COLUMN-Centrica buys an option on Britain's shale future: Kemp

Thu Jun 13, 2013 2:00pm BST

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By John Kemp

LONDON, June 13 (Reuters) - Britain's shale gas industry remains more of a concept than reality. But Centrica's decision to buy a stake in one of the most promising tracts provides the capital, technical expertise and political muscle to move to the next stage of development.

Centrica announced Thursday that it has bought a 25 percent stake in Petroleum Exploration and Development Licence (PEDL) 165 which covers the Bowland shale in Lancashire, from Cuadrilla Resources and AJ Lucas.

Centrica will pay £40 million in cash now, with a further £60 million payable if the company elects to continue into the development phase.

In the meantime, Centrica will also pay up to £60 million to cover the cost of drilling exploration and appraisal wells to establish whether shale gas can be produced commercially in the area.

BOWLAND SHALE PLAY

Like its main rival, IGas, Cuadrilla holds attractive exploration and development licences covering areas in both northwest and southeast England that have already produced oil and gas from conventional wells, and are known to have extensive shale formations which might produce far more if they were stimulated using hydraulic fracturing.

However, so far Cuadrilla has only drilled three wells in Bowland, and only one of them has been fractured, at Preese Hall.

Initial drilling confirmed the thickness of the formation and the presence of gas. Cuadrilla has estimated there could be 200 trillion cubic feet of gas in place in its licence area.

But the company was forced to suspend hydraulic fracturing after attempts to stimulate the Preese Hall well induced a series of small seismic tremors from nearby fault in 2011.

The moratorium was lifted by the government in December, allowing fracturing operations to resume, subject to a strict monitoring process.

CASH AND RISK-SHARING

Before committing to large-scale development, many more wells need to be drilled and fractured to confirm the extent of the play, its organic content, the proportion converted to gas, and flow rates following fracturing, as well as identify any particularly productive sweet spots for development.

In practice, Cuadrilla and IGas are both "concept companies." They have successfully marketed the potential of Britain's shale to investors and politicians, but lack the financial resources to undertake the cost and risk of an extensive drilling programme. Both need strong financial partners to scale up exploration programmes and turn theoretical resources into proved reserves.

Cuadrilla and IGas have each produced credible but optimistic estimates for the potential amount of gas locked away in the country's main shale formations. In its own licence area, which borders Cuadrilla's, IGas claims there could be up to 172 trillion cubic feet of gas in place.

These ambitious estimates seem likely to win a cautious endorsement from the British Geological Survey (BGS) when it publishes its own updated estimates this summer, which are expected to show a big upward revisions of the amount of gas in place.

Cuadrilla and IGas have worked hard to rally support from Britain's business establishment and elements of its political class behind the idea shale gas could provide much needed jobs, tax revenue and energy as the country's conventional oil and gas resources decline.

Both companies have some experience navigating the complex permitting regime that governs drilling and fracturing, which requires at least 10 different licences from four different sets of authorities, according to a recent pro-shale report by the Institute of Directors ("Getting shale gas working" May 2013).

Cuadrilla sponsored the IOD report as part of its effort to convince policymakers of the benefits of shale and encourage them to remove the barriers to development, particularly in the regulatory area.

IGas has revenues from conventional oil and gas wells. But neither company has the financial resources to undertake a substantial drilling programme that entails a high risk of failure.

It has always seemed inevitable that Cuadrilla and IGas would need to bring in partners with bigger balance sheets to fund more drilling and share the risk.

CREDIBILITY AND EXPERIENCE

Centrica makes a particularly attractive partner because it brings with it credibility as a major gas producer, extensive expertise with drilling, safety and environmental compliance, and its own network of contacts with politicians and regulators.

Cuadrilla will remain the operator, and Centrica's experience is mostly with conventional gas, but its involvement lends the engineering reputation, compliance and assurance systems that will be needed to convince politicians and local communities shale can be developed in a safe and non-disruptive manner.

In exchange, Centrica gets a fairly cheap option on one of Britain's most promising shale plays.

Britain's last onshore licensing round was held in 2008, before the transformational potential of shale was understood and the country's resources had been estimated, and drew only limited interest.

Most of the licences awarded in the 13th round went to small speculative developers, many of which have subsequently been consolidated or listed on London's Alternative Investment Market (AIM).

The 14th onshore round, due next year, seems likely to draw keener interest, given the upward revisions to Britain's shale resources, though some of the most promising shale blocks have already been taken ().

Buying into PEDL 165 has given Centrica priority access to one of the two most promising tracts drilled so far.

Such transactions are inherently strategic and risky, but if Britain's shale industry lives up to a fraction of the hopes for it, Centrica will be a prime beneficiary.

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