1. SHALE GAS iN USA
GAME CHANGING TURNAROUND IN GAS MARKETS
PREPARED BY:
JIGYASA PURWAR

2. Contents
INTRODUCTION .................................................................................................................................... 3
HISTORY ................................................................................................................................................. 4
CURRENT SHALE GAS MARKET CHARACTERISTICS .................................................................. 5
IMPACT OF SHALE GAS ...................................................................................................................... 5
DEPRESSED GAS PRICES ........................................................................................................................ 5
REVIVAL OF PETROCHEMICALS & MANUFACTURING........................................................................... 5
REDUCED DEMAND FOR COAL.............................................................................................................. 6
CLEANER ELECTRICITY ........................................................................................................................... 6
EMPLOYMENT GENERATION ................................................................................................................ 6
GEO-POLITICAL CONSEQUENCES .......................................................................................................... 6
ENVIRONMENTAL IMPACT .................................................................................................................... 6
EXPORT OF U.S. SHALE GAS .................................................................................................................. 7
ECONOMIC ANALYSIS OF SHALE GAS SCENARIOS .................................................................... 7
COST BENEFIT ANALYSIS ....................................................................................................................... 7
OPEC’S PRISONER DILEMMA & GAS CARTEL ........................................................................................ 8
CONCLUSION ......................................................................................................................................... 9
APPENDIX ............................................................................................................................................. 10
REFERENCES ....................................................................................................................................... 13

3. INTRODUCTION
Shale gas is essentially natural gas formed from being trapped within shale formations. It has
become an increasingly important source of natural gas in the United States over the last few
years. Its importance can be gauged by the fact that in 2000, it was only 1% of U.S. Natural Gas
Production but by 2010, it was about 20% and Energy Information Administration
(www.eia.gov) estimates that by 2035, it will be 46% of United States gas supplies (Figure 1).
This sudden glut has had very interesting ramifications in the market. Natural Gas prices are at
historic lows and this low price is impacting other industries which have now begun using
natural gas as fuel source due to the cost advantage.
This unconventional gas boom has also put the United States firmly in the path of energy
independence – something which can give a lot of political leverage over the OPEC cartel. Its
game-changing impact has been in the fact that it is going to turn U.S. from a gas importer to gas
exporter –especially to European markets where gas prices are at a record high. The domestic gas
price is likely to rise in the next few years, because of increasing demand. Yet it will remain far
below European and Asian prices, so the industry and exports should still grow. America is
estimated to have enough gas to sustain its current production rate for over a century.
To say this change is astonishing is an underestimation. Barely five years ago, was U.S. expected
to be a big gas importer. Between 2000 and 2010 it built infrastructure to re-gasify over 100
billion cubic meters (bcm) of imported liquefied natural gas (LNG). Yet in 2011, American LNG
imports were less than 20 bcm. Efforts are now under way to convert idle re-gasification
terminals into liquefaction facilities, in order to export LNG. All this has happened in a matter of
four years. In what is another reflection of America’s continued and accelerated march to energy
independence, a recent International Energy Association report8 says that by 2017, America will
become the largest oil producer surpassing the likes of Saudi Arabia and Russia. It will be totally
self-sufficient in energy by 2035. Politically and economically, it is news of huge significance
and impact.
It will be hard to find a market turn-around bigger than this!

