Shale Game

July, 2010 (Bloomberg Markets) -- Natural gas trapped in bands of rock may deliver abundant energy and billions in profits. Companies and environmentalists are clashing as the world rushes to drill.

When Victoria Switzer awoke on a cold night in March, her dog was staring out the window at the flame roaring from a natural- gas-drilling rig 2,000 feet behind her house. She remembers trees silhouetted in a demonic dance as the plume burned off gas that had been building up under her land.

She discovered later that such flaring can occur when Cabot Oil & Gas Corp. and dozens more companies drill for gas trapped in shale rock. The deposits, stretching from Texas to New York, and as far away as Australia and China, represent what may be the biggest energy bonanza in decades -- one that Switzer, 57, recalls thinking the Earth isn’t surrendering without a fight, Bloomberg Markets reports in its July issue.

Switzer, a retired teacher in Pennsylvania, is on the front line of a shale gas rush that’s dividing communities, creating millionaires and shaking up global energy markets.

Companies from India’s Reliance Industries Ltd. to Japan’s Mitsui & Co. are spending billions of dollars to dislodge natural gas from a band of Pennsylvania shale -- sedimentary rock composed of mud, quartz and calcite.

Photographer: Daniel Acker/Bloomberg

Victoria Switzer says gas drilling has disrupted her retirement in Pennsylvania. Close

Victoria Switzer says gas drilling has disrupted her retirement in Pennsylvania.

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Photographer: Daniel Acker/Bloomberg

Victoria Switzer says gas drilling has disrupted her retirement in Pennsylvania.

Shale gas proponents, led by 91-year-old oil patch billionaire George Mitchell, who invented the process to extract it, say the U.S. should plumb all forms of natural gas. That would help unhook the nation from coal and foreign petroleum.

Gas is about two-thirds cheaper than oil and greener too. It produces 117 pounds (53 kilograms) of carbon dioxide per million British thermal units (MMBtu) of energy equivalent compared with 156 for gasoline and 205 for coal.

‘De-OPEC-ize’

“This discovery will change the course of world history, not just to de-carbonize the economy but to de-OPEC-ize it,” Chesapeake Energy Corp. Chief Executive Officer Aubrey McClendon said in December in Copenhagen as the United Nations climate conference was under way.

Chesapeake, based in Oklahoma City, has profited by selling drilling rights and gas reserves for $10.7 billion during the past 2 1/2 years, quadruple the $2.7 billion it paid. McClendon -- with $33 billion in assets left to sell -- says he’s open for business.

Shale gas has plenty of detractors. Environmentalists say fracking, a process in which drillers blast water into a well to shatter rock and unleash the gas, threatens pristine watersheds. Dish, a hamlet of 180 residents north of Fort Worth, Texas, has almost as many wells, compressors and pipelines as people.

‘Children, Old People’

Last year, the Texas Commission on Environmental Quality found benzene, which it classifies as a carcinogen, at 10,700 times the safe long-term exposure limit next to a well 6 miles (10 kilometers) west of town on which a valve had been left open.

“We have children, old people, pregnant women,” Mayor Calvin Tillman says. “They’re not supposed to be subjected to toxins.”

Switzer, who moved to Dimock Township, Pennsylvania, to build a $350,000 dream home with her husband, Jimmy, in 2004, had no idea how shale gas would consume her village of 1,400.

She says she found so much methane in her well that her water bubbled like Alka-Seltzer. Neighbor Norma Fiorentino says methane in her well blew an 8-inch-thick (20-centimeter-thick) concrete slab off the top. The $180 bonus Cabot paid to drill on Switzer’s 7.2 acres (2.9 hectares) and the $900 in royalties she gets each month don’t compensate, she says.

‘Beads and Baubles’

“I feel like one of the Indians who sold Manhattan for beads and baubles,” she says.

The economics of shale don’t look great right now for big companies either. Natural gas prices plunged to $2.41 per MMBtu in September 2009 from $13.69 in July 2008 as the recession cut demand while drilling accelerated. On May 24, gas traded at $4.04.

James Barrow, who invests one-ninth of his $50 billion portfolio in energy stocks as president of Dallas-based Barrow Hanley Mewhinney & Strauss, says leases signed as gas peaked in 2008 make drilling necessary -- even in a slump. When this new gas hits the market, the price could again sink into the mid-$2 range, he says.

For companies to profit from new wells, gas has to rise to $7.50, says Ben Dell, a Sanford C. Bernstein & Co. analyst in New York. He predicts it’s only a matter of time before firms trim production, which he says will boost gas to $8.50 by 2011.

