On the 6th of June, Japan's Ministry of Economy, Trade and Industry (METI) announced
the Resumption of the Gas Production Test under the Second Offshore Methane Hydrate
Production Test.
This is what they said:
"Concerning the second offshore methane hydrate production test, since May 4, 2017,
ANRE has been advancing a gas production test in the offshore sea area along Atsumi Peninsula
to Shima Peninsula (Daini Atsumi Knoll) using the Deep Sea Drilling Vessel 'Chikyu.'
However, on May 15, 2017, it decided to suspend the test due to a significant amount of sand
entering a gas production well.
In response, ANRE advanced an operation for switching the gas production wells from the
first one to the second one for which a different preventive measure against sand entry is in
place.
Following this effort, on May 31, 2017, it began a depressurization operation and, on
June 5, 2017, confirmed the production of gas."
Sand flowing into the well samples has been a gritty problem for the Agency for Natural
Resources and Energy – ANRE since 2013.
They continue to invest because Japan relies on imports for the majority of its energy
needs, especially since the reduction in nuclear capacity after the Tahoku earthquake and tsunami
in 2011.
They have led the way in terms of research into the commercial extraction of methane
hydrate or 'Fire Ice' as it is more commonly known.
Methane hydrates are solid ice-like crystals formed from a mixture of methane and water
at specific pressures in the deep ocean or at low temperatures closer to the surface,
in permafrost.
For a primer on methane hydrate and its potential, this article from the EIA – Potential of
gas hydrates is great, but practical development is far off.
Important Developments
During the last two months, there have been some important developments.
Firstly the successful extraction of gas by the Japanese, albeit, they have run into the
problem of sand getting into the pipes again, which poses an environmental risk.
Secondly, China has successfully extracted gas from methane hydrate deposits in the South
China Sea.
This article from the BBC – China claims breakthrough in mining 'flammable ice'
provides more detail.
The Chinese began investment in Fire Ice back in 2006, committing $100m, not far behind
the investment commitments of Japan.
Japan and China are not alone in possessing methane hydrate deposits.
The map below, which was produced by the US Geological Survey, shows the global distribution
of deposits.
For countries such as Japan, South Korea and India, methane hydrate could transform their
circumstances, especially in terms of energy security.
Estimates of global reserves of methane hydrate range from 10,000 to 100,000trn cubic feet
(TCF).
In 2015, the global demand for natural gas was 124bn cubic feet.
Even at the lower estimate, there are 80 years of global supply at current rates of consumption.
This could be a game changer for the energy industry.
Joint Efforts
The challenge is to extract methane hydrate efficiently and competitively.
Oceanic deposits are normally found at depths of around 1500 metres.
Even estimating the size of deposits is difficult in these locations.
Alaskan and Siberian permafrost reserves are more easily assessed.
Japan has spent $179m on research and development but last week METI announced that they would
now work in partnership with the US and India.
The Nikkei Asian Review described it in these terms
"Under the new plan, Japan will end its lone efforts and pursue cooperation with others.
The country has been spending tens of millions of yen per day on its tests.
By working with other nations, it seeks to reduce the cost."
"A joint trial with the U.S. to produce methane hydrate on land in the state of Alaska
is expected to begin as early as next year.
Test production with India off that country's east coast may also kick off in 2018."
"The new blueprint will define methane hydrate as an alternative to liquefied natural gas.
Based on the assumption that Japan will be paying $11 to $12 per 1 million British thermal
units of LNG in the 2030s to 2050s, the plan will set the target production cost for methane
hydrate over the period at $6 to $7."
In the shorter term, METI hopes to increase daily production from around 20,000 cubic
metres/day to around 56,000 cubic metres/day which they believe will bring the cost of
extraction down to $16/million BTUs.
That is still three times the price of liquid natural gas (LNG) however.
You might be forgiven for wondering why the Japanese, despite being the world's largest
importer of LNG, are bothering with methane hydrate, but this chart from BP shows the
evolution of natural gas prices over the last two decades.
Japan was squeezed by rising fuel costs between 2009 and 2012 only to be confronted by the
yen weakening from USD/JPY 80 to USD/JPY 120, from 2012 to 2014.
If Abenomics succeeds and the yen embarks upon a structural decline, domestically extracted
methane hydrate might be a saviour.
Cooperating internationally makes sense for Japan.
The US launched a national research and development programme in 1982.
They have deep water pilot projects in the Gulf of Mexico, off the coast of South Carolina
as well as in the permafrost of the Alaska North Slope.
Technical Challenges
As deep sea drilling technology advances, the cost of extraction should start to decline
but as this 2014 BBC article – Methane hydrate: Dirty fuel or energy saviour?
explains, there are a number of risks:
"Quite apart from reaching them at the bottom of deep ocean shelves, not to mention operating
at low temperatures and extremely high pressure, there is the potentially serious issue of
destabilising the seabed, which can lead to submarine landslides."
"A greater potential threat is methane escape.
Extracting the gas from a localised area of hydrates does not present too many difficulties,
but preventing the breakdown of hydrates and subsequent release of methane in surrounding
structures is more difficult."
"And escaping methane has serious consequences for global warming – recent studies suggest
the gas is 30 times more damaging than CO2."
Given the long term scale of the potential reward, it may seem surprising that the Japan
have only invested $179m to date, however these projects have been entirely government
funded.
Commercial operators are waiting for clarification over the cost of extraction and size of viable
reserves before entering the fray.
Most analysts suggest commercial production is unlikely before 2025.
With the price of natural gas depressed, development may be delayed further but in the longer term
methane hydrate will become a major global source of energy.
Like the fracking revolution of the past decade, it is only a matter of when.
The history of fracking can be traced back to 1862 and the first patent was filed in
1865.
Deep sea mining and drilling technologies are advancing quickly in several different
arenas.
The currently depressed price of LNG is only one factor holding back the development process.
Conclusions and Investment Opportunities
Predicting the timing of technological breakthroughs is futile, however, the US energy sector is
currently witnessing a resurgence in profitability.
In their June 16th bulletin, FactSet Research estimated that Q2 profits for the S&P 500
will rise 6.5%.
They go on to highlight the sector which has led the field, Energy:
"At the sector level, nine sectors are projected to report year-over-year growth in earnings
for the quarter.
However, the Energy sector is projected to report the highest earnings growth of all
eleven sectors at 401%."
"This sector is also expected to be the largest contributor to earnings growth for
the S&P 500 for Q2 2017.
If the Energy sector is excluded, the estimated earnings growth rate for the index for Q2
2017 would fall to 3.6% from 6.5%."
The price of Brent Crude Oil has been falling but the previous investment in technology
combined with some aggressive cost cutting in the recent past has been the driving force
behind this spectacular increase in Energy Sector profitability.
Between 2014 and 2016 Energy Sector capital expenditure fell nearly 40%.
A rebound is to be expected in the capex over the next couple of years.
It may be too soon for this to spill over to commercial investment in methane hydrate,
but developments in Japan and China during the past two months suggest a breakthrough
may be imminent.
The next phase of investment may be about to begin.
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