Shale Play

I just read an interesting interview from The Oil Drum with Matt Simmons, the president of Simmons & Company, Int’l, a firm that finances international oil and gas exploration. Simmons has given a number of prescient warnings about fossil fuel supply and price hikes. One thing he discusses is so-called shale gas. I’d like to discuss shale gas, its implications for our everyday lives, and the realities of the situation.

First, understand that an underground oil or natural gas deposit is not like a buried fuel tank. The resource isn’t in a big open pool. It’s more like an underground sponge, the sponge itself being rock and the pores filled with oil and/or natural gas. The bigger the pores in this sponge the more oil it contains per cubic whatever. The better connected the pores, the higher the permeability, and the more easily the oil or natural gas will flow through it to a drilled well.

The most commonly exploited oil and gas containing rock is sandstone. Here’s your insider term of art for the day: The unit of permeability of oil bearing rock is the Darcy. (Jane Austen would approve) An easy flowing sandstone formation in the Middle East might have a permeability between 1 and 5 Darcies. By comparison, a shale formation in the U.S. might have a permeability of 0.5 milliDarcies, or thousandths of a Darcy. Tough to pump gas through that. This used to be a huge barrier to exploiting shale gas.

The other barrier was the thinness of the shale layers. The Bakken Shale formation that underlies the north-central U.S. and southern Canada is about 200,000 square miles in size, but only 10 to 150 feet thick. Imagine a sponge about 1/16” thick and the size of two football fields and you’ll get an idea of the proportion. Drilling standard vertical wells into this was essentially useless. A few feet of the well would be exposed to nearly impermeable shale, yielding no commercial quantities of natural gas.

The two interlocking solutions to this problem are horizontal drilling and hydrofracturing. The drillers have figured out how to steer the drill bit so that they can drill down to the shale and then sideways through the thin shale layer, exposing more of the well to the gas bearing rock. Then they open up cracks in the shale by pumping a mixture of water and sand into the well under extremely high pressure, forcing apart the rock and propping the cracks open with the sand. The increased permeability means that the natural gas comes flowing out of the well at a commercially viable rate.

Here's an animation of horizontal drilling, minus the hydrofracturing:

There are problems with this. It is expensive. The price for a thousand cubic feet of gas has to be up around $6 or $7 for the drillers to break even. Right now, due mostly to the economic downturn, it is floating around half that. Also, the wells are short lived. Where a traditional gas well might produce at a viable flow rate for years, a horizontally drilled and “fracked” shale well might only last months. Then the well has to be capped, the area remediated, the equipment transported to a new site, perhaps only a mile or two away, and the whole process started again. Each well is a big faucet on a small bucket.

Here I’ll quote a section of the interview by Steve Andrews of ASPO-USA (Association for the Study of Peak Oil) with Matt Simmons, from the April 20 Peak Oil Review:

Q: My last question: have you been surprised by the gas industry’s growth in shale gas?

Simmons: I’ve been surprised by the hype that assumes there’s been major growth in shale gas. I don’t think there has been any data of any reliability that proves we’ve actually had the growth in shale gas that we think we have.

Q: Some people here in the industry in Colorado are promoting it big time. They see it as a game changer. Couldn’t they be right?

Simmons: I’ve never seen the industry hype something crazier. Here are some numbers that I find enlightening. Of all the shale plays, the only one that we have significant production history on is the Barnett Shale. In the Haynesville, I think there are around 20 or 30 well-tests so far, and I don’t know that there are that many in the Marcellus. Consider these figures in the March 22 Barnett Shale Newsletter. It shows Barnett Shale total natural gas production by year, 1982 to 2008, all counties and fields in the Fort Worth Basin. In 2004—3890, then 4973, then 6542, then 9180, then finally 12104; and I thought, gee, we increased production X%, but then I realized that’s the number of wells! In 2008, we went to 4.8 Bcf a day, from 3.56 the year before—or up 1.24 Bcf/day. We’re looking for an increase of 8 Bcf, according to the EIA numbers, so the Barnett Shale did 1/6th of that.

Here’s another interesting set of numbers. All the big natural players have all now reported their results. The top 10 players increased their production in 2008 over 2007 to the tune of 685 mmcf/day. Unfortunately that was mostly offset by the top 10 gas decliners, led by ExxonMobil, BP, ConocoPhillips, Chevron, RoyalDutch/Shell, Marathon, Newfield, Hess, and they dropped 601 mmcf/day. So we netted out a plus 84 mmcf/day. Then you have about another 800 coming from about 40 individual reporting companies, but none of them are big enough—even if they tripled their production—to really make a difference. So that means that to match the growth that the EIA believes happened, then the residue—these hundreds and hundreds of mom-and-pop operators—would have to have grown their cumulative production twice as fast as the top 10, which obviously didn’t happen.

