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The Biggest lie in Stock Market History Revealed

UK Dash for Shale Natural Gas - A Faustian Bargain

Politics / Natural Gas Dec 22, 2012 - 05:09 AM GMT

By: Raul_I_Meijer

Politics

The UK is set to embark on its second dash for gas. The first, beginning in the early 1990s, occurred when gas was first permitted to be used for power generation. Prior to that it had been considered a premium fuel too valuable to be used in this way. The regulatory change initiated a substantial building programme for combined cycle gas plants, fuelled by North Sea gas. Very quickly gas generation became a major component of baseload in the UK, despite warnings that North Sea gas was a temporary bonus and its depletion would leave a structural dependency on Russian gas.


Twenty years later, now that those warnings have been borne out, the UK is increasingly concerned about security of gas supply. The extent of the gas dependency has been greatly increased in the meantime by the housing bubble years, during which many very large, open plan homes were constructed, requiring gas for heating. Also, many more existing homes than previously have installed gas or electric central heating systems, and often these homes are poorly insulated.

As the years of cheap gas are over and gas prices rise inexorably, the structural dependency on cheap gas begins to cause real pain. Household energy bills are at record levels, having risen between 6-11% in 2012 and predicted to rise again in early 2013.

Fuel poverty is sharply increasing:

At the Fair Energy summit today, hosted by The Independent and Policy Review Intelligence, Ed Davey, the Energy Secretary, will remind energy companies about new rules which mean they will have to be more open about the reason why electricity and gas bills are increasing. He says companies are exaggerating the expense of the Government's energy efficiency measures.

His comments will follow the shocking claim from the Government's Fuel Poverty Advisory Group that 300,000 homes will be pushed into fuel poverty by Christmas. A household is considered to be in fuel poverty if it needs to spend more than 10 per cent of its income on fuel for adequate heating.

The group also warns that unless the Government tackles the problem of people being forced to choose between heating and eating, nine million households could fall into fuel poverty by 2016. It is estimated that six million households are already in fuel poverty.

The timing is particularly unfortunate, as the gas crunch is hitting at the same time as the credit bubble is bursting, falling house prices are leading to negative equity, austerity measures are being imposed, including welfare cuts for many of the poorest, unemployment is rising and household budgets are being considerably squeezed. The UK is also facing its third cold winter in a row. Estimates suggest that for every 1% increase in energy prices, about 40,000 households are pushed into fuel poverty.

In response, the British government has mandated The Energy Company Obligation to improve the energy efficiency of the housing stock, but there are concerns that these measures would initially add to energy bills:

The Energy Company Obligation (ECO), designed to cut bills of poor households by forcing suppliers to fit solid wall insulation, offer energy efficient boilers and other energy-saving measures, could add up to £116 to the average bill and push families that did not receive support further into fuel poverty. It said that while there were 2.7m fuel poor households in England alone, it expected the measure to help between 125,000 and 250,000 households out of fuel poverty by 2023.

Previous governments, going back at least twenty years, had been repeatedly advised to address the poor energy efficiency of the housing stock, particularly for public housing. They could have done this when mitigation would have been readily affordable, but chose to wait until the transition, if it can be afforded at all in a period of financial crisis, will be far more painful.

The current government has taken the fateful decision to pin its hopes, and much of the energy future of the country, on trying to prop up falling conventional gas supplies with unconventional alternatives. The second dash for gas has been launched with the lifting of the interim ban on fracking (imposed after minor seismic events in fracked areas) and plans to build 30 new gas plants. In his recent autumn statement, Chancellor George Osborne has announced the creation of a new Office for Unconventional Oil and Gas, along with plans for a system of generous tax incentives.

 

A wholesale commitment has been made to the 'shale gas revolution', with the promise of decades worth of affordable gas, and that the American experience of falling gas prices can be replicated in the UK. The Chancellor has indicated that he "does not want British families and business to be left behind as gas prices tumble on the other side of the Atlantic". The hype has been considerable, despite the acknowledgement that, even if the gas is plentiful and the technology successful in extracting it, unconventional gas could not make a substantial contribution to current levels of gas demand for at least a decade. Britain will be in energy difficulties long before that.

