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3.8.2011 New Drilling Technologies Shake Up Global Market

By Frank Dohmen, Alexander Jung and Jan Puhl

While the world fears a new oil price shock, the entire energy market is on the verge of a revolution. Companies are using increasingly sophisticated technology to tap new sources of natural gas. Drilling is also underway in Germany, where both the potential and the risks seem enormous.

It was May when globalization came to Lebien, a small town in Poland. The telephone rang and Elzbieta Religa answered. The caller said she represented Lane Energy, a subsidiary of a British company that invests in natural resources. She said her boss wanted to speak with Religa and told her that the company had found something interesting in the earth beneath Lebien's homes and farms.

Religa is a sturdy-looking farmer with three hectares (7.4 acres) of land, 20 hogs and three dogs. Lebien is in the northern Polish region of Kashubia, some 90 kilometers (56 miles) from Gdansk. The town has 960 inhabitants and only its main street is paved. Most of the houses were built by Germans before World War II.

"The woman said there's gas here," says Religa. "Thousands of meters below the earth, locked into the rock, but somehow they can get it out." Religa is currently serving her third term as the Soltys, or mayor, of Lebien. She invited the people from Lane Energy to a meeting at town hall. They arrived in small buses, managers and engineers, Americans, Britons, Canadians and one Indian. The guests paid for a lavish buffet.

The company built its first drilling rig a few months later. One evening, Religa saw a bright light on the other side of a forested area. Lane was burning off the first of the gas being pumped out of the well. The flames were as tall as houses.

Now the drill hole has been sealed with a head-high pipe and three valve wheels. Thanks to the gas, thousands of new jobs will soon be created in Poland -- and elsewhere.

Tapping Unconventional Sources

In many parts of the world, geologists are now testing the ground for natural gas trapped in shale (shale gas), sandstone (tight gas) or coal seams, gas that has been largely unreachable in the past. Using a new technology called hydraulic fracturing, or "fracking," a sort of controlled earthquake, companies are now bringing the gas to the surface all over the globe, in Australia, China, India, Indonesia, Latin America and Europe. The entire planet is being resurveyed.

The authorities in Poland have awarded 70 concessions for exploratory drilling in the last two years. The race for the best reserves is also in full swing in Canada, where the Chinese are leading the pack. The Chinese energy company PetroChina has just spent $5.4 billion (€3.9 billion) on a Canadian project.

In the United States, however, the natural gas revolution is the furthest along. Newly discovered reserves there are already being exploited.

About half of the natural gas consumed in the United States now comes from so-called unconventional sources. The country has already replaced Russia as the world's leading natural gas producer. "We have twice as much gas as the Saudis have oil," boasts Texan investor T. Boone Pickens.

The euphoria is being fueled all the more by current global fears of new oil price shocks. The crisis in the Middle East makes it painfully clear, once again, how dependent the world's economy is on petroleum reserves in the Arab world -- and how sensitively prices and growth react to any changes in the region.

When the unrest began in Libya, the international commodities markets fell into a panic within hours. The oil price, which had hovered around $80 to $90 for months, broke through the magic $100-a-barrel (159 liters) barrier within hours and peaked at about $117 on Friday.

This was not so much a factor of Libya being such an important supplier on world markets. What had traders and dealers so concerned and triggered worldwide panic buys was the fear that the crisis could spread to the United Arab Emirates (UAE) and Saudi Arabia.

Together, the UAE and Saudi Arabia are sitting on the world's largest oil reserves. Unrest with possible interruptions in delivery would drive the price of oil to astronomic heights. The most recent upturn in the global economy would come to a precipitous end -- yet again.
Since the last oil price crisis in the 1970s, the industrialized nations have been trying to reduce their dependency on oil from the OPEC countries, with moderate success.

The world's thirst for energy is massive, and there are few alternatives to oil. This could make the exploitation of the new natural gas reserves all the more important.

Part 2: Will Shift to Natural Gas Undermind Renewable Energies?

A revolution has gotten underway at a rate that has even surprised experts. US energy expert Daniel Yergin calls it "the biggest energy innovation of the decade." Today's estimates of the volume of gas reserves considered exploitable are several times higher than a few years ago, with prognoses ranging from two to six times as high as earlier estimates.

So far, though, engineers have not pumped a single cubic meter of gas out of the earth in most places, except in the United States. And even if the prospects are promising, there is always the risk that instead of encountering so-called "sweet spots," or locations with high concentrations of natural gas, engineers will hit "dry holes."

Nevertheless, the expectation is that the energy mix will soon shift significantly toward natural gas. In its latest global energy forecast, ExxonMobil predicts that natural gas will replace coal as the most important source of electricity by 2030.