4. HISTORY
Shale gas was first extracted as a resource in Fredonia, NY in 1821 in shallow, low-pressure
fractures1. Horizontal drilling began in the 1930s, and in 1947 a well was first ‘fracked’ in the
U.S2.Work on industrial-scale shale gas production did not begin until the 1970s, when declining
production potential from conventional gas deposits in the United States spurred the federal
government to invest in R&D that ultimately led to directional and horizontal drilling, micro
seismic imaging, and massive hydraulic fracturing. Early federal government investments in
shale gas began with the Eastern Gas Shale’s Project in 1976 and the annual FERC-approved
research budget of the Gas Research Institute, where the federal government began extensive
research funding in 1982, disseminating the results to industry2. The federal government also
provided tax credits and rules benefitting the industry in the 1980 Energy Act2.The Department
of Energy later partnered with private gas companies to complete the first successful air-drilled
multi-fracture horizontal well in shale in 1986. The federal government further incentivized
drilling in shale via tax credit for unconventional gas from 1980-2000. Mitchell Energy achieved
the first economical shale fracture in 1998 using an innovative process called slick-water
fracturing3. As the success of Mitchell Energy became apparent, other companies aggressively
entered the play, so that by 2005, the Barnett Shale alone was producing nearly 0.5 trillion cubic
feet of natural gas per year. As producers gained confidence in the ability to produce natural gas
profitably in the Barnett Shale, with confirmation provided by results from the Fayetteville Shale
in Arkansas, they began pursuing other shale plays, including Haynesville, Marcellus, Woodford,
Eagle Ford, and others.
For the large part of early 2000s, big independent oil companies and national oil companies shied
away from shale gas deposits citing unreliable technology, unproven reserves and general
aversion to pure gas deposits. Shale gas plays were the battleground for medium sized
independent companies and small operators. All that changed in December 2009 when Exxon
announced its acquisition of XTO Energy for $41 billion. XTO Energy was the biggest player in
natural gas fields and by buying it, Exxon suddenly catapulted itself into a major gas producer.
At that time, Exxon found a lot of synergy for the deal due to the increase in reliability of the
fracking technology as well as its own assessment of gas reserves which had proven to be more
than anticipated. Record 10 year highs for gas prices also helped in providing economic
justification for the deal. Exxon’s acquisition, as it turned out, was just the first of many and
natural gas industry witnessed a series of acquisitions, mergers and entry of national oil
companies in the U.S. gas market. The standard strategy followed by these companies has been
to buy up acreage from US independents, and apply superior balance-sheet power to increase
exploration and production. The next major to enter the natural gas market was the mining giant,
BHP Billiton, which announced its entry by its acquisition of Petrohawk Energy. BHP was just
part of a rush into shale gas acreage in the southern states of the US by a large herd of oil majors,
including BP, Total, Chevron, PETRONAS, CNOOC, Petro China, BG, Shell, Mitsubishi and
Mitsui, and they are all victims of their own success. This increased activity has resulted in a
production surge that will eventually turn the US into a petroleum products exporter, but is
crushing its domestic gas prices in the meantime.

5. CURRENT SHALE GAS MARKET CHARACTERISTICS
In the past 5 years has shale gas been recognized as a "game changer" for the U.S. natural gas
market. The proliferation of activity into new shale plays has increased dry shale gas production
in the United States. Higher natural-gas prices in recent years (2003-2008) and advances in
hydraulic fracturing and horizontal completions had made shale-gas wells more profitable in the
recent past. However, the recent successes in Shale gas mean that North America has been the
leader in developing and producing shale gas. The great economic success of the Barnett Shale
play in Texas in particular has spurred the search for other sources of shale gas across the United
States and Canada. A Department of Energy report states that in the first quarter 2012, USA
imported 840 Bcf (785 from Canada) while exporting 400 Bcf (mostly to Canada); both mainly
by pipeline. Almost none is exported by ship as LNG, as that would require expensive facilities.
Gas Prices have gone down to $3/MMBtu due to shale gas as compared to Europe where they
are around $10/MMBtu. This cost advantage coupled with the gas glut in U.S. has established a
strong case for gas exports.
IMPACT OF SHALE GAS
The increase in shale gas activity has resulted in several interesting positive and negative
consequences for the U.S. and international markets. Some are listed below:
DEPRESSED GAS PRICES
The abundance of shale gas supplies has dramatically reduced the gas prices as shown in Figure
3. In the short term, this price depression will make U.S. Shale gas operations unprofitable. This
could prompt companies to scale back production to keep prices in check. However, such an
option can rarely be exercised with full effect due to operational complications. Even if the U.S.
allows gas to be exported, the rise in price would still be checked. A recent study conducted by
NERA Economic Consulting5 concluded that exports could raise the domestic price of natural
gas by between 22 cents and $1.11 per million cubic feet within five years.
REVIVAL OF PETROCHEMICALS & MANUFACTURING
The glut of cheap gas has helped underpin a revival in manufacturing and helped lower
electricity costs for consumers. Natural Gas is a very important feedstock used by several
companies and the current gas prices ensure that they now enjoy second-lowest energy costs in
the world6 after the middle-east companies. Recently, LyondellBasell(NYSE:LSB) reported that
its costs to produce ethylene, a key chemical for plastic production, fell by 46% due to
availability of cheap natural gas. Its stocks have seen 52-week highs in recent times. Dow
Chemical also recently announced plans to spend $4 billion over the next five years, building
plants, to cash on cheap U.S. Shale Gas. The company said it made economic sense since every
10 cent drop in ethylene cost boosts its earnings by $200 million.