Matt Ridley, former chairman of Northern Rock and author of Genome and The Rational Optimist, offered this hyperbolic, but ill-informed, endorsement:

As recently as 10 years ago, there was a consensus that gas was going to run out in a few decades and grow ever more expensive in the meantime. Such pessimism is now a distant memory everywhere, except perhaps in the forecasting models of the Department of Energy and Climate Change. Gas, the most abundant fossil fuel, is going to last at least a century, probably much longer.

London Mayor Boris Johnson is on the record with even more over-the-top pronouncements:

We are…increasingly and humiliatingly dependent on Vladimir Putin’s gas or on the atomic power of the French state. And then in the region of Blackpool – as if by a miracle – we may have found the solution. The extraction of shale gas by hydraulic fracture, or fracking, seems an answer to the nation’s prayers. There is loads of the stuff, apparently – about 1.3 trillion barrels; and if we could get it out we could power our toasters and dishwashers for the foreseeable future. By offering the hope of cheap electricity, fracking would make Britain once again competitive in sectors of industry – bauxite smelting springs to mind – where we have lost hope…

…In their mad denunciations of fracking, the Greens and the eco-warriors betray the mindset of people who cannot bear a piece of unadulterated good news. Beware this new technology, they wail. Do not tamper with the corsets of Gaia! Don’t probe her loamy undergarments with so much as a finger — or else the goddess of the earth will erupt with seismic revenge. Dig out this shale gas, they warn, and our water will be poisoned and our children will be stunted and our cattle will be victims of terrible intestinal explosions.

Clearly the mayor has no idea of the energy intensity of bauxite smelting, and no understanding of net energy, along with very little respect for the very real concerns surrounding shale gas. Still, he is really only propagating the exceptionally optimistic forecasts of Cuadrilla Resources, which has been doing the preliminary drilling in the Blackpool area:

The huge scale of a natural gas field discovered under the north-west of England has been revealed, potentially revolutionising the UK's energy outlook and creating thousands of jobs, but environmental groups are alarmed at the controversial method by which the gas is extracted.

Preliminary wells drilled around Blackpool have uncovered 5.6tn cubic metres (200tn cubic ft) – equal to the kind of recoverable reserves of big energy exporting countries such as Venezuela, according to Cuadrilla Resources, a small energy company which has the former BP boss Lord Browne on its board. It said up to 800 more wells might be drilled in the region, creating 5,600 jobs and promising a repeat of the "shale gas revolution" that swept the US, sending local energy prices spinning downwards.

To compare shale gas in in Lancashire to Venezuela is simply laughable, especially on the basis of a handful of exploratory wells in one small region of the country, but then so is suggesting that the US will be the next Saudi Arabia based on shale energy resources. It seems the shale hype is rife on both sides of the Atlantic. Estimates such as 120 years UK supply, and a £1.5 trillion injection into the economy, are being enthusiastically bandied about, albeit with minor acknowledgement that not all of it may be recoverable.

We have covered the shale energy situation in the US at TAE before in detail, both with regard to gas and to oil. To recap, the energy profit ratio is extremely low, meaning that scarcely any more energy is produced than had to be invested in production. Depletion rates are very high, setting producers on a drilling treadmill that runs ever faster. Fracking is both capital and energy intensive, requiring a substantial surplus of both, well in advance of needing a return on either one.

As we have pointed out before, prices are set by perception, not by reality. The perception of a gas glut is what has depressed gas prices in the US, not realistic long term prospects of producing gas in meaningful quantities. The reality is quite different, as the insiders know perfectly well:

Geologist and official from Anglo-European Energy:

After buying production for over 20 years, hopefully I know the characteristics of great wells (flat decline curves, low operating costs, large production), and as you know, the shale plays have none of these. The herd mentality into the shale will eventually end possibly like the sub-prime mortgage did. In the meantime it is very difficult to sell any kind of prospect that is not a shale play.

Analyst from PNC Wealth Management (2011):

Money is pouring in from investors even though shale gas is inherently unprofitable. Reminds you of dot-coms.

