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ENERGYFINANCIAL TIMES SPECIAL REPORT | Tuesday June 28 2011

www.ft.com/energy-june2011 | twitter.com/ftreports

In December last year, Gen-eral Electric announced itwas buying Wellstream, theworlds second-largest sup-plier of flexible pipes for theoil and gas industry, forabout 800m ($1,300).

The deal capped months

of pursuit by GE of the UKcompany during which itwas twice rebuffed.

For GE, which has identi-fied energy services as akey area for investment, itsdogged pursuit was worthit, as Wellstream had twoattractions: its technologyand a significant presencein Brazil, one of the newfrontiers of oil exploration.

The acquisition, among aflurry of others in the oiland gas services sector overthe past 12 months, sig-nalled not only that there isample growth in the sectorbut that, despite BPs spillin the Gulf of Mexico, deep-water drilling had not suf-fered a prolonged down-turn, as many analysts hadfeared would happen.

The search for resourcesis taking big oil companiesinto the deep water in coun-tries such as Brazil, as well

as other areas that involvecomplex drilling.

Unconventional drillingtechniques are also in focusin the wake of the develop-ment of shale gas in NorthAmerica.

The demand for bettertechnology, combined withan industry that is flushwith cash because of highoil prices analysts expectthe five largest publiclylisted oil companies aloneto plough a record $128bninto capital investment thisyear means service com-panies are in demand.

Tighter regulation andincreased costs after the BPaccident are also expectedto increase demand forthese companies services,in particular those withmodern fleets of deep-waterrigs, such as Pride Interna-tional of the US and SeaD-

rill, the Norwegian drillingcompany, which commandhigher rates than shallow-water rigs.

The new regulationscould make it harder forsome smaller service com-panies to compete.

Christopher Pilot, manag-ing director, head of EMEAoilfield services coverage atGoldman Sachs says: Aslong as the o il p ri ceremains above $70-$80 a bar-rel for Brent crude, servicecompanies should do well as the price dips belowthese levels, internationaloil companies start debat-ing capex versus dividendreductions . . . capex tendsto lose out.

The increasing demandand high crude prices areunderpinning merger andacquisition activity.

In February, Ensco pro-posed to buy Pride Interna-

tional for $7.3bn in cash andstock to create the worldssecond-largest offshoredriller after Transocean.

The deal followed a stringof smaller transactions,including GEs purchase ofWellstream, Seadrillsacquisition of Scorpion Off-shore and Noble Corpora-tions of Frontier Drilling.

Mark McComiskey, man-aging director at FirstReserve Corporation, theprivate equity group thathas invested more than$3bn in oilfield servicesover the past five years,says there is strongdemand for rig businessesand equipment and servicesbusinesses.

Last year, First Reservesold Dresser, a Texas-basedmaker of gas engines usedto power oil and natural gasproduction, to GE.

First Reserve, adds Mr

McComiskey, is looking atseveral areas to invest,including unconventionalgas in North America, inparticular companies withservice expertise that can

Highcost ofoil givesboost toservices

M&A

Spare cash and tighter regulationare leading tomore consolidation,says Sylvia Pfeifer

At the start of this year,US motorists weregrumbling about payingmore than $3 for a gal-

lon of petrol. The culprit was thehigh price of oil, which was trad-ing close to $100 a barrel.

Before last Thursday, the priceof a barrel of Brent crude hadsoared close to $120 a barrel having peaked so far this year at$127.02 a barrel in April andthe price at the pump was touch-ing $4 a gallon

The lesson for consumers isinescapable. Energy, from thepetrol that drives our cars to theelectricity that powers ourhomes is likely to get ever moreexpensive.

It is a lesson that has alreadybeen heeded by western govern-ments, which last Thursdayreleased the biggest amount ofoil from their emergency strate-gic stocks since 1991.

The International EnergyAgency (IEA), the advisory bodyfor western countries, agreed torelease 60m barrels of oil in thecoming month to offset thedaily production loss of 1.5m bar-rels of oil from Libya, the northAfrican country engulfed in civilwar.

The surprise announcementsent Brent crude prices tumblingto $108 a barrel on the day.

The move, only the third suchin the history of the IEA, whichwas established in 1974 as acounterbalance to Opec after theArab oil crisis, underlined howconcerned western governmentshave become about the impact ofhigh crude prices on the eco-nomic recovery.

The IEAs twitchiness is under-standable.

The two events that have dom-inated the energy world in thepast two months, a crisis at aJapanese nuclear plant and the

ongoing civil unrest in the Mid-dle East, have driven home thepoint that energy is becomingmore expensive.

The events in Japan and theMiddle East helped trigger theshort-term jump in prices thatangered US drivers, and put aquestion-mark over long-heldassumptions about the sourceand cost of energy supplies.Despite the wests attempts tocurb its appetite for power, there

is no sign of global demanddiminishing.

If anything, the world isbecoming more hungry forpower, according to ChristofRhl, chief economist at BP,with global consumption growthlast year at its highest since1973. China accounted for 20.3

per cent, surpassing the US tobecome the worlds biggest con-sumer of energy.

Bob Dudley, BP chief execu-tive, drove the point home to anaudience in London last week,noting that on current trends,we believe the world will requireabout 40 per cent more energy in20 years time than it consumestoday. He added: Thats basi-cally two more United States. Ortwo more Chinas worth of con-sumption.

The IEA forecasts that globaldemand will grow 36 per cent by2035, forcing governments todiversify their energy mix andenhance sourcing security.

Questions are also being raisedover the viability of some of thealternatives to fossil fuels.

The near meltdown at theFukushima Daiichi nuclear plantin Japan after a devastatingearthquake and tsunami hasforced governments to re-assesstheir commitments to nuclear

power and how to plug anysupply gaps that might resultfrom changing course.

One of the most radicalresponses to the crisis has beenin Germany, where the coalitiongovernment of Angela Merkelabandoned a planned extensionof the countrys nuclear reactorsand reverted to shutting themdown by 2022.

The decision constitutes one ofthe biggest bets made by anadvanced industrial country onrenewable energy.

Under the plan, eight reactors,or 8.5GW of capacity and about 8per cent of Germanys annualelectricity production, will beclosed permanently this year.