Soaring Consumption

If gas stays above $4, a price that lets companies cover costs on existing wells, U.S. output could grow 20 percent to 65 billion cubic feet (1.8 billion cubic meters) a day from 2008 through 2030, says Peter Wells, director of U.K. research firm Neftex Petroleum Consultants Ltd. Shale gas production could quadruple to more than 20 billion cubic feet, he says.

That would help meet rising power demand. Global energy consumption will soar 44 percent by 2030 from 2006, the U.S. Energy Department says. China and India will siphon off 28 percent by then, according to the DOE forecast. Demand is rising because the planet’s population will balloon to 8.2 billion in 2030 from 6.8 billion today.

Hydroelectric, wind and other renewable sources will plug only part of the gap: They’ll contribute 17 percent of U.S. electricity generation by 2035 from 9.1 percent in 2009, the DOE says.

“Taking advantage of the new natural gas finds, the shale finds, would be an important piece of how we begin to break our dependence on foreign oil,” Carol Browner, President Barack Obama’s senior energy adviser, told a Washington audience in April.

Investors Primed

Investors are primed for a boom. Chesapeake’s shares fell 47 percent from the beginning of 2008 to $20.75 on May 24 as gas prices sank. Bernstein’s Dell predicted in mid-May that shares would rise to $34 during the next 12 months while companies curb output, reducing supply as rebounding economies demand more energy.

The stock prices of Chesapeake and fellow gas developers Petrohawk Energy Corp. and Range Resources Corp. don’t reflect the firms’ shale holdings, says David Heikkinen, a Tudor Pickering Holt & Co. analyst in Houston.

Fort Worth-based Range has assets valued at $65 a share, he says, a third more than its May 24 stock price of $42.47.

Range began plumbing the Marcellus shale that underlies New York, Pennsylvania and West Virginia in 2004. The band of rock - - so designated because it pokes through the surface near a city of that name in northern New York -- may contain 262 trillion cubic feet of recoverable gas, the DOE estimates. The U.S. uses 20 TCF annually, mostly for power plants and home heating.

That means the Marcellus shale alone could supply America’s needs for more than a decade.

Getting a Bargain

Range CEO John Pinkerton says he got a bargain when his company paid $1,000 an acre for Marcellus drilling rights near Pittsburgh starting in 2004. India’s Reliance paid 14 times more in April, a price Pinkerton says he wouldn’t consider.

“If I sold today for $14,000 an acre, I’d be selling for a quarter of what it’s worth,” Pinkerton told investors in April.

Range has 200 wells in Washington County south of Pittsburgh and may add another 4,300 in the county over 10 years.

Even oil and coal companies are raising their bets on gas. In December, Exxon Mobil Corp. agreed to pay $41 billion in stock and assumed debt for Fort Worth-based XTO Energy Inc., the biggest U.S. gas producer.

Outside North America, unexplored geology and nonexistent pipelines make it harder to gauge how much shale gas exists.

“Regions including China, India, Australia and Europe are thought to hold large resources,” the International Energy Agency said in November.

Liking the Odds

Firms are taking those odds. European oil giants BP Plc and Royal Dutch Shell Plc are looking in China. Chevron Corp., ConocoPhillips and Exxon purchased drilling licenses in Poland.

“Companies are rushing to get the last available license,” says Henryk Jacek Jezierski, Poland’s chief national geologist.

Consol Energy Inc., the second-largest U.S. coal producer by market value, owns land near Pittsburgh that’s in the heart of Marcellus shale. It also bought shale assets valued at $4.4 billion in April. CEO Brett Harvey says coal will remain the bedrock of the U.S. economy far into the future. He’s not ignoring gas.

Because Consol already owns the Pittsburgh-area property, it can charge as little as $3.71 MMBtu for gas and still earn a 20 percent after-tax return, he says. Firms forced to pay $5,000 an acre for drilling rights and a 20 percent leasing royalty would have to charge $5.18, he says.

“If there’s a flood of gas at $4, guess who’s going to produce it?” Harvey says. “We are.”

Managing a Windfall

Pennsylvania is no stranger to energy euphoria. Edwin Drake drilled the world’s first successful oil well in 1859 in Titusville, 240 miles west of the Switzers’ home in Dimock. Now it’s learning to manage its latest windfall.

In October, companies will be required to disclose the chemical composition of fracking water, says John Hanger, secretary of Pennsylvania’s Department of Environmental Protection. The department is doubling its number of oil and gas enforcers to 193.