Analyst from IHS Drilling Data (2009):

The word in the world of independents is that the shale plays are just giant Ponzi schemes and the economics just do not work.

Retired geologist for major oil and gas company (2011):

As I think you would agree, we are looking at a bubble here with caveats. The caveats are how corporate hubris and bad science have caused a lot of folks to think that gas is nearly too cheap to meter. And now these corporate giants are having an Enron moment, they want to bend light to hide the truth. The bubble will burst, folks will get run over, reason will be restored, if only temporarily.

Official from Bold Minerals LLC (2010):

The ‘bait and switch’ where one massive set of capital outlays in the ‘best’ shale uncovered was soon to be eclipsed by the recognition of even better shales which required even more outlays before a thorough technical assessment of existing shale positions had been obtained could only be classified as a type of ‘mania’. It has no precedent in financial scale to any of the previous lease plays that experienced a speculative frenzy in domestic onshore petroleum history.

Official at Phoenix Canada Oil Company (2010):

It is my strong view that we will see a near collapse of that play, probably sooner rather than later. Perhaps we will see a repeat of the coal bed methane (CBM) play 'disappearance' -- where that 'exciting' development faded into history 'without a trace'!

Official from Schlumberger (2010):

All about making money. I'm working on a shale gas well that was just drilled in Europe. Looks like crap, but the operator will flip it based on ‘potential’ and make some money on it. Always a greater sucker....

The low gas prices seen in the US have been a financial disaster for the production companies, although in a classic ponzi move they have made money flipping land leases even as they lost it on producing gas at a higher cost than they could sell it for. Drilling rigs are already deserting shale gas plays in the US in favour of shale oil - the next great white hope (which happens to suffer from all the same deficiencies as shale gas).

Rig count is a leading indicator of production, so we can expect shale gas production in the US to fall substantially. As production falls, we could see the US shift from perceived glut into real shortage, given the dependence there on affordable gas for both heating and electricity. We could then see a major price spike.

This is exactly the boom and bust dynamic the UK is proposing to set itself up for as North sea depletion rates pick up steam and desperation sets in. After all, it was a similar desperation over conventional gas prospects that drove the industry in the US into trying to develop unconventional supplies. However, the UK is unlikely to experience the full upward and downward swing seen in the US. It is far more likely the reserves will prove to have been overstated, and opposition to fracking in the UK countryside will be huge - far larger than the already substantial protests against on-shore windfarms.

Unlike the US, where landowners are paid royalties for the gas under their land, in the UK, mineral rights are the property of the government. The disparity between where costs and impacts would lie and where benefits would accrue increases the odds of opposition even further. The inevitable protests could delay the process well into the era of financial crisis, at which point it would not be realistically affordable.

The choice to pursue the shale option has been labelled a dangerous gamble:

Professor John Stevens, Senior Research Fellow in Energy, Environment and Resources at independent analysis organization Chatham House, opposes the government's promotion of shale gas as a viable energy alternative.

"Osborne's view of the future of energy is misleading and dangerous. It is misleading because it ignores the very real barriers to shale gas development in the U.K. and Europe more generally," he said this week.

"The U.S. revolution was triggered by favorable factors such as geology, tax breaks and a vibrant service industry among many others. However, in Western Europe the geology is less favorable, notably with the shale containing a higher clay content making it more difficult to use hydraulic fracturing (fracking)," he said. He called the U.K's "dash for shale gas" a"dangerous gamble."

Stevens added that the government's hope that shale would reduce the rising costs of energy in the U.K. were flawed.

"[The government's view] assumes that gas will be cheaper in the future and, as already explained, while this could be the case it will certainly not be the result of any shale gas revolution in U.K. or Europe in the next five to ten years."

As Professor Stevens points out, circumstances in the US and the UK are not at all similar. The UK is far more densely populated, and land-use in the countryside is tightly controlled. Fracking requires space and infrastructure:

Melissa Stark, Managing Director of Accenture's Clean energy group, said shale gas can require a number of wells over one site. Even if the number of wells can be reduced by horizontal drilling, the site will need roads, machinery and storