Watch out OPEC! The Shale Revolution is After Your Market Share

It looks like OPEC has started to figure out that this shale thing might be a problem for them.  The evidence?  In the latest edition of OPECs bi-monthly bulletin, there is an article about the environmental risks of shale gas drilling in the north of England.  OPEC?  Environmental risk?  Hmmm.

The following paragraphs are from an insightful posting last Friday titled ‘Wary OPEC Highlights Dangers of Shale Revolution’ in WSJ’s ‘The Source’, by James Herron.

The last thing you’d expect to find in the magazine of the Organization of Petroleum Exporting Countries is an article focusing on the environmental risks of hydrocarbon drilling.  Yet that’s precisely what appears in a report in the latest bi-monthly bulletin from the petroleum powerhouse.  [OPEC Bulletin, Vol XLIII, No 1, Dec 2011/Jan 2012, Page 57 “Extraction of shale gas and environmental goals not compatible“]  The OPEC Bulletin article highlights the environmental risks of drilling for shale gas in the north of England.

Could it be that OPEC, which produces just over a third of the world’s oil, is beginning to see a threat in the new technology that is releasing huge deposits of gas and oil trapped in shale rock beneath the feet of some of its biggest customers?

OPEC is not the first giant hydrocarbon producer to give unlikely voice to environmental concerns about shale drilling.  Russia’s gas monopoly, Gazprom, has spoken against the practice for years.  Indeed, Gazprom’s story says a lot about why OPEC might be concerned.

Turn the clock back five years and the growth in Russia’s control over vital supplies of natural gas to Europe was seemingly irreversible. Vladimir Putin was the bogeyman who could sever Europe’s energy supply at any moment and Gazprom was expected to gobble up major European utilities wholesale.

But that picture has changed. Gazprom sold a phenomenal 160 billion cubic meters of gas into Europe in 2008, but that volume fell to 140 bcm in 2009 as the recession bit and failed to recover in 2010 even as the economy bounced back. Gazprom’s share of the European market peaked at 30% in 2008, but fell to 26% in 2010.

The boom in shale gas production in the U.S. has played a significant part in this. It turned what was supposed to be a major import market for liquefied natural gas into one that is drowning in gas. Cargoes of LNG from places like Qatar that were intended for the U.S. started turning up unexpectedly on the doorstep of Europe and stealing market share from Russia.

Meanwhile, Gazprom was busy making itself increasingly uncompetitive by stubbornly sticking to a formula that links the price of its gas to the much higher price of oil.

The company has only recently begun to address this problem by offering lower prices to customers in its major European markets.  Gazprom’s deliveries to Europe recovered somewhat in 2011, helped no doubt by the diversion of extra LNG to Japan after the earthquake shut down many nuclear reactors. However, by the middle of this decade Gazprom may also be competing with LNG exports from the U.S., where the natural gas price is just a fraction of Europe.

This is a cautionary tale for OPEC because the shale gas revolution has also set the stage for a shale oil revolution.  The industry is only in its early days, but the U.S. Energy Information Administration is already saying that, thanks to shale, domestic oil production has reversed its decline and will increase by 1.2 million barrels a day by 2020. More bullish analysts, such as Goldman Sachs, put this figure closer to 2 million barrels a day.

Plenty of other major energy importers, notably China, hope to mimic what the U.S. has achieved.

It’s much too early to say if shale technology will transform the oil market as it has done for gas, but such a thing is not without precedent.

Decades ago, just as the world was reeling from a series of oil supply crises and big price hikes, new technology opened up the North Sea and Alaska to oil drilling.  This helped loosen OPEC’s hold on the world oil market, which fell from over 50% market share in 1975 to under 30% in 1985.