House of Commons - Shale Gas - Energy and Climate Change Committee

Shale Gas - Energy and Climate Change Committee Contents

4 UK Policy Implications

Gas Markets and Prices

55. Professor Paul Stevens of Chatham House told us that "gas is essentially a regional rather than a truly global market because of the 'tyranny of distance' […]—the high cost of transporting gas, which is a high-volume, low-value commodity—restrict[ing] trade to specific regions [and leading to] a range of regional prices".[107] He added that compared to oil "gas has much less flexibility in terms of transport and trade".[108]

56. DECC noted that the extent to which shale gas production in the US affected global markets depended on the "extent to which it exceeds, or falls below, market expectations and therefore helps push the global market into over- or under-capacity". The US's net imports are projected to fall from 2.6 tcf [72.8 bcm] in 2009 to 1.3 tcf [36.4 bcm] in 2025 and 0.3 tcf [8.4 bcm] in 2035.[109] However, the Geological Society believed that the impact of US shale gas on global gas markets is often overstated and any reduced US dependence on LNG has been largely offset by rapidly increasing demand in the Middle East, Latin America and South and East Asia.[110]

57. Professor Paul Stevens believed it was possible that shale gas could replicate the conditions in the oil industry in the 1970s that led to the formation of OPEC, and could lead to the formation of an "Organisation of Gas Exporting Countries (OGEC)" to control supply and prices.[111] OPEC was formed in the 1960s, but it was not until the 1970s (when OPEC countries controlled the majority of the world's spare oil capacity) that they began to set production quotas in order to influence international oil pricing.[112] Professor Stevens observed that since "Eleven gas-exporting countries attended the first ministerial 'seminar' in Tehran in 2001 which resulted in the establishment of the Gas Exporting Countries Forum (GECF) […] there has been constant speculation about the possibility of the GECF turning into an OGEC and trying to behave like a cartel". He added that "if prices stay low or go even lower […] there is a strong incentive for GECF to step in to try to defend falling prices […] it was precisely this mechanism that prompted the creation of OPEC in 1960". However, Jonathan Craig—Fellow of the Geological Society of London—told us that the distribution of "unconventional gas resources is much wider than that of conventional resources, so a lot of countries come into play" making "the chances […] quite slim" that an OPEC-like cartel for gas could form.[113]

58. Scotia Gas Networks (SGN) believed that if "the availability of the gas resources increase through the production of shale gas, wholesale prices could be reduced" which would result in the increased use of gas and potentially lead to lower greenhouse gas emissions. However, SSE believed that owing to the relatively high production cost of shale gas most of the potential resource will not be commercially viable unless the whole sale price of gas were to rise in the future.[114] They added that the discovery of large shale gas resources around the world could benefit the UK through further reducing wholesale prices by widening the gap between supply and demand. However, Mr Mitchell (Chair of the Blackpool Green Party) believed that the "cost of the processes involved in fracking, disposal of waste and of infrastructure, including new roads and treatment centres, will add to energy prices".[115] Figure 4 is a chart from the Oxford Institute of Energy Studies (OIES) estimating the costs of European shale gas production versus other new sources of supply in 2020 (note $/mcf means $ per thousand cubic feet).

Figure 4—estimated costs of European shale gas versus other supplies in 2020

Source: Memorandum from Ofgem (Ev w13 )

59. Further cost analysis from OIES calculated that unconventional natural gas would have a break-even price of $8-12/mcf ($8-12/28.3 cm or $8-12/MBtu), which led them to the conclusion that unconventional gas "will hardly be cost competitive with gas imports over the next decade". [116] They added that to ensure production subsidies would be needed if future gas prices fail to reach a level close to $10/mcf.[117]