6. REDUCED DEMAND FOR COAL
The sudden increase in gas supplies has meant that it has begun replacing coal and other fuels as
a preferred energy source for power plants that have easy access to this gas. This preference is
illustrated in Figure 4. Domestic demand for thermal coal has dropped sharply with the Dow
Jones Coal Index falling over 40% this year with some established companies in this index like
Arch Coal(NYSE:ACI) hitting 12-year lows.This has resulted in a lot of companies postponing
capacity addition by 5 years, closing some coal mines and even lay-offs. It is just the opposite
story from petrochemical companies.
CLEANER ELECTRICITY
The persistence of low natural gas prices has had an impact on the utility industry as well. The
abundant supply has provided economic justification for gas combined cycle power plants. These
power plants will gradually replace our nation’s aging coal-fired generation fleet. Our electricity
will become cleaner, cheaper, and more efficient, and the superior ability of natural gas
combined cycle turbines to ramp up quickly will allow easier grid integration of variable energy
sources like wind and solar power.
EMPLOYMENT GENERATION
The proliferation of activity in unconventional gas could not have come at a better time for the
American economy. This period of gas-boom coincided with the worst economic recession in
recent decades to provide a glimmer of hope in an otherwise gloomy scenario. By some
estimates, it has added more than 600,000 jobs to the economy and over the next few years the
job addition will stretch to millions. Another important fact is that this addition has happened in
regions with traditionally low industrial activity – North Dakota, Arkansas & Pennsylvania.
GEO-POLITICAL CONSEQUENCES
The rise of the natural gas production in U.S. will have geo-political consequences as well.
Pipelines from Russia now supply a big chunk of the natural gas to Western Europe, but
alternative sources could undercut Moscow's sway. In Asia, the U.S. can bolster allies such as
Japan and South Korea by helping lessen their dependence on gas imports from unstable regions.
It also gives U.S. a handy leverage to use against the arm-twisting tactics of the OPEC Cartel.
The shock waves of America's gas boom are being felt elsewhere in the world as well.
Development of Russia's vast Shtokmangas field in the Barents Sea, $40 billion project which
was intended to supply America with LNG has stalled. Qatari LNG, once earmarked for
America, is going to energy-starved Japan. Yet a bigger change is expected, with large-scale
shale-gas production possible in China, Australia, Argentina and several European countries,
including Poland and Ukraine.
ENVIRONMENTAL IMPACT
Most of the natural gas production relies on a technique called ‘fracking’. Specialized fluids at
high pressure are injected in the formation to break the rock and release the trapped natural gas.
For a single well, multiple fractures are done. Environmentalists have long been raising the
concern of polluting ground water with this technology. Besides this, there is also an adverse
impact on the renewable energy industry. It is suffering a downturn as a result of competing with
natural gas generation on a cost basis, and a federal production tax credit that seems poised to
expire at the end of this year. Installation of new renewable energy facilities has now all but