Switzer says it’s about time. She says she’s had nothing but trouble since Houston-based Cabot arrived in 2006. It sank 50 wells in 2009 and plans 81 this year. Convoys loaded with drilling rigs, pipes and compressors crisscross the village. Her creek ran red with spilled diesel after a truck slid on ice and hit a tree. Some neighbors are moving. Switzer wants Cabot shut down instead.

“They said we’d never notice the drilling,” she says of Cabot. “Now, we won’t be able to remember when they weren’t here.”

Methane Migration

The Switzers and 31 neighbors are suing Cabot for negligence. The company had until June 1 to respond. Cabot spokesman George Stark declined to comment on the suit.

Separately, and without acknowledging any wrongdoing, Cabot agreed with Pennsylvania officials on April 15 to stop drilling in Dimock for a year, cap three wells with casings that the state deemed defective and pay a $240,000 fine.

Ken Komoroski, a Cabot attorney, says there’s no proof drilling polluted Dimock’s water. He says loose soil collapsed at a well, snapping the drilling pipe and dragging the bit 1,700 feet (520 meters) underground. Methane may have migrated through the cavity into aquifers as Cabot recovered the bit, he says. Cabot now tests for methane and uses latex to ensure well casings are cemented properly.

‘More Like Texas’

“In the big picture, drilling is going very well,” Komoroski says. “Pennsylvania is going to look more like Texas.”

Shale gas pioneer Mitchell can take credit if that happens. His parents, Greek immigrants who ran a dry cleaning store, put him through Texas A&M University, where he majored in geology and petroleum engineering. In 1946, he started consulting for a company he later bought and renamed Mitchell Energy & Development Corp.

Mitchell knew gas had become embedded in shale, the most common sedimentary rock, when ancient seabeds were covered and compressed by erosion. Starting in 1981, he experimented with drilling down and then horizontally. He fracked the wells, pumping fluid to blast out the gas -- testing the method sparking today’s boom.

“We tried propane, diesel, anything you can think of,” says Mitchell, who uses a motorized scooter to zip around in his Houston office, where he greets emissaries from China and Europe who have been bitten by the shale bug. “Water with a small amount of sand worked best.”

Better Bet

By 1993, Mitchell had developed shale gas extraction into a viable business. Rivals didn’t pay attention until prices rose in tandem with oil and passed $4 a decade later. Mitchell sold his company to Oklahoma City-based Devon Energy Corp. for $3.1 billion in 2002. Since then, he has invested $25 million in Alta Resources LLC, which has five wells near Montrose in northeastern Pennsylvania and may drill 500 more.

Mitchell says shale gas is a better bet than oil. A typical gas well near Fort Worth costs $4 million and is virtually assured of success. In the Gulf of Mexico, oil companies spend $300 million drilling through 1,000 feet of water and 35,000 feet of rock and can still come up empty.

“They decided they better start working on shale gas,” he says.

Persistent Risk

The U.S. Congress is investigating offshore drilling for a more tragic reason. On April 20, an explosion at a BP oil rig began spewing at least 5,000 barrels of crude a day. The disaster killed 11 people, wiped $58.3 billion off BP’s value as of May 24 and prompted the governors of Florida and California to withdraw support for ocean drilling.

While Chesapeake’s McClendon, 50, expects offshore drilling to become more difficult, shale gas has its own drawbacks, Neftex’s Wells says.

“With deep-water exploration, there is a very small risk of a catastrophic event,” he says. “With shale gas, there is a persistent risk of long-term contamination of groundwater. This doesn’t have easy-to-see TV imagery, like oiled-up seabirds. It needs scientific explanation for which the public is not trained.”

The Doghouse

BP had started looking for gas before the oil spill. In 2008, it paid Chesapeake $1.75 billion for rights on 90,000 acres near Stuart, Oklahoma, 100 miles south of Tulsa. BP has since tripled initial output from wells on this land to 10 million cubic feet a day.

On a sunny February afternoon, workers prepare new wells using a road grader to scrape flat a 5-acre patch called the drill pad. They’ll cover the area with rubber and surround it with 18-inch-high berms to contain any spilled liquid from fracking or drilling debris. They’ll bore as many as eight wells in the pad.

From a 14-story white rig with a blue platform, workers in a control room called the doghouse use computers to manipulate hydraulic lifts that arrange 30-foot sections of black pipe into rows. Mechanical claws screw one pipe to a volleyball-size drill bit studded with diamonds and the other pipes to each other. An 11-ton rotating clamp called a top drive pushes the pieces into the pad to start the well.

