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a significant progress by industry, there yet remains another test the presents our economic model, major cost components and
UK fracking resource must pass in order to render shale gas results from production simulation, Section IV presents and
extraction feasible – it must be economically extractible and discusses the results, and Section V concludes.
sustainably so. Developing unconventional resources is much more
expensive and risky, and for shale gas wells, producing in II. THE BOWLAND SHALE PLAY AND THE UK PETROLEUM TAX
commercial volumes is conditional upon drilling horizontal wells and
hydraulic fracturing, techniques which increase CAPEX. Meanwhile,
REGIME
investment in shale gas development projects is sensitive to gas price A. The Bowland Shale Gas Play
and technical and geological risks. Using a Two-Factor Model, the
economics of the Bowland shale wells were analyzed and the The British Geological Survey (BGS) produced a report for
operational conditions under which fracking is profitable in the UK the Department of Energy and Climate Change (DECC) in
was characterized. We find that there is a great degree of flexibility 2012 in which it identifies the geological maps where Britain’s
about Opex spending; hence Opex does not pose much threat to the most prolific shale gas potential is located. Geological models
fracking industry in the UK. However, we discover Bowland shale indicate that carboniferous organic rich basinal marine shale
gas wells fail to add value at gas price of $8/ Mmbtu. A minimum gas
formations are present in the Bowland- Hodder unit of Central
price of $12/Mmbtu at Opex of no more than $2/ Mcf and no more
than $14.95M Capex are required to create value within the present Britain among others running roughly through North-East
petroleum tax regime, in the UK fracking industry. England to the South and South-West coast [2] (Fig. 1). Of the
basins assessed by the British Geological Survey in 2010, the
Keywords—Capex, economical, investment, profitability, shale Bowland Basin (Fig. 2) was the largest in the assessment area,
gas development, sustainable. continuing westwards below the Irish Sea, where the Upper
Bowland Hodder, is a source rock for conventional fields [2].
I. INTRODUCTION
TABLE I
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Vol:9, No:7, 2015
annd other UK pplay with the proven shale gas plays of North
Am merica.
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Fig. 2 V
Values Depth too the top of the B
Bowland-Hoddder unit [2]
TABLE II
SUMMARY OF POSITIVE
O , NEGATIV
VE AND UNKNOWN
N OR POORLY KNO
OWN FACTORS AF
FFECTING THE UK
K’S CARBONIFERO
OUS POTENTIAL SHALE GAS PLAY [2]
Positive factorss Negative factoors U
Unknown or poorrly known
Variable orgganic content iin lower unit Limited well peenetrations in low
wer unit isopach thick
Thhickness of >2% TOC intervals
isopach thick areas. areas.
Soome Type II keroogen Some Type IIII kerogen Gas yield
Brittle shale (interbbedded w/brittle llimestones) Structural com
mplexity and inveersion IP and decline rrate
Relatively low
w gamma responsse compared to
Thhermal maturity >
>1.1 R0 >3.5 R0 Extent of over-ppressuring
North Americcan analogues
Evvidence of gas inn shale wells and producing fieldss Lower unit isopach thick areass have no North
soourced from Bowland Shale American shaale gas analogues
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The first shalle gas well to be hydraulicaally fractured in the giveen developmeent consent before 16th March M 1993 annd is
UK K, Cuadrilla Resources
R Ltdd.’s Preese Haall 1 well is loocated thuss not covered hhere (see [7] ffor further detaail).