A Cascade of Effects

And because only half as much CO2 is emitted during gas combustion as in coal combustion, the new boom will also have consequences for the world's climate, and for prices in the emissions trading market. The business of trading pollution rights will likely come under pressure, which in turn will affect renewable forms of energy. The cheaper CO2 rights become, the harder it is for electricity produced with wind power or solar energy to compete in the market.

Hence, the new global gas rush is also triggering a cascade of effects that will change the world energy market and radically change companies. Corporations like Exxon, BP and Shell, which have seen themselves primarily as oil producers for generations, are now investing billions in the gas industry.

Electric utilities like Germany's RWE have to consider whether it will even be economically viable to use coal to generate electricity in the future. And gas distributors like Germany's E.on Ruhrgas are asking themselves whether their old business models are still viable and what they should do to prepare for the new gas age.

A few weeks ago E.on Ruhrgas moved into its new headquarters building on the outskirts of the western German city of Essen: two glass towers connected by a glittering steel bridge. Maps are provided at the main entrance to help the roughly 2,000 employees find their way around. The company's strategists could use similar guidance, as Europe's largest gas distributor tries to find a way out of the crisis it faces as a result of the boom in unconventional sources of gas.

Excess supply is depressing prices, allowing Ruhrgas's competitors to undercut the German distributor. It costs Ruhrgas more money just to keep up. "The more cubic meters of gas we buy, the more we have to pay at the moment," says CEO Klaus Schäfer. The company recently lost €500 million ($690 million) -- in only two quarters.

Shakeup Expected in European Market

Schäfer has been at the head of Ruhrgas for only a few months. He was brought in to revive the business, but everyone knows that the days are gone when producers and distributors divided up the European market. Things will also change for consumers.

This is how the system has worked until now: The big European players, like Gazprom in Russia and Statoil in Norway, exploit their reserves and then transport the gas through thousands of kilometers of pipelines to deliver it to the border of Germany or other European nations. From there, distributors like Ruhrgas or Wintershall feed the gas into their networks and sell it to municipal utilities or industrial customers. It was a profitable business for everyone involved.

Prices were not even negotiated -- they were dictated. Long-term agreements were in place with terms of up to 40 years, and they were based on the so-called gas-oil price link, which means that gas prices follow oil prices, only with a few months' delay. The distributors added a healthy margin of up to 30 percent for the distribution, storage and sale of the gas. For a company like Ruhrgas, this meant that with its roughly €2 billion in annual profits, it was the most important subsidiary within the E.on group.

But ever since efforts began to tap the new gas reserves, such astronomical profits have been a thing of the past. For the first time, something resembling competition has developed in the gas industry.

The volumes being traded on the spot markets are getting bigger and bigger. New competitors are buying up gas at favorable terms, which benefits consumers, who can now choose from among an average of 31 gas providers, as compared with only eight providers two years ago. "It's a rapid development that's nothing short of a revolution for the international gas markets," says Ruhrgas CEO Schäfer.

Now he and his counterparts in the industry have little choice but to renegotiate the terms of their agreements with the producing companies in Moscow and Stavanger, Norway, in the hope of at least making up for some of their losses retroactively. This is no easy task. "There is no reason for price adjustments," says Gazprom Germania CEO Vladimir Kotenev, who points out that the excitement over the new reserves is temporary. The partners have made a lot of money together in the past, says the former Russian ambassador to Germany, and now they'll just have to "endure a dry spell" together.

Geologists have long known that much larger reserves existed in addition to the known, easily exploitable gas wells. The problem was that there were no technologies to extract the gas from the porous rock at a reasonable cost.

Part 3: Bad News for Russia

That has since changed. Today drilling companies can drive their wells thousands of meters beneath the surface, divert the drill heads and even continue drilling horizontally. The engineers can control their high-tech moles with such great precision that they can reach a target location, down to the last meter, even when it's eight kilometers (about five miles) away. Once the target has been reached, an armada of vehicles, the "frack trucks," is dispatched to the well site.

The trucks bring giant 2,400 horsepower pumps to the site, where about a dozen of these monsters are connected. They force a fluid mixture into the gas deposit at a pressure of about 1,000 bar. The mixture consists of millions of liters of water, special sand and chemicals, including toxic substances. Some of the chemicals are designed to kill bacteria that inhibit the flow of gas. The process produces enough pressure underground to fracture the rock.

This creates fine cracks, some of them hundreds of meters long. The sand keeps the fractures open, hence the term "fracking," or fracturing. The fluid is pumped out of the well and the gas escapes like carbon dioxide from a soft-drink bottle: powerfully at first, and then more slowly for several months until the pressure is so low that the fracking procedure has to be repeated.

