With a ban on gas exports from the US to countries like India, recent investments in shale gas may appear puzzling. However, there is more to it than meets the eye.
Earlier this month, Oil India Ltd and Indian Oil Corporation together snapped up a 30 per cent stake in Houston-based Carrizo Oil & Gas’s Niobrara shale gas asset in Colorado for $85.2 million. This will make it not just the third partnership forged by Indian companies with Carrizo, but also the most recent play for shale gas assets by them. While Reliance Industries Ltd (RIL) has a 60 per cent stake in US-based Marcellus’ shale play in Carrizo, GAIL has a 20 per cent stake in Eagle Ford Shale (see chart).
However, with ONGC Videsh Ltd (OVL), the pioneering Indian company in overseas oil acquisitions, yet to make any dent in the shale- gas business, the question is whether these acquisitions are savvy plays or just flawed deals.
Shale gas — a type of natural gas trapped in fine-grained sedimentary rocks called shales — has become one of the darlings of the energy industry. Comprising an insignificant amount of the US’s energy basket around 12 years ago, shale gas now accounts for around 20 per cent of the country’s energy needs and estimates suggest this would go up to 50 per cent in the next few decades.
Still, does buying this cheap source of gas make business sense? After all, exports of shale gas from the US are severely restricted and banned to non-Free Trade Agreement (FTA) countries like India. The restrictions are being slowly lifted and the ban may eventually be reversed, but there is no specific timetable on either plan.
Liquid is key
Of course, these forays give Indian companies important exposure to the shale-gas business. When India finally opens up to this new form of unconventional gas, these companies would not be entering an entirely new domain. But, to many analysts, these buys don’t make much sense, since natural gas price in the US, currently hovering around $3.21 a million British thermal unit (mBtu), is lower than what it was five years ago. The low gas price is, however, being looked as an asset-buying opportunity by some. “We felt the acquisition was a prudent one as that was at a time when the US gas prices were low. It is a strategic decision,” says Ananth Kumar, director (finance), Oil India.
In general, liquid gas is a preferred purchase, as it is more versatile and can also generate other products. Even in the US, all major players are focusing on assets that have a decent amount of liquid, because on a dry-gas asset — given the nature of extracting shale gas — one would probably not make much money if the gas price is below $4.5 per mBtu. This is the minimum break-even a company would need in order to make a reasonable internal rate of return. Thus, most of the companies with assets in the US are trying to focus on those with liquid components. “If half of the hydrocarbon comes out as liquid, one can get a realisation at $10-15 discount to West Texas Intermediate (WTI). With those realisations, economics improve. Even in the case of RIL, it is focusing increasingly on its Pioneer Natural Resources joint venture, where around 35-40 per cent of the overall output is in the form of natural gas liquids,” says an analyst who does not want to be named.
Learning from shale
RIL, too, seems to have realised this and is targeting more than just pure gas sales. It plans to use its shale gas production for power generation and petrochemicals in the US or to produce value-added items like dimethyl ether or methanol. “Even if we do not look at downstream products, we will be able to recover our investment next year if gas prices are above $4 an mBtu,” acknowledges P M S Prasad, executive director, RIL. He is confident that by next year the prices will touch $5-6 an mBtu.
The shale gas play in which GAIL has invested is also liquid-rich and, therefore, it is not impacted much by low natural gas prices, says B C Tripathi, chairman and managing director, GAIL. Shale acquisition for the company is, in fact, an entry point into the highly developed gas market of the US. It is building on this acquisition and exploring other opportunities in North America, particularly those with linkages to export options. It has signed a deal with Cheniere Energy Partners to import 3.5 million tonnes of liquefied natural gas (LNG) annually from its Sabine Pass terminal. Going forward, GAIL is considering expanding its shale gas portfolio in the North American market by pursuing other opportunities besides participating in integrated LNG projects.
The Eagle Ford shale gas projects, where GAIL is participating, are in the development and production stage, with around 25 wells already producing gas. With a 20 per cent share, GAIL has rights to an average daily production of 1,300 barrels oil equivalent. “Over nine million barrels of oil equivalent (mboe) of recoverable reserves would accrue to GAIL through this transaction,” says Tripathi. The government-controlled company has invested $135 million in shale gas in the US and about $170 million more is expected to be invested in the next five years.
In RIL’s case, the aggregate investment in shale business stood at $4.83 billion at the end of the second quarter of this financial year. RIL was the first Indian company to enter the US shale business in April 2010, when it acquired 40 per cent stake in Atlas Energy for $1.7 billion. By August of the same year, the company had interest in two more shale assets through 45 per cent equity in Pioneer Natural Resources and 60 per cent in Carrizo Oil and Gas.
With this, RIL has presence in the Marcellus and Eagle Ford shale plays in the US. “Considering that the company has a huge cash surplus, we are ready to make investments that give 15-16 per cent return. The acquisitions are part of our strategy to diversify our exploration and production portfolio. Besides, it will help us make a footprint in unconventional gas,” says Prasad. RIL’s shale gas business in the US comprises three upstream joint ventures — with Chevron, Pioneer and Carrizo Oil & Gas — and a midstream joint venture with Pioneer.
The shale gas scenario, however, has another uncertainty. A study done by INTEK Inc for the US Energy Information Administration says the long-term production profiles of shale wells and their estimated ultimate recovery of oil and natural gas are uncertain, because most shale gas and shale oil wells are only a few years old, and their long-term productivity is untested. In emerging shale fields, production has been confined largely to those areas known as “sweet spots” that have the highest known production rates for the play. If the production rates for the sweet spots are used to infer the productive potential of entire plays, their output potential will, probably, be overstated. Besides, the report points out that many shale plays, like the Marcellus shale, are so large that only portions have been extensively production-tested.
And, what to make of the export ban to non-FTA countries? Policy decision on exports is likely to happen only after the US elections. “It is very difficult to make predictions, given the volatility and number of vagaries of the oil and gas market in the US. However, we expect the valuation to go up once exports to non-FTA countries are allowed by the department of energy,” says Tripathi.
The major focus of GAIL’s strategy for acquiring overseas gas assets is to source LNG and gain technical expertise in shale gas through secondment of its E&P teams in the joint venture. This would allow GAIL to develop shale gas in India as and when the regulations are in place and the sector is opened for investment.
The shale gas scenario is India, however, does not look too encouraging. Shale gas requires a minimum land holding of about 80-160 acres, but average land holdings in India are less than an acre. Besides, access for gas gathering stations and huge requirement of water pose additional challenges. Unlike the US, where the owner of a land has the right over mineral resources below the surface as well, a resident in India has only surficial right and mineral resources belong to the government. In the US, a person gets 20-30 per cent share in the revenue accruing from the mineral.
Considering this, Indian companies are better off heading West and learning from their experiences for now so that they can strike when the time is ripe.