Opinionista Saliem Fakir & Manisha Gulati 14 July 2014

Frackonomics II – What can we learn from the US experience?

There could be some truth to the idea that if you come from WWF, our views are biased. But bias is a currency that seems widespread when it comes to the shale-gas debate in South Africa. Some opinions are biased with absolutely no foundation and others are slanted by the facts and science of the moment.

How you choose between different facts undoubtedly reflects your own position and view on matters. It is important that views be substantiated and opinions encourage a healthy debate by either providing new information or casting a different interpretation of the same facts that is accessed in the public domain.

What we are keen on is avoiding cherry-picking facts but at the same time ensuring peer review of our own work.

In presenting our latest thinking, sometimes we will err, other times we will be forced to avail ourselves to some facts because there is no better information; at other times we will avoid saying something about things we know little about.

The WWF is not only about the bees, birds and rhinos, which is the common uninformed caricature of the WWF’s work.

Inside, within the bosom of the WWF, there are people like the authors above who are working to figure out the world. We mean the long-term future. We are unashamedly interested in an economy that can be run without fossil fuels. If we do not do it, who else will?

We do want to understand a couple of things: Which economies will be the frontrunners in the pursuit of this dream, and if it can be done, what will new technologies do to the current economic models? More importantly, at what scale, pace and cost can a new type of energy economy be created?

Inevitably, pushing for such a vision involves an invidious juggling role of holding realism and a dream within the same head space and allowing this tension to plays itself out and see what results it can reap.

On the shale-gas question we have done extensive research from the geology, technology, to the economics and financing of shale-gas in the US. Our work is still ongoing. We share mere vignettes of our first impressions and analysis based on our preliminary work as to the relevance of the US experience to the South African debate. Here are few more pointers from the last time we left off.

Firstly, it behoves repeating: gas prices have nothing to do with actual well-head costs (what it costs to produce gas from a well). It is perfectly possible for production costs to be much higher than the market price for gas or the opposite to be true. Gas prices are a result of demand and supply conditions in the US. If gas prices are too low production of gas will be reduced until gas prices increase to making shale-gas production more economical.

In the US wholesale gas prices are liberalised and determined by the common collection point called the Henry Hub. In the United Kingdom it is the National Balance Point. It is possible that average well-head costs, on a field basis, can track Henry Hub indexed prices or be out of sync with each other.

In local debates the idea of cheap gas is taken out of context and this misunderstanding is, unfortunately, also perpetuated in the National Development Plan (NDP) and other analysis.

It is possible that in the future US gas prices could rise once production oversupply of gas tapers.

Prices in South Africa will be different and possibly regulated. Nonetheless, gas prices for heating or gas converted to electricity in the US is regulated by energy commissions or regulators at the state level.

Electricity or retail gas prices are influenced by other factors and often not determined by the cost of wholesale gas prices that are supplied by gas producers. At best electricity or gas for heating cost in the US can either remain the same or increase depending on how the downstream energy market is structured and regulated.

Secondly, the presence of sunk infrastructure cost, a well-developed financial sector that has experience in oil and gas industries, the presence of original equipment suppliers, service industries, knowledge of geology and many other aspects of the US oil and gas industry is a great advantage for the economics of shale-gas in the US. The US oil and gas industry is close to 150 years old. Shale-gas production in the US is literally a ‘plug-and-play’ regime because of the prior endowment and legacy bequeathed by the oil and gas industry to shale-gas development.

In countries with no prior experience or where the actual geology is not fully understood the initial costs of gas production are likely to be higher as the learning rates are low. All of this impacting on the economics and financing of shale-gas production.

Learning rate effects on shale-gas production are evident if one considers how long it takes to drill a well in China compared to the US. In China, an average well takes about 11 months to drill and in the US; if we take the Marcellus shale fields as an example, the average is about 18-25 days. All of this matters because leasing drills and others services cost money.

Our own research shows that problems with geology and technology in countries such as Mexico, China and Poland is putting a damper on earlier optimism that have led these countries into shale-gas plays with the similar drum of hype being beaten on our own shores. They may well resolve these problems but what is evident is that replicating the US experience is still very far off for these countries.

Finally, even if the gas prices were to be cheap in South Africa, it should not be construed that a beneficiation pathway is straightforward. Arguments about downstream economic benefits have, hitherto, been far too simplistic and glib in the commentary.

It is likely that in the first ten to fifteen years most of the shale-gas will be exported because large-scale domestic beneficiation will take time to develop as it will require national policy and allocation of public funds whether it is to convert gas to fuel, power or other uses.

For this you need infrastructure investment and other types of support, including gas price support. This will not come from the multinationals scouring the parched Karoo for shale-gas their objectives are different to national interests.

Larger consumers are likely to benefit more than smaller consumers because of the advantages wholesale pricing gives to large users and the long-term contracts they can sign.

Competition in the downstream and midstream gas supply market can also influence how much benefit from low gas prices are passed onto consumers. It is possible that an electric utility may find it more advantageous to switch to gas because of lower fuel costs and keep the benefit for itself.

Nonetheless, final electricity prices are not only determined by cheap fuel like coal or gas but also reflect transmission, distribution and other costs by the time the consumer is able to switch their lights on.

Our research further shows that in the US the biggest economic benefit from cheap gas is in sectors that rely on gas for a feedstock in the production of fertiliser, plastics and other chemicals or as a substitute fuel.

In the bigger scheme of things, though, these industries muster a small share of the total US manufacturing sector and the economy as a whole. In GDP in terms the effect is small but within a sector or industry the competitiveness of US industries have been dramatic. In addition, the US has a better trade balance if it imports less oil and gas.

The South African shale-gas debate is so tarnished with propaganda or subject to public relations speak that sanguine and good economics flew out of the window. Even good economic analysis is always subject to debate, as not all facts can be fully known because facts themselves can be moving targets; nor are all interpretations flawless or non-disputable. DM


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