RIL's Shale Bet Fades As the US Floats on Gas

When Reliance Industries was negotiating its $3.4 bn investments in US shale companies- the world was different. America was energy starved and looking desperately for ways to reduce dependence on the Gulf. For RIL, shale gas was seen as the next big thing, after its offshore find earlier in the decade. It would give the energy giant knowledge of the new ways of gas production, as well as allow it to ride the gas price boom. Three years down the picture is different. The United States is floating in natural gas- storages all over the country will max out in the next few months and prices are at ten-year lows.

Some say producers may soon have to give away the gas free- with money being made only on associated liquids and condensates that were initially considered by-products. RIL is `right-sizing’ its activity in the shale fields and the portfolio mix on its investments in shale assets. Like other producers here, it will focus on ramping up its production in liquid-rich fields and cutting costs at fields where there are little or no liquids. Gas prices that peaked at $13 a unit (measured as mmbtu-million british thermal units) in 2008, are marginally above $2 now. Prognosis for gas prices over the next few years is not too bright. But the associated liquids still trade at roughly 50 per cent of oil prices- which are still very high.

In its Annual report for 2011-12 released this week, the RIL management says it will take a prudent approach to the shale production ramp up. The company has three big investments in US shale. Two of the joint ventures with Chevron and Carrizo are in the Marcellus formation in eastern US and one is in Eagle Ford in Texas with Pioneer Natural Resources. Investments in all the three ventures has been largely on drilling wells- as shale extraction requires hundreds of wells to be dug. The company has set aggresive cost-cutting targets for the Chevron joint venture.

``It has now become a rush for liquids,’’ says Bill Holland, the Washington DC based associate editor at Platts gas daily. Smart companies are trying to figure how to reduce their costs and improve fracking techniques, he says. It costs only 80 cents to get out a unit of gas at Marcellus- so companies there are still making money. The real challenge is to keep head above water in the dry fields- which produce only gas and no liquids. Analysts here expect consolidation among shale gas companies later this year. Private equity firms like KKR are already buying up a lot of assets at valuations that are much lower than the peak. Most of these deals are with the intention of flipping over the assets, when circumstances change. KKR Natural Resources, the PE firm’s vehicle for gas investments already has a $900m portfolio.

Despite the sorry rate of return on the shale gas at the moment, there is one good reason for Reliance to stay invested in US shale. And this is to do with being at the cutting edge of fracking- the technique for gas extraction from dense rock. In what will surely be a first for an Indian company, Reliance Industries may soon become the operator of shale fields in Pennsylvania. The contract in the joint venture with Carrizo, where it has invested close to $500m allows this. This would be a big step for the company in terms of figuring out the operations first hand. Many Chinese, Korean and French companies continue to remain invested the shale ventures for this reason. Cash rich companies such as Reliance Industries and CNOOC (China National Offshore Oil Company) have to a great extent, bankrolled shale ventures of small and medium sized US companies.

CNOOC invested over $2.4bn for a stake in Chesapeake Oil’s lease holdings in various shale fields. Like India, China is trying hard to replicate the US success in shale- so far with mixed results. The current glut of gas in the United States is in sharp contrast to the energy shortages in India and China. In India, the ministry of petroleum and natural gas has kicked off initial rounds to explore shale formations for gas. Once the process is underway, it could well be RIL’s day in the sun- once more.