Schlumberger Can Gain From UK Lifting Its Fracking Ban

The United Kingdom cleared the way for hydraulic fracturing for shale gas last week, ending an 18-month ban that was imposed following two minor tremors that were apparently caused by the procedure. While the move to lift the ban was widely anticipated, hydraulic fracturing will now be subject to more stringent rules to mitigate environmental risks. (See Also: Schlumberger Benefits As The UK Looks To Resume Shale Exploration) Given the relatively nascent stage of the British shale gas sector, we believe that Schlumberger (NYSE:SLB), a leading provider of services and technologies for unconventional plays such as shale gas, could benefit.

What is Hydraulic Fracturing ?

Shale gas reserves are trapped within shale rocks and need to be stimulated so that gas can flow up to the well head. A procedure called hydraulic fracturing that involves pumping a mixture of water, sand and other additives into shale gas wells at high pressures is used to create cracks in the rock to free up the gas. While the adoption of the procedure has grown steadily over the last decade, particularly in the US,  it has come with its fair share of critics who contend that it consumes too much water, contaminates the ground water supply and could potentially cause earthquakes.

What Prompted The UK To Lift The Ban?

Natural gas production in the UK has been falling for several years with monthly production declining from around 350 billion cubic feet (bcf) in 2000 to under 200 bcf in 2011. The country’s conventional gas reserves have been declining as well with mature fields accounting for a bulk of current production. This has caused an increasing dependence on imports (over 50% of current supply), which has driven up energy prices. ^[1]

Tapping into the country’s shale gas reserves could unlock a relatively inexpensive and clean energy resource while helping the UK improve its energy independence. For instance, the shale gas boom in the United States helped to bring down natural gas prices to around $3-4 per million British thermal units; in comparison prices in Europe rule at around $10-11 per MMBtu.

While the reserves are estimated to be quite large, there is still uncertainty about the exact volumes given that only a few seismic analysis studies have been performed country wide. The British Geological Survey (BGS) previously estimated reserves at around 5.3 trillion cubic feet (tcf) while Cuadrilla Resources, a shale gas operator, pegs the number as high as 200 tcf. The BGS is expected to update its numbers in 2013. ^[2]

More Stringent Regulations, Tax Breaks In The Offing

Given the potential that shale gas could offer, the British government is playing a proactive role to ensure the development of the resource while balancing public concerns of its environmental and safety impacts. Earlier this month the government announced that it would create a dedicated government office to simplify regulation and would offer tax breaks to the fledgling industry. Any UK oil and gas firm with an onshore license would have rights to shale gas reserves in its license area.

The government will also oversee new safety measures that include requirements for operators to monitor seismic activity before drilling and throughout the entire drilling process, adopting a traffic light system to stop drilling when conditions are not favorable, and requiring the disclosures of chemicals used in hydraulic fracturing.

Opportunities And Risks For Schlumberger

Schlumberger has among the largest fracking fleets in the world, a large part of which is located in North America, a market which is currently oversupplied and is reeling under low prices (the US is home to nearly 80% of global fracking capacity). ^[3] The supply of fracking equipment in Europe is not as well-entrenched as it is in North America. Besides, the higher natural gas prices in the UK would give the company better control over the pricing of fracking services.

Given that the shale gas industry is the UK  is still in its nascent stage, oil and gas firms may require experienced contractors such as Schlumberger which has built its competence in unconventional plays thanks to its exposure to the US shale gas sector. Schlumberger has invested significantly in developing efficient fracturing methods that require less pumping equipment and raw materials. These technologies will lower the environmental impact of fracking besides reducing logistics costs and provide a smaller operational footprint, which could prove to be a welcome advantage for the company in European markets.

However, there are some risks involved as it may take several months for firms to get the requisite approvals to begin exploration activity and could take even longer to bring production on a commercial scale. The industry is still in a very nascent stage with only one firm, Cuadrilla Resources, having carried out fracking in the country. The structure of the shale formations in the UK and the potential recovery rates are also yet to be estimated.

We have a $86 price estimate for Sclumberger, which is about 25% ahead of the current market price.

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1. US EIA [↩]
2. Britain Lifts Shale Gas Ban, Imposes Tighter Rules, Reuters [↩]
3. Pacwest Consulting Partners [↩]