The EIA started reading the hype. And even though they probably have been puzzled that the number of gas wells completed went from 8,000 to 10,000 a year up to last year’s 33,000, and all we did was tread water for nine years. So right at the end of the year last year they started showing month-to-month growth year-over-year of 5%. Then in January they knocked their model up to 9%, so every month it was up 9%, year-over-year. They just knew, because they read the hype. We won’t have any real numbers until the states report what they collect, in the 3rd quarter of 2009. But I think we have the numbers in [from the companies] to say that we barely grew supply. Too bad we destroyed the industry.

Barnett Shale also has a production profile where peak initial production happens virtually when you come on stream, because of the way you frac the wells. By the end of the first year you’re down 70%.

Q: So you thing that the shale gas story is the most hyped story…

Simmons: It’s the most hyped play since Kashagan, which was later derisively called “Cash is gone.”

So what does this mean for you? For a while a lot of people were thinking that our natural gas troubles had been pushed out a few decades into the future by a glut of shale gas. 52% of American homes are heated by the stuff. Most of the peak period electricity that we use comes from natural gas fueled power plants. The retail price of electricity faithfully tracks the price of natural gas. It seems that happy days are not here again on the retail electricity front. The price will stay depressed for a while, but once the economy starts to pick up the supply will tighten. There will be a lag while exploration and drilling try to catch up. As I noted in a previous post, there is roughly a two-decade lag between the discovery of conventional natural gas and its peak production.

The other important thing to consider is that companies are going after this stuff at all.

A few years ago there was a big hoo-ha over a well in the Gulf of Mexico called Jack #2, drilled in 7000 feet of water and through 28,000 feet of rock, which produced 6,000 barrels a day. A huge expense and brilliant technical feat to get 0.03% of our daily needs.

The shale plays are similar. Gas companies are spending big dollars on complex processes to extract expensive gas from marginal sources. It means that all the easy, cheap stuff is gone. It may be futile. In the end, geology trumps technology. Or, as Wendell Berry wrote, “Nature bats last.” So don’t bank on cheap natural gas or cheap electricity five years down the road, whatever the hype.

The debut of The Maven

Your Minor Heretic is a compulsive investigator. I tend to do research before I buy anything. I do more research than is really necessary or practical. I thought I should share some of the results of my efforts, if only to bring the overall utility in line with the labor expended. Check out the Maven link above for an ongoing look at the world of material goods.

Secrets and Rights

The Vermont House of representatives passed a bill granting marriage rights to same sex couples last Thursday. The vote was 94-52; not the two thirds needed to override Governor Douglas’s promised veto. No doubt the Governor’s mailbox is full these days.

The controversy has me thinking of two stories about people in my life.

Let’s call them Holmes and Watson. They were friends of my parents, and then friends of mine. They were part of my parents’ circle of friends, two of the usual suspects at a dinner or cocktail party. Their names went together in a guest list. “We’re having the Smiths, the Taylors, Holmes and Watson, and the Petersons.” They were in middle age when I first met them, a pair of solid citizens who ran a successful local business. They were involved in local politics and charity, volunteering and giving. They were both World War II veterans, which was how they met. They were not ostentatious about their sexual orientation, but they presented themselves to the community as a pair. They were together for over fifty years. When Holmes was in his mid-eighties he became ill and died. He and Watson had exercised enough forethought to put in place powers of attorney and living wills. Nevertheless, without that preparation, Watson would have had no inherent right to make those final medical decisions nor to bury his partner of five decades. They held up their end of the bargain, with each other and with the community. The community accepted them and respected them, but ultimately failed to do right by them.

Then there is my own maternal grandfather, who died a couple of decades ago. I was doing some genealogical research a few years ago and came up with the surprising fact that he was born into a Hasidic Jewish family. My mother was as surprised as I was. All we knew was that he had left his family at the age of 14 and made his way in the world. He had distanced himself from his family to the degree that my mother had never met them. He had gone to Yale, gotten a medical degree, and become a professor at the University of Virginia, marrying my grandmother in the late 1920’s.

I have never found out why he left his family and hid his origins. I have a theory, though. A smart young Jew never would have been allowed into Yale in that era, and probably never would have obtained a position at the University of Virginia. More importantly for my personal existence, he definitely would not have been allowed to marry a well-bred young woman from an old Virginia family. He had to remain closeted to the grave.