It wasn't major corporations like Exxon, Shell and BP that developed this method, but small drilling companies funded by venture capital companies that believed in the revolution. They began drilling in Texas in the 1990s, in a formation called the Barnett Shale, now one of the largest natural gas fields in the world.

Today fracking is being used to pump natural gas out of about 3,000 wells in the United States, with 120 to 150 wells being added every month. "It's become (normal) manufacturing," says Andrew Ross, managing director of Elixir Petroleum. The actual procedure lasts only about a week, and then the fracking team moves on to the next on a long list of wells.

Production using this new method is generally more expensive than with a conventional gas well, but there has been some progress in bringing down costs. The drilling engineers at Talisman Energy, for example, managed to cut costs in half in the Marcellus Shale field in the northeastern United States.

Pressure Will 'Help Keep Prices Down'

With each new project, more and more gas floods into the market, which is already saturated today, as evidenced by price trends in the United States. Almost every other commodity has become more expensive in the last year, while the price of natural gas has dropped by 27 percent. And the pricing pressure could continue if the gas supply keeps growing, says John Corben of the International Energy Agency in Paris. "It will help keep prices down."

This is bad news for Russia. The Kremlin derives a large share of its national budget from the exploitation of mineral resources. The Russians have invested billions in the infrastructure needed to develop key markets in Europe for the long term. That infrastructure includes the Nord Stream pipeline through the Baltic Sea, which is slated to go into operation later this year.

The final preparations are now underway at the construction site in Lubmin on Germany's Baltic Sea coast. This is where the pipes emerge from the waters of the Bay of Greifswald, marking the end of the two 1,224-kilometer (765-mile) pipelines that were installed on the sea floor using special ships. Just past the beach in Lubmin, workers are building giant valves, each as tall as a two-story building. The valves will regulate the flow of gas in the future. Nord Stream is expected to supply about 26 million households with electricity and heat.

But whether the investment will pay off is still unclear. The old calculations, from the days when the gas-oil price link was still fully applicable, are now obsolete. Even less clear is the outlook for the two other major European projects: South Stream, which will link Russia with Europe farther south, and, most of all, for Nabucco, the European Union alternative, which will transport gas from non-Russian suppliers and is intended to make Europe less dependent on Russia. Companies within the Nabucco consortium are already in exploratory talks with the EU, with the goal of bringing together segments of the Nabucco and South Stream projects, currently competitors.

Will Poland Become Next Norway?

In addition to changing worldwide energy markets, the emergence of new gas sources is leading to shifts in the global balance of power. Indeed, the dominant position of classic production countries, especially Russia, could soon erode strongly. Poland, on the other hand, could become a relevant player in the global market. Polish Foreign Minister Radoslav Sikorski already envisions transforming his country into the "next Norway" -- rich, important and independent -- particularly of its giant neighbor Russia.

The United States, for its part, is on a sure path to becoming a self-provider and even exporter instead of a gas importer. The new developments will "significantly improve the energy security of the United States," raves President Barack Obama.

The world market is expanding, the selection is broadening and the consuming countries are becoming less dependent on the producing countries. Germany still gets 40 percent of its natural gas from Russia, but it is quite possible that more and more gas will be coming from the United States in the future. A gas rush has even erupted in Germany, a country with few natural resources.

About a dozen companies have already staked claims in the western states of North Rhine-Westphalia and Lower Saxony, where they are searching for economically viable deposits. The most promising site to date is in a field near Lünne, a town with a population of 1,900 in the Elmsland region.

Exxon has erected a massive drilling rig in a field where corn was growing a year ago. The energy company is pumping rock samples the surface from a depth of about 1,500 meters (4,920 feet). Its goal is to find out whether it is worthwhile to produce natural gas, using the new methods, in this region about 40 kilometers from the Dutch border.

Part 4: Is Drilling a Threat to Idyllic Landscape?

Workers in orange overalls are puttering around with the drill pipes. The men are engineers with a Scottish specialty company Exxon hired to sink the well, as the work is referred to in the industry. The teams work day and night. Floodlights keep the Lünne 1 site bathed in bright light.

"It looks like a football field here," says Markus Rolink. He and his wife and their three children live only a field away from the drilling site. The 37-year-old teacher at a special needs school, sporting an earring and a five-day beard, says that he hadn't planned to become politically involved again, ever since campaigning for the Green Party as a university student. But he changed his mind when he heard about the drilling plans.

Rolink is worried that this idyllic rural landscape could soon be destroyed, especially when trucks carrying chemicals start rumbling down the road to the drill site. He is also concerned about the possibility of future accidents. "Then we'll have plenty of energy, but no water," he says sarcastically.

'Who Will Want to Live Here Anymore?'