in its 500 squarre mile block in the Bowlannd basin in Western
W T
The UK’s shalle gas industryy is very younng and governm ment
Laancashire [2],, although opperation at PH H1 were susppended propposals thus farr point to a coommitment to offer incentivves to
foollowing two induced
i minorr earthquakes of 2.3 ML annd 1.5 induustry to stim mulate investm ments at this early stage. The
M
ML magnitudess in the Blackppool area [5] outccome of a 2013 governmentt consultation with industry on a
propposed fiscal rregime for shhale gas includes a proposaal of
B. The UK Peetroleum Tax Regime
R
shalle gas pad allowance whiich aims to exempt part of a
The current ppetroleum taxx regime of thhe UK comprrises 3 commpany’s profitts chargeable to SC and reduce the effecctive
m
major elemennts- ring feence corporaation tax R RFCT, tax to 30% [6] as well as ann the carryingg forward of, and
suupplementary charge, SC annd petroleum revenue tax (PRT) upliifting unrecoovered first year capex at 10%. T These
[66]. RFCT workks in similar waysw as tradittional corporaate tax, inceentives are onnly at the propposal stage. In consequencce, at
exxcept that RFC CT restricts thhe extent to wwhich taxable pprofits pressent it is clearr from the UK K Government that profits from
froom oil and ggas operationss in the UK aand UK contiinental shalle gas producttion would be subject to thee RFCT regim me for
shhelf may be appplied to recovver finance coosts and lossess from
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OMIC MODELLIING
III. ECONO wass the IRR whiich calculates the rate of reeturn at whichh the
NPV V is zero. Thee decision criteria used was to reject the N NPV
A. Investmentt Decision Criiteria
if itt is negative and reject thhe IRR if lesss than the cosst of
The decisionn to invest in tthe Bowland shale
s was evaaluated capiital or a comppany’s expectted return from m capital projjects.
baased on a disscounted cashh flow valuatiion. All cash flows Furtther decision variables
v focuused on measuuring the efficiiency
arrising from thee shale gas prooject were foreecast and discoounted of innvestments inn the Bowland shale as well as risk factorss and
ussing an assumeed cost of capital and discouunt factor of 10%
1 to thesse are discusseed further in thhe sections thaat follow.
acccount for the time value off money. A deecision variabble, the
NP PV was then derived from (1) as the sum m of the discoounted B
B. Production Profile
P
caash inflows annd outflows oover the projecct life. The N NPV is Regeneris and Cuadrilla Reesources Ltd. [9] investigatted 3
R
seensitive to the discount rate and could chhange the econnomics posssible drilling scenarios assuming 10 w wells per pad and
annd acceptabiliity of a projject drasticallly, hence a lower simu
mulating acrosss several padss found that iit was possible to
discount rate; aand cost of cappital is usuallyy better preferrred as drilll 400 wells uusing 20 pads in 9 years asssuming theree is a
it generally favoors the acceptaability of projeects. builld-up of activiity in the initiaal years. Shale gas wells haave a
mucch shorter lifeespan and peaak quickly althhough they haave a
NPV ∑ (1) highh initial flow rrate [10].
Inn order to maaintain and grrow production additional w wells
whhere reprresents the project
p net ccash flows aand µ needd drilling eachh year and thiss is a substantiial ongoing caapital
reppresents the ccost of capitall. Another deccision variablee used requuirement. “Prroduction in sshale plays caan certainly grow g
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veery rapidly; but drillers’ experience sso far shows that assuumptions havee been explainned below
m
maintaining verry high rates of o production for years—lett alone
22. Capital Expeenditure (CAP PEX)
deecades—is noo sure thing” [10, p. 5]. For F this reasoon, we
asssume averagees of 58 new w wells, with a sspacing requirrement CCapital expendditure for a shhale gas projeect comprises well
off 40 acres, aree brought on sstream each yyear in our moodel in drillling and commpletions costss, pipeline innfrastructure costs,
c
orrder to maintain and grow production.
p A total of 1,1600 wells roadd constructionn costs, land aacquisition andd permitting costs,
c
weere assumed tto be investedd in over the life of the pproject. geological and ggeophysical costs and relaated facility costs. c
Beeyond year 20 it is assumed a furthher investmeent is Althhough capex sspending depeends on the specific subsurrface
unneconomic beecause sweet spots have been b exploiteed and propperties and ttechnological solutions, [33] notes thatt the
fuurther investmment results inn lower and loower rate of rreturn. averrage US shalle wells in thhe Haynesvillee ranged betw ween
Prroduction from m already com mpleted wells just before year 20 $7MM and $10M inn 2010. Ernst & Young [155] estimate £330M
wiill however continue unttil year 30, bring our ccentral per well pad withh 10 vertical wwells and 40 laaterals in a padd; i.e.
