KPMG GLOBAL ENERGY INSTITUTE Shale Development: Global Update Focus on US, China, Argentina, Australia, Indonesia and UK kpmg.com/shale Introduction A rapid evolution Shale is fast transforming itself from ‘tomorrow’s big thing’ to become an essential part of the global energy sector. Although the US is still way out in front in terms of commercializing this valuable asset, other markets are playing an accelerated game of catch-up, with a series of discoveries and technological advances. Energy security is the word on every government’s lips, with shale promising to bring greater self-sufficiency, significant revenue from industrialization, exporting surplus volumes, and a reduced carbon footprint. This report discusses the global shale market and looks at developments in the big three – US, China and Argentina – as well as in Australia, Indonesia and the UK. It provides some compelling insights into an evolving sector as well as some pointers to the future shape of global shale markets. © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. Contents 02 Summary 04 Focus on the United States 10 Focus on China 14 Focus on the Argentina 16 Focus on Australia 20 Focus on Indonesia 24 Focus on United Kingdom 26 Conclusion © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. 2 Shale Development: Global Update Summar y • Despite a recent recovery, continued depressed gas prices have led many US companies to diversify, shifting their assets towards higher growth, oil and ’wet’ plays. • Capital continues to flow into the North American market, and is increasingly being allocated to the exploration and development of existing holdings, partly at the expense of M&A activity. • With a continued positive outlook for proven unconventional reserves, an overstretched US midstream infrastructure highlights additional concerns over resource accessibility, US export policy, environmental harmonization and water management. • Attracted by new discoveries, access to world-leading technology and the prospect of a US industrial revival, foreign buyers, non-traditional players, large independents and majors are all poised to continue their active pursuit of North American shale gas and oil for the foreseeable future. • Although the Chinese market has yet to break through to the China commercialization phase, the government has ambitious targets for shale output by 2015. • As a sign of its commitment to shale, the Chinese government is offering subsidies for development. • European and US players are moving into the market in a series of joint ventures, with China’s shale exploration and development looking to benefit from new joint venture partners’ expertise and experience. • Argentina’s significant potential is being held back to some extent by fears Argentina over the political and regulatory environment. • Substantial infrastructure developments are helping to expand opportunities for both domestic consumption and export. • Although a late developer, the changing dynamics of both domestic and Australia international gas markets have significantly improved shale gas opportunities. • High labor costs and a shortage of essential skills continue to be a challenge. • A number of deals with overseas partners suggest that the Australian shale sector is primed for take-off. • To overcome shortfalls in future supply and gain greater energy security, Indonesia Indonesia’s government is tendering for oil and gas exploration blocks. • There are few incentives for developing shale gas, and unclear exploitation rights where site boundaries conflict with conventional oil and gas operators. • Despite investing in unconventional blocks to boost production, shale gas development is still in its infancy, and the country will need to import gas for the next 5-10 years. • Despite firm commitment from the government, the UK is many years UK away from any kind of commercial shale industry. • Exploration has been modest and tentative, with considerable opposition to hydraulic fracturing (fracking), making permits difficult to acquire. © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. Shale Development: Global Update 3 Several other countries are actively exploring the shale oil and shale gas resources available within their borders. The EIA recently released a report on the technically recoverable shale oil and shale gas resources in 41 countries outside of the US. The charts below outlines the top ten countries with the largest resources of shale oil and shale gas as per this assessment. The term technically recoverable resources correspond to the quantity of oil and natural gas that could be produced with present technology, regardless of the costs associated with production and oil and natural gas prices. Top 10 countries with technically recoverable shale oil resources Rank Country Shale oil (billion barrels) 1 Russia 75 2 US* 58 (48) 3 China 32 4 Argentina 27 5 Libya 26 6 Australia 18 7 