Reasons to be cautious about shale gas

By Mike Scott

In the past five years, the US gas market has been transformed. In that time, the US has moved from being a net importer of gas paying high prices to becoming self-sufficient in low-priced domestically produced gas and looking to export to other countries.

The reason for this dramatic turnround? Shale gas. It has been known for decades that gas exists in shale rock, says Andy Steinhubl, co-head of the North American oil and gas practice at Bain, but it was only recently with advances in the technology of hydraulic fracturing (fracking) and horizontal drilling – and an increase in energy prices – that it became viable to extract it.

The shift in the US market, where gas prices have fallen from $10-$13 per million cubic feet to $4-$5/mcf, has led to great excitement in other parts of the world as governments savour the prospect of reducing their energy dependence and perhaps building an export industry of their own.

Significant shale reserves have been discovered in Europe, Australia and China, among others. In Europe, the biggest reserves are believed to be in Poland, Ukraine and France, and a significant source has also been discovered in the UK.

It has also led to fears that the discovery of this new source of gas will hit investment in other, cleaner forms of energy such as nuclear and renewables.

However, there are a number of reasons to be cautious about the likely impact of shale outside the US, where a number of factors combined to help the industry take off.

The country had 2,000 land rigs involved in drilling in declining oil fields and thus readily available to switch to shale gas exploration, a dense service sector and a highly skilled workforce, along with supportive economics, says Luis Barallat, head of gas and LNG at Boston Consulting. “Almost none of this applies in Europe,” he adds. “There are fewer than 50 rigs operating in Europe today. The amount of resources in terms of drilling rigs, human capital and know-how are not comparable with the US.” Similar considerations apply in Asia and Australia.

Another stumbling block is property rights. “In the EU, landowners do not generally own rights to the subsurface so the willingness for landowners to permit the carrying on continuous drilling could well prove an impediment as compared to the US, where the landowners share in the financial benefits of the development through royalty payments and similar arrangements,” says Martin Stewart-Smith, a partner at law firm Morgan Lewis.

In addition, the geology of most reserves outside North America is less conducive to development because deeper drilling is required. Drilling for shale gas requires a large number of wells, which is more problematic in densely populated Europe than in the US.

“And if anyone thinks China is suddenly going to emerge as a major shale gas producer, just look at where their shale gas basins are,” points out Ben Caldecott, head of European policy at Climate Change Capital. “They are in the most water constrained parts of the country. The Tarim basin, for example, is literally underneath a desert.”

Finally, environmental fears over drilling may also hold back the development of the industry. There have been concerns about fracking fluid getting into the water table and France, for example, has imposed a moratorium on shale gas exploration. However, this stance may have more to do with the preponderance of nuclear power in its energy mix than safety concerns.

The safety concerns have been overstated, suggests Elizabeth Shepherd, head of environment at law firm Eversheds. “Hydraulic fracturing has been conducted in developed countries since the late 1940s and it has never been found to contaminate underground sources of drinking water. The technology has been safely applied so far to more than 1.2m individual wells, mostly in North America, but also in thousands of wells (including geothermal energy wells) across Europe.”

Nonetheless, Europe is still some years away from developing shale gas at significant scale, says Ronan O’Regan, a director at PwC. “Most of the work happening at the moment is around drilling to establish the size of the resource and there has been no real confirmation of the quality or quantity of resources.”

But if the growth of the industry will not be as rapid as in the US, it will develop in time into a significant source of supply with implications for energy markets. However, its main impact will be on other fossil fuel sources such as LNG, Russian gas and coal rather than on renewable energy and it will largely hit individual markets.

“We think Poland will be among the countries with the best opportunities for shale gas development,” says Rafał Dudzinski, vice-president of PGNIG, the Polish oil and gas group. Poland is keen to develop shale gas both to move it away from dependency on Russian gas and to help it shift its power sector, which is 95 per cent coal-powered, to less polluting gas. It has the additional advantage that in the areas where its shale reserves are located, population density is much lower than in western Europe.

Spending on clean energy is unlikely to be affected because it is so linked to national and EU climate targets, backed up by incentives such as feed-in tariffs. “At an EU level I don’t think shale gas will have a negative impact on renewable investment as the primary drivers for renewable investment is government commitment to renewable energy as a means to achieving carbon reduction,” Mr O’Regan says.

But if it brings down gas prices, shale gas will compete directly with nuclear as a supplier of baseload power, that is generation capacity that runs continuously, and at an expected lower cost, so it may add to the pressures on the nuclear industry.

The bigger danger from the point of view of meeting emissions targets is that fossil fuel production gets “locked in” for another 20-30 years because of the advent of this new source of supply.

“In Europe there is a real risk that we lock in more gas infrastructure than is desirable” on the basis that gas prices will be permanently low, warns Mr Caldecott, even though it is more likely that lower prices in the near term will give way to rising prices in the longer term “given global demand and supply fundamentals”, he says.

However, Mr O’Regan says shale gas supplies could help the transition from fossil fuels to low carbon energy by switching from the provision of baseload power to being used as back up for intermittent power sources such as solar and wind as these sources make up a larger part of the energy mix. “If gas plants built in the 2015-2020 period are designed to run baseload and convert to more flexible operation in later life, this will minimise the risk of lock in,” he says.

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