Rolink and his neighbors have joined forces and formed the Schönes Lünne (Beautiful Lünne) initiative. About 80 Lünne residents have come together for an evening meeting at a local farm, where they are sitting on wooden benches in a barn heated with a woodstove. They are watching a TV report about fracking in the United States that aired on German public broadcaster ARD. The film portrays people who could no longer sell their houses, polluted water and elevated cancer rates.

"Who will want to live here anymore?" a woman asks, breaking the silence after the film ends. A farmer says she is worried about her crops and wants to know what will happen if the fracking fluid leaks into the topsoil. "Who will liable?" The more the local residents discuss the issue, the more anxious and determined to resist gas drilling they become. "We have to think about ways to fight this," says one man. "All I can say is: Gorleben." He's referring to the controversial experimental storage site for nuclear waste in Germany.

Opposition to the gas industry's plans is taking shape, and not just in the Emsland region. In the neighboring state of North Rhine-Westphalia, where drilling companies are perforating coal seams to search for gas, citizens are organizing against the efforts. Many have seen "Gasland," the film by US director Josh Fox, who uses a suggestive style similar to that of filmmaker Michael Moore ("Fahrenheit 9/11") in his indictment of the industry.

In the most powerful scene in the film, Fox shows a man using a lighter to set the water coming from a faucet on fire. Fox claims that fracking has contaminated groundwater with toxic gas. It's a controversial charge, with US authorities insisting that the drilling cannot be blamed, at least not in this case. But despite its contradictions, Fox has made an impact with such images. He has alarmed citizens -- and the industry, now that "Gasland" was nominated for an Oscar in the Best Documentary Feature category.

Elixir Petroleum's Ross calls the nomination incomprehensible and says that the film really belongs in the comedy category. Energy in Depth, an industry association, even warned against awarding the Oscar to a film filled with such "mistakes, inconsistencies and lies."

'We Have to Answer Questions'

It's up to the industry to take the initiative and explain the technology, says Bruno Courme, managing director of Gas Shales Europe, a subsidiary of French energy conglomerate Total. "We have to answer questions," he says. And there are many of them.

One is about the ingredients of the fracking fluid that's injected into the rock. Even more important: How contaminated is the sludge that shoots back up to the surface? And how is it properly disposed of? The wastewater contains large amounts of salt, and it often contains benzene, xylene and toluene, all highly toxic substances that could contaminate groundwater.

The gas industry's engineers insist that contact with groundwater is highly unlikely, because the layers of rock containing the gas are so much deeper. But they do admit to other potential weak points, for instance, when the steel pipes in the borehole are not properly cemented together. The US environmental authorities have documented a number of such accidents, in which wastewater has harmed the environment.

Not everything is going swimmingly in the German gas production industry, either. In Söhlingen, where Exxon is producing natural gas, wastewater containing toxic chemicals was leaked from the site about three years ago. Citizens' initiatives have since demanded that the authorities tighten their inspection regimens. Many regulations of Germany's outdated mining law are not relevant to the new technologies.

Green Party members of the German parliament, the Bundestag, want to change this. "Citizens need to be more involved," says Oliver Krischer, the party's energy policy expert. The North Rhine-Westphalia state government is also pushing for a revision of the law and plans to launch an initiative in the Bundesrat, the upper legislative chamber that represents Germany's states.

One way or another, it will take years before the data from the exploratory drilling have been analyzed and producers have decided whether the German sites are worth exploiting. Only one thing is clear, namely that gas's share of the energy mix worldwide will keep on growing and the fuel will become more important, which will also have consequences for the gas supply in Germany. "Precisely this circumstance opens up new possibilities," says RWE executive board member Leonhard Birnbaum.

In all likelihood, gas-fired power plants will become increasingly common, replacing old coal plants. They would be the ideal supplement to a fluctuating flow of energy from renewable sources. Gas also offers new prospects as a fuel. Logistics companies in the United States are already thinking about converting their fleets to natural gas. The old postulate that natural gas is too valuable to burn is no longer true.

"A lot of things that didn't make much sense a few years ago" says Ruhrgas CEO Schäfer, now have to be "reevaluated." Apparently, this also holds true for the national energy plan the German government unveiled last fall. Natural gas plays only a secondary role in the document, because the experts had based their assumptions on higher prices and smaller reserves.

In the end, issues of geology are probably not as likely to hold up the gas revolution. The biggest obstacle, says London antitrust expert Alan Riley, lies in the question of whether society will accept unconventional drilling for natural gas --- and, of course, whether the gas price will decouple itself from the oil price in the long term.

Ruhrgas CEO Schäfer, at any rate, is convinced that the trend "is unstoppable, especially given the current price developments in the oil markets."