cuumulative prodduction from tthe field to 4 T Tcf; an averagge well eachh 1 vertical well has 4 laterals and they cost £333M,
prroduction of 33.4 Bcf over 30 years. This is equivalent to the resuulting in averrage well cosst of £6.6M. Similarly, in this
paper, a 10 – welll pad drillingg program is assumed
a with each
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peerformance off the average w well of the top 7 shale playss in the
US [10]. padd comprising 1 vertical welll and 4 laterrals of an aveerage
Table III summmarizes key assumptions and Fig. 4 prresents lenggth of 4000 ft. and each is assumed to cosst between £8.97M
the resulting ggraph from ouur productionn simulation. Initial andd £12M compprising site prreparatory woork for permittting,
floow rates for shale
s gas wellls are typicallly high but rrapidly drillling and relaated costs annd fracking aand related ccosts
deecline later beffore flatteningg out over the life of the weell [11] inclluding techniccal testing cossts. These havve been conveerted
[10]. Since iniitial productiion rates are unknown foor the intoo dollars usinng 2013 exchhange rate at $/ £0.60 [9] and
Boowland shale, we have assuumed this as 3,666 Mcfd ffor our escaalated at 3% pper annum to aallow for inflaation. Regenriss and
ceentral scenarioo. Cuaadrilla [9] esstimate that additional innfrastructure costs c
US shale gaas wells decllined at 23% % in 2001 [122] but commprising the coost of producinng, supplyingg and installingg gas
deeclined betweeen 32% and 42% in 2012. IIt is noteworthhy that conversion as 155% of drillingg and fracturinng costs and Peel
these decline rrates are a function of tthe geologicaal and Gass and Oil Lttd. [16] preddicts £5M peer well pad site.
geeophysical chaaracteristics ofo the shale pplay and here again Althhough in thiss paper we aassume gas prroduced from m the
simmilar propertiies have beenn assumed forr the US shalle and Bow wland shale iss largely dry, a related capex factor of 155% is
Boowland shale.. A decline raate of 40% w was assumed ffor the assuumed each yyear to cater for minor additional
a surrface
Boowland shale w wells. faciility costs succh as well stiimulation cossts, manifolds and
flowwlines to connnect to mainn UK gas piipeline and oor to
construct electricity generationn plant at eachh well pad sitee and
to cconnect to thhe national ggrid. We asssume there iss no
requuirement for thhe constructioon of a central treatment faccility.
Thee full range off capex assump
mptions are sum mmarized in T Table
III. Capex is deprreciated at 20%% on straight lline basis.
3. Operating Exxpenditure (O OPEX)
UK shale gas is currently at its explorration phase. It is
U
therrefore difficuult to source actual operrating costs from
induustry relating tto shale gas licenses with anny accuracy. O
Opex
commprises a fixeed expendituree per well peer year as weell as
variiable Opex to cater forr gathering, compression and
(treaatment where required). IoD D [17] estimaate fixed Opexx for
F
Fig. 4 Simulatedd Production Proofile for the Bow
wland Shale Gaas Play
the Bowland shaale at £0.5 M and variable Opex at 2.5% % of
cummulative capeex per year. Kaiser [3], however, while w
C. Major Cosst Componentss and Gas Pricce studdying the econnomics of Haahnville shale in the US, noted n
1. Land Acquuisition Cost thatt average Opeex were $0.855, $0.80, and $0.50, per Mcf in
20008, 2009, andd 2010 respecctively. Brow wning, Ikonnikkova,
The UK oil and Gas Liceensing Regim me however reequires
Gullen and Tinkeer [11] reportt $25,000 fixeed Opex per year
opperators to seecure access rights
r from thhe legal ownners of
pluss 13% overheaads and a variiable Opex off $1.66/ Mcf aand a
onnshore lands aand adjacent llands, separateely for the puurposes
one-off abandonm ment cost of $75,000.In thhis paper, variable
off drilling wellls [13], [14]. Land acquisition costs cann be a
Opeex is assumedd at $1.5/ Mccf for the P500 well and a fixed f
goood part of thhe cost of onsshore drilling expenditure. In the
annuual Opex of $$25,000 plus 15% 1 overheadd. These will ccater
US these have been as ranging between $3000 per acrre and
for water disposal, gatheringg, and depleetion. Dry gaas is
$225,000 per accre. In this ppaper, land accquisition cossts are
cheaaper to prodduce and we assume the need for surrface
asssumed to be $11,700 (£77,000) per acrre. All majorr costs
equipment for sepparation is rem moved. Abanddonment costss are
involved in thhis work, theeir distributionn and all reelevant
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Therm. These have been converted into $/ MMBtu at 10.028 The pre-tax results indicate acceptable economics for the
using Barclays Bank’s $/ £ exchange rate forecast of $1.54/ £. Bowland shale gas wells with P50 wells yielding a NPV @
