The

U.S. Shale Revolution: Global Rebalancing?

Managing Energy Business

IIM Ahmedabad



Submitted by:

Group A3
Mohammed Farhan
Konrad Stepien
Lalit Singh
Rajat Agnihotri
Randeep Malhan

Table of Contents


1. Introduction to Shale Energy

2. U.S. Shale Energy Revolution

3. Oil & Gas Primer

4. U.S. Shale Energys Global Impact

5. U.S. dilemma whether to export LNG

6. Key Takeaways and Conclusion

1. Introduction to Shale Energy

Shale Energy is a type of unconventional energy natural gas, petroleum, and other
forms of Hydro-Carbon (H-C) liquids derived from the Shale formation of rocks.
The two very important characteristics of the Shale rock high porosity, low
permeability make the energy extraction from Shale formations very difficult.
The origins of energy from Shale can be traced to the late 19th or early 20th century;
however, the extraction of Shale Energy in economically feasible manner is very
recent and can be credited to Fracking and Directional Drilling.

2. U.S. Shale Energy Revolution

Today it is widely known around the world that the U.S. is experiencing a Shale
Energy boom. While Saudi Arabia and Russia may be thought of as the two largest
oil producers in the world, to many it may be a surprise that the U.S. is the worlds
largest oil producer thanks to the Shale Revolution. Fig. 1 shows the oil
production for a few major oil-producing countries based on Energy Information
Administration (EIA) data.

Fig.1 (Oil Production in Thousands of Barrels per Day)
In order to understand what caused the U.S. Shale Energy Revolution, it is important
to look at the historical energy consumption, production, and import in the United

States. Fig. 2 shows the historical Natural Gas production and consumption in the
U.S.
72

~ 70

62
52
42
32
22

Daily Total Consumption

Daily Production
Daily Consumption - Power Generation
Daily Consumption - Industrial
Daily Consumption - Residential
Daily Consumption - Commercial
Daily Consumption - Other
Daily Consumption - Lease & Plant Fuel

1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014

12

Fig.2 (U.S. Natural Gas Consumption, Production in Billion Cubic-Feet per Day)
Source: EIA
Up until the mid to late 1980s, the U.S. natural gas production kept pace with the
consumption. Over the next 15 years, consumption (demand) grew rapidly while
production (local supply) could not keep pace. As a result there was a need to
import significant amount of natural gas and therefore, several Liquefied Natural
Gas (LNG) regasification terminals were being build in the U.S. in the 1990s. To dig
deeper into the sudden consumption growth we break down the consumption by
different sectors. There is no data provided by EIA on consumption by the
industrial and the power generation sectors prior 1997. However, from the figure
above, one can guess that it must have been the power generation sector that
resulted in the rapid natural gas consumption growth in the U.S. The industrial

sectors natural gas consumption saw a decline as steel, cement, chemicals and other
heavy energy intensive industries moved their plants to developing countries.

In addition to the energy deficit, there were few more drivers behind the Shale
Energy boom in the U.S. U.S. desire to become energy independent, federal grants
and subsidies that helped spur R&D in energy, horizontal and directional drilling
technology, and finally George P. Mitchells father of fracking perseverance.
Fracking had been used for decades in the U.S. but it was George Mitchell who spent
over 15 years continuously improving the fracking technology in the Barnett Shale
play such that fracking in the Shale plays has become economically viable. As a
result, starting from about 2005 U.S. produced a lot of natural gas from Shale plays
and within the next 7-8 years domestic production once again was sufficient to meet
consumption. The U.S. now has access to abundant energy in the form of oil and
natural gas in the Shale plays and some of the natural gas can be exported to other
world markets in the form of LNG to take advantage of the price arbitrage. As a
result, over the last 5-6 years over 40 applications have been filed with the
Department of Energy (DOE) to build LNG terminals to ship natural gas.

3. Oil & Gas Primer
In order to understand the U.S. Shale Energy revolution from a global perspective, it
is important to understand some key terms/terminology related to oil & gas. There
are two important properties of oil viscosity and purity. Oil can be light or heavy
based on its viscosity. Oil can also have impurities in the form of organic elements
such as Sulfur. If oil has less Sulfur, it is called Sweet Oil whereas more Sulfur makes
the oil Sour. Oil from around the world has different combination of these two
properties. For example, West Texas Intermediate (WTI) from the Eagle Ford basin
in Texas is typically Light Sweet Oil whereas oil from Saudi Arabia is Heavy Sour.
While both Light Sweet and Heavy Sour are processed to produce end products such
as petrol, diesel and hundreds of other distillates, the refineries are typically build to
handle one or the other type of oil. A recent example is the expansion of BPs

Whiting refinery in Illinois the expansion unit is designed to handle the dirty crude
from Canada.