It also commits Europes larg-est economy to doubling itsenergy from renewable sourcesto 35 per cent this decade.

Most experts believe Germanywill be able to meet the energydemands of its citizens but doubt

its ability to meet tough domes-tic climate change targets, to cutcarbon emissions by 40 per centby 2020 compared with 1990.

While more power from renew-ables may be the ambition, inthe short to medium term, natu-ral gas is emerging as a winnerfrom countries plans to scaleback their nuclear power.

Analysts at Deutsche Bank, forexample, expect emissions byGermanys power sector to rise

by 370m tonnes between 2011 and2020 as a result of the increaseduse of gas and other fossil fuels.

The IEA has cited slowergrowth in nuclear power afterthe recent events in Japan asone of the factors behind newestimates suggesting the worldcould be entering a golden ageof gas.

According to the agency, theuse of natural gas could rise by

more than 50 per cent by 2035from last year.

Industry executives have wel-comed a more prominent role fornatural gas in the energy mix.

Malcolm Brinded, executivedirector of exploration and pro-duction at Royal Dutch Shell, theAnglo-Dutch company, told aconference in the Netherlandsthis year that gas is abundant,acceptable and affordable.

Gas, he added, was a destina-

tion fuel, not simply a transi-tion fuel on the way to a low-carbon future.

For the worlds large inte-grated oil and gas companiesthese developments are goodnews. Shell, for example, willproduce more gas than oil fromnext year.

The industry is awash withcash, thanks to high oil prices,with analysts expecting the topfive international listed compa-nies to spend $128bn on capitalinvestment this year alone.

The one challenge for theindustry is growth. The majorscontinue to struggle to replacetheir production reserves suc-cess in exploration is vital.

In some cases their spending ispaying off. ExxonMobil an-nounced this month it had madetwo significant oil discoveriesand a gas discovery in the deepwater of the Gulf of Mexico. Weestimate a recoverable resource

of more than 700m barrels of oilequivalent combined in ourKeathley Canyon blocks, saidSteve Greenlee, president of Exx-onMobil Exploration at the time.

The likely reliance on fossilfuels in the medium term meanstargets for the reduction of car-bon dioxide emissions will beharder to achieve. The jump ingas usage will help reduce airpollution in many cities, in par-ticular in China, and cut the use

of coal, but it could lead to a

global temperature rise of 3.5C,according to the IEA.

While natural gas is thecleanest fossil fuel, it is still afossil fuel, says Nobuo Tanaka,chief executive of the IEA.

Its increased use could mus-cle out low-carbon fuels such asrenewables and nuclear, particu-larly in the wake of the incidentat Fukushima . . . An expansionof gas alone is no panacea forclimate change, he adds.

Mr Rhl says strong demandand increased use of fossil fuelsis bad news for carbon dioxideemissions from energy use.

Today, renewables account foronly a small proportion of sup-ply. According to BP, wind,solar, geothermal and biofuelsused for power generation andtransport contributed about 1.8per cent of global primaryenergy supply last year. Chinabecame the largest windpowergenerator, overtaking the US and

accounting for 48 per cent of allnew capacity.However, there is room for

optimism, as more of the energycoming onstream is from renew-ables. Over the past 10 years,their share has almost trebled,says Mr Rhl. Over the pastfive years, their contribution tothe growth of primary energywas almost 10 per cent, higherthan the growth contribution ofpetroleum-based products.

Building a pipeline to theUS from Canada to bringfuel from that northernneighbours vast tar sandsoperations should be aneasy feat to accomplish.

Not only is the US desper-ate for fuel, but Canada isstable and friendly.

Its fuel will be cheaper toimport than that of far-offnations and its stabilitywould ensure a steadysource of supply. On top ofthat, two such pipelinesfrom Canada already havebeen built.

Indeed, Jim Vines, part-ner in the energy environ-

mental practice at King &Spalding, an internationallaw practice, believes it willbe tough for the US Depart-ment of State to say thisthird pipeline, Keystone XL,is so different.

Denial of this permit bythe US would be vulnerable

to a serious challenge in the

World Trade Organisation,he says.

But the Keystone XLpipeline is not only subjectto criticism by environmen-talists about the import ofthe high carbon fuel.

A series of spills from thefirst Keystone pipeline ledUS authorities to suspendits operation temporarilythis summer. The timingcould not be worse forTransCanada, the pipelineoperator, which is waitingfor the state department todecide by year-end whetherto let it progress with itsKeystone XL extensionpipeline.

TransCanada needs toensure the pipeline is safe,secure and can operatewithout the risk of leaks,says congressman EdwardMarkey, the top Democraton the Natural ResourcesCommittee of the House of

Representatives.These concerns need to

be fully addressed, as theadministration and statedepartment evaluate theKeystone XL project.

TransCanada was able toobtain approval to restartits Keystone pipeline in a

few days and points out

that the last incident, at apumping station in Kansas,had involved less than 10barrels of oil.

Almost a ll the o ilreleases over the past 12months on Keystone havebeen minor averaging justfive to 10 gallons of oil,says Russ Girling, Trans-Canadas president andchief executive.

The vast majority of thatoil was confined to ourproperty and in all caseswas cleaned up quickly.

None of the incidentsinvolved the pipe in theground the integrity of

Keystone is sound.But that the first Key-

stone has suffered 11 spillsin its first year is a worryfor environmentalists.

Susan Casey-Lefkowitz,director of the internationalprogramme at the NaturalResources Defense Council,

an environmental group,

notes the highly corrosivenature of bitumen, which iswhat the tar sands are com-posed of.

This is a concern, shesays, because Keystone XLis to cross the OgallalaAquifer, a freshwatersource for eight states.

The Keystone XL is a2,673km, 0.9m crude oilpipeline that would start inAlberta and extend south-east through Saskatchewan,Montana, South Dakota andNebraska.

It would incorporate aportion of the KeystonePipeline that runs throughNebraska and Kansas toserve Oklahoma, beforecontinuing, to serve thePort Arthur market inTexas.

Ms Casey-Lefkowitz saysthe Keystone XL pipeline isredundant, because thereare already the first Key-

stone and the Alberta Clip-per pipelines bringing tarsands fuel into the US.

Its not necessary forenergy security, she says.Bringing this oil across USheartland, farms and theOgallala Aquifer is a realdanger for communities.

A growing number ofenvironmentalists and localofficials also object to thehigher carbon content of tarsands fuel.

The mayors of 25 townsand cities wrote a letter onMarch 24, to Hillary Clin-ton, secretary of state,expressing grave concernsabout expanded tar sandsoil imports.

Specifically, we are con-cerned about the impacts ofthe proposed Keystone XL

pipeline that would trans-port tar sands oil fromAlberta to Texas, increasingour dependence on thishigh carbon fuel for decadesto come, at a time when we,as local governments, areworking hard to decreaseour dependence on oil.

Nonetheless, some sup-porters of Keystone XL saythe carbon footprint will beless if fuel is exported tothe US in a pipeline ratherthan shipped in a tankeracross the ocean to China.

Kenneth Medlock, energyexpert at Rice University,says there is a projectunder way to export thefuel to the Pacific Basin.

The protests are notgoing to stop tar sandsdevelopment, Mr Medlock

says. You have to think ofthe world as one big bath-tub. It doesnt matter whichend of the tub you fill from,as long as you are addingsupply. The oil is going toflow.

That said, it is uncertainwhether that oil will flow

through the plannedEnbridge Northern Gate-way pipeline system aimedat taking some to alterna-tive markets.

That pipeline, whichwould run 1,170km fromAlberta to a new port inKitimat, on the coast ofBritish Columbia, has alsomet fierce opposition.

Mr Vines focuses his com-ments on Keystone XL: Inthe US, big energy projectstend to go through a

lengthy regulatory processand a lengthy litigationprocess.

If the Canadians havethe perseverance to workthrough these two proc-esses, which I think theydo, the pipeline will getbuilt.

Third pipeline from Canadaawaits crucial US decisionOil sandsSheila McNulty onconcerns over leaksand the impact on the environment

West takes

action onprices andsupplyA move by consumernations to release oil from their strategicstocks has helped coolthe market down, fornow. Sylvia Pfeifer

surveys the situation

Inside this issueUK emissions Mixed reviewsfor coalition sustainabilitypolicies swift progress isrequired if targets are to be metPage 2

US oil recovery Hydraulicfracturing (using fracking fluid,below) and horizontal drilling areexpanding supplies Page 2

Australian LNG Franticinvestment is spurred by Asiandemand Page 2

Renewables policy Solarindustry feels chill of UK cutsPage 2

Shale gas in EuropeRegulators must balanceenvironmental and energy supplyconcerns Page 3

China There is no need tobe unconventional yet.Conventional assets arestill young, productive andcapital-efficient Page 3

The Arctic If there is oil, it willbe surprising if humanity showsthe restraint not to use itPage 4

Line from the sands: Canada is stable and importing from there cheaper TransCanada

The protests arenot going tostop tar sandsdevelopment

In deep again: ExxonMobil this month announced two significant oil discoveries and a gas discovery in the Gulf of Mexico

Continued on Page 4

8/2/2019 FT Energy July

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2 FINANCIAL TIMES TUESDAY JUNE 28 2011

Energy

Frantic investment spurred by Asian demand

On a remote and ecologi-cally sensitive island offWestern Australia, one ofthe worlds most ambitiousenergy projects is beingbuilt. It is hoped it willtransform the country intoa natural gas exporter torival market leader Qatar.

The Gorgon liquefied nat-ural gas (LNG) project onBarrow Island, operated

and half owned by Chevronwith large minority stakesheld by ExxonMobil andRoyal Dutch Shell, is beingdeveloped at cost of A$43bn($45.5bn) making it Aus-tralias largest single-resource project.

Gorgon may be the big-

gest but there are at least adozen more LNG projects,including Browse, Preludeand Wheatstone that areeither under constructionor in advanced planning.

The frantic pace of invest-ment in the Australian gasindustry by many of theworlds biggest energygroups has been spurred byrising energy demand inAsia, led by China, Japanand South Korea.

We have a resource basein a really good neighbour-hood, said John Gass, pres-ident of Chevrons gas unit,on a recent trip to Aus-tralia. Australia is the epi-centre for Chevrons natu-

ral gas portfolio.That i s impor tant

because the Asia-Pacificmarket has the highestgrowth. It is expanding atseveral times the rate ofother regions, he adds.

The latest World EnergyOutlook from the Interna-

tional Energy Agency fore-casts that Chinas demandfor natural gas could rise by5.9 per cent a year between2008 and 2035, comparedwith a 0.5 per cent annualrise over the same periodfor nations in the Organisa-tion for Economic Co-opera-tion and Development.

At that rate, China willaccount for 8.7 per cent ofglobal gas consumption by2035, compared with 2.7 percent in 2008.

Australia is regarded as asafe investment destinationin spite of Canberras high-profile battle last year withmining groups over aresources rent tax.

It is also well placed inthe Asia-Pacific region toservice the needs of Chinaand other big customers.

Japans strong interest inAustral ian LNG hasincreased further in thelight of a review of itsenergy strategy after the

Fukushima nuclear acci-dent. This could spurJapans Inpex to give thefinal go-ahead for its Ich-thys project in WesternAustralia this year.

The world gas industrywas given a further boost inMay, when Germany said it

planned to close its 17nuclear power plants.

Craig McMahon, a Perth-based analyst with WoodMackenzie, the industryconsultancy, is scepticalwhether all the projectsbeing planned in Australiawill reach fruition and

believes some competingventures will merge.

There is a huge upsurgein projects, but it is highlyunlikely that Australia willbe able to deliver all toschedule. The projects willbe operating within the con-fines of the [national]labour market.

The more advancedprojects have the best pros-pects, he believes. Gorgonhas first mover advantage,he says, but the sheerscale of the project and theenvironmental provisionsmakes it a real challenge todel iver on t ime andbudget. But Gorgons back-ers believe that 18 months

into its construction phasethe project is on target toship its first gas in 2014.

Chevron argues the chal-lenges of the project, whichinclude laying hundreds ofkilometres of pipes on theocean floor to carry gasback to the island for

processing, are on a parwith the building of theChannel tunnel.