Gas prices are escalated at 3% per annum to cater for inflation. 10% of $3.6 billion and an IRR of 22%. The total investment
The central case gas price used is $9.55/ MMBtu. of $20.4 billion in 1160 wells in this scenario is recouped in
E. The Two-Factor Model approximately 6 years from production and renders the project
very competitive with a breakeven gas price of $7.69/
The development of shale gas wells very much depends on
MMBtu. The post – tax results, however, are markedly
gas price [3], [11], [10] in addition to a host of other factors
unfavorable for the central scenario with a negative NPV of
including Opex, Capex, production volumes, etc. The effects
$1.9 billion and a breakeven gas price of more than $11/
of variations in these input parameters on the decision to
MMBtu. The IRR is 2.5% and thus given cost of capital of
develop the Bowland shale wells was evaluated using the
10%, this renders the project uneconomical. We attribute this
sensitivity of the project NPV and IRR. The method of
to the present petroleum tax environment in which shale gas
sensitivity analysis applied here follows the concepts laid out
finds itself. We argue that the present tax regime is
in the Two-factor model used by [3] to appraise the
unfavorable for the fracking industry which unnecessarily
profitability of Haynesville shale gas wells in the US. The
introduces a high degree of uncertainty in an operator’s cash
output from a discounted cash flow analysis for 3 production
flows. In contrast, the P10 results are far more robust and
well scenarios following the triangular distribution (P10, P50
better than the P50 economics. This is due to the favorable
and P90) was used to quantify the complete range of
reservoir conditions assumed for the present scenario with an
prospective outcomes of the project. The P50 represents the
annual decline rate of 30%. This rate is typical of US shale
average and most likely case while the defined expected
plays [11], [18] and thus can be thought of as a very much
boundaries for all outcomes were represented by the P10
conservative assumption for our P10 scenario, if indeed the
(optimistic outcome) and P90 (pessimistic outcome). P10
Bowland shale is equivalent to prolific shale plays in the US
production profile yields the most favorable economics
per BGS/ DECC’s prediction. The post-tax NPV now recovers
whereas the P90 results in the least favorable economics, with
from negative in the P50 scenario and sits at about $15 billion
the scale of the differences between these 2 scenarios
with pay out occurring in just about 3 years with a breakeven
indicating possible sets of results as well as the possible risks
gas price of $5.77/ MMBtu and an IRR of 75%. This
and rewards to the project. Here, we use the project input
economics is very much robust and supports any argument to
parameters to capture the operating conditions under which
invest in the Bowland shale play. P90 economics are just
the shale gas production form the Bowland shale is
prohibitive of any investment in the Bowland shale with a post
economically viable. Table III summarizes the input
–tax breakeven price of $17.45/ MMBtu. It is significant to
parameters and their notations. The input variables are
note, however, that the present petroleum tax regime appears
combined thus; gas price and capex, gas price and Opex, and
to be regressive in the shale gas environment. The P50 case
Opex and capex. Every other variable is held unchanged and
results in Government Take of approximately 90% and leaves
output variables are NPV and IRR. Tables IV–VIII present the
the fracking company just about10% cash flows, which is
results.
insufficient to even cover their investment. The P10 scenario
which is much more economically profitable sees the
IV. RESULTS
Government Take reduce overwhelmingly by approximately
A. Results of the DCF Analyses 40%. If not addressed this will be a major obstacle to the
In this section we present results of the 30-years DCF development of the Bowand shale gas and the UK’s shale gas
model to evaluate the economic viability of Bowland shale gas in general as such a regressive fiscal environment has been
wells. found to discourage investments in hydrocarbons – leaving
suboptimal benefits to the government and contractor in the
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long term [19] [20]. Even though the shale gas fiscal regime is $2.27 billion and $5.73billion at $5MM. It appears that in
still under creation in the UK, it will be very necessary to order for an operator to produce the P50 and P90 wells, they
introduce high order progressive features to offset any have to be very much cost efficient and leverage any
tendencies of discouraging capital spending by the fracking geological challenges that may come with shale gas extraction
companies within the tax framework. We therefore highlight in the Bowland basin.