Natural Gas consists mostly Methane (~85%), some Ethane, and some Natural Gas
Liquids (NGLs). Methane can be used as a clean burning fuel; ethane can be used as
feed-stock/raw-material in the petrochemicals industry; NGLs are nothing but a
form of petroleum.

4. U.S. Shale Energys Global Impact

We will evaluate the impact of U.S. Shale Oil separately from U.S. Shale Natural Gas.

U.S. Shale Oil Global Impact

Fig. 3 below shows the U.S.s daily petroleum consumption, domestic production,
and import in Millions of Barrels/Day.

25.00
20.00

18.96

15.00
12.3

10.00
5.00
0.00

7.7
US Oil Consumption (MMB/D)
US Oil Production (MMB/D)
US Oil Import (MMB/D)

Fig. 3 (U.S.s Daily Consumption, Production, Import in Million Barrels per Day)
Source: EIA
While the total petroleum import by the U.S. has been steadily declining since 2005,
the picture can be misleading. We need to break down the total import into import

from major countries. Fig. 4 below shows the bulk of U.S. petroleum import from
different countries. It is interesting to see that import from countries such as
Venezuela, Nigeria, Angola, Algeria, and Mexico has been declining, whereas the
import from Saudi Arabia, Canada and Kuwait has been increasing over the last 5-7
years. This is because the oil Light Sweet Oil from African and S. American
countries can be readily substituted with domestic Shale Oil, which is also Light
Sweet. Refineries are typically built to refine one or the other type of oil, not both.
Most of the refineries in the U.S. are built to refine the heavy type of oil. Therefore,
unless new refining capacity to refine light oil is build or billions of dollars are spent
to convert the existing refineries to be more flexible, U.S. will be dependent on the
heavy oil from Canada, Saudi Arabia, Kuwait and other Middle East Countries.

2.50

2.00

1.50

1.00

0.50

0.00
1973 1979 1985 1991 1997 2003 2009 2015

Import from
Nigeria
Import from
Angola
Import from
Algeria
Import from
Venezuela
Import from
Brazil
Import from
Mexico
Import from
Colombia
Import from
Russia
Import from
Kuwait
Import from
Saudi
Import from
Canada

Fig. 4 (U.S.s Daily Import from major countries in Million Barrels/Day) Source: EIA

In the future, the U.S. dependence on heavy oil might reduce as well. The existing
refineries that are specialized for heavy crude can be converted for light crude.
Although huge investments are required for such conversion, given the easy
availability and low cost of Shale oil, refineries will shift. The U.S. can use this
reduced dependence on imported oil as a political leverage as well. It can stop
imports from countries like Nigeria and force them to act on corruption.

Oil exporting countries such as Saudi Arabia, Kuwait, UAE, and Venezuela have
certain fixed costs of running society and social programs. These countries are very
sensitive about the oil they need to sell. The low cost producers will continue with
their oil production to support their economy. The high cost oil producing countries
like Algeria and Libya will be squeezed severely. As Shale boom is having varied
impact on different OPEC members, a rift can arise leading to dismantling of OPEC.

U.S. Shale Natural Gas Global Impact
Shale Gas boom in the U.S. has had and will have a future widespread impact all
around the world. As a result of cheap abundant natural gas in the U.S. the
Power/Utilities companies are spending billions of dollars to decommission old coal
fired power plants and to build new natural gas power plants. While in the near-
term future converting from coal to natural gas may reduce greenhouse emissions,
this may have negative consequences over long run; this is because power/utilities
company will not build more of unconventional power (wind, solar, geothermal)
when they can have access to cheap natural gas. This may also dis-incentivize R&D
in universities and national labs from coming up with new breakthroughs in wind,
solar, geothermal or even other yet undiscovered unconventional energy because
the power generation industry will be reluctant to build new generation capacity
once they have spent billions of dollars in constructing new natural gas fired plants.

