Gazprom: Think Twice About Shale Gas

The economics of shale gas development in Europe just don’t add up, according to Sergei Komlev, Head of Contract Structuring and Price Formation at Gazprom Export, the trade arm of Russia’s Gazprom. He was one voice of dissension at Shale Gas Eastern Europe 2011 in Warsaw, Poland.

“I’m an economist by description,” he explained, “so my speech will be about prices.”

“At the beginning of the shale gas revolution, we in Gazprom were excited too,” he recalled, “investigating plans to produce natural gas in the US using fracking and other techniques. However, as our understanding got deeper, we became less sanguine.”

Mr. Komlev said that while Gazprom saw shale gas as a positive development for the industry, making gas a more secure and abundant fuel than it has ever been, the Russian enterprise did not plan to invest because of higher production costs. He admitted that shale gas was likely to be part of the US market, following price adjustments.

“We’re skeptical about reproducing the revolution,” he said. “We’re still sanguine over CBM and are monitoring shale gas developments and LNG.”

Komlev said he had read in a Polish newspaper that Poland could become a second Norway. “I started to imagine what would happen with our long term contract with Poland, expiring in 2022, which is for delivery of 11 billion cubic meters per year. I can imagine Poland would break relations with Russia, and start production of shale gas.”

He had come up with a scenario to portend how Poland could produce shale gas and replace the gas from its Gazprom contract.

“If we consider a Marcellus type field and imagine what Poland has to do to produce this 11 BCM, it requires drilling nearly 3,000 wells at almost $3 million per well, and would need less than 33 leased rigs (costing about $33 million in total) and nearly 14 billion liters of water.”

Indeed, those costs didn’t sound cheap.

Komlev said: “I think Poland has to think twice before moving into this direction, especially if the decision is about politics and not the costs of shale gas production.”

He reiterated that costs were his emphasis.

Komlev showed a slide of the “10 Pure Play Shale gas Producers Active in US,” including companies like Southwestern Energy, Petrohawk Energy and Carizzo Oil & Gas. “They’ve increased total reserves by 20% in 2010, and production for the group grew by 16% - all of which looks good.”

“Our study shows that if you take all the costs of shale gas production since 2005, there is $6 per MMBTU cost if you take all of the finding and development costs (to find and develop new reserves), plus cash costs: production costs, interest, etc.”

He added: “If they say they can produce at $3/MMBTU, it’s just the tip of the iceberg. In fact, costs are much higher.”

According to one of Mr. Komlev’s slides, in 2010 the average “Full Cycle Costs” for his group of shale gas producers exceeded “Realized Gas Prices” by 44.76 per MCM. However, for several of the surveyed enterprises, costs fell under realized natural gas prices.

He commented: “Companies were selling at a loss, some at a price which was lower than their costs. The situation is only deteriorating. The differential in 2009 was $30 higher.

“It’s very hard for shale gas producers to stop dreaming,” explained Komlev. “We can say that shale gas production reminds one of riding a bicycle: if you stop pedaling, you fall. Hedging is the second explanation – your revenues allow you to meet your costs and you are allowed to survive for a certain amount of time until your situation improves.”

As for the impact of hedging, he said the benefits were expected to fall in terms of the weak natural gas environment. Producers, he added, used a range of hedging tools, like futures contracts, call options, put options, collars and swaps.

“Let’s look at the forward curve in June 2010. Producers were able to hedge their positions, now the forward curve is flat and there’s no chance for these companies to hedge their position. Producers of shale gas will be facing this when their costs will be higher than the existing price for natural gas – it’s inevitable,” insisted Komlev.

He said wellhead prices were equal to the Henry Hub price, and that situation was not sustainable – a definite change needed to take place. “It will be in the range of $6-7 per MBTU, and could be the end of the miracle of cheap shale gas. We all know that trees do not know grow from the sky,” he concluded.

One audience participant inquired about his thoughts on liquid rich shale plays that could even subsidize natural gas.

Komlev replied: “We are also interested in major shale gas producers turning to liquids. To underpin the costs of shale gas, these companies are more and more involved in producing liquids, because of the growing disparity between the oil price and gas price.