Thursday, 16 January 2014

Shale gas – It is not as important as politicians would have you believe

The US shale industry has enabled a renaissance in US industrial production. The Prime Minister and Chancellor are hoping that a UK shale boom can create the same dramatic benefits for the UK economy.

Despite the Coalition Government’s growing affection for shale gas, we believe it is unlikely to fix the UK’s looming energy crisis, or provide any significant contribution to gas production this decade. The chancellor, George Osborne, believes that shale gas has “huge potential” to provide employment, help diversify the UK’s energy mix, and reduce energy bills. The shale boom in the US has resulted in significantly lower gas prices, which in turn has helped boost the country’s recovery and resulted in a re-shoring of industrial production. US natural gas prices are about one third lower than those in Europe.

The US has a number of advantages over the UK when it comes to shale gas exploration such as the mineral rights, a history of on shore drilling, and less stringent environmental standards.

However, the fact that the UK is coming later to the shale gas party could be a benefit. Advances in fracking technology could mean that the UK is potentially able to take advantage of lower cost pad drilling at an early stage in the development of the industry.

We estimate that breakeven rates for shale in the UK could be $90/bbl (on an oil equivalent basis) compared to $70/bbl for US shale. However the higher gas price in the UK means exploration companies could achieve better margins even at higher breakeven rates. The offset to this is obviously the fact that commercial volumes are likely to be significantly lower in the UK than in the US.

Last year, the British Geological Survey reported that the Bowland shale, which covers 11 counties in the North and Midlands, could contain up to 1,300tn cubic feet of gas. It is estimated that the UK has some of richest shale deposits in Europe, followed by Poland.

We believe the shale industry is unlikely to produce commercial volumes of gas until the end of this decade and that it is unlikely to have a meaning full impact on gas prices. This is due to two reasons, firstly commercially available volumes are likely to be significantly lower in the UK than in the US, and secondly if UK shale is successful, exploration companies could export the gas to achieve higher prices.

The tax breaks available for on-shore unconventional drilling compared to off-shore conventional North Sea gas mean the Government is already in effect subsiding on-shore shale. The current proposal is for a 30% tax, providing the exploration company uses the most efficient drilling method, which compares to a 65% tax for off-shore North Sea exploration.

The announcement this week from the Government that local authorities will be able to retain 100% of the rates collected from shale sites will help to reduce local resistance, but there remains significant opposition to on-shore drilling due to concerns about water pollution, increased traffic and earthquakes.

Source: Bloomberg

Perhaps politician’s time would be much better spent working out how the Government rather than consumers are going to pay for the 100GW of new generation capacity which would be required in the UK to meet the country’s current 2030 carbon reductions targets.

Elaine Coverley, Head of Equity Research 
and Iain Armstrong Oil and Gas Equity Analyst

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