Some 90 per cent of Chev-rons share of Gorgon gashas been presold to Japa-nese and South Koreancustomers under long-termagreements, while Exxonhas struck a deal withPetroChina for its portion.

This investment is sohuge that you would haveto have confidence in theofftake [gas supply agree-ments concerning futureproduction], says RoyKrzywosinski, head ofChevron Australia.

In another sign of howgas is shaking up big

energy groups, Chevron hasalso forecast that by theend of the decade naturalgas will account for 40 percent of its oil and gas port-folio, from about 30 per centnow.

That is largely driven bywhat is happening in Aus-

tralia, Mr Krzywosinskisays.

To date, Australia hasonly two producing LNGprojects, the Woodside-oper-ated North West Shelf andConocoPhilips Darwindevelopment, with a third,Pluto another Woodsideproject due to deliver itsfirst gas later this year.

There are also at leastfour coal-bed methane toLNG projects being devel-oped in Queensland in theeast of the country thathave been formally sanc-tioned or should be soon.

As projects come onstream, the Australian gassector should lose its repu-

tation for not always livingup to its promise.

If output grows from thecurrent 15m tonnes a yearto more than 70m by theend of the decade, as ana-lysts expect, it will secure aposition as one of theworlds leading producers.

Australian LNG

Peter Smith looksat the prospects forambitious projects

There is a hugeupsurge in projectsbut it is highlyunlikely Australiacan deliver all toschedule

Solar industryfeels chillof UK cuts

Until this month, scores offarmers in the south-west ofEngland were planning anew business model.

Instead of using theirland solely to grow crops,they decided it would makemore commercial sense toturn over large areas to therenewable energy industry.

Fields across Cornwallwere rented by solar powercompanies, with the aim ofinstalling large systemscapable of generating up to5MW of electricity.

Most of these schemes arenow in jeopardy.

In February, the govern-ment proposed to reducethe subsidies, known asfeed-in tariffs, paid toschemes capable of generat-ing more than 50kW.

After a period of consulta-tion, Greg Barker, the cli-mate change minister,announced on June 10 thatthis decision would becomepolicy, with the cuts takingeffect from August 1.

The UKs nascent solarindustry now faces radicalchange. Any schemes asidefrom the smallest will havea much-reduced level ofgovernment support.

Subsidies for the mostambitious defined asthose generating from250kW to 5MW face a 72per cent cut in feed-in tar-iffs, reducing paymentsfrom 30.7p to 8.5p a kW

hour.The government says that

reform was necessary toprevent large schemes fromsoaking up funds thatwere intended to encouragesolar power for householdsand small businesses.

Without action, thescheme would be over-whelmed, says Mr Barker.

The coalition inherited asolar power subsidy systemfrom the previous govern-ment predicated on a seriesof assumptions that turnedout to be false.

The return on solar powergeneration was forecast tobe about 5 per cent, wellbelow the level required forcommercial interest.

Meanwhile, the govern-ment assumed that anyplanning applications forbig schemes would makeslow progress across thebureaucratic hurdles set bylocal councils.

In fact, improved technol-ogy has reduced the cost ofphotovoltaic solar arrays,doubling possible returns toat least 10 per cent.

Meanwhile, Cornwallscouncil, in particular,decided to encourage theseschemes by processing plan-ning applications muchfaster than expected.

The government arguesthat without its changes,the 400m ($650m) set asidefor feed-in tariffs wouldhave been absorbed by thelargest schemes.

Left unspoken is anothervital reason for the reform.Last years spending reviewcut 10 per cent off the sumfor the subsidies by 2014-15.The changes were, in effect,

forced by the need toreduce the cost of thefeed-in tariffs.

Critics say the UK willpay dearly for a short-sighted decision, takenlargely for reasons of prag-matism over principle.

If big schemes are robbedof their commercial viabil-ity, the country will be una-ble to develop an upstreamsupply chain with sufficienteconomies of scale.

This could leave a choicebetween two unpalatableoptions.

Either the country willlose the option of buildinglarge-scale solar schemes,or it will rely on othercountries, notably Ger-many, for the componentsand technology, therebymissing out on the indus-trial benefits.

The Solar Trade Associa-tion has given warning thatthe new policy will effec-tively kill the UK solarindustry for all installationsover 50kW. Howard Johns,chairman of the STA, saysthe decision had beenforced by budget cuts.

Crushing solar makeszero economic sense for UKplc, because it will lose usbig manufacturing opportu-nities, jobs and global com-petitiveness. It also riskslocking us into more expen-sive energy options, hesays.

In general, energy policyhas been a subject of cross-party consensus. The solarfeed-in tariff cuts are anexception.

Huw Irranca-Davies, theshadow energy minister,says the decision hammersa nail into the coffin ofmany modest, medium-scalecommunity, school and hos-pital schemes, risking thou-sands of jobs in an industrythat was beginning to flour-ish.

But more than 90 per centof the UKs solar installa-tions are on the roofs ofindividual households andwill be unaffected.

However, Daniel Gutt-man, director of renewablesfor PwC, the consultancy,points out that a largescale system is significantlycheaper than a rooftopinstallation.

He adds: The structureof the tariff bands meansthe most expensive, ineffi-cient part of the market isbeing stimulated, while sys-tems on social housing, fac-tories and large retail siteswill slow down or halt.

Meanwhile, new solarcompanies that haveinvested on the basis of theprevious system face anagonising choice. Theymust either abandon theirplans, or rush to completethem before the cuts comeinto effect on August 1.

Privately, industry fig-ures say they will be reluc-tant to take investmentdecisions on the basis ofgovernment assurancesever again. Yet, in thepresent budgetary climate,the coalition can reasonablyargue that it had no choice.

Renewables policy

Feed-in tariffs forbig schemes to fallsharply in August,writes David Blair

If you had only been read-ing international news-papers, you would probablybe quite impressed at theUK coalition governmentsenvironmental credentials.

A striking example of agovernment committing tobig environmental initia-tives while also pursuingausterity measures, is howthe New York Timesdescribed the UKs Mayannouncement it wouldhalve its greenhouse gasemissions from 1990 levelsby 2027.

In Britain, however, thegovernment has had farmore mixed reviews.