60. The International Energy Agency (IEA) has estimated that recoverable unconventional gas reserves could cost between $2.70/MBtu and $9/MBtu ($3-9/mcf or $3-9/28.3cm) to produce, but it noted that production costs in North America were "declining significantly over time and are now towards the lower end of that range—hence becoming competitive with conventional supplies".[118] Shell pointed out that in Europe, Wood Mackenzie (a global energy consultancy) has estimated that "the costs of developing unconventional gas would have to fall by a minimum of 20% for European gas shale to be economical with current European gas pricing".[119]

61. According to the OIES "the pricing of unconventional gas volumes will have to be sustained at a level above $8-10/mcf" in order for it to be economic, which is "higher than historical prices and current market expectations".[120] Gas prices are currently indexed to the price of oil, and the OIES believed that unconventional production was incapable of moving gas into a spot market (where the price is quoted for immediate delivery of a commodity). They believed that "unconventional gas will not be a price setter at a European level", adding, "the arrival of large new gas volumes could have a downward effect on prices, as it has in the US, but this seems unlikely".[121] However, Professor Paul Stevens of Chatham House noted that "it appears most observers currently expect shale gas economics to be superior to those for conventional gas […] we could see shale gas setting such a low price that conventional drilling suffers significantly".[122]

62. The Geological Society's Jonathan Craig cited another independent assessment made by Wood Mackenzie that determined the break-even price of unconventional gas as "about $5 per mcf […] in the European countries [it] tends to be a bit higher […] because drilling costs tend to be rather higher".[123] He told us that "the gas price in the US at the moment is lower than that […] a lot of the shale gas operations in the US are probably marginally economic".[124] Nick Grealy disagreed with that assessment, telling us "the history of shale gas has been one of continuous improvement in the economics and how much is produced". [125]

63. The Executive Chairman of Devon Energy stated that high natural gas prices of $11 were "kind of like a Saturday night drunk […] It may feel good at the time" but it was not sustainable.[126] However, he explained that the then current market price of $3.75 was too low for the industry to maintain gas production in the long term.126 As can be seen in Figure 5 (based on data from the US Department of Energy's Energy Information Agency), US gas prices were low for many years but began to rise steeply in the late 1990s before falling back to 2000-levels in 2010.

Figure 5—US Natural Gas Wellhead Price (Dollars per Thousand Cubic Feet), 'Natural Gas Navigator',

Source: US Department of Energy's Energy Information Administration.

64. The Minister told us "I don't think we are expecting this [shale gas] to have the same [impact in terms of] price change as it has in the United States, where the significance has been greater than we think it could possibly be in the United Kingdom".[127] Jonathan Craig agreed when he told us that unconventional gas production in the UK will "Make a contribution but not a big enough contribution that is going to have a major effect on the prices of gas in the UK".[128]

65. We conclude that a glut in shale gas production could drive the price of conventional gas down, but there is uncertainty as to the extent of this. If there were to be a fall in prices it is unlikely to be as dramatic as that seen in the US.

Security of Supply

66. According to the Oxford Institute for Energy Studies (OIES), "The rise of unconventional gas production, and in particular shale gas, has been the greatest revolution in the US energy landscape since the Second World War".[129] However, they believe that in the UK production would have to overcome very significant challenges including "land availability and access, logistics operations, and service sector capacity" in order to contribute significantly to security of supply.129 Nonetheless, Richard Selley, of Imperial College London, told us that "The opportunity for developing indigenous gas resources on land in this country is a tremendous one from the security point of view".[130]

67. Jonathan Craig—a Fellow of the Geological Society of London—believed that it was "too early to say at this point in time how big [the contribution of shale gas to UK energy security] will be".[131] He added that "our old conventional [North Sea gas] fields are declining very rapidly […] it is estimated that [globally] by 2020 we need to replace about 70% to 75% of our existing production with new sources of natural gas, both conventional and unconventional".[132] Nick Grealy, of the gas policy blog No Hot Air, believed "the whole thing about energy security is a bit of a red herring. Right now, 88% of our supplies come from the North Sea […] most of our imports come from Norway and the Netherlands", countries with a strong record of supplying gas to the UK.[133]