here that the post-tax economics of the Bowland shale play are At gas price of $12/ MMBtu and higher, P10 wells are
not very stable as much as they are robust for the pre-tax economical for most capex scenarios, except for $20MM. P50
results. We attribute this to the application of the conventional wells are mostly profitable but only fairly so in relation to P90
oil and gas tax regime, which has rather proved regressive, to wells.
the shale gas industry and wish to mention that once resolved Important from the foregoing is that the Bowland shale
investment in the Bowland shale, should be very much viable. wells cannot be developed for less than $10MM in a low price
Government take is very high during low price, high cost environment. Given that investment in shale gas wells are
environment but overwhelmingly shrinks during favorable typically much more expensive, low gas price prohibits
economic environments. investing in these wells for most scenarios. These must be
managed in order to render shale gas extraction attractive
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TABLE IV
PRE-TAX ECONOMICS FROM DCF ANALYSIS
enough, especially as gas from shale has to compete against
Economic Indicators Unit P10 P50 P90
conventional gas.
Pre-Tax TABLE V
POT Year 1.26 5.96 n/a GAS PRICE, CAPEX SENSITIVITY ANALYSIS
NPV at 10% MM$ 31,269 3,635 (8,736) NPV (Gas, CAPEX) Sensitivity Analysis ($ Billions)
IRR % 125.36 22.35 n/a P10, OPEX = $1.5/Mcf
Economic Limit Year 30 30 25 Gas Price CAPEX/Well ($MM)
Break Event Gas Price $/MMBTU 3.98 7.69 11.93 ($/MMBTU) 5 10 15 20 25
Post-Tax 4 -0.23 -2.00 -7.25 -9.98 -14.00
POT Year 2.71 20.97 n/a 8 5.73 2.27 -1.21 -4.70 -8.16
NPV at 10% MM$ 14,921 (1,944) (10,465) 12 11.67 8.21 4.75 1.29 -2.18
IRR % 75.55 2.53 n/a 16 17.58 14.15 10.69 7.23 3.77
Economic Limit Year 30 27 25 P50, OPEX = $1.5/Mcf
Break Event Gas Price $/MMBTU 5.77 11.30 17.45 Gas Price CAPEX/Well ($MM)
Government Take % 49.24 89.77 n/a ($/MMBTU) 5 10 15 20 25
IOC Take % 50.76 10.23 n/a 4 -1.22 -4.76 -7.73 -11.76 -15.82
8 3.25 -0.22 -3.71 -7.15 -10.73
B. Gas Price and Capital Expenditure Sensitivities
12 7.66 4.20 0.74 -2.70 -6.21
Table V summarizes the results from modelling the 16 12.06 8.62 5.16 1.70 -1.76
sensitivity of gas price and capital expenditure variations P90, OPEX = $1.5/Mcf
alone. This enabled the capturing of the implications of Gas Price CAPEX/Well ($MM)
differing gas prices scenarios for investment requirements and ($/MMBTU) 5 10 15 20 25
hence a measure of the risks and rewards for any investment in 4 -1.57 -5.08 -8.37 -12.41 -16.49
the Bowland shale wells as indicated by the elasticity of the 8 2.36 -1.11 -4.61 -8.11 -11.65
NPV to such variations. Every other model parameter was 12 6.23 2.77 -0.70 -4.17 -7.67
held constant as follows; $11,670/ ac for land acquisition 16 10.09 6.64 3.18 -0.29 -3.75
costs, 40 acre well spacing, $1.5/ Mcf for operating expenses
C. Gas Price and Operating Expenditure Sensitivities
and 10% cost of capital.