Environmental campaign-ers were broadly supportiveof the emissions targets,although industry groups

such as EEF, the manufac-turers organisation, saidthe move was a bad deci-sion that would threatenUK competitiveness.

More broadly, the coali-tions environmental com-

mitment has been the sub-ject of considerable debate.Plans to sell off public for-

ests prompted such an out-cry that the governmentended up retreating in Feb-ruary.

Ministers have alsosparked criticism from thesolar industry for slashingsubsidies for large solarpanel installations (see arti-cle right).

And, as the governmentsfirst year in power ended inMay, the claim that DavidCameron, the prime minis-ter, made within days oftaking office that he wantedto lead the greenest gov-ernment ever was dis-missed as vanishinglyremote by Jonathon Por-ritt, former head of the UKSustainable DevelopmentCommission.

Mr Porritt, whose com-

mission was axed in anearly round of budget cuts,audited more than 70 poli-cies in a study for Friendsof the Earth, the environ-ment organisation, andfound little or no progress

on more than three-quar-ters of them.In line with other envi-

ronmental groups, he wasdisappointed by a refusal toallow the new greeninvestment bank whichaims to invest in low-carbon infrastructure toborrow funds until 2015 andby the abandonment ofplans to make airlines pay aper plane duty, rather thana per passenger tax.

The government hasbacked several initiativesthat Mr Porritt and greengroups have praised, includ-ing a move to roll outsmart meters to helpmake electricity use moreefficient to 30m homesand businesses from 2014,and schemes such as therenewable heat initiative,which encourages technolo-gies such as ground or

water source heat pumps.But if the UK is to meet

its long-term target ofreducing greenhouse gasemissions by 80 per centfrom 1990 levels by 2050, itwill have to make serious

progress on its renewableenergy ambitions.At present, only about 3

per cent of total UK energyuse for electricity, trans-

port and heating and cool-ing comes from renewablesources.

Chris Huhne, the energysecretary, has pointed outthis puts the UK ahead ofonly Malta and Luxem-bourg in recent EuropeanUnion rankings. The pro-portion has to go up to 15per cent by 2020 under anEU directive the UK hassigned up to.

The challenges are espe-cially acute when it comesto electricity some 30-40per cent will have to comefrom renewable sources by2020 to meet the govern-ments targets, up from

about 7 per cent in 2010.For nearly a decade, thegovernment has encouragedinvestment through itsRenewables Obligation Cer-tificate (ROC) scheme,which requires suppliers topresent certificates to provethat a certain amount oftheir energy comes fromrenewable sources.

That is set to changeunder electricity reformsthat ministers are now con-sidering, which have beendescribed as the biggestshake-up of the power mar-ket since the industrysrestructuring and privatisa-tion in the early 1990s.

David Kennedy, chiefexecutive of the Committeeon Climate Change, thebody that advises the gov-ernment on how to meet itscarbon targets, says themove is necessary because

the existing system didnothing to encourageinvestment in low-carbonsources of energy such asnuclear, or new technolo-gies such as carbon captureand storage.

The changes create uncer-tainty. Mr Kennedy says:Investors need to feel con-fident and at the momenttheres a lot of uncertainty,because of the move fromthe ROC regime whichinvestors are comfortablewith to the EMR, [electric-ity market reform bill],where we dont really knowany of the details.

The government is plan-ning to issue a white papersetting out its reforms inJuly, but Mr Kennedy wor-ries about whether it willgive investors all the detailthey need.

That will be a problem, hesays, because: You cannotexpect people to takeinvestments forward orboards to approve fundingof projects, when they dontknow what market theyregoing to be selling into.

UK emissions

There must be swiftprogress if targetsare to be met,

says Pilita Clark

Mixed reviews for sustainability policies

Permian

Basin sees

reversal

of fortune

Joe Moroles recalls whenbusiness was so bad in thePermian Basin two yearsago that restaurants were

virtually empty.The Halliburton project co-ordi-

nator for Chevron, the oil group,says servers were able to attendto the every need of the few cus-tomers. You couldnt have half aglass of iced tea without someonefilling it up, he says.

Now those same restaurants inthis west Texas oil region arestruggling to keep staff from leav-ing for the oil patch, where busi-ness began picking up with theprice of oil in 2010.

Demand for workers hasattracted waiters, teachers, andeven police officers to set pipes,transport rigs and truck out oil inthe 110F heat.

All of a sudden, drilling turnedaround; we were short on equip-ment, short on employees, MrMoroles says.

Producers began applying tech-nology that had enabled a triplingof US natural gas supplies to theoilfields in the Permian, the larg-est oil producing basin in the US.

The goal is to increase produc-tion in an area that already pro-duces 1m barrels a day and isbelieved to contain a quarter ofthe 20bn barrels of US oil reservesconsidered recoverable.

Oil companies have been snap-ping up acreage or returning tofields that they had long held on

to, in the hope of such a boom.Everybody is looking for any-

thing they can get right now,says Jerry Mathews, productionforeman for Devon Energy, an oiland gas group.

A couple of years ago, Devonwas only drilling when it had to,on contracts that required activ-ity to hold leases.

Now it is determined to drill 300wells for between $1m and $8ma well across the dry flatlands ofbrush and cactus.

With 1,000 companies operatingin the Permian, drilling crewscannot keep up with demand.

Companies are desperately seek-ing truck drivers to take thecrude from these far-out fields torefineries.

There are no pipelines wherethe new drilling is taking place

just oil pumps bobbing up anddown on otherwise abandonedflatlands as far as the eye can see.

Anyone in this part of theworld who wants to work canhave a job, says Don Mayberry,production superintendent in thePermian for Devon Energy.

The same horizontal drillingand multi-staged hydraulic frac-turing process pumping water,sand and chemicals into rock athigh pressure that has increaseddomestic gas supplies to morethan 100 years worth at currentusage rates is starting to expandoil supplies too.

US production rose last year toits highest level in almost a dec-ade, thanks to these unconven-tional production techniques.

According to the US govern-ments Energy InformationAdministration, domestic produc-tion of crude oil and related liq-uids rose 3 per cent last year toan average of 7.51m b/d its high-est level since 2002.