68. Shell believed that "unconventional gas resources […] could enhance the diversity of gas supplies to Europe and the UK".[134] With the caveat that "Large scale discoveries of shale gas resources do not necessarily mean large scale production will follow", OFGEM stated that such production "is likely to improve the security of supply outlook".[135] Regarding the definition of "energy security", the Geological Society added that this "may be achieved by means other than moving towards self-sufficiency based on domestic resources", in other words, importing from secure suppliers.[136] They saw the possibility of a positive impact on security of gas supply, but not before 2020.[137]

69. The Geological Society quoted BP's view that the "usable shale gas resource in Europe is limited, and that any impact is likely to be local rather than pan-European".[138] They added that outside of Europe, the only significant shale gas resources that might impact on UK energy policy were to be found in North Africa and Russia, the implication being that other countries are unlikely to export their resources to us.[139] However, as Russia still has "significant untapped conventional resources" they are likely to pursue them first before they begin exploiting shale gas.[140] Jonathan Craig argued that the discovery and production of significant amounts of shale gas in the US has "allowed us to move away from the need to look for gas resources in some more difficult environments around the world, particularly in the Arctic".[141]

70. The UK Government appears to take a more upbeat view of the potential of indigenous shale gas resources to contribute to energy security. The Minister told us that, "We are now net importers of gas. We are very committed indeed to getting the resources that we can from the North Sea, but if there are gas resources that are available to us onshore as well, we believe it is the national interests that those should be developed".[142]

71. Shale gas has the potential to diversify and secure European energy supplies. Domestic prospects—onshore and potentially offshore—could reduce the UK's dependence on imports, but the effect on energy security is unlikely to be enormous. We conclude that energy security considerations should not be the main driver of policy on the exploitation of shale gas.

Government Support for Shale Gas Production

72. The Oxford Institute for Energy Studies (OIES) identified a set of catalysts, both policy and market-based, that triggered the "revolution" in unconventional gas production in the US:

Policy-based: tax credits, lack of restrictive regulations (on land-access, permitting and environmental aspects.)
Market-based: increasing profitability of gas operations, technological developments, credit availability, and a competitive service industry.[143]

Professor Stevens of Chatham House noted that in the US the Crude Oil Windfall Profit Tax 1980 introduced a tax credit on unconventional fuel production that remained in force until 2002, whereas in Europe "only Hungary has any form of tax advantage for unconventional gas".[144]

73. As far back as 1985, research undertaken by Imperial College London concluded that the UK had considerable potential for shale gas exploitation, but that exploration was not then economically viable under the prevailing tax regime.[145] Current wholesale gas prices are approximately 53p/therm.[146]^,This would mean that 150 bcm (billion cubic metres)—the UK shale gas reserves estimated by the British Geological Survey—of gas would be worth approximately £28 billion.[147] Despite the tax advantage of the shale gas industry in the US, evidence to us suggested that the unconventional gas industry in the UK was not seeking a similar benefit in this country. Andrew Austin told us that IGas Energy was "seeking to demonstrate that we can make it at the current tax rates and under the current regime", to which Cuadrilla's Dennis Carlton added "there is no need at this point in time for [tax breaks or] incentives to be put in place".[148] Neither Nick Grealy nor Jonathan Craig the Geological Society saw a need for the Government to subsidise the shale gas industry in the UK.[149] In written evidence to us, the Geological Society stated that several policy instruments were available to the Government beyond tax breaks should it wish "to influence resource prices in order to stimulate investment", including "subsidies […] feed-in tariffs […] regulation, and carbon pricing".[150]

74. The Minister told us that "I can't see any reason for changing support the support that is offered […] I think it would be market-driven, but […] subject to very strict safety and environmental protections".[151] Regarding tax credits for shale gas production, the Minister told us that "would ultimately be a matter for the Chancellor" adding that in the North Sea "the tax regime has adapted in order to encourage development".[152]