Within 10 Feet

The bit and drilling pipes, which are surrounded by three rings of metal casings cemented in place to protect aquifers, go down 8,000 feet. Workers activate a motor in the pipe, which has a slight bend near the bit, so that 1,000 feet of drilling produces a 90-degree turn.

After probing for 3 miles, the driller, from his perch in the doghouse, can place the bit within 10 feet of his target, says Bryant Chapman, BP’s vice president for North American gas operations.

Next comes fracking. Workers park 40 tractor-trailers loaded with pumps, sand, chemicals and portable containment tanks on the pad and spend three days blasting 5 million gallons (19 million liters) of water into the well.

As much as 40 percent flows back out. In Texas, the water is injected into underground rock. In Pennsylvania, which lacks suitable deep-rock formations, the water gets recycled or goes to treatment plants.

Fracking worries people far from Stuart and Dimock. New York City serves 8 million residents from a watershed so pristine it’s exempt from federal filtration requirements.

Fracking Concern

A consulting firm hired by the city, Hazen & Sawyer PC, said in December that chemicals from fracked wells could have a catastrophic impact. Some, like pesticide 2,2-dibromo-3- nitrilopropionamide, are toxic. Each well needs 82 tons of assorted chemicals for reasons such as killing bacteria and inhibiting corrosion, the report says. New York has banned shale gas drilling statewide until it adopts new rules.

“We firmly believe, based on the best available science and current industry and technological practices, that drilling cannot be permitted in the city’s watershed,” Mayor Michael Bloomberg said in an April press release.

Bloomberg is the founder and majority owner of Bloomberg LP, the parent of Bloomberg News.

Range CEO Pinkerton says New York’s leaders are ignoring facts.

“They’re cuckoo for Cocoa Puffs,” he says, quoting a 1960s breakfast cereal slogan.

Squaring Off

Pinkerton, 56, says all Marcellus wells that will ever be built will use less water than one nuclear plant and that damage from coal mines is much worse than shale drilling.

As the drilling debate intensifies, shale gas supporters and opponents are squaring off along the Delaware River, the waterway U.S. General George Washington crossed on Christmas Day in 1776 to defeat Hessian mercenaries.

In April, Pennsylvania issued a permit for the first of up to nine exploratory shale wells in the river basin for New York- based Hess Corp. and Houston-based Newfield Exploration Co. The first well will be 2.5 miles west of the Delaware and 15 miles north of Honesdale.

Pat Carullo says drilling is a beast that can’t be tamed. Carullo, 56, co-founded Damascus Citizens for Sustainability, which wants case-by-case reviews of new wells.

“The gas industry thought they could spread money around like pimps and drill anywhere in the watershed,” he says. “I’ll be dead before that happens.”

Preserving the Farm

Marian Schweighofer, executive director of the Northern Wayne Property Owners Alliance, is rooting for shale gas. If commercial drilling is banned in the river basin, she’d lose out on income for the 712-acre farm in Tyler Hill that’s been in her family for four generations. Marian and her husband Edward, both 54, have gotten $500,000 from Hess so far.

Jack Ivey is contemplating the riches shale gas can bring. He leased 111 acres in Montrose to Mitchell’s Alta for $310,800. Ivey, 80, hopes for at least $346 a day from the first well if gas prices hold up. Royalties may reach $1,734 a day with five more wells.

“Hopefully, I’ll live five or six years so I can get some of this money,” he says.

Mitchell predicts companies will win public support for drilling in Pennsylvania the way they did in Texas.

“With money,” he says, and pauses, as if no elaboration is needed.

Learning From Dimock

Billions of dollars -- and energy for the 21st century -- are at stake. In Australia, Beach Energy Ltd. wants to explore an area that may hold 200 TCF of shale gas. China may produce a quarter of its gas from shale deposits in the next 20 years, the DOE says.

Before Schweighofer’s group signed on for drilling, members toured Dimock and met Victoria Switzer. They hired a lawyer and insisted on stronger well casings than Pennsylvania requires and that farmers be allowed to keep drilling equipment out of their best fields.

Switzer, now a shale gas veteran, says she hopes the world can learn from her and her neighbors that there are costs as well as benefits from unlocking a treasure the Earth has guarded for hundreds of millions of years.

John Lippert is a senior writer on Bloomberg Markets at jlippert@bloomberg.net

#<535521.2245115.2.1.46.17993.25># -0- Jun/17/2010 15:45 GMT

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