Throughout history couples have been barred from marrying because of religion, ethnicity, politics, and class. As I just pointed out, a religious difference that would be irrelevant today was, within living memory, an absolute bar to marriage. It is only in the past few decades that we have started to fully acknowledge our equality and change the law to match our new understanding. This latest law is part of that movement. The governor will almost certainly veto it, but he is pushing back against history. Someday people will look back at this with a kind of incomprehension, the way we might look at my grandfather’s secret life. It’s just sad that for some time yet we will fail in our responsibilities to our fellow citizens.

Governor Douglas’s contact page, by the way, is http://governor.vermont.gov/contact.html .

Update on Tuesday, April 7, 2009 at 3:14PM by Minor Heretic

Today the Vermont House overrode the Governor's veto by one vote, 100-49. The law takes effect September 1st. Equality under the law begins for all Vermonters this fall. The leaves will turn colors again - it will be a great season for weddings.

Simple Math

I just read an article in Harper’s Magazine by Thomas Geoghegan (Infinite Debt: How unlimited interest rates destroyed the economy) about uncontrolled interest rates and how they got us into the present financial crisis. Part of the thesis is tied to a principle of investment – return is linked to risk. Traditionally this is interpreted to mean that investors demand greater return from investments that have greater risk of failure. Thus, corporate bonds pay more than your federally insured savings account. It works the other way as well. Greater return promotes greater risk taking.

I did some simple math.

Imagine you have a bank and you issue ten credit cards with a 10% interest rate. Customers carry an average of $1,000 on their account. None of them defaults. You make $1,000 x 10 x 10% = $1,000.

Now imagine that you pull the usual credit card company sleaziness (shortening the grace period, for instance, or penalizing for a late payment on a different account) and nail all your customers with a 25% penalty rate. One of your customers can’t manage it and defaults. In this scenario you make interest on nine customers ($1000 x 9 x 25% = $2,250) and lose the $1,000 from your defaulter. Your total take is $1,250. You have a 10% default rate and you are making 25% more money. This pushes the practice of banking towards the same gambling ethos of venture capital investing. The rule of thumb for venture capitalists is that three out of five investments will go bust, one will hold its own, and one will gush enough profits to make up for the three failures. For banks, the short term income from penalty rates and fees more than makes up for the defaults, inspiring them to issue cards to anybody with a pulse. Damn the credit ratings, full speed ahead.

Of course, not all credit card holders are paying penalty rates, and a 10% default rate would be disastrous if it applied to all customers. In fact, default rates among credit card holders is climbing past 5%. Here is Geoghegan’s premise displayed perfectly. In the short run the credit card companies made out like bandits (which, in fact, they are). In the longer term they are experiencing a financial “tragedy of the commons” as consumers crumple under multiple credit pressures.

I’d like to revive a proposal from Anthony Pollina’s campaign for Governor of Vermont. The citizens of this small state pay out roughly $250 million a year in credit card interest payments. Some unfortunate people are paying those punitive rates. At the same time we are trying to deal with a state budget shortfall in the tens of millions. We should have a State of Vermont credit card, with the profits going into the general fund. Even if we charge a humane 10% it would still mean something like $100 million into the state coffers. Why should we make an interest payment to an out of state credit card company and then turn around and write another check to the state tax department? We could write both checks in one.

It would be a multiple win. Vermonters would save money on the combination of debt and taxes. Many would be spared those rapacious fees and interest rates. The budget gap would close and then some. The money would have a chance to stay in state.

I know, I know: politics. There will be a group of conservatives, and not-so-conservatives, screaming about socialism and big government, and letting private industry do its thing. Because private banks have been so smart and good, right? You love your 26% interest rate and huge penalty fees for being a day late. This is one of those situations where ideology trumps common sense and the common good. Our Republican governor would veto such a proposal. He seems to regard government as a publicly funded organization for serving big business.

I still think the idea has legs. The combination of tax and debt relief could have even the most ardent ideologue going over credit card bills with a thoughtful look. Political principle could yield, as it generally does, to the bottom line.

The Big Ponzi

 Bernie Madoff sleeps behind concrete walls now, separated from the $60 billion he stole from gullible investors. For those of you who were too busy watching your retirement accounts waste away or searching for a new job, what Madoff created was the classic Ponzi, or pyramid scheme. He established a plausible sounding investment fund and convinced people to hand him their money. He invested none of it, but paid off early investors with the investments of later investors. Those investors, in turn, received healthy returns on “investment” from later investors. And so on, till he got caught. He should have gotten caught earlier. A money manager named Harry Markopolos notified the Securities and Exchange Commission that the returns coming out of Madoff’s fund were mathematically impossible, but he was ignored.

