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Fracking floors energy giants

The Independent, 19 August 2012

BHP Billiton is about to become the next victim of the latest asset bubble to
burst – US shale gas, the rock-based hydrocarbon that is released via the
controversial process of fracking.
A fortnight after writing $2.84bn (£1.84bn) off the value of its Fayetteville
shale gas business in Arkansas, BHP is poised to reveal on Wednesday that the
charge helped push down its profits by a massive 40 per cent – to $14.2bn – in
the year to June 30.

The FTSE 100 mining giant was forced into the writedown after a decade-long
stampede into the brave new world of US shale gas produced so much of the stuff that its price
tumbled to 10-year lows, taking the value of its producers with them.

"Put simply, the surge in shale gas production has caused a massive near-term
oversupply which has caused the gas price to plunge," said Glynn Williams, a
partner at oil and gas services investment firm Epi-V.

"The problem is exacerbated because the minerals leasing system in the US
obliges lessees to drill fairly quickly or relinquish their drilling rights," he

BHP's chief executive Marius Kloppers and Mike Yeager, the group's petroleum
head, will forgo their bonuses as retribution for paying $4.75bn for the
Fayetteville assets in February 2011. Just 18 months later, the business had
lost more than half its value as the US gas price fell from $3.88 per thousand
cubic feet when the deal was struck to as little as $1.91 in April, before
recovering slightly to now hover around $2.75.

Today's mildly-improved US gas price is well below its peak of $14 per
thousand cubic feet in 2005 when US looked set to become a major importer and
the shale industry was in its infancy. Meanwhile, it's only about a quarter of
the price in Europe and about an eighth of what the Japanese will pay – but for
now, these markets are off-limits for America which doesn't have the liquefied
natural gas (LNG) plants needed to liquefy the gas at minus 160C, shrinking it
to 1/600th of its original size so that it can be shipped overseas.

Ill-timed as BHP's acquisition undoubtedly was, Kloppers and Yeager are by no
means alone in overpaying for assets at the top of the market. On the last
Friday of July, BG, the former exploration arm of British Gas, took a $1.3bn
exceptional US fracking-related hit, and on the same day the Canadian giant
Encana announced a $1.7bn writedown, largely on the back of its US business. A
few days later, BP announced it would also take $2.1bn worth of, largely US
fracking-related, writedowns.

Fracking, or hydraulic fracturing – which blasts gas from the rock with a
mixture of water, sand and chemicals – has become increasingly popular in recent
years as technological developments have made the rock-based reserves cheaper
and easier to access.

The practice is far more advanced in the US, where it has caused a huge deal
of controversy amid allegations that it causes earthquakes and pollutes ground
water. Some countries, such as France and Switzerland have banned it, others,
such as Poland and China are in the early stages of development, while Britain
is still working out whether to allow it to continue and, if so, on what

But while protests in the US have largely failed to curb the shale gas
industry's development, the plummeting gas price is now doing the job for them.
The number of shale gas rigs operating in the US has tumbled by 44 per cent in
the past year to stand at about 300 now, according to industry estimates.

Take Chesapeake, the world's biggest shale gas producer. It's in the process
of cutting its gas drilling activities by about two-thirds this year in a move
that will reduce production by about 7 per cent next year – it's first decline
in 23 years.

Although America's shale gas producers have suffered a collective shock to
the system in recent months, their medium to long-term future actually looks
quite promising – thanks initially to the vast amounts of oil which the rocks
contain, which has traditionally taken second place to the gas deposits.

Hydrocarbon producers such as Chesapeake and BHP are furiously switching
their fracking resources from gas to oil, which is unlikely to suffer the same
depression in its price as gas as the US has the infrastructure in place to
export much of the additional oil it produces from shale. As a result, the
number of shale oil rigs has leapt by 35 per cent to about 860 in the past

In the longer term, frackers will also benefit as falling gas production
pushes up prices, with experts at the analyst Raymond James forecasting that gas
will roughly double to about $5 per thousand cubic feet in the next 18 months or

Furthermore, as an expected flurry of LNG export terminals begin to come
onstream in about three years, fracking companies will have a valuable further
outlet for their gas – the relatively lucrative European and Asian markets.

The US government may choose to veto some of these LNG plants pending a study
due in the next few months into their impact on the US price. However, with one
project – from Cheniere Energy Partners – already given the green light, experts
are hopeful that there could be more such facilities to come.

Not that any of this is likely to have much of a bearing on the UK's
fledgling shale gas industry. Activity here is on hold pending a Government
decision on whether to ban the practice after it was found to have caused as
many as 50 earthquakes in the Blackpool area last spring. A Department of Energy
and Climate Change inquiry into the earthquakes concluded that fracking can be
done safely and the Government is expected to give the industry the green light
in the autumn.

But given the relative scarcity of Britain's estimated recoverable shale gas
reserves, compared to the US, and the need to make up for the energy shortfall
left by dwindling supplies of North Sea oil, such a move would be unlikely to
herald an age of exceptionally low gas prices in the UK.