High costs hammer huge gas potential

Western Australia has an abundance of gas and explorers are looking for more, both offshore and onshore, but there are questions over how much growth the industry can sustain.

SEVENTY kilometres off the coast of Exmouth, near the Ningaloo marine park, Shell is drilling the Palta-1 gas exploration well.

It’s the latest of many exploration and development wells to be drilled in the area, which accounts for about 40 per cent of Australia’s oil production.

For industry players like Chevron, Santos and Apache, it’s the reported cost of $60 million that has really caught attention.

It’s an example of the high costs that pervade the oil and gas industry in Australia, from exploration through to construction of liquefied natural gas (LNG) plants.

Just last week, Chevron highlighted the cost pressures when it disclosed the cost of building the Gorgon LNG project had risen from $43 billion to $52 billion.

Despite this setback, Chevron is looking to stay upbeat, with vice chairman George Kirkland saying the Gorgon project’s economics remain attractive.

“While investment requirements have grown, oil prices, which directly impact the overall revenue stream, have increased by approximately 80 per cent over the same time period,” Mr Kirkland said.

He said Chevron’s exploration program “continues to discover additional gas resources, which could support future expansions of our Australian LNG developments”.

In September, Chevon announced its 15th gas discovery in WA waters since 2009.

Apache, Santos, Inpex, Total and others are also continuing the search for more gas off the state’s coast.

Last month, Santos announced a significant gas discovery at the Crown-1 exploration well in the Browse Basin, off the Kimberly coast.

These discoveries add to the state’s enormous offshore gas reserves, which total 142 trillion cubic feet (Tcf). To put this in context, the state uses about 1 Tcf per annum.

There is also growing interest in the state’s onshore gas fields, which the US Energy Information Administration has estimated contains 288Tcf.

Most of that gas is in the Canning Basin, located inland from Broome, and that is where companies like Buru Energy, New Standard Energy and Oil Basins have focused their efforts.

Companies like Alcoa, Mitsubishi, ConocoPhillips, Fortescue Metals Group and Hess have also invested in onshore exploration, either directly or in partnership with juniors.

They have been encouraged by the spectacular growth of the shale gas industry in the United States.

Unconventional gas - mostly shale - has come to account for about 20 per cent of the market and the EIA expects that to increase to 45 per cent by 2035.

Repeating that success in a remote location like the Canning Basin will be challenging.

Lack of infrastructure, lack of a service industry, remote locations and lack of water supplies are some of the barriers noted by Patersons analyst Alexis Clark in a WA shale gas research report.

Against this backdrop, many Australian companies have chosen to invest elsewhere.

Tap Oil is exploring in Thailand, Grand Gulf Energy is exploring in Louisiana and Strike Energy is exploring in the US and the Cooper Basin in South Australia, which has established pipeline infrastmcture linking the gas fields to east coast markets.

It was in the Cooper Basin that Santos recently developed the first commercial shale gas well in Australia.

Patersons, for one, believes WA-focused explorers will overcome the challenges.

“The existence of a high WA gas price is one of the critical determinants of the commercialisation of the resource and we believe these other technical challenges should be overcome in time,” its report concluded.

However, Professor Peter Hartley, the BHP Billiton Chair in Energy and Resource Economics at the University of WA, sees the market evolving differently.

“It’s very expensive relative to conventional gas but in our view the Canning Basin will play a critical role later this century in enablmg Western Australia to continue producing LNG exports for a long time.”
In the short term, Professor Hartley sees other big changes affecting the gas industry in WA.

Traditionally, LNG prices have been linked to the oil price but there is a push by gas buyers to make the much lower Henry Hub gas price in the US the new benchmark.

There has also been a lot of speculation the US would soon become a gas exporter, potentially eroding Australia’s competitive position in Asian markets.

Speaking at an APPEA seminar this week, Professor Hartley said the world LNG market was growing in size but was also becoming more competitive.

He believes the sustainability of long-term sales contracts, which traditionally have underpinned big LNG projects, is under threat, with buyers demanding more flexibility to take advantage of spot-buying opportunities.

“In this context, cost blowouts on Australian resource projects are a major issue,” he said.

He does not see US shale gas as a direct threat to Australian exporters. He sees the biggest competition coming from the Middle East and Russia, which will be able to supply the Chinese market via pipelines.

In addition, he expects increased Chinese production from its shale gas deposits will limit the growth of Australian LNG exports.