Another industry in the U.S. that is benefitting from the cheap shale gas is the
Petrochemicals Industry. One of the largest commodity products that are produced
by the petrochemicals industry is plastic, which again can be of several different

types. One such type of plastic is Polyethylene, which goes into making grocery
bags, pipes, and milk jugs among others. Polyethylene is produced from ethylene
gas, which in turn is generally produced from naphtha a petroleum distillate.
However, ethylene can also be produced from ethane gas, which is a minor
constituent of natural gas. Now, with the abundant and cheap natural gas in the U.S.,
chemical companies can use the cheaper ethane as the feedstock instead of more
expensive naphtha to produce ethylene. There is a race in the U.S. to build the first
ethylene plant that will use ethane as the feedstock and it is expected that Chevron
Phillips Chemical Company (CPChem) will be the first with their $5Bn investment at
their Cedar Bayou complex just outside of Houston. There are several billions of
dollars in planned Capex by ExxonMobil, Shell, Dow Chemical, Sasol, Formosa
Plastics, Occidental Chemical, Asiall, and Odebrecht to build ethane crackers and
other downstream assets in the U.S. [1] There is also a fear that this will result in
excess capacity for ethylene and eventually drive prices down. As a result, the last
players to build ethylene plants stand to lose. [2]

Perhaps the largest and the most significant impact Shale gas in the U.S. is having is
on construction of new LNG plants. There are over 40 applications with the DOE to
build LNG terminals that will export approximately 40Bcf/d of natural gas [3], which
is over 50% of current production of approximately 70Bcf/d. As a result, we can
expect natural gas prices in the U.S. to rise in the future for all types of consumers
retail, industrial, commercial, power. There is a big push from Dow Chemical, which
can use natural gas both as a feedstock and source of energy, to keep natural gas
within the U.S. [4] The DOE has already approved about 10Bcf/d of LNG exports. As
the DOE approves more LNG plants we can expect a shift in natural gas markets
from regional to a more global.

Another industry benefiting from the U.S. Shale gas boom is Investment Banking. In
the last 3-4 years, Energy Investment Banking in Houston has been extremely hot
with billions of dollars in deals done every year. The credit market has become

liquid and there is a strong appetite for high yield credit offering (loans/bonds).
Take for example, American Energy Partners, founded by Aubrey McClendon the
well-known former CEO of Chesapeake Energy. Within one year, American Energy
Partners raised over $10Bn in mostly loans/bonds and some equity [5]. There is a
fear that the availability of cheap credit may be spurring inefficient highly levered
Exploration & Production (E&P) independent companies that will go bust as soon as
gas falls further within the next couple of years.

The impact of Shale Gas in the U.S. can also be felt in India on a little known crop
Guar in the U.S. Guar is very difficult to grow in the U.S. India is the dominant
grower of guar. Guar beans and gum is used in the food and beverage industries.
Guar gum is also one of the constituents in the fracking fluid. Fig. 4 below shows
that guar gum prices shot up 6 folds between 2011 and 2012 as the U.S. Shale
industry was booming.

Fig. 3 (Guar gum prices in the U.S.)

U.S. shale gas revolutions impact can also be felt in places like Russia, Europe, Japan,
China, and Australia. With LNG terminals being built in the U.S. to export gas to
Europe, Japan, S. Korea and other Asian markets these countries no longer have to
solely rely upon and be threatened by a sudden gas supply cut-off by Russia. As a
result, Europe and Japan have successfully renegotiated or signed new contracts
with Russia, which has lowered Japans gas import bill by as much as 30% [6].

Chinas expected shale gas reserves maybe the largest in the world, yet the country
lags access to fracking technology [7]. Therefore, China is building strategic
relationships with companies such as Devon Energy by buying its Mississippi Lime
shale assets in the U.S. As a result, Devon will be able to get a step in Chinas door
and China on the other hand will have access to fracking technology.

While Australia may not be a major Shale gas producer, it is definitely one of the
major LNG exporters. In the last 10 years or so Chevron and other oil companies
have spent over $50Bn to build LNG terminals to ship gas to the Asian markets, in
particular Japan and S. Korea. Another $50Bn plus LNG terminals investments are
planned for the future. There is a fear now that these projects may end up being
negative NPV due to the U.S. Shale Gas boom.

