinterpretation of the relevance of US experience for South Africa. The game-changing case in our view still has to be made. DM

Saliem Fakir is head of the World Wide Fund for Nature South Africa’s living planet unit and Manisha Gulati is its energy economist.

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