Renewables versus Shale Gas

75. Friends of the Earth were concerned that the exploitation of large amounts of shale gas could undermine investment in renewable energy, adding that gas is "already threatening renewable investment, even before shale gas is considered".[153] The Tyndall Centre agreed: "if money is invested in shale gas then there is a real risk that this could delay the development and deployment of [zero-carbon technologies]".[154] While DECC argued that if unconventional gas production displaced high carbon fuels such as coal, there could be "reduced emissions in the short- to medium-term", they also admitted that this could reduce the incentive for investment in "the low-carbon alternatives required to meet longer-term emission goals".[155] Professor Stevens of Chatham House posed the question "who will commit large sums of money to expensive renewables" in a world where low carbon gas is abundant and cheap.[156]

76. DECC believe that if gas was to play a long-term role in UK energy policy, this would "suggest a greater need for effective CCS [carbon capture and storage] technology for gas plants".[157] They add that, alongside "tighter national emission targets and policies to support innovation and deployment of low-carbon technologies", gas could be an "effective bridge to help deliver greater near-term [emissions] reductions".[158] Professor Kevin Anderson, Director of the Tyndall Centre, questioned whether shale gas could act as a "bridge" to a low-carbon economy: "We need to make that transition to renewables as a matter of some significant urgency. If that is the case, then any mechanism that takes away the incentives to move towards renewables cannot be a good deal".[159] However, Nick Grealy—of the gas-commentary blog No Hot Air—told us, "Gas is low carbon. It is not zero carbon […] we can't make the perfect the enemy of the good".[160]

77. During evidence given to our Electricity Market Reform inquiry, Professor Dieter Helm compared investment in wind to investment in gas-fired electricity generation:

We are projected to spend—I don't know—£100 billion on the offshore wind programme, which is over nine or 10 years, so £10 billion a year [...] Ask yourself the following question [...] if you close some coal stations quickly today and replace them with gas CCGTs [combined cycle gas turbines] quickly today, how much would you have to close, and bring on those CCGTs in two to three years' time, to achieve the same reductions as the £100 billion being spent on wind [...] it would probably cost less than £10 billion.[161]

78. IGas Energy made the case that the UK Government's commitment to renewable energy sources would require "new, low-carbon, flexible gas-fired power plants to compensate for the intermittency of wind generation".[162] SSE agreed. However, they also acknowledged that this would also lock carbon into the UK's energy system for a number of decades.[163]

79. As to whether shale gas and renewables could be used in parallel in order to meet climate change targets, Professor Anderson believed that it was not possible to use a fossil fuel to meet the UK's 2°C target.[164] He told us that "shale gas would take about as long [to deliver the UK's targets] as a lot of the renewables", while at the same time locking carbon into the energy mix.[165] Jennifer Banks of WWF questioned whether there would even be enough shale gas produced before 2020 to create the bridging effect.[166]

80. An Emissions Performance Standard (EPS) is one method whereby the UK could try to ensure that a potential influx of shale gas into the UK does not disincentivise investment in more-expensive, but lower carbon, renewables. An EPS is in essence a measure to limit the amount of carbon dioxide (CO₂) that can be emitted from electricity generating power stations. In this case it could be used to ensure that gas power stations providing base load electricity would be unable to operate after a certain date without carbon capture and storage technology (CCS), and increase the incentive to invest in lower carbon renewables. In our 2010 report on Emissions Performance Standards we concluded that an EPS offers a more certain and predictable way to prevent lock-in to high carbon infrastructure than other means.[167]

81. The Minister told us he was "wary" about referring to gas as a "transition fuel", adding that "we have to start explaining what is going to be required in terms of emission levels and what is going to be required in terms of CCS retrofitting […] [so people can make] investment decisions".[168] Mr Hendry added that the UK could not meet its carbon reduction commitments "without moving heating away from gas. We can do that to some extent through biogas; we can do it through renewable heat".[169] DECC add that if shale gas proved to be commercially extractable, they would expect the "main effect of shale gas to be to reduce our dependence on imported gas, rather than displacing renewables".[170]