Ultimately it would have all come to light, for that is the foible of a pyramid scheme – it can’t last forever. The person running the scam has to plunder an ever-widening circle of suckers to pay off the existing suckers. Eventually the scamster runs out of human beings with sufficient money and the flow of returns stops. Only the man in the cell knows what he intended to do at that point. Run for a non-extraditing country? Go into permanent hiding? Give himself up?

Madoff’s investment con, at $60 billion, has been called the biggest pyramid scheme in history. Not so. We are in the middle of a larger one, planetary in scope, and named for its scale: globalization.

The corporate giants of the world have taken advantage of an economic trifecta. Its three parts are:

• The post-WWII prosperity of the United States
• Cheap and safe trans-oceanic shipping
• The so-called Green Revolution, which applied petroleum to farming in the poorer parts of the world, increasing productivity per acre. Combined with commodity cropping it resulted in driving peasants off their land, creating a hungry, cheap industrial labor force.

The push of these factors, plus the pull of the re-regulation of the banking industry sucked investment out of U.S. manufacturing. The best way to make money, if you don’t give a damn about humanity, is to have impoverished people make things for you and then sell these things to relatively wealthy people who have borrowed money to buy them.

The U.S. trade deficit stands at about $700 billion per year, double what it was back in 2000. We borrow a Wall Street bailout every year overseas, mostly to pay for consumer goods, oil, and automobiles. Our total debt is about $6.5 trillion, with the interest payments amounting to roughly $2000 per American worker per year. Another decade of this and we’ll be $12 trillion in the hole. That is, if the Asians and the Arabs keep lending us money. At some point the U.S. foreign debt will get so ridiculous that we will be unable to support it. Like the Ponzi artist, we’ll run out of suckers. Except that we are the suckers.

Historical note: The British ran into this problem a couple of hundred years ago because of their national addiction to tea. (Also porcelain and silk.) They imported tons of the stuff from China, the world’s sole producer at the time. The Chinese imperial government wanted silver, and only silver, for their commodity. The British coffers were draining. Their solution was to promote the use of opium, grown in British-controlled India, in China. They created millions of Chinese addicts and accepted only silver for their commodity. The silver went back to England and was recycled to China for tea.

The international corporations that buy cheap and ship across oceans to sell dear have sold us on the idea that restricting imports is bad. Never mind that control of the flow of money, goods, and people across national boundaries is part of the basic definition of national sovereignty. It is called “protectionism” and it has acquired the 1950’s taint of “communism.” Better that we should go bankrupt as a nation than actually control our borders for our own benefit. I’m not advocating a cessation of trade, but a modification of trade rules that will eventually eliminate our trade deficit.

Radically improving our energy efficiency in terms of transportation and heating would cut our oil-based deficit, presently hovering around $300 billion. The roughly $325 billion we blow overseas annually on consumer goods would require changes in both domestic and international politics. We need to revamp farm subsidies in the U.S. back to price supports, rather than the present practice of forking over cash. That would stop the flood of ultra-cheap grain that puts small farmers around the world out of business and feeds the labor demand of sweatshops. (Side effect: a slowing of the flow undocumented workers, formerly farmers, from Mexico.) We should scrap the present General Agreement on Tariffs and Trade (GATT) and start over with something more beneficial to ordinary Americans.

There are a couple of things we could do to even the odds with the sweatshops of the third world. One would be a sweat labor tariff. We can estimate the advantage a country such as China or Malaysia gets by either having lax labor laws or unenforced labor laws. Let’s say that underpaying and overworking people in unsafe conditions gives them a 10% price advantage over a situation where their people earn a living wage in decent conditions. We should put a 15% surcharge on their goods so that fair wages and safe conditions are to their advantage. Many countries also have nonexistent, lax, or unenforced environmental laws, which give them an economic break. I’d advocate the same tariff format for that issue. China in particular has engaged in manipulation of its currency, pegging it to the dollar at an artificially weak rate. This gives Chinese goods the equivalent of a 40% discount and discourages imports into China. The Chinese government would fight hard to retain this advantage, and there is not much the U.S. can do by itself to combat the currency manipulation. China and the U.S. are locked in mutual dependency – they need our bottomless demand for consumer goods and we need their bottomless supply of loans.

There are three end games for the U.S. trade deficit. We could essentially go bankrupt when international creditor nations decide we are no longer financially sound. International trade could shrink dramatically due to energy costs and political instability. We could decide as a nation to stop participating in the global Ponzi scheme and restart the U.S. manufacturing sector. The second option could end up being the only option by petro-geological default. Still, it would be beneficial to develop the third option before we run out of energy or money.