At $4/ MMBtu gas price, the project fails to be profitable In Table VI, the impact of gas price and Opex sensitivities
under all CAPEX scenarios for all well types, including P10 is measured. Here, capex is fixed, just as every other input
wells. Operators are thus unlikely to hold their acreage under variable as before, at $14.95MM per well. Well spacing is
low gas price conditions. Given, the lower levels of losses for fixed at 40 acres and land acquisition cost of $11,670/ ac is
lower CAPEX scenarios such as $5MM and $10MM, a risk- used.
taking and highly efficient operator may wish to use their P10 and P50 wells fail to create value under all capex
expertise to drill sweet spots in order to leverage their costs scenarios at $4/ MMBtu and $8/MMBtu, except for P10 wells
and produce high quality shale. Similar to Kaiser’s [3] that are marginally profitable at $8MM and $0.50/ McfOpex.
discovery in his Haynesville shale study, if wells in such a low Both well types are profitable at gas price of $12/ MMBtu and
price environment turn out to be average producers then the higher for almost all Opex scenarios, except for P50 wells that
Bowland shale will not be profitable in such environments. may be brought on stream for slightly less than $2.5/ Mcf. It is
At $8/ MMBtu gas price, most wells types are still noteworthy that the white portion of the matrix representing
uneconomical under most capex scenarios although P10 wells the profit window is larger for the present analysis than it was
may be brought on stream at $10 MM for a marginal NPV of for the “Gas price, Capex” analysis. This is indicative of the
fact that the Opex chosen for our analysis is favorable and that
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Opex may not be a big hindrance to the development of shale TABLE VII
CAPEX, OPEX SENSITIVITY ANALYSIS
gas in the Bowland basin. When gas price is $12/ MMBtu P10
NPV (CAPEX, OPEX) Sensitivity Analysis ($ Billion)
wells are profitable across the entire matrix. P50 wells may
P10, Gas Price= $ 9.55/MMBTU
also be brought in for all Opex scenarios up to a little under
CAPEX OPEX ($/Mcf)
$2.5/Mcf. Such a wide variation in Opex allows the operator a ($MM) 0.5 1 1.5 2 2.5
high degree of flexibility in spending and project management 5 9.48 8.75 8.03 7.31 6.59
in order to create value/ make profits. It appears that the safety 10 6.02 5.30 4.57 3.85 3.13
net for making Bowland shale profitable under Opex scenarios 15 2.56 1.84 1.12 0.39 -0.34
is gas price of $12/ MMBtu and opex of not more than $2/ 20 -0.91 -1.64 -2.37 -3.10 -3.83
Mcf. P90 wells are not profitable for the most part of the 25 -4.40 -5.13 -5.86 -6.59 -7.32
analysis except at gas price of $16/ MMBtu and across the P50, Gas Price= $ 9.55/MMBTU
entire Opex range. CAPEX OPEX ($/Mcf)
($MM) 0.5 1 1.5 2 2.5
TABLE VI
5 6.03 5.49 4.96 4.42 3.88
GAS PRICE, OPEX SENSITIVITY ANALYSIS
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TABLE VIII which has rather proved regressive, to the shale gas industry
POST-TAX IRR FOR ALL P50 PROFILES
but we wish to add that once resolved investment in the
IRR Post-Tax Sensitivity Analysis for P50 Profiles (%)
Bowland shale will be very much viable and sustainable.
P50, OPEX = $1.5/Mcf
Finally, at realistic gas price of $8/ MMBtu or less the
Gas Price CAPEX/Well ($MM)
Bowland shale play fails to create value in the present tax
($/MMBTU) 5 10 15 20 25
environment. There is a potentially bright operational future
4 n/a n/a n/a n/a n/a
8 35.24 8.84
for the Bowland shale play; however, it appears that low gas
n/a n/a n/a
12 65.58 31.00 12.78 2.03 n/a
price render production of the play economically
16 93.43 51.93 28.88 14.93 5.82 unsustainable under the present ring fence petroleum tax
P50, CAPEX= $ 14.95MM regime.
Gas Price OPEX ($/Mcf)
($/MMBTU) 0.5 1 1.5 2 2.5 REFERENCES
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[2] DECC (2013) “The Carboniferous Bowland Shale Gas Study: Geology
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[18] Baihly, J., Altman, R., Malpani, R., and Luo, F. (eds.) (2010).
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[19] Johnston, D. (2003) International Exploration Economics, Risk, and
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