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A global fracking revolution? Curb your enthusiasm.

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(Read caption) Oil rigs belonging to PetroChina are seen near the banks of a snow covered lake in Daqing in northeastern China's Heilongjiang province last year. Set to replace the US as the world's largest importer of oil next year, China has teamed with Royal Dutch Shell to use hydraulic fracturing (fracking) to develop its unconventional oil resources.

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With recent headlines trumpeting the entry of Saudi Arabia and China into the shale game, enthusiasm for unconventional natural resources has reached a fevered pitch. Countries in all corners of the world are poised to bolster the global economy when, only a few years ago, concerns abounded that demand would unsustainably exceed supply. Any increase in supply is an investment in future energy security worldwide.

However, it may be time to put a damper on some of the enthusiasm.

What is good for the global economy in the long term may very well cause problems for the countries pursuing shale energy in the short term. Indeed, the stress of infrastructure investments, resource constraints, environmental concerns, and the risk of financial losses from temporary, price-depressing energy gluts could cause nations like Saudi Arabia and China to abandon shale energy before they reap its benefits. Thus, government policy will be key in determining the scale of the shale boom – even in the United States, which has reached a crucial fork in the road in shaping the future of its shale industry.

Saudi Arabia’s chief concern is the immediate need to develop the critical infrastructure necessary to make shale plays a possibility. Much of Saudi Arabia’s shale resources lay in remote, dry areas where no existing extraction or transport facilities exist. Moreover, in order to access this shale, Saudi Arabia will need to commit to the costly, energy- and resource-intensive process of hydraulic fracturing. Not only does Saudi Arabia need to establish the infrastructure to obtain shale gas, but it also needs to develop a viable way to transport the vast amounts of water required to get the process started. In addition, producers will need to bolster their ranks of skilled workers. These challenges indicate that it could take up to five or six years before Saudi Arabia achieves meaningful production. The global energy economy can change substantially in that time frame, and fluctuations in energy prices can make such a vast investment risky. 

China, which is expected to surpass the US next year as the world's largest importer of oil, recently overcame one of the largest challenges blocking access to its shale reserves: finding the right partner. In late March, the Chinese government awarded Royal Dutch Shell a $1 billion-a-year contract to work with China National Petroleum Corp. to help drill the wells and introduce hydraulic fracturing technology to the country. Yet China still lacks a wide-reaching pipeline network that would allow it to bring its shale product to market, and it is unclear if China’s already-stressed water supply can sustain fracking processes. A looming issue will be whether China’s coal industry – which currently accounts for 15 percent of the country’s water usage – is able to sacrifice any of its share of the limited resource.

In addition, Chinese shale formations pose a set of challenges not seen in the US, including a higher clay composition in the formations and deeper deposits. As China works to overcome these obstacles, it will need to increase its natural gas imports in order to keep pace with growing demand, placing further strain on resources as domestic supply races to catch up with domestic demand – and foreign supply.

The US is in a better position, economically, as it pursues its unconventional resources.  Pricing, however, remains a thorn in shale producers’ sides as they work to rapidly bring shale to market against more conventional oil sources. The break-even pricing for shale oil, shale gas, and oil from the Canadian oil sands is much higher than the break-even price for conventional resources elsewhere, forcing North American producers to churn out more product than their conventional competitors in Saudi Arabia and elsewhere.

At the same time, US refining capacity is ill-equipped to manage the influx of unconventional resources. The country is at a critical junction where it needs to make decisions about how to handle its new-found primacy in the global energy market. Many US refineries have been built to process the heavy sour crude oil typical of Mexican, Venezuelan, and Canadian reserves, as opposed to the light sweet crude found in shale. The US has two choices for addressing this issue: It can either build more refineries geared toward light sweet crude (a costly endeavor) or it can lift the ban on US crude exports established during the height of the 1970s energy crisis.

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A handful of oil and gas companies, such as Kinder Morgan, are finding workarounds to the ban by building “mini-refineries” that process the crude just to the point where it can be labeled a refined product. Others, such as Valero, have been granted exceptions by the US government to export small amounts of their crude to refineries in Quebec. However, in order for the United States to fully take advantage of its shale reserves, it will need to make some difficult decisions about the best way to move forward.

The major obstacle all these countries share is the environmental impact of hydraulic fracturing, which further crimps enthusiasm for shale and undermines its long-term viability. Oil and gas companies need to work with their respective governments — rather than against them — in order to determine the most responsible way forward. This could mean accepting reduced production in exchange for a more limited environmental impact, or receiving financial assistance in developing cleaner, lower-impact technologies for access to these resources.

One thing is certain: Shale plays will be crucial in keeping up with mushrooming energy demands worldwide as populations increase, emerging markets work to keep the lights on, and developing economies continue their progress. Demand in Asia will continue to grow exponentially, especially in China and India, while countries like Japan seek a safer alternative to nuclear power.

 Shale producers are poised to fill a crucial gap in world energy needs, but it is by no means a panacea. We may expect that some of today’s enthusiasm will wane as more producers and countries, unable to sustain near- to mid-term instability in exchange for future security, throw in the towel.

– Charles Dewhurst is the global leader for the international natural resources group at BDO International and leader of the natural resources practice at BDO USA LLP.

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