This has increased investor

interest, with the number of rigsactively drilling at 1,860; up 321year on year, according to BakerHughes, the oil services company.

Most of them 1,808 are onland and use the new technology,

which enables drilling down10,000 feet or more and then turn-ing the drill bit so it pushes hori-zontally, as much as 10,000 feet, toexpose a much wider area toextraction from a single well.

The pipe pushed down thisway is set for a series of small

explosions along its length.Water laced with fine sand and

chemicals to kill bacteria andhelp the sand f low is thenpumped through, in a series ofstages, at high pressures, to frac-ture the rock surrounding theexplosion sites.

The sand keeps the new pas-sageways open so the oil canescape.

While the industry has beenusing hydraulic fracturing andhorizontal drilling for years toextract gas, the technology hasbecome better and cheaper.

It is now economical to use theprocess to extract more fromexisting oil wells and from rocksuch as shale, which the industrylong ignored as too hard forextraction.

Shale is something peopledidnt think about as productive,Mr Mayberry says. People have

been drilling through it for years;now were finding out how pro-ductive this stuff can be.

The Permian Basin covers100,000 square miles, in westTexas and south-east New Mexico.It was originally believed to hold106bn barrels of hydrocarbons.

Since the first commercial wellwas drilled here in the 1920s,about 40bn barrels of oil equiva-lent have been produced, 30bn ofwhich were oil. That leaves some60bn in the ground.

This is a huge basin with atremendous amount of oil and gasdown there , says MitchMamoulides, Chevrons managerfor the Permian South. The chal-lenge is getting it out.

This year, Chevron is planningto drill 350 wells there, up from200 last year. It operates 11,000wells in the area, some of them 70years old.

US oil recovery

Hydraulic fracturingand horizontal drillingare expanding supplies,writes Sheila McNulty

With 1,000 companies now operating in the Permian Basin, drilling crews cannot keep up with demand Alamy

People have beendrilling through [shalerock] for years; nowwere finding out howproductive it can be

DavidKennedy: atthe momentthere is a lotof investmentuncertainty

ContributorsSylvia PfeiferEnergy Editor

David BlairEnergy Correspondent

Pilita ClarkEnvironmentCorrespondent

Ed CrooksUS Energy & IndustryEditor

Leslie HookBeijing Correspondent

Sheila McNultyUS Energy Correspondent

Peter SmithAustralia-PacificCorrespondent

Ursula MiltonCommissioning EditorSteven BirdDesigner

Andy MearsPicture Editor

For advertising contact:Liam Sweeney on:++44 (0) 20 7873 4148;e-mail:liam.sweeney@ft.com

HowardJohns:Crushingsolar makesno economicsense

8/2/2019 FT Energy July

3/4

FINANCIAL TIMES TUESDAY JUNE 28 2011 3

Energy

ChinaNo need to be unconventionalyet

China, the worlds largestenergy consumer, has atendency to make a splashwhen it enters global energymarkets.

In oil markets, crudeprices rose along withChinas import volumes inthe early 2000s, after thecountry became a netimporter of oil in 1993.

In coal markets, its shiftto being a net importer ofthermal coal in 2009pushed prices to theircurrent record highs.

The country may soon

have the same effect onnatural gas, say analysts.

The government plans topromote natural gasconsumption because it iscleaner-burning than oil orcoal.

Under Beijings blueprint,gas use will more thandouble during the next fiveyears to reach 260bn cu m,making China the worldsthird-largest gas marketafter Russia and the US.

But where will this naturalgas come from?

Currently, China producesmost of its own gas,importing 4 per cent ofsupply from central Asiaand a further 11 per centfrom LNG shipments.

A key question is, to whatextent domestic supplieswill be able to keep up withgrowing demand.

Ever since the US beganproducing unconventionalgas on a large scale fromshale rock or locked in coaldeposits geologists havebeen looking for the nextbig unconventionaldiscovery.

In addition to Europe,where some unconventionalgas wells are being drilled,many eyes have lighted onChina, which is geologicallyextremely diverse and notyet surveyed to the sameextent as the US.

Unconventional gas is adream come true forChinas energypolicymakers, notes arecent report from Jefferies,an investment bank.

However, it warns thatunconventional gas in Chinais at least a decade away.

[Chinas] conventionalassets are still young,untapped, productive andcapital-efficient.

China does not need toinvest in unconventional gasuntil the easy conventionalgas is gone, the reportnotes.

Investment and drilling ofconventional natural gasbegan in the country inearnest about 10 years ago,and reserves remain high.

Although the governmenthas offered some

incentives forunconventional

production,including a

specialtariff

for coal-bed methane, it hasyet to be produced on alarge scale.

Last year, unconventionalgas accounted for onlyabout 1 per cent of Chinastotal production.

Because its oil and gasproduction is dominated bystate-owned energy giantssuch as PetroChina,Sinopec and Cnooc, thesuccess of unconventionalgas will depend to a largeextent on the appetite andprofit incentives of thesethree companies.

Crucially, PetroChina andSinopec own all nationalpipeline infrastructure.Independent producerstypically have difficultyaccessing existing pipelines.

As a result, some smallproducers choose to trucktheir gas to market to avoidtough pipeline negotiations.

According to a report byWood Mackenzie, theconsultancy, last year,Chinese unconventional gascould supply as much as340m cu m of gas a dayby 2030, potentially cuttingthe need for imports.

Imports of LNG will fallafter 2020 as a result ofunconventional gasdevelopment, the reportsays.

However, on the ground,industry executives paint amore mixed picture.

Shale gas in China isreally different from the US it is not as promising,says Steve Zou, chiefexecutive of Asian AmericanGas, an energy companythat has coal-bed methaneconcessions in Shanxiprovince in the north of thecountry.

In the area of coal-bedmethane, he saysgovernment support will becrucial for the sector.

One complication forcoal-bed methane is conflictwith the coal miners, headds.

One boost for the sectorwas an industry reshuffle in2009, which ended themonopoly of China UnitedCoalbed Methane.

While the domestic supplypicture may be murky forunconventional gas, thegovernment push in thatdirection has promptedlarge Chinese oil companies

to boost investment inunconventional gasoverseas, partly to perfectthe technical expertiseneeded for its production.