5. U.S. dilemma whether to export LNG

With a big global impact that the U.S. shale energy can have, the U.S. government is
faced with even a bigger dilemma whether to allow LNG export or keep natural gas
at home. The major reason thats encouraging the companies to export is the huge
price differential that exists between the price in the U.S. (~$2.50/MMBTU) and
prices in Europe (~$10/MMBTU) and Asia (~$15/MMBTU), which exists because of
very high transportation costs (gas first liquefied at -160 degree Celsius and then
shipped). In fact this is the reason why some companies from Japan and Europe are
tying up with U.S. companies to build export terminals as it will benefit them to
source cheap gas from there. So although extraction companies are in favor of

promoting exports, power generation and manufacturing companies are against it,
as they will lose access to cheap gas. But the U.S. authorities will decide based on
many considerations. Some of them are listed below.
Should Export

If the U.S. decides to distribute more export licenses it will reduce its
current account deficit, as it will generate huge amounts of cash through
exports.

Another factor that favors export is the inflow of FDI. As mentioned earlier
companies from other countries will be investing in the U.S. to build LNG
terminals for the export of natural gas.

Dont Export

One of the core reasons behind not exporting the gas is public interest.
When export is allowed the domestic prices will rise which will act against
the interest of the public, which expects lower oil and gas prices.

According to a Deloitte report, if the U.S. prohibits export of natural gas its
GDP will see a greater jump than it would have been otherwise. Also the
increase in the number of jobs is higher in the former case due to industrial
boom due to much lower oil and gas prices.

A major reason behind big companies shifting their manufacturing hubs to

developing countries is lower labor and raw material costs. But if the price
of gas remains around $4 in the U.S. many companies will re-shift their
manufacturing hub back to the U.S.

One of the biggest advantages of not exporting is the energy security for the
U.S. If the U.S. decides not to export and satisfy its own domestic demand, it
will become self-sufficient with respect to energy and it will also reflect in
its political leverage as it will no more be afraid of other countries cutting
off their oil and gas supply.

6. Key Takeaways and Conclusion

Shale energy extraction is a high risk, high return game. Risk is high because low oil
price makes shale oil extraction non-economical. Returns can be high if the U.S.
achieves energy independence and exports LNG to global gas markets. Saudi and
OPEC are betting on high stakes by not cutting oil production to sustain lower oil
prices ($40/barrel) to eliminate U.S. shale oil industry. OPEC needs a high price to
balance its budgets. By cutting prices, the OPEC nations are playing havoc with their
country budgets. Yes, Saudi, UAE, Kuwait have surplus cash reserves right now,
something they can bank upon in the years to come. But what about other OPEC
nations (Iran for example) that are not sitting on cash surplus! Perhaps this could
lead to a rift among OPEC members and finally dismantling of OPEC. At the global
front, Russia too is struggling with low oil prices coupled with the Rouble declining
in value. They no longer have the gas monopoly in the Asian markets. There is an
environmental concern that the fracking fluid, full of harmful chemicals, used in the
fracking process leaks into water tables.

On the subject matter whether the U.S. should allow LNG export or not, we are
recommending to take a conservative wait-and-watch approach. The DOE has
already approved ~10Bncf/d of LNG export this is approximately 15% of current
production. Any more export than this could create a shortage at home. The U.S.
should keep an eye on natural gas price impact at home and its consumption and
production pattern in the next 4-7 years as a result of the ~10Bncf/d export. In
addition, U.S. should also look out for a response by China and Russia. If additional
Shale discoveries at home are made in the near term future, and production
surpasses consumption even with the ~10Bncf/d export, then the U.S. can afford to
export more LNG.

REFERENCES
[1]http://www.chemistryviews.org/details/news/5754791/New_Ethane_Crackers_
Planned.html
[2] www.Platts.com/petrochemicals Can Shale gale save the naphtha crackers?
January 2013 By Jim Foster
[3] Summary of LNG Export Applications, Department of Energy, October 2013
[4] http://www.bloomberg.com/news/articles/2013-01-24/dow-chemical-fights-
ally-exxon-s-natural-gas-export-push
[5] Source Company website
[6] http://www.ft.com/intl/cms/s/0/a47a6efa-490e-11e2-b94d-
00144feab49a.html#axzz3RXftmLJi
[7] U.S. Energy Information Administration, Technically Recoverable Shale Oil and
Shale Gas Resources: An assessment of 137 Shale Formations in 41 Countries
Outside the United States, June 10, 2013
http://www.globalresearch.ca/the-fracked-up-usa-shale-gas-bubble/5326504