“Australia cannot rest on a belief that its resource endowments alone will ensure a bright future,” he told the seminar.

Technical breakthrough

Historically, the production of unconventional gas has been difficult because it’s typically locked in tight geological formations at least 2km underground.

Its production is reliant on ‘well stimulation’ for the gas to be released from the rocks - a technique often referred to as ‘fraccing’ as it fractures the rocks enabling the gas to be released.

Given that there is also less gas produced per well, and wells need to be drilled much deeper than in conventional gas plays, US gas operators have been prompted to drill horizontally in an effort to reduce costs.
Now that these modem technologies have been proven in North America, exploration in WA has accelerated as companies look to obtain similar payoffs here.

Department of Mines and Petroleum geologist Nina Triche says the Canning Basin alone is “an order of magnitude larger” than any US shale gas plays bar one, with approximately 125,000 square kilometres of shale gas rock.

Buru leads the way

When it comes to who’s who of unconventional gas exploration in WA, Buru Energy has emerged as the big name in the past year.

The company’s discovery of oil at its Ungani 1 well just over a year ago was a catalyst for renewed vigour in the Canning Basin - it was the first significant oil discovery in the basin in more than 20 years.

Buru has indicated commercial production of the Ungani oil is likely next year.

But the company also has two unconventional wet gas exploration programs under way in its Valhalla and Yulleroo fields, which sit within Buru’s vast array of exploration permits across the basin.

First gas is targeted for 2015 enabled by financial backing from Mitsibushi - it has committed $100 million to progress the unconventional gas projects.

Under the terms of the joint venture, struck in 2010, Mitsibushi will earn a 50 per cent interest with initial funding of 80 per cent of exploration costs in 2012 - amounting to $40 million.

An additional $50 million will be provided to cover development costs.

But Buru has also been given a pass by the state government, which others have been left without.

Last month Premier Colin Barnett announced the government had reached an agreement with Buru and Mitsibushi, which circumvents traditional laws on petroleum exploration.

Under the government’s Petroleum and Geothermal Energy Resources Act 1967, companies with petroleum exploration permits are supposed to relinquish 50 per cent of the area that make up the permit.

In practice that rarely occurs, but the State Agreement between Buru and the government has removed the possibility entirely.

The result is that Buru has control over five core exploration permits up until 2024 without the need for any acreage to be surrendered back to the government.

Buru said the agreement gave it the security needed to invest in exploration, while the government has also trumpeted upsides for the state.

Mr Barnett said the agreement was necessary if WA was to succeed in its pursuit of unconventional gas.

“The Petroleum and Geothermal Energy Resources Act 1967 was not drafted with the recently emerging unconventional gas sector in mind,” Mr Barnett said.

“The limited suspension of relinquishment obligations recognises that proving the technical and economic feasibility of the Canning Basin’s commercial shale gas potential will require some years of high-level expenditure and technical development.

“This has been the case for shale gas in the United States of America despite the presence of the most experienced petroleum services sector in the world.”

Under the agreement Buru is also required to submit a proposal to the state for the development of a gas pipeline and project to deliver gas into the domestic market, which Mr Barnett said would help to secure the state’s future energy supply.

“It ensures that the development of that gas will be, in the first instance, for the Western Australian domestic market. It has priority,” Mr Barnett said.

Should Buru and Mitsubishi uncover gas reserves significant enough to justify an export business, 15 per cent will be reserved for the domestic market.

Herbert Smith Freehills advised Buru and Mitsubishi on the agreement. Lead partner Stuart Barrymore said the joint venture had been grappling with how to pursue exploration and appraisal with the possibility of having to relinquish some areas.

“There was a very real risk that the gas exploration effort in the Canning Basin region would become fragmented with long lead times before adequate resources could be found, tested, aggregated, developed and sold,” Mr Barrymore said in reference to Buru operating without the state agreement.

But the agreement has not been received well by all. Industry commentator and editor of the Oil and Gas Radar Paul Sullivan told WA Business News some competing companies had considered the agreement an act of favouritism.

“While the state agreement with Buru has many obvious benefits, there is some disquiet in the oil and gas industry about one party being able to make such an agreement which appears to contravene the state’s own petroleum regulations,” Mr Sullivan said.

“Every other onshore explorer has to follow the standard regulations ... Buru has effectively circumvented this part of the Petroleum Act by locking up a large section of land without any reduction in area for up to 50 years. This could be interpreted as the state government playing favourites and trying to pick winners.”