Venezuela 13 8 Mexico 13 9 Pakistan 9 10 Canada 9 World Total 345 (335) *EIA estimates used for ranking order. ARI estimates in parentheses. Source: EIA Technically Recoverable Shale Oil and Shale Gas Resources, 10 June 2013, accessed via http://www.eia.gov/analysis/studies/worldshalegas/ Top 10 countries with technically recoverable shale gas resources Rank Country Shale gas (trillion cubic meters (tcm)) 1 China 31.6 2 Argentina 22.7 3 Algeria 20 4 US* 18.8 32.9 5 Canada 16.2 6 Mexico 15.4 7 Australia 12.4 8 South Africa 11 9 Russia 8.1 10 Brazil 6.9 World Total 207 221 *EIA estimates used for ranking order. ARI estimates in parentheses. Source: EIA, Technically Recoverable Shale Oil and Shale Gas Resources, 10 June 2013, accessed via http://www.eia.gov/analysis/studies/worldshalegas/ © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. 4 Shale Development: Global Update FOCUS on the United States © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. Shale Development: Global Update 5 Current environment Total production of oil and natural gas in the US from 2007—35 Continued discoveries in unconventional 8 35 oil reserves, coupled with growing production, efficiency improvements 7 and a relatively slow recovery in North American demand, have all contributed tDhipaoonorvaare o devsc1suertro8p yn 16n iit dnt8g5trei i a0n5tlm luasibu0or ocre0snnemnhd blcctae d hieu(lldle2esnbi o 3.tptid con Atrre c e afafcveftls ul)eeseys iblr,inteog i tg c(dpnh2tr cmimeo0gfif1swa)cee1 esianitn, n ne lpt Uog2 trrow s Si0dfcv r 0(e eenopb5csramrc l .ittitmc nhuo eeer )sa l Oil production (million barrels per day)23456 223050 Total gas production (trillion cubic feet) gas production is forecasted to remain effectively flat until 2015.1 1 Having peaked at well over 12 US dollars (USD) per million British 0 15 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 0 0 0 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 3 3 3 3 3 3 thermal units (mmBtu) in June 2008, 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 prices plummeted to approximately Tight oil and Shale oil Oil – Other Gas US$2/mmBtu in April 2012, before Source: Energy Information Administration (EIA) rebounding, marginally, to almost US$4/mmBtu in March 2013.2 In the face of such volatility, many operators and investors have shifted their capital Natural gas production by source (trillion cubic feet) investment and asset exposure to the 25 12 development of unconventionals, as well as ‘wet’ gas reserves, which trade at a premium to dry gas. n 20 10 o Gis‘anwhsav uesNett spo ’i tngrrmot ahsdeso uD/nmoctai elekt-orio nsg to taaheis’lasnfi vp esBerilovda dekdsi k uvbaeecannrtsdti oiea nenndsv,d esw Tnueh cxihlae s ’ gas and Shale gas producti 1105 468 Gas – Other production Eagle Ford basins both register high ht g Ti 5 rig counts, and continue to enjoy a 2 disproportionate share of M&A activity. In addition, shale expansion continues, 0 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 50 0 0 0 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 3 3 3 3 3 3 with deep shale structures such as the 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 Texas Cline and California’s Monterey, Tight gas and Shale gas Gas – Other as well as the redevelopment of the Source: Energy Information Administration (EIA) Texas Permian Basin. 1 US Energy Information Administration, Annual Energy Outlook 2013, Market Trends, 15 April 2013, accessed via http://www.eia.gov/forecasts/aeo/MT_naturalgas.cfm 2 Henry Hub Gulf Coast Natural Gas Spot Price, US Energy Information Administration, 1 May 2013. © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. 6 Shale Development: Global Update Despite the current price of dry gas, expected to drive some of this increase, and-drill’ strategy; pouring capital into certain investors are taking a chance stimulating the construction of gas management teams that are acquiring and buying dry gas reserves. Such a utility plants and other key facilities, rights to drill and prospect.  bold move is contrary to wider market while potential increases in demand Against this backdrop, infrastructure and trends, and reflects a belief that dry gas tied to the reindustrialization of the US midstream logistics continue to be over- demand coupled with lower production is also likely to play a role. Conversely, burdened as commodity production growth will stage a comeback in the the high price of developed liquid stretches the transportation, storage longer term, leading to higher prices. assets has led buyers to invest in and refining capacities of an aging The decline in drilling and storage is undeveloped acreage, adopting a ‘lease- architecture. The subsequent transport and processing bottlenecks in the US have led to swings in differentials – some of them significant. Master North American rig count by select named basins Limited Partnerships (MLPs) have helped repurpose corporate balance 600 sheets by dropping midstream assets into tax advantaged structures, freeing additional capital for other projects. 