7. dried up, unable to compete on a grid now flooded with a low-cost, high-energy fuel that can
provide power on demand.
EXPORT OF U.S. SHALE GAS
The biggest turn-around that this gas glut has resulted is in putting the U.S. on the path from
being a gas importer to a gas exported. The gas price depression widens the gap between gas
prices in U.S. and other countries especially in Europe and builds a strong case for exporting gas.
A recent study commissioned by the U.S. government5 predicts that there are massive economic
benefits to be unlocked by allowing export of domestically produced shale gas. Gas producers
are eager to export more, while big consumers including manufacturers and chemical companies
are not in favor because exports could raise domestic prices. Environmental groups, meanwhile,
fear that allowing exports would encourage more natural-gas production.
The looming prospect of the U.S.'s becoming a major exporter of natural gas underscores how
the energy revolution is transforming the nation's economic prospects. Just a few years ago,
many energy companies were planning to build facilities to import liquefied natural gas into the
U.S. But thanks to technological advances, combining hydraulic fracturing and horizontal
drilling, the U.S. has in a short time become a gas-producing powerhouse.
One export terminal—Sabine Pass Liquefaction LLC in Louisiana—has already received
Department of Energy approval. Fifteen other projects, which could export as much as 21.5
billion cubic feet of gas per day, are awaiting approval. That is roughly one-third of total U.S.
production!! One potential exporter is the largest U.S. gas producer, Exxon Mobil Corp., which
is teaming up with Qatar Petroleum for a facility near Port Arthur, Texas. This also opens the
prospect that natural gas could become more of a globally traded commodity like crude oil.
Currently, the difficulty of shipping natural gas means that prices in Asia and Europe are several
times the U.S. price.
ECONOMIC ANALYSIS OF SHALE GAS SCENARIOS
COST BENEFIT ANALYSIS
For the purpose of this paper, we will focus on one independent gas producer, Chesapeake
Energy. As per its annual report9, its total expenses to produce 1 MCF of gas were around $3.09.
At the 2010 price of $4.48/mcf, it was making a net profit of $1.39/mcf. For a predominant gas
producer like Chesapeake, this means that its fortunes are very closely linked to the gas prices.
However, the profits of producer companies are hardly any basis to determine benefits. It is the
gain to the consumers that defines that. This means that we look at a traditional demand-supply
curve for natural gas as shown in Figure 5.
The benefit to the consumers is the difference between the market price and the price customer is
willing to pay. The area above the current price, as shown in Figure 5, illustrates this ‘Consumer
Surplus’ benefit. For better estimation of the customer benefit from a particular gas producer, it
is essential to know the slope of the demand curve. In the scenario of a supply glut like in the
current market scenario, this slope turns to zero. With a large number of shale gas producers in

8. the same basin/region, any costs will approximately be the same for all producers eliminating
any particular demand curve for any particular producer. Considering that each producer faces
the same demand, hypothetical demand is a pro-rata share of the basin demand and is downward
sloping.
To put a figure around this consumer surplus, let us assume that this price depression does not
lead to any increased consumption. The Henry Hub spot price for gas was $3.95/mcf in 2012 and
$7.97/mcf in 2008. The difference in prices over three successive years was $4.02/mcf. The total
gas production in 2008 was 25.6 tcf. This puts the consumer surplus value at around $102
billion, a conservative estimate given our simplifying assumption. This very large amount of
consumer gain from technology induced price depression is virtually an elephant in the room. As
long as current production is maintained, it is likely that this benefit will be seen year over year.
OPEC’S PRISONER DILEMMA & GAS CARTEL
Organization of Petroleum Exporting Countries (OPEC) has long indulged in building a cartel
around oil supplies. It is essentially an organization of countries whose fortunes are over-reliant
on its oil exports. Unlike other commodities, oil exhibits a greater degree of scarcity and is a
major indicator and influence on the economy worldwide. OPEC plays a major part in
determining its price. However, OPEC has not been able to achieve its objective of fixing oil
price and maximizing profit for its member nations. The problem that OPEC faces can be
described by a common game theory model known as the Prisoner's Dilemma.
The way OPEC works is that they will take orders from their customers. Returning to the group,
they will set production quotas for each of their members to satisfy the at a price point of their
choosing. If everyone behaves according to the rules they set, the suppliers (OPEC), with perfect
information and control on supply, will profit in a similar manner as a monopoly.
However, the system begins to break down when they start to lose control over the inelastic
demand and as well as when their individual suppliers misbehave. Let's look at a scenario.
The world economy has become so weakthat the demand for fuel has plummeted. Thismeans the
demand curve shifts left or at least becoming less steep and more elastic and weakens OPEC's
ability to keep prices up at least in the short term. This deflates the price of oil and makes it
harder for individual OPEC member countries to maintain enough cash and net exports to
support the GDP which is largely dependent on oil export. Possibly, one of the members will
cheat and produce more oil than in its OPEC stated quota in order to generate revenue to cover
the shortfall from the drop in oil prices. This shifts the supply curve to the right and drops the
price further compounding the effect. This is exactly the same model as the well documented
game theory model (Cheater’s Paradox) where OPEC members are the prisoners, producing
additional oil is considered cheating and the reward matrix is expressed as marginal increments
in GDP.This process repeats until the supply stabilizes and the price finds a new home, much
lower than is expected (which is exactly the case in the current economic environment).
U.S. has long been held hostage to OPEC’s cartelization of oil. Being a big oil consumer, its
economic health has often been dictated by OPEC’s price fixes and has led to political stand-offs
as well. It was so much of a problem that America decided to create a strategic oil reserve

