Tough Choices in "An Embarrassment of Riches"
Along with the sudden abundance of massive shale gas reserves in the U.S. comes a unique and profitable problem.
Thanks to the infrastructure challenges presented by the shale gas boom, some companies are now having a hard time deciding which projects to emphasize.
Royal Dutch/Shell (NYSE: RDS-A) is a good case in point.
As Gas Business Briefing (GBB) noted this morning in its on-point analysis, Shell has several huge North American projects pending to employ gas and gas liquids from shale plays. However, company heads now acknowledge that not all of them can be built.
According to CFO Simon Henry, Shell has “an embarrassment of riches of high-quality opportunities for new LNG, gas-to-liquids and then downstream gas-to-chemicals.”
Yet Henry says, “We can’t do all of these.”
As you’ll see, this “problem” is going to create some fantastic new opportunities for investors.
Here’s what I mean by that…
A Multi-Billion Dollar Leap of Faith
In this case, extracting the gas is only the first stage. Determining large working capital investments among competing processing and delivery systems, on the other hand, is now rapidly emerging as a major hurdle.
At issue, are the massive capital infusions, along with the significant employment and tax base advantages provided to the localities receiving the projects. And as the new phase of unconventional gas development kicks in, there are some genuine cross-regional competitions emerging.
But part of the problem for Shell and others is the complete lack of a track record in this new market. That means selecting one location or project over another is a multi-decade and multi-billion dollar leap of faith
Unfortunately, exploiting the profitability of the shale revolution requires huge expansions in midstream and downstream operations. And the fact is companies will need to move before the production volume ramps up and the higher volume has no other place to go but storage.
In Shell’s case, the company recently pointed to its Pennsylvania ethane cracker, a gas-to-liquids (GTL) facility along the Gulf Coast, and a liquefied natural gas (LNG) export project in Canada as being particularly at risk right now.
According to Shell CEO, Peter Voser, the company “cannot afford to take all three together at once and, if we could, I am not sure we have the engineers and the project managers to do so. Those three opportunities are all large-scale investment. And they are all approaching what we call the concept selection stage” before the company goes into the front-end engineering and design (FEED) phase.
“We are already doing some of that detail design in LNG Canada, but we are not there yet,” Voser said.
As GBB noted in today’s analysis, LNG Canada is a joint venture of Shell Canada, Korea Gas (KOGAS), Japanese major Mitsubishi and Chinese state giant PetroChina to build and operate an export terminal in Kitimat, British Columbia.
In July, LNG Canada applied to Canada’s National Energy Board for a license to export up to 24 million tons of LNG annually for 25 years. Tomorrow (November 13), that project begins a 30-day public comment period as part of its environmental assessment.
Meanwhile, several observers have noted that Shell cannot proceed with all three projects at the same time because the capital outlays are simply too big.
In addition, as GBB quotes Steve Lewandowski of consultancy HIS, the gas to liquids (GTL) and the LNG export proposals “both compete for natural gas,” He adds that, “The cracker is indirectly impacted by shale gas, but it’s really about ethane, the liquids recovered from the gas plays.”
As for the LNG, Lewandowski continues, “If there are no exports, the gas stays in the ground and the companies lose money.” As for the GTL project, it “is really looking at the price of natural gas versus crude oil. The U.S. has an appetite for diesel, as does the rest of the world.”
The Cheapest of the Three?…
The proposed $4 billion ethane cracker, meant to capitalize on Marcellus and Utica shale production, faces another set of challenges, and not just a dearth of infrastructure to support the plant and competition from other NGL takeaway projects. This would require that Shell move back into the polyethylene business, a major petrochemical market the company exited from several years ago.
Shell announced in August it was seeking bids for ethane feedstock for its proposed facility in southwestern Pennsylvania, which would take up to five years to build. The complex would produce about 1million tons of ethylene annually from up to 80,000 barrels per day of ethane. The proposed cracker is a clear example of the difficulties facing developers as new demands emerge for interconnected facilities and services.
While a feeder pipeline could be introduced between the cracker and the Marcus Hook port near Philadelphia (allowing Shell to export production), the cracker needs significant storage capacity. That is an issue nobody at Shell has thus far discussed and an essential element still unbudgeted in the overall projections.
Still, outside estimates place the Pennsylvania cracker plant as the cheapest of the three to build. In contrast, the cost of a large-scale GTL facility on the Gulf coast is much greater than the price tag for a cracker. For example, South African Sasol (NYSE: SSL) is in the FEED stage for its GTL facility on the Gulf Coast.
Plans call for that plant to process about 900,000 million cubic feet of gas a day into some 96,000 barrels per day of diesel and other products. But it is now estimated to cost between $11and $14 billion. And Shell’s GTL plans are even bigger – projected to convert 1.3 billion cubic feet per day into 140,000 barrels of product.
LNG terminals and GTL plants remain more expensive than crackers. They also take longer to build. That time consideration places longer-term projects at the mercy of raw material, steel, and construction cost rises.
Meanwhile, Shell has made inroads with LNG exports in the U.S., investing in the Elba Island export facility in Georgia, which is “small, modular and highly profitable,” according to Voser.
In January, Shell and Kinder Morgan (NYSE: KMI) announced they would partner to export LNG from the East Coast, the latest of some 20 export projects announced in North America.
Elba Island already has permission from the U.S. Department of Energy for LNG shipments to countries having free trade agreements with the U.S.
But there is no firm projection of profitability in the absence of formal contracts and without final project design.
All of this means two things as we experience the next phase of the shale age.
First, market networking remains unclear, as participants await anything resembling a master plan for facilities and usage.
Second, cross-sector (upstream, midstream, downstream) logistics will be at a premium, with needs ranging from early planning, through FEED and construction designs, to finalization of facilities and operations. This will put a premium on services in a wide range of evaluation and coordination applications.
And that will open up some interesting new investment opportunities
PS. Shell’s “embarrassment of riches” is nothing compared to the $43 trillion in oil the Russians are about to start pumping out of the Arctic Circle. But here’s the real key: Every drop of it hinges on a small Western company that is about to go ballistic right now. I have all the details right here.