Cnooc, the countryslargest offshore producer,inked two deals to developshale oilfields in the US jointly with ChesapeakeEnergy late last year andearly this year.

And PetroChina, the listedsubsidiary of Chinas largestoil and gas producer CNPC, jointly invested $3.2bntogether with Shell in anAustralian coal-bed methane

company lastyear.

LeslieHook

Safety spur:valve-checking ata gas plant insouth-west China

On a r ecent d ay in June,three oil and gas companiesannounced their intentionto list on the London mar-

ket. After a dry period for flotations inthe sector, the flurry underlinedresurgent investor appetite.

The smallest of the three, the Aimlisting of 3Legs Resources, was never-theless significant, highlighting inves-tor support for the exploration forunconventional gas in Europe, a trendthat barely registered four years agowhen the company was established.

Chaired by Tim Eggar, the formerUK Conservative party energy minis-ter, 3Legs Resources raised 62.5m($101m) from the flotation. The moneywill be used to develop its shale gaslicences in the onshore Baltic Basin in

northern Poland where it is drillingwith US partner ConocoPhillips.

The development of shale gas hastransformed the North American

energy landscape and its supportersbelieve unconventional gas has the

ability to revolutionise the Europeanmarket, which is also home to vastresources.

A report this year by the US EnergyInformation Administration analysed48 shale gas basins in 32 countries,and estimated the technicallyrecoverable resource in Europe at624,000bn cu ft comp ar ed with862,000bn cu ft in the US.

The resources hold the potential tocover European gas demand for atleast 60 years, according to a study bythe European Centre for Energy andResource Security.

However, 3Legs Resources debut onthe market comes at an uncertaintime for the industry, as governmentsand regulators try to balance con-cerns about the impact on the envi-ronment of the technology used toextract the gas with the need for aviable source of energy that has lowercarbon dioxide emissions than coal.

In June, Frances upper house, theSenate, adopted a bill banning explo-ration for hydrocarbons using hydrau-lic fracturing or fracking.

The process, which involves pump-ing water, sand and chemicals at highpressure into the shale rock to releasegas trapped thousands of feet under-

ground, has prompted concerns aboutthe contamination of water supplies

with the chemicals used. Opponentsalso warn that not enough is knownabout the effects of the process.

A study by scientists at Duke Uni-versity in North Carolina publishedthis year found that in one region ofPennsylvania, water from wells inareas with active shale gas productionhad, on average, 17 times more gas init than in areas where there was nodrilling.

That study has been challenged, butsome industry figures admit thatbadly executed extraction can causegas to leak into water supplies. TheDuke study also provided some sup-port for the industry, by finding noevidence that the chemicals used infracking which are pumped deepunderground were leaking intowater wells, which are much shal-lower.

The adoption of the b ill b y theFrench Senate means that it shouldsoon become law and the governmenthas also temporarily halted all shalegas and oil drilling.

In the UK, Cuadrilla Resources, the

first company to explore for shale gas,has suspended the use of frackingpending a review by the British Geo-logical Survey after possible links

between the activity and two smallearthquakes near Blackpool. The gov-ernment, however, continues to sup-port the process.

Despite the controversy, MarkMiller, chief executive of Cuadrilla,believes shale gas has a future inEurope.

It could take several months beforethe company can return to fracking atits British site, but it hopes to drill itsthird well in July. It owns its ownfracking equipment, which means itcould move it to another project.

Other executives such as Peter Clut-terbuck, chief executive of 3Legs

Resources, argue the future for shalegas in Europe depends on where youare looking, as it is country specific.

Poland, site of the companys big-

gest investment and where some ofthe worlds largest oil and gas compa-nies, including ExxonMobil and Chev-r on, hav e b ought up acr eage toexplore for shale gas, has a differentattitude, he says.

The governments reaction andthat from the local communities isvery positive, he says, adding thatthe country wants to be rid of itsdependence on imports of Russiangas.

In Germany, where the governmentrecently announced it would phaseout all nuclear reactors by 2022 in thewake of the Japanese crisis, the coun-

try will need to make a decision abouthow it will meet the supply gap.

Many analysts believe natural gas,including shale, will be the winner.

Nevertheless, companies face otherhurdles in Europe before shale gasbecomes a commercial reality.

Unlike in the US, where the ownerof the land also owns the subsoil, inmost European countries the stateowns the rights and receives the roy-alties, giving landowners less incen-tive to allow drilling on their land.

Fatih Birol, the chief economist ofthe International Energy Agency,warned in June that if companieswanted to see a golden age for naturalgas they would need to come up withgolden standards of practice fordeveloping unconventional resources.

It is a point not lost on the compa-nies. The industry has a lot to do interms of public relations, admits MrClutterbuck. It needs to respond.

Golden age will needgolden standards firstShale gas in Europe

Regulators must balanceenvironmental andenergy-supply concerns,reports Sylvia Pfeifer

Cuadrilla Resources in the UK has suspended fracking on the north-west coast after two small earthquakes Alamy

8/2/2019 FT Energy July

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4 FINANCIAL TIMES TUESDAY JUNE 28 2011

Energy

be taken to countries such asChina, which is hoping todevelop its own shale gasresources. Current hot spotsinclude unconventional gas inthe US, offshore west Africa,Brazil and Australia.

First Reserve is not alone intargeting companies with drill-ing techniques for unconven-tional resources.

One of the recent deals, forexample, was the purchase of a70 per cent stake in Frac TechHoldings by SingaporesTemasek, the state-ownedinvestment firm, and RRJ Capi-tal, a newly formed privateequity fund launched by Rich-ard Ong, a dealmaker.

Texas-based Frac Tech is animportant provider of pressure-pumping equipment for the USoil and gas industry. When thedeal was announced in April,

analysts suggested the newinvestors were likely to targetthe Asian market, in particularChina.

A report issued by the USEnergy Information Administra-tion, part of the Department ofEnergy, in April estimatedChinas recoverable shale gasreserves could exceed those ofthe US by 50 per cent.

In addition to the M&A activ-ity, experts believe many of thecompanies that were taken pri-vate in 2007-2008 will return tothe market in the next couple ofyears, as investors look to exit.