9. (currently estimated to be 100 billion barrels of oil) that could be released on presidential orders
in the U.S. market to depress any artificial price hike implemented by the OPEC cartel. Since
U.S. was an importer of OPEC oil, this move made sense as a hedge against artificial rise in oil
prices. With the rapid increase in shale gas and associated oil, domestic oil production has risen
sufficiently that America is no longer as heavily dependent on OPEC oil.
There is so much glut in production that there is even a talk of forming a gas cartel with U.S. on
the lines of OPEC10. The idea of a ‘Gas Opec’ has been around for years, with Russia and Iran
signaling interest back in early 2007. Algeria, which was opposed to the idea back then, has
become much keener on production limits as the gas price has plummeted relative to crude oil.
The whole thing seems to be a bit of a prisoners’ dilemma, with few countries having confidence
that production cuts would be successful enough to warrant the short-term pain of losing export
revenue. OPEC itself, while effective, is hardly a model of quota discipline and relies heavily on
a few states – mainly Saudi Arabia, by far the biggest producer – to enforce production
cuts.Qatar, the world’s biggest gas exporter, has invested heavily in building new LNG facilities
and is not interested in reducing production. Russia, another of the group’s biggest exporters, no
longer supports the idea either, despite recent comments from Gazprom dismissing the success of
US shale gas.
CONCLUSION
Shale gas is dramatically altering the dynamics of the gas world, including several investment
strategies that were based on gas shortfalls in America. LNG import facilities built to cover for
that shortfall are now left stranded or are being converted to export facilities. The abundant lowcost gas from shale and other sources presents a tremendous opportunity for value creation
across several sectors in the economy. As in all changing markets, there will be winners and
losers. Those who hedge their risks in time stand the chance of great economic benefit. Without
doubt, the biggest contribution of shale gas has been in putting America firmly on the path of
energy independence and thus freeing itself from any arm-twisting by the OPEC. Just for this,
the shale gas boom needs to go down as one of the biggest market-changing events in recent
times.

10. APPENDIX
Figure 1 - U.S. Natural Gas Production4
Figure 2 - U.S. Energy Production and Consumption (in Quadrillion BTU)4

11. Figure 3 – Henry Hub U.S. Natural Gas Prices ($/MMBtu)4
Figure 4 – U.S. Energy Production by Fuel4

12. Figure 5 – Natural Gas Supply-Demand Curve Analysis

13. Figure 6 – U.S. Shale Fields
REFERENCES
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
http://www.dec.ny.gov/docs/materials_minerals_pdf/nyserda2.pdf
http://www.chathamhouse.org/publications/papers/view/185311
http://www.economist.com/node/21558459
http://www.eia.gov/
http://finance.yahoo.com/news/u-gas-exports-clear-hurdle-022400484.html?l=1
http://beta.fool.com/tdalmoe/2012/08/01/shale-gas-boom-double-edged-earningssword/8324/
http://www.economist.com/node/21556242
http://finance.yahoo.com/blogs/daily-ticker/u-pass-saudi-arabia-energy-production-iea-says170907660.html?l=1
http://www.chk.com/Media/Publications/AnnualReport/Pages/default.aspx
http://blogs.ft.com/energy-source/2010/04/19/gas-opec-looks-less-likely/#axzz2ELaoFKHk