BMI View: Shale gas regulations would provide clarity for investors seeking to tap South Africa's shale gas potential. However, we note the investment certainty this provides could be undermined by an unappealing incentive structure provided by a proposed Minerals and Petroleum Development Amendment Bill that is being considered. Domestic concerns about the environmental impact of fracking could also stall the passing of the bill. Shale gas production is likely to remain a long-term prospect that would only have a material impact beyond our ten-year forecast period to 2022.
In an important move, the Cabinet of South Africa proposed a new set of regulations that would govern shale gas exploration and production (E&P). The new framework comes just over a year after South Africa lifted a moratorium on hydraulic fracturing (fracking) opening the door to investment in tapping the country's sizable shale gas deposits , which recoverable gas resources US Energy Information Administration (EIA) estimates could be as large as 10.9trn cubic metres (tcm) . Expressions of interest have already come major international oil companies like Royal Dutch Shell which have pledged significant investment.
| Tapping Shale Gas Potential |
|EIA's Estimates Of Countries With The Largest Shale Gas Potential (tcm)|
The proposals target regulations surrounding hydraulic fracturing (fracking) in particular, to ensure that it would be conducted 'in a socially and environmentally balanced manner', according to the Department of Mineral Resources' official press release. This draft regulation covers the following:
Protection of freshwater resources;
Disclosure of all chemicals used in fracking and rehabilitation of any well s that were depleted during E&P;
Mechanism to determine the buffer zone for sites where shale gas exploration and a Square Kilometre Array (SKA) project are both based in;
Technical provisions for the following: site assessment, selection and preparation; well design and construction; operations and management; well suspension and abandonment.
These regulations are based on recommendations provided in an official study into fracking published in 2012. This will be open for public comm ent for 30 days after its publication in the Government Gazette, after which it would be passed to the Cabinet for final approval.
The pace of regulatory developments for South Africa's oil and gas sector has particularly picked up in 2013, reflecting the eagerness of the country in tapping domestic resources to meet its energy mee ts. The country has negligible proven oil and gas reserves and is a net importer of both products. In 2012, its net imports of crude oil stood at about 295,200 barrels per day (b/d) while net gas imports via pipeline from Mozambique was about 3.3bn cubic metres (bcm) - or about 70% of its total oil and 21% of its total gas needs.
| Tapping Shale To Reduce Import Dependency |
|South Africa Net Oil (LHS, '000b/d) & Gas (RHS, bcm) Exports, 2000-2012|
The country has been largely reliant on coal for much of its energy mix - supplying some 90% of current power needs - and has been a frontrunner in coal-to-liquids (CTL) technology to substitute fuel imports. However, to meet climate change objectives the state is pushing for a greater diversification of energy sources, and gas is grow significantly in South Africa's electricity generation mix by 2030 , according to its Integrated Resource Plan released in 2010.
| Shifting Gas Up |
|Share Of Various Energy Sources In Electricity Generation In 2009 (Inner Circle) & Government Target By 2030 (Outer Circle)|
Given an expected increase in South Africa's power demand as more households are connected to the grid, its demand for gas is also expected to increase. Part of this demand is to be met through imports - national oil company (NOC) PetroSA is looking to develop an liquefied natural gas (LNG) import terminal - but development of domestic gas resources would be key to achieving these ambitious targets without excessive reliance on gas imports. This is provided that domestic upstream development is complemented by adequate financing into the power sector, which has attracted limited new investment owing to the slow pace of privatisation.
Its coalbed methane (CBM) and shale gas potential promises to boost indigenous production and large returns for the government. According to the 2012 official shale gas study, 840bcm of shale gas production could yield as much as one trillion rand (US$1.01bn) in income for South Africa at 2012 prices and curren c y exchange rates. Trade minister Rob Davies expressed his optimism in a news conference in August 2013 that South Africa's shale gas resources could be larger than the gas discovered in neighbouring Mozambique in recent years and could be 'a very, very significant game changer in terms of the energy situation in South Africa'.