But that statement has been rejected by Mr Barnett. “The reason the state government and Buru have entered into this agreement is because both its exploration efforts and its proposed project are more developed than that of any other explorer at this point in time,” he told WA Business News.

“Any request for a State Agreement from another explorer in the region would be dealt with on its merits.”

Other players

One of those explorers in the running for future negotiations with the government is New Standard Energy, which is also exploring in the Canning Basin backed financially and technically by global explorer ConocoPhillips.

In September 2011, the pair announced a farm-in agreement, which will result in ConocoPhillips obtaining an ultimate 75 per cent interest in New Standard’s Goldwyer Project for $119.5 million.

The funding will be provided over four phases of a three-well exploration program, which began in August this year. The second phase of the program will be carried out next year with the final phase of exploration involving a full pilot development program planned for 2015.

Outside of its agreement with ConocoPhillips, New Standard Energy is also progressing exploration of two separate unconventional gas plays: the Merlinleigh Project in the Carnarvon Basin is fully owned by New Standard and has the benefit of being strategically placed adjacent to the Dampier to Bunbury pipeline infrastructure.

New Standard also owns 50 per cent of the Laurel Project in the Canning Basin near to Bum’s interests.

That particular space in the Canning Basin is becoming a crowded area (see map), with US oil and gas giant Hess entering the market after buying Kingsway Oil for an undisclosed sum.

The exploration permits held by Kingsway lie adjacent to New Standard’s interest in the basin and south of Bum’s site of exploration.

Meanwhile, Fortescue Metals Group has also moved into the Canning Basin after obtaining a stake in Melbourne-based company Oil Basins; for a $4.2 million investment FMG gained 18 per cent ownership.

Oil Basins is negotiating a native title agreement with traditional owners so it can progress exploration just north of Buru’s interests.

Perth Basin could be first

While the Canning Basin’s potential in terms of size is impressive, it could well be explorers focused on the Perth Basin further south which are first off the block.

A joint venture between AWE, Norwest Energy and Indian company Bharat PetroResources has been steadily increasing its exploration spend on unconventional gas.

In the 2011-12 financial year AWE’s share of expenditure on WA exploration was $16 million. That ramped up to $10 million in the three months to September. The joint venture is one of the first to begin testing the well stimulation - or ‘fraccing’ technology and recently reported positive results from the stimulation campaign carried out at its Arrowsmith-2 well.

“The tight gas and shale gas testing program has successfully achieved its initial objectives,” AWE managing director Bruce Clement said.

“To date the company has been involved with the hydraulic fracture stimulation of three wells ... where all zones targeted have been successfully stimulated and hydrocarbons have been recovered from each.”

Mr Clement said further testing was planned for the three wells, following which the company would be in a position to decide on whether developing the project was feasible.

Alcoa has also taken an interest in the potential for unconventional gas in the Perth Basin. In 2008 it entered an agreement with Latent Petroleum -which was later acquired by Transerv Energy - to appraise the Warro field for tight gas.

Alcoa is progressively investing $100 million in the project to ultimately earn a 65 per cent stake in the project.

The joint venture is now examining 3D seismic surveys completed in 2011 to establish priority drilling locations for its next phase of exploration drilling to be carried out next year.

The project has two significant upsides; it is located only 35km from key gas pipelines and Alcoa has indicated the likelihood of it being a main buyer for any gas produced.

Also exploring in the Perth Basin is a j oint venture between CalEnergy Resources and Whicher Range Energy, and Empire Oil and Gas.

Empire holds an impressive portfolio of 32 prospective exploration targets, both in the Perth Basin and the Carnarvon Basin, where a joint venture between Tap Oil and Rusa Resources also has an early-stage interest.

Sudden surge

Much of the above activity in onshore exploration for unconventional gas has been relatively recent - exemplified by the most advanced player Bum only establishing its forward plan with Mitsibushi a year ago.

But while the ramped up investment is an encouraging sign for a new stream of resources revenue for the state, it will undoubtedly have to overcome the same stumbling blocks other resources markets have had to tackle, if not more.

The recurring theme of remote locations and lack of infrastructure has the potential to besiege oil and gas explorers much like it has done for iron ore players in the Pilbara, as well as high operating costs.

But in addition, explorers will have to continue convincing interested parties that the fraccing technology is safe and will not jeopardise water quality or resources - without it WA’s enormous gas reserves could remain dormant as they have done for thousands of years.