400 MLPs have funneled private capital into the development of infrastructure such 200 as compression stations, gathering networks, lines and storage terminals. 0 Although the required infrastructure will 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 take decades to build, and gas prices Eagle Ford Haynesville Marcellus Permian Williston may not recover for several years, there is no questioning shale’s overall Source: Baker Hughes potential. In 2007, shale accounted for less than one-tenth of total gas production; by 20353 it is forecasted to reach half of total gas production. Issues and US land rig count by Oil vs. Gas opportunities 1,500 1,500 1,373 1,417 1,383 1,372 1,330 1,262 Reindustrialization of the US 1,200 1,130 1,200 The abundance of hydrocarbons in 1,043 the US, along with competitively 900 938 priced natural gas, has rejuvenated the 900 900 808 880 894 874 outlook for the US industrial landscape, with the prospective creation of tens 600 722 600 of billions of dollars’ worth of capital 593 486 investments in the gas-intensive 300 423 423 376 300 manufacturing and chemicals sector and hundreds of thousands of new 0 0 jobs.4 It has also sparked a political 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 and economic debate over whether to: a) move forward with some of Oil Gas the pending Liquified Natural Gas Source: Baker Hughes (LNG) projects, and export to Asian markets where prices are higher, or b) retain a global competitive advantage in the US by allocating gas supplies to help develop domestic 3 US Energy Information Administration, Annual Energy Outlook 2013, Market Trends, 15 April 2013, accessed via http://www.eia.gov/forecasts/aeo/MT_naturalgas.cfm 4 US Manufacturing and LNG Exports: Economic Contributions to the US Economy and Impacts on US Natural Gas Prices, Charles River Associates, 25 February 2013. © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. Shale Development: Global Update 7 Major hub gas prices TCPL Alberta, AECO $2.25 -19% Algonquin City-Gates Dawn, Ontario $4.08 PG&E Malin $3.10 +46% +11% $2.72 -3% Ventura Transport Point Kern River Wyoming $2.69 Transco, zone 6 NY $2.67 -3% $3.40 -4% Chicago City-Gates +22% PG&E Citygate $2.91 Columbia Gas TCO Appalachia $3.10 Panhandle Texas, Oklahoma +4% $2.79 +11% $2.64 0% El Paso San Juan -5% $2.62 -6% SoCalGas-Citygate $3.05 +9% El Paso Permian TETCO Zone M-1 (Kosi) $2.68 Columbia GT Co. Mainline $2.75 -4% $2.72 -2% -2% FGT Zone 3 $2.96 Waha +6% $2.70 Henry Hub -3% Katy $2.79 $2.73 0% -2% Tennessee Texas, Zone 0 $2.69 -3% 2012 average price ($/mmBtu) Average differential from 2012 average Henry Hub price Source: Federal Energy Regulatory Commission (FERC) chemical and industrial complexes. materials adds considerable costs, LNG prospects The former would create some upward especially when using rail. US LNG exports are forecasted to rise lift on prices for energy producers and to around 0.18-0.24 billion cubic meters In order to fully exploit the potential of bring significant LNG construction (bcm) or 6.5-8.5 billion cubic feet (bcf) by shale gas, it is estimated that, between opportunities in the US, while the latter the end of the decade. A handful of US 2011 and 2035, the sector needs would facilitate a continued recovery in projects have a realistic chance of being US$2 trillion in upstream investments for domestic manufacturing by mitigating built; Cheniere’s Sabine Pass, Freeport wet gas production, and US$1.7 trillion price pressure on natural gas and LNG, Sempra’s Cameron, Dominion’s for dry gas. An additional US$205 billion refined products. Cove Point and Southern Union’s Lake capital spending would be required for Charles.6 A number of LNG facilities are Infrastructure gas infrastructure development, with awaiting permits, including terminals In certain regions of the US, there is a mainline gas transmission expanded by along the US coastline, where the lack of pipelines, terminals and storage about 35,600 miles and an additional Eastern Seaboard in particular has a solid to hold and transport shale gas and oil 589 billion cubic feet (bcf) of working gas infrastructure for export. As of June 2013, to the customer base. Moving these storage.5 5 Historic opportunities from the shale gas revolution, KKR report, Nov 2012 6 US Manufacturing Renaissance, Is It a Masterpiece or a (Head) Fake? Morgan Stanley Blue Paper, 29 April 2013. © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. 