Moving With Industry Interest
There had been some industry interest in South Africa's shale gas potential - from the likes of major oil and gas players such as Statoil and Chesapeake Energy - as early as in 2009 but a moratorium on fracking in 2011 over environmental concerns had impeded progress. The government lifted this ban in September 2012, Royal Dutch Shell ha s been among the leaders in pledging investment to target shale gas since . Shortly after in December 2012, Chevron entered into a farm-in agreement with Toronto-listed junior Falcon Oil & Gas for exploration rights in the Karoo basin, where much of South Africa's shale potential lies ( see 'Chevron Taps Shale Potential', December 19 2012 ).
Clarity on South Africa's shale gas regulatory regime should pave the way for shale gas exploration to progress. Trade minister Rob Davies had hoped that the country could begin exploration in earnest in April 2014 before the term of the existing government ends.
Hinging On Mineral Law Bill
However, the certainty brought about by shale gas regulations could be negated by an ambiguous oil law that the country is looking to pass ( see 'Ambiguous Oil Law Could Delay Investment Despite Total Interest', September 30 ) . The Minerals and Petroleum Development Amendment Bill, which regulates both the wider oil and gas sector, has been met with much controversy specifically over the following points:
Ownership: The Minister of Mineral Resources would have the power to declare certain resources to be strategic to the country and take a larger share in ownership of projects or companies. This could be unappealing for investors looking at projects requiring large capital investments and with high exploration risks.
Lack of a separate law for the oil and gas sector: Under the amended bill, the much more underdeveloped oil and gas sector would be regulated under the same law as South Africa's mature mining sector. Given the lack of domestic expertise in the oil and gas sector unlike the mining sector, there is a greater need to attract foreign investment. However, there is no separate incentive structure to provide better terms for oil and gas exploration and production (E&P).
The relatively new nature of shale gas E&P and the lack of adequate oilfield services support would raise the costs of investing in shale gas in South Africa. Shale gas plays have yet to be de-risked in the country as no drilling has taken place. Without addressing the above-mentioned issues in the wider Minerals and Petroleum Development Act governing and framing rewards to be reaped from participating in shale gas E&P, shale gas regulations alone would not be sufficient to provide investor certainty.
Even within the shale gas draft law itself, the state stands to enjoy a 20% stake in shale gas blocks and would have the option to acquire an additional 30%, though it would pay market rates and addtionaly interest should it exercise this option . Adventurous independents and capital-rich majors looking to move away from their cautious corporate strategy could take up the challenge, but the unattractiveness of South Africa's upstream regulatory regime could undermine interest in its shale gas potential.
Domestic Ecological Concerns
We also see the risk of a delay in the passing of this draft due to continued questions surrounding the environmental impact of shale gas exploration. With much of South Africa's shale gas potential thought to lie in the ecologically diverse and environmentally sensitive Karoo basin, concerns regarding the impact on wildlife and agriculture have been among the primary challenges to raising greater public support for fracking.
Indeed bowing to such concerns, prior to unveiling the draft regulations the government declared shale gas extraction a 'controlled activity' that requires a water license that can only be issued to companies after an evaluation of the impact of industrial activities on ground water supplies. The government has argued the new regulations have adequately addressed concerns regarding the environmental and social consequences of shale gas exploration and reflect the best practices from abroad. However, some domestic opposition is still expected that could stall a cabinet decision on the law.
A Long-Term Hope
While gas could help the country meet ambitious power targets as well as offer upside to the fuels supply via gas-to-liquids (GTL) technology, commercial production of shale gas is unlikely to materialise in any significant amount within our current forecast period. Industry sources cite a 7 - 10 year time frame for shale gas development in South Africa, with extractions costs ranging from US$9mn British thermal units (/mnBTU) to US$16/mnBTU. At these breakeven costs, gas imports could prove more competitive than domestic shale gas developments in the short-term.