Reasons to be cautious about shale gas prospects

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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