A KPMG report on the economic benefits for fracking in South Africa is speculative and does not reflect the true nature of shale-gas drilling and its economics, explains Saliem Fakir, head of policy and futures unit at WWF-SA.
KPMG released a report titled: Potential Benefits of onshore gas development in South Africa; the report was commissioned by Rhino Oil and Gas exploration as part of its bid to be granted exploration rights over a swathe of land in Kwa-Zulu Natal and the Eastern Cape.
A KPMG report has punted fracking as an economic boom for South Africa, explaining that it could add R11bn to its gross domestic product.
These are areas outside of the Karoo and in which the Strategic Environmental Assessment the Department of Environmental Affairs (DEA) has commissioned the CSIR to conduct does not cover. Like all economic reports, they depend on assumptions. KPMG, pre-emptively, places a disclaimer that its own economic report is speculative. The problem is KPMG is a well- known brand and a reputable auditing firm, which people will take liberty in lifting figures without explaining assumptions and context. What is speculative becomes fact in the public domain.
Rhino Oil and Gas understands this just like Shell did when it also commissioned a speculative report by a consulting firm, Econometrix, a few years back. Figures from the Econometrix’s study were bandied around as if they were fact.
All of these are designed to conjure hype and avoid the hard questions of the economic realities of shale –gas. Fracking is a high intensity, high cost business that is subject to the vagaries of geological attributes as it is to the efficiency with which technology can be made to work. Outside of the US the ability to crack the economics of shale has proven to be somewhat of a challenge. A report we did two years ago touches on this and is available here.
So, what are the issues with the existing KPMG report?
Firstly, it is a confusing blend of assumptions in that it fails to appreciate the big difference between conventional gas resources and unconventional. It is for this reason the report puzzlingly uses well- head prices from conventional gas fields in Mozambique. These reserves are good sources, low cost and well-head costs have been competitive.
It is therefore not a good proxy because if you really understood shale-gas extraction then you would know well-head costs vary per well in a field that may comprise hundred, two hundred or a thousand wells. Each wells’ production rate, in what is called Estimated Ultimately Recoverable Reserve (EUR), sets the economic limit. The EUR tells us the cost per volume that can be extracted from a well as long as possible.
The industry ratio for cost recovery is that 10% to 20% of the best wells ought to cover the cost of the 90% or 80% of the poor producing wells. Experts are of the view that the South African ratio is 10:90.
Unless, these statistical analysis are done of a sample of wells it would be hard to even fathom what an average wellhead cost for shale gas would look like in South Africa. Speculation is useless without exploratory production drills.
Given the nature of shale-gas, well-head prices are unlikely to be as cheap as conventional gas. In our report, we have seen price ranges from $7-$13 MMBtu for well-head prices based on studies of various institutions.
No relation to reality
Secondly, if you attribute a low well-head cost assumption and market prices modelling multiplier effects will look good.
This is anyway the intent of such reports to paint a promising picture. The Econometrix report does the same thing and fabulously comes up with numbers that have no relation to reality of shale-gas drilling.
The Econometric report like the KPMG report is just full of wild or educated guesses. It too was speculative with no cost estimates for exploratory drilling in South African conditions. If, you want to have more rigorous approaches modelling should account for different well-head and market prices. One possible set of proxy prices would be to use LNG import prices from different export destinations. Gas prices will determine the extent of market penetration and how much of gas can be sold domestically.
Economic benefit for company, not consumer
Thirdly, the report makes assumptions about consumer welfare and surplus. Consumer benefits depend on market conditions that relate to the degree of competition in the gas market.
This means that onshore gas must be cheaper than other sources of energy consumers currently rely on. If cheap gas is used for power generation, we must hold the assumption that the power utility will transfer the price benefit to the consumer.
Two things tell us that things can be different. The Competition Commission Tribunal placed an anti-competitive enquiry on the Liquid Petroleum Gas (LPG) market as more consumer demand grew LPG prices skyrocketed despite some competition in the market. Producers and suppliers were exercising market power over powerless consumers and possible price collusion.
Where full costs of electricity become increasingly difficult to transfer to consumers with the current tariff structure of cheap gas, as a substitute fuel source, it will be a boon to the electricity power company rather than the consumer.
We have seen similar trends in other parts of the world where the benefit of cheap gas is retained by the power company, while prices for consumers either do not come down and often they go up.
Why the Karoo?
Fourthly, the report keeps referring to the Karoo basin but Rhino Oil and Gas’s application is outside of the Karoo that covers shale and coal bed methane.
The geological conditions, economic activities and level of population density are different. The higher the population density the more likely the cost of extraction will go up because of environmental concerns, local resistance and litigation.
The report does not clarify how it treats well-head costs for coal bed methane (CBM) and the portion of gas resources that will be derived from CBM versus shale sources. We presume it cannot do so because a lot more geological survey and other technical work have to be done to identify the best resource locations.
Yet, we cannot say shale gas well-head cost and CBM costs will be same. CBM may use fracking, but not exclusively as it depends on the depth of the coal, their thickness, length and the extent to which these coal seams are water saturated (unlike shale gas CBM requires water decanting to release gas rather than pumping fluids to create fractures).
The extraction costs for the two will be different and the proportion of gas from shale or CBM will determine average well-head costs for the area exploration firms are currently looking to exploit.
Short-thrift of environmental costs
Fifthly, the report makes short-thrift of environmental costs. As our own economic framework study shows it can make or break the economics.
The costs involve on-site management of environmental damage, dealing with waste water and long-term rehabilitation costs of well-sites.
You cannot ignore these. They add to the overall drilling costs.
A hit on agricultural and tourism sectors
Sixthly, the increased sales of gas will no doubt create jobs but drilling activities will also likely reduce jobs in the agricultural and tourism sectors.
Job creation estimates are more realistic if you take net job effects and not just the creation of jobs through on-shore gas activities in isolation.
In this way a truer picture of job creation and losses is painted.
The KPMG report is a broad stroke report, speculative and does not really reflect the true nature of shale-gas drilling and its economics.