In 2011 the US installed a record 1,855 MW of solar panels, while total US wind turbine capacity recently passed the 50,000 MW milestone for the first time.  Yet despite these impressive gains, wind and solar power, together with geothermal and other "non-hydro" renewables,  accounted for less than 5% of US electricity generation last year and only 2% of primary energy consumption, compared to 62% for oil and natural gas combined.  The global energy mix depicted in the pie chart below reflects similar proportions.   This helps explain the continued emphasis by companies and investors on developing new oil and gas technologies and resources, despite strong regulatory and incentive support from governments around the world for renewable energy solutions.

Oil and gas still enjoy inherent advantages, compared to other technologies.  Foremost among these are energy density, deliverability and ease of storage.  For example, the 9.3 gallon gasoline tank of Chevrolet's Volt range-extended electric vehicle holds nearly 20 times as much chemical energy as its 16 kilowatt-hour battery pack and can be refilled in under three minutes, compared to 4-10 hours for the latter, depending on supplied voltage.  Meanwhile, both oil and natural gas can be transported across continents and oceans by pipelines and tankers, or stored for extended periods in above- or below-ground facilities.  By comparison, the transmission, integration and storage of the electricity produced by many renewable energy technologies pose greater challenges.

Renewables have a number of attributes that complement oil and gas within an overall energy portfolio, particularly in terms of sustainability.  However, with the exception of biofuels, which face other obstacles, they are not yet effective substitutes for them on the required scale. The output of wind and solar power depends on natural flows that are available much less than half the time, nor can it be stored easily or, in most cases, cost-effectively. The best wind and solar resources are often far from the markets to be supplied, requiring expensive and often controversial transmission lines.  Distributed solar power avoids some of these problems but still requires grid-based backup generation, which increasingly relies on fast-reacting natural gas turbines.

Biofuels have been the most effective oil substitutes, so far, but food-crop-based fuels such as grain ethanol and biodiesel produced from oilseeds or animal fat cannot yield sufficient quantities to replace oil at current consumption rates.  Such biofuels currently account for just 2% of global liquid fuel supply. Even Brazil produces much more oil than ethanol.  Advanced biofuels from non-food sources such as cellulose or algae show great promise but have not yet been produced in truly commercial quantities.  Their value chains also pose new challenges, including the handling of enormous quantities of diffuse biomass and their requirement for relatively large land footprints.  As a result of all these limitations, the global transportation sector will likely be dominated by petroleum for many years.  The International Energy Agency projected last year that fossil fuels will still account for 75% of global energy in 2035.

For at least the next several decades, renewables and oil and gas are likely to coexist in an expanding energy market in which the needs of developed country consumers must continue to be met, albeit more efficiently, at the same time that developing country demand grows and increasing numbers of currently unserved customers gain access to energy.  Meeting these diverse needs affordably and in an environmentally acceptable manner will require the contribution of energy sources of all types, including oil and gas from reservoirs that are just now being discovered or accessed using new techniques.

Oil exploration used to be a high risk and high reward industry. Investing millions of dollars in projects that had a possibility of absolutely no return (the infamous “dry hole”) required a gamblers mentality that to a large degree is no longer present in the onshore US oil and gas business anymore. As the number of colorful wildcatters has declined, the oil industry has become more institutionalized.  The reason this has occurred in a large part is due to the change in how the industry quantifies or views risk. 

When developing an onshore project, there are 3 main reserve considerations that management reviews before approving any well. The three risk factors are Pg, Pm, and possible recoverable reserves. Pg is the chance that you will locate a reservoir with hydrocarbons present in it. This number in the past could vary widely even sometimes going as low as 20%. Of course, if you were drilling wells with such high chances of failure, you needed to have a large possible recoverable reserve value allowing you to hit a “gangbusters well” with huge amounts of oil and gas in it. Generally, these types of high risk and reward wells would be drilled in multiple well packages to allow you to have a managed portfolio risk. Although, often times, someone would come up with a unique target drilling program and sell it to a group of oil and gas investors and “prospect” it out. This type of investment appealed to a large number of high net worth individuals since essentially you were engaging in a treasure hunt 1 to 4 miles under the earth. The final risk factor is Pm which is the risk of not having a mechanical failure (drilling a well which has a producible pathway for the hydrocarbons). There is always a risk of mechanical failure in any oil and gas operation due to the complexities of targeting reservoirs at high temperatures, pressures, and depths.  This risk was especially true when you were drilling a well in a new area you have never done before (the” true wildcat”).