82. Conventional sources of natural gas in the North Sea are diminishing. We conclude that if a significant amount of shale gas enters the UK market (whether from domestic sources, imported from another European country, or from the global market via LNG) it will probably discourage investment in more-expensive—but lower carbon—renewables. The UK needs to manage this risk in order to achieve its aim of generating more electricity from renewable and other low carbon sources This could be done through the progressive implementation of an Emissions Performance Standard (EPS) that would prevent gas power stations operating as base load providers after a certain date unless fitted with carbon capture and storage.

83. We conclude that shale gas has the potential to shift the balance in the energy markets that the Department has tried to create away from low carbon electricity generation. We recommend that the Department take account of the impact of shale gas in its decisions on reform of the electricity market and its expectations of future investment in the energy industry.

LNG

84. Before their "shale gas revolution", the US imported significant amounts of liquefied natural gas (LNG), but these imports began to decrease with the increase in production of domestic shale gas. According to US Energy Information Administration (EIA) statistics, US LNG imports fell by almost a third between 2005 and 2010.[171] This "displaced" LNG can therefore become available elsewhere in the world".[172] There is even the prospect of US LNG exports.[173]

85. The British Geological Survey predicted that shale gas production around the world "will temporarily reduce the importance of the large LNG exporters"[174] such as Qatar (the world's largest LNG exporter).[175] DECC statistics indicate that in 2009 the UK imported the equivalent of approximately 10 bcm of LNG.[176] Jonathan Craig, however, argued that the increased availability of LNG will not eliminate the market and competition for LNG.[177]

86. The Minister noted that "in the United States they may wish to turn what was intended to be import infrastructure [for LNG] into export infrastructure",[178] but he saw no prospect of that happening in the UK: "the North Sea […] is inevitably in a decline […] Of the 20-plus gigawatt of consented plant [by DECC], over 60% is gas […] that will require us to have import capacity".[179]

Regulatory Challenges

87. All rights and ownership of the hydrocarbon resources of Great Britain (and the UK territorial waters) are vested in the Crown by the Petroleum Act 1998. The Secretary of State for DECC awards licences to search for and extract these resources during licensing rounds; the next onshore licensing round will be the 14^th. Safety is overseen by the Department of Work and Pension's Health and Safety Executive, while environmental concerns are monitored by the Department for the Environment, Food and Rural Affairs' Environment Agency and the Scottish Environmental Protection Agency (SEPA). Simon Toole of DECC told us that these four key agencies—have "established a regular set of meetings to ensure that [they] keep abreast of shale gas development". [180] DECC added that this group has been meeting "fairly regularly since 11 February [2011]".[181]

88. Onshore licences do not include any rights of access, making it the licensee's responsibility to "obtain all the relevant authorisations and planning permissions from the respective authorities and landowners".[182] In 1996 the then Department of Trade and Industry simplified the onshore licensing regime for the 8^th Licensing Round with the introduction of Petroleum Exploration and Development Licences (PEDL).[183] PEDL's are composed of three terms; the Initial Term requires the completion of "Work Programme"; the Second Term requires completion of a "Development Programme"; and the Third Term is the production phase. During a new licensing round, applications for PEDLs are made for a number of unlicensed 10 km by 10 km blocks, corresponding to the Ordnance Survey grid. In Northern Ireland, onshore licences are granted by the Energy Division of the Department of Enterprise, Trade and Investment.[184] All EU Member States are required to follow guidelines laid down in the 1994 Hydrocarbons Licensing Directive 94/22/EC.[185] However, there is no specific mention of shale gas, or unconventional gas in UK legislation.