8 Shale Development: Global Update of the three import terminals and Tax legislation Basin are producing oil and the Eagle 20 export terminals proposed to the There is a continued lack of consensus Ford output consists of oil and wet Federal Energy Regulatory Commission in Washington regarding the repeal of gas, while Barnett and Haynesville are (FERC), only two – Sabine, on the federal tax benefits for those funding mostly dry gas. Although the value of border between Texas and Louisiana drilling costs; developers are monitoring transactions in Bakken has risen slightly and Freeport McMoran, in Texas – have such developments closely. between 2011 and 2012 to US$7 billion, been approved to export LNG to non-FTA the number of deals (32 vs. 42) has fallen. M&A trends countries. Sabine Pass’ terminal is the The Permian had just over US$5 billion only one actually under construction. At With dry gas prices remaining low, shale of transactions in 2012, which was a big a recent congressional hearing, a DOE gas transactions (as a percentage of leap from the previous year, despite the official told lawmakers that it took about total upstream transaction value) have number of deals remaining steady at 17.9 two months to approve the most recent subsequently decreased from 38 percent Some of this activity includes private application. Although newly appointed in 2011 to just 6 percent in 2012.7 This equity investment, which appears to be Energy Secretary Ernest Moniz said has created a valuation gap, as current flowing into the purchase of undeveloped he'll review the permit process before owners are increasingly unwilling to part acreage as part of lease-and-build the next application, analysts took that with gas assets at depressed valuations, strategies, with a focus on liquids. to mean that new permits could start while buyers are steadfastly reluctant Despite the general shift in M&A rolling out as fast as one every two to offer more. As a result, operators towards liquids, some majors months. Despite the slow progress of and investors are devoting more time continue to increase exposure to shale these approvals, and the aforementioned to developing existing reserves and gas through M&A and/or reserve debate over whether to retain gas for improving production efficiency, while development. For example, Exxon now domestic use, all the conditions appear de-risking their asset exposure. gets about 50 percent of its production to be in place for the US to become a Tight oil/shale oil deals rose in 2012 from from, and has 50 percent of its reserves major exporter, should it so desire. US$15.5 billion to US$20.3 billion.8 Of in, natural gas.10 In addition, utility Inconsistent environmental the major basins, Bakken and Permian providers are starting to buy into dry regulations gas as an alternative to the spot market, As the fracking debate rumbles on, fact- In the US oil and gas sector, shale-led entering into joint ventures with shale finding missions and studies abound transactions compared to total operators to secure their longer term at federal and state levels, with no sign upstream transaction value supply base. of a consensus. A lack of consistency 2011 2012 MLPs have become a popular and from state-to-state has led investors to US$120.9B tax-efficient way to invest in the energy shun certain states (such as New York) in sector, with several players using favor of those that are more supportive this structure to exit, fully or in part, of development (such as Texas, North their upstream resources. Oil and gas Dakota, Pennsylvania and West Virginia).  US$92.5B producer Linn Energy announced in Water management and availability February 2013 that it was buying the With West Texas suffering its worst US$39.4B US$92.2B drilling company Berry Petroleum Co., drought in decades, accessing sufficient for approximately US$2.5 billion, to gain water to further develop the booming more oil exposure and to broaden its Permian basin is a big concern. Other presence in California, Texas and the regions are also struggling with securing Rockies.11 US$35.4B this vital resource. Disposing of this water US$7.7B New market entrants in an acceptable, environmentally friendly Over the past five years or so, a number manner is an additional challenge, with US$17.7B US$21.0B of foreign national oil companies basins using vast amounts in the fracking (NOCs) have entered the market via process. Permits for disposal wells are Tight oil/Shale oil Tight gas/Shale gas joint ventures, with some of these hard to come by in certain states, which Other upstream transactions investors now starting to take direct once again highlights the inconsistency in positions with exposure to resources. regulatory regimes across the US. Source: IHS Herald, http://www.ihs.com/products/ herold/e nergy-transaction-research/index.aspx Requiring significant capital to develop 7 M&A, IHS Herold, 23 April 2013 accessed via http://www.ihs.com/products/herold/energy-transaction-research/index.aspx 8 Ibid. 9 Ibid. 10 Exxon’s big bet on shale gas, Fortune, 30 April 2012. 11 M&As And Investments Decreased In Oil & Gas Industry In Q1 2013, ASD Reports, 3 May 2013, accessed via https://www.asdreports.com/news.asp?pr_id=1425. © 2014 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.