FORTUNE:

Oil from stone

By Jon Birger, Fortune senior writer

They are then expected to prove the commercial and environmental viability of their process, and if they do, they will be granted a second RD&D lease for an additional 5,100 acres. (Five thousand acres may not sound huge, but Shell believes that the most promising parts of the Green River Formation could yield more than one million barrels per acre using ICP.) Shell applied for and received three RD&D leases; EGL, Chevron (Charts, Fortune 500), and Alabama-based Oil Shale Exploration Co. got one each.

Jeremy Boak, a researcher at the Colorado School of Mines and the organizer of an annual oil shale conference there, believes Shell's oil shale technology is far ahead of the competition. Indeed, when FORTUNE met last spring with Chevron's oil shale team and its partners from the Los Alamos National Laboratory, the Chevroners indicated they were still fine-tuning the production process outlined in their lease application.

This involves fracturing the oil shale using explosives or high-pressure carbon dioxide, and then decomposing the kerogen into liquid fuel using supercritical CO2 or other solvents. The idea has not been field-tested yet.

Though there's no shortage of oil companies now looking to get into oil shale, Vinegar is confident that Shell's 200 oil shale patents, which cover everything from the composition and spacing of the heating rods to the molecular structure of the light oil ICP creates, will make it difficult for a competitor to come up with a competitive in situ process. (Indeed, there was some griping at the recent School of Mines conference about the breadth of Shell's patents.) Even so, it will probably be at least 18 months before Shell breaks ground on its first RD&D project and years before the oil hits market. The reason for the delay: another test.

Because there's no mining and because most of the action occurs underground, ICP is more environmentally benign than surface retorting or even tar sands production in Canada. But one big challenge is preventing the oil from leaching into ground water. Vinegar's solution was to create an impenetrable "freeze wall" of frozen rock and ice around the perimeter of the heating and production wells.

On a football-field-sized parcel of its own land, Shell is spending an estimated $30 million on a test that involves drilling 150 well bores and filling them with coolant in order to freeze surrounding rock and water to a temperature of minus-60 degrees Fahrenheit. "I do realize," says Vinegar, "that the whole idea of heating an area [to 650 degrees Fahrenheit] and simultaneously freezing around the circumference to keep the water out sounds almost like science fiction." Regardless, the freeze wall passed a smaller-scale test in 2004, and Vinegar says everything is proceeding as expected with the latest one.

All this cooling and heating, of course, consumes energy. Can it possibly be worth it? Yes, says Vinegar, who estimates ICP's ratio of energy produced to energy consumed will range from 3-to-1 to 7-to-1, depending upon the scale of the project. Moreover, the power needed to perform the heating and cooling will be generated entirely from natural gas produced onsite by the ICP process. Shell plans on building its own large power plant and is exploring ways to sequester any CO2 produced.

Water is another worry. ICP uses a lot of water, mainly to refine the oil and purify the natural gas. (Shell plans on building a refinery onsite, which is news in itself: It would be the first new refinery built in the U.S. in 30 years.) Shell appears to be on solid legal footing with its water plans, as it owns senior rights for local river water.

And some of the water it intends to utilize will be salinated water pumped from deep aquifers that are not part of the conventional water supply. Nevertheless, the potential for political backlash remains high, given that this is a part of the country where water is scarce and fights over water rights get nasty. "It will certainly be an issue," says former Rifle mayor David Ling. "There's an old expression around here: We talk over whiskey and fight over water."

The last thing Shell wants is a fight with Coloradans. The 2005 energy act set up some guidelines for commercial leasing in addition to the RD&D program. Once Shell completes an environmental-impact report, presumably by 2008 or 2009, the Department of the Interior is expected to consult with the states to gauge whether there's sufficient support to proceed. Thus far, Colorado Governor Bill Ritter has been cool to the idea without damning it altogether.

In a September letter to a DOE panel exploring ways to expedite oil shale production, Ritter - a Democrat who took office in January - cautioned that "proposed oil shale development overlaps areas with increasing tourism and recreational opportunities. Oil shale leasing on top of this existing network of energy development and changing land uses will put more pressure on an already fragile ecosystem and public temperament."

Ritter also asserted Colorado's right to regulate any in-state oil shale projects, though his letter did hint at a possible compromise, one that (surprise, surprise) boils down to money: "Bonus lease payments from federal leases for local government facilities and services [would] help mitigate impacts to local communities and build public acceptance for oil shale developments."

At the moment, the greens have been quiet on oil shale, perhaps because ICP is an upgrade over the former method. (Shell says its reclamation methods will restore land to its former appearance.) If you ask environmentalists, they do raise objections. "All the information we have points to industrial oil shale development as an enormous threat to our environment and a huge backward step," says Amy Mall, a senior policy analyst based in Boulder with the Natural Resources Defense Council.

There is no question that any large-scale oil shale development would dramatically affect the area, and the problem of how to mitigate greenhouse gas emissions has not been solved. That said, opposition to oil shale is nowhere near as loud and organized as the fight to stop drilling in Alaska's Arctic National Wildlife Refuge. Northwestern Colorado is certainly scenic - high desert plateaus interspersed with lush river valleys - but it's no ANWR.

Around Rifle (pop. 6,800), people seem at peace with Shell's oil shale plans, says Ling. There's already a thriving natural-gas industry in the region, so the idea of digging for oil doesn't give locals the shivers the way it would in more touristed, populated parts of the state. All that being said, once Shell gets closer to commercial production - Vinegar says it will be no sooner than 2015 - the politics will surely get prickly.

Shell insists that it has no beef with Governor Ritter's desire to proceed slowly. Even so, it's not leaving anything to chance. Shell has a public relations team devoted to oil shale and, in a shrewd move, the company has hired former U.S. Secretary of the Interior Gale Norton as an in-house lawyer. The stakes are huge. Assuming only $20 in profit for each barrel produced (at today's inflated oil prices, it would be more like $50), 300,000 barrels per day would add $2.2 billion to Shell's annual pretax profits. And three million barrels a day would be worth $22 billion.

It could be decades before Shell hits the really big numbers, if it happens at all. The logistics are daunting. It has taken the tar sands industry of Canada almost 30 years to reach its current production of about a million barrels a day (although it could be double that by 2010).

A mature oil shale industry might employ tens of thousands of workers in sparsely populated parts of Colorado, Utah and Wyoming - and that doesn't include the indirect employment from shop, restaurants and other businesses serving oil companies and their workers. "There's a real question of how we manage that kind of development," says Dammer of the DOE.

While it waits for its latest freeze wall to freeze and for the BLM to grind its way toward some sort of commercial leasing program, Shell is exploring other applications for ICP. It is negotiating with Jordan to test it on that country's oil shale reserves and investigating whether ICP can produce oil from Canadian tar sands - in which Shell also has major investments - more efficiently than current methods.

For his part, Vinegar's attention is focused squarely on Colorado. "So many Americans have no idea that they're sitting on a resource several times the size of Saudi Arabia's," he says. "The fact is that it's entirely possible to produce this stuff. Our technology works. There's no doubt about it."

- Telis Demos, reporter associate, contributed to this story. Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.