89. Evidence to us was mixed on whether specific regulation was needed for the extraction of shale gas. IGas believed that there was a need "to ensure a robust licensing and regulatory system that protects the public while maximizing the rate of extraction".[186] Shell commented that as unconventional gas exploration required more wells to be drilled "regulators will need to review whether they have the appropriate framework and resources available to deal with the increased level of well permitting, environmental permitting and legislation, production license permitting etc".[187] However, IGas believed that the UK regulatory system was already "more rigorous and effective than in many countries" as the "onshore industry has inherited the culture of safety that has pervaded the UK offshore oil and gas industry since the Piper Alpha disaster".[188] Cuadrilla agreed that the UK already "possesses a strict regulatory framework governing onshore oil and gas exploration, including unconventional".[189]

90. DECC "does not believe that there is a requirement for UK oil and gas legislation to specifically refer to unconventional gas" as the technologies used for exploration and production are not new.[190] However, Professor Stevens of Chatham House observed that unconventional exploration "techniques are so different from conventional operations that they are simply not part of the existing regulations [in Europe]", adding that the "laws and regulations covering oil and gas exploration and development in Western Europe do not even make reference to unconventional gas".[191]

91. Nick Grealy told us that "Regulation is to be welcomed and will not add any significant costs to shale exploration".[192] Professor Anderson added, "I think just relying on existing legislative framework for a new process is not sufficient".[193] The US EPA is due to report preliminary findings on the effects of hydraulic fracturing on drinking water in 2012.[194] Interestingly, the Oxford Institute for Energy Studies (OIES) believed that the "US needs to clear its environmental debate before Europe can fully embrace unconventional gas".[195] DECC told us that "Planning and environmental considerations are likely to limit the number of surface locations from which wells can be drilled".[196]

92. We examined the Minister on whether UK should take the initiative within the EU to start discussing a common set of standards for shale gas. He responded:"my nervousness about common standards is that they end up being the lowest common denominator, and standards get driven down rather than driven up [...] [we] should be the gold standard that others should aspire to".[197] He noted that in the EU, "Energy remains a retained policy area. It is not something where there is a European competence".[198] DECC believed that the UK had a "robust regime which is fit for purpose" and will ensure that unconventional gas operations are carried out in a "safe and environmentally sound manner".[199]

93. We recommend that UK legislation and regulation should take specific account of the challenges unique to shale gas exploration and production; specifically, the combination of hydraulic fracturing and horizontal drilling at multiple wells that requires large volumes of water and chemicals, and leads to the production of large volumes of waste water that must be managed and disposed of.

94. We note that stronger environmental regulations and increased population density means that in the UK, and Europe more broadly, shale gas development here will follow a different route to that of the US. Although energy is not an EU-level competence, the UK Government will need to work with its European partners to ensure, so far as is possible, a reasonable degree of level competition between domestic shale gas producers.

95. We recommend that the UK Government monitors carefully the regulatory approach adopted by Poland and any other EU countries where shale gas exploration and production takes place. We recommend that the Government explores the possibilities of common environmental standards within the EU for shale gas exploration and production.

107 Paul Stevens, "The 'Shale Gas Revolution': Hype and Reality", Chatham House, September 2010, p 1-2 Back

108 Paul Stevens, "The 'Shale Gas Revolution': Hype and Reality", Chatham House, September 2010, p 1-2 Back

109 Ev 57 (DECC) Back

110 Ev 92 (GSoL) Back

111 Paul Stevens, "The 'Shale Gas Revolution': Hype and Reality", Chatham House, September 2010, p vi Back

112 Morgan Downey, "Oil 101", Wooden Table Press, 2009, p 11 Back

113 Q 180 Back

114 Ev w9 (SSE) Back

115 Ev w36 (Mitchell) Back

116 Florence Gény, "Can Unconventional Gas be a Game Changer in European Markets?", OIES, December 2010, p 101 Back

117 Florence Gény, "Can Unconventional Gas be a Game Changer in European Markets?", OIES, December 2010, p 102 Back

118 Ev w19 (Shell) Back