Although the industry is cycli-cal, given the almost military-scale build up of capital by bigcompanies in countries such asBrazil, most analysts expectconsolidation to continue.

In the post-BP Macondoworld, if you are an interna-tional oil company, you wantsomeone you can rely on with arelatively big balance sheet,

says Keith Morris of EvolutionSecurities. There is also agreater tendency among theinternational companies to takeservice companies and use themglobally, he adds.

High oilprices giveboost toservicesContinued from Page 1

The Arctic seas north ofAlaska are one of thethree great remainingoil and gas prospects in

the US, along with the onshoreshales and the deep waters ofthe Gulf of Mexico. They are the

least known and hence the mostintriguing. They are also themost controversial.

The prospect of oil drilling inthe as-yet barely touched Arctic,with its unique ecosystem andwildlife, has outraged environ-mentalists.

The fact that exploration hasbeen facilitated by the shrinkingArctic ice, thought to be a con-sequence of global warmingcaused by burning fossil fuels, isan irony that has made the pro-tests even fiercer.

Royal Dutch Shell, Europeslargest oil company, whichhopes to be a pioneer in develop-ing the US Arctic, has beenrepeatedly frustrated in itsplans, first launched in 2007, toexplore the Beaufort and Chuk-chi seas off Alaska.

Yet in spite of opposition anddelays, it is likely that sooner orlater the resources of the regionwill be developed.

US political opinion, which

was encouraged to be suspiciousof drilling by BPs DeepwaterHorizon disaster in the Gulf ofMexico in April 2010, has beenswinging back in favour, drivenby persistently high unemploy-

ment and petrol prices thathave come close to $4 a gallon.

Victories of the generallymore pro-oil Republican party inthe midterm elections lastNovember have given freshimpetus to the campaign by theoil companies to be allowed todrill in more parts of the US,including the Arctic.

The administration of Presi-dent Barack Obama has beenunenthusiastic about Arcticdrilling, but the strength of itsscepticism has wavered.

In March 2010, while propos-ing to open up other areas of theUS coast, it was cautious aboutallowing more exploration in

the Arctic, although companiesthat bought licences in salesunder George W. Bush, the pre-ceding president were stillallowed to drill.

After the BP spill, drilling wasbanned for the year, but lastmonth Mr Obama sounded morepositive, talking about stream-lining the permitting process forArctic exploration. Republicansin the House of Representativeshave been pushing for legisla-tion to put that into effect.

After giving up on drilling inthe summer of this year becauseit could not secure the air pollu-tion permits it needed, Shellnow hopes to drill five wells inthe summer of 2012 five yearsafter it began trying and havingspent $2.2bn on leases.

Its persistence and investmentof time and money are justifiedby the scale of the potentialprize. The US sectors of theBeaufort and Chukchi seas areestimated to hold about 25bn

barrels of oil and 127,000bn cu ftof gas; respectively about 81 percent and 47 per cent of provedUS reserves.

Large discoveries offshorecould prolong the l ife of

Alaskas oil industry, which isthreatened by the decline of itsmature onshore fields discov-ered in the 1960s and 1970s.

Volumes flowing through theTrans Alaska Pipeline system,which carries oil from the NorthSlope field across the state to aterminal on the south coast,have been dropping steadily asthe reservoirs decline, meaningthat the oil is becoming steadilycolder and more sluggish.

Eventually, it may not flow atall, companies say, and the pipe-line will be useless.

Additional production, forexample from new offshore Arc-tic fields, would provide enoughoil to keep the system working.

Against those benefits ofincreased oil development in thereg ion, there are some

unique risks attached to thethreat of a BP-style spill.

First, there is simply theremoteness of the area. To fightthe Deepwater Horizon spill, BPand the US Coast Guard

deployed dozens of aircraft,thousands of vessels, and tens ofthousands of people. None ofthese would be accessible in far-flung northern Alaska to any-thing like the same extent.

Second, the behaviour of spiltoil in Arctic waters would bedifferent from in the Gulf ofMexico. In colder temperatures,digestion by microbes and evap-oration, which seem to havecleared up a large proportion ofthe BP spill, will work moreslowly.

Third, ice could make theclean-up more difficult. Tacklingoil trapped under it, for exam-ple, could be a particular prob-lem.

Shell says that it is addressingall these concerns, and notessome of the issues in the BP

spill do not apply in Alaska.For example, its wells will be

in only about 140 feet of water,compared with the ill-fatedMacondo well in the Gulf, whichwas in 5,000 feet of water.

Pete Slaiby, Shells Alaskavice-president, says the com-pany has also been investing torectify any problems that theBP disaster exposed, such as theneed to have equipment to catchoil leaking from a burst well onthe seabed.

Shell could have containmentdeployed in just one hour, hesays. However, assurances fromthe company are unlikely to beaccepted by environmentalists.

Cairn Energy, a British inde-pendent oil group, has been thesubject of action by Greenpeace,the environmental group, withprotesters boarding a rig usedfor drilling exploration wells offthe Greenland, another littleexplored Arctic region.

When drilling in the US Arcticfinally goes ahead, Shell can

expect to run up against similarprotests. Though the objectionswill undoubtedly be ferocious,they will not change one simplefact: if the oil is there, eventu-ally is will be extracted.

With fossil fuels expected toprovide the majority of theworlds energy for decades tocome, no large-scale alternativeto oil for transport fuel on thehorizon, and development inemerging economies creatinghundreds of millions of consum-ers, demand for crude is set togrow for the foreseeable future.

Yet the sources of new oilproduction the deep waters ofBrazil and west Africa, Canadastar sands, Iraq, maybe SaudiArabia all have drawbacks interms of technical or politicaldifficulty, or both. Seen in thatcontext, the challenges of theArctic do not look insuperable.

It is still not known for cer-tain that the oil is there; thefirst wells will be important forshaping views about the accu-

racy of estimates.If Arctic oil does live up to its

promise, however, it will be sur-prising if humanity collectivelyshows the forbearance not touse it.

Ice-bound,little known,

and highlycontroversialUS offshore Arctic

If oil is there, it willbe surprising ifhumanity shows therestraint not to use it,says Ed Crooks

Snow flow: producers say that oil from new offshore Arctic fields would help keep the Trans Alaska pipeline system working Alamy