Nowadays, the game has changed.  With the development of resource plays (see my first post) , Pg has become almost 100%.  Statistically, it is almost impossible to have a dry hole in a resource play since you know the oil and gas is always going to be there. The Pm factor is also 90% or even greater. Due to the repeatability of resource plays, the drilling & completion program has to manage with less risk and has transferable knowledge to be improved upon from previously drilled wells.  The one downside of resource plays is that the wells don’t necessarily produce as much as wells drilled in the past. However, there is a level of consistency present which results in more stable profitability and returns. Most importantly, operators are able to optimize reducing drilling and completion costs over time of individual wells and increasing reserves as they learn what factors are important in each reservoir.  Operators are able to deploy large multi-billion dollar capital programs and numerous rigs on a scale that was not possible in the past due to the repeatability of these resources. The effect of this can be seen in the large increase in natural gas and oil production the US has been experiencing over the last few years (as discussed by Geoffrey Styles, in the previous post).

In conclusion, although the elephant hunt of the past might be over in the US, the advent of resource plays has guaranteed the US a long and stable supply of energy. It makes for a little bit less of excitement, but when your money is involved that is probably for the best.

The epicenter of the global shale energy revolution is in the US, where shale gas now supplies roughly 30% of the country's natural gas demand and more than 7% of its total energy needs, while shale oil--also called "tight oil"--has helped reduce US oil imports.  However, this US lead mainly reflects the head start provided by the early application of key innovations to large deposits like the Barnett and Marcellus shales, which are becoming household names.  These factors don't guarantee the US a permanent edge in either shale reserves or output, because the geological distribution of shale gas and oil is very much global, as indicated in this 2011 Energy Information Agency map, which covered less than half the world's countries.  China's offer this week of 20 shale gas exploration blocks for lease comes on the heels of earlier estimates that China holds 25 trillion cubic meters (TCM) of shale gas, or 883 trillion cubic feet (TCF),  and potentially as much as 36 TCM (1,271 TCF).  Either figure puts China at the top of the global shale resource league table. 

In some respects, shale energy could be even more transformational in China than in the US.  Consider that shale gas emerged in America just as the economy was entering a recession.  GDP and demand for energy in all its forms have remained weak, forcing shale developers to capture market share from other suppliers.  Many of the gains made against coal and other sources of electricity came as a result of slumping natural gas prices, as supply exceeded demand and gas imports were squeezed out of the market.  Moreover, pipeline natural gas, whether from shale or conventional wells, is no novelty in the US, having accounted for one-fifth to one-fourth of total energy consumption for six decades.  It is a major energy source for the residential, commercial, industrial and utility sectors, though it occupies only a tiny niche in transportation.  US shale gas is likely to continue to displace other fuels at the margin, but it remains to be seen to what extent it will fuel growth outside gas's long-established roles. 

By contrast gas accounted for just 4% of China's total energy consumption in 2010, according to BP's annual Statistical Review, compared to 70% for coal, 18% for oil, and 8% for hydropower, other renewables and nuclear power combined.  China's official GDP growth target for 2012 is 7.5%, slower than in recent years, yet still robust compared to the OECD countries.  Even with China's commitments to improve the energy intensity of its economy, that economic growth will translate into substantial energy demand growth. Shale gas stands to capture large portions of that growth, if developers can achieve well productivity comparable to US shales and attract the infrastructure investments required to deliver the gas to market.  And with the environmental drawbacks of China's coal dependence becoming increasingly apparent, shale gas could materially improve both air pollution and greenhouse gas emissions in the world's largest energy consuming country. 

China won't be the only country seeking to apply the shale extraction techniques perfected in the US to their own enormous, untapped resources.  South Africa, with technically recoverable shale gas resources estimated to exceed Canada's, just lifted its moratorium on shale exploration.  Meanwhile, Ukraine, with Europe's third-largest shale gas resources, earlier this year chose Royal Dutch Shell and Chevron to explore two large shale prospects and was reportedly considering another tender for this month.

Developing China's shale resources won't be easy, as the Financial Times noted on Tuesday.  China-based companies have invested in shale plays outside China partly to gain expertise, while also inviting foreign companies to participate in China.  The combination of horizontal drilling and hydraulic fracturing that has been so successful elsewhere must be adapted to the different geology of China's shale deposits.  Just as importantly, drillers must adapt the shale business model to an environment with regulations, legal system and property rights quite different from the unique mix of state-level rules and privately held mineral rights that prevail in most of the US "shale patch."  None of this looks insurmountable, and the potential prize is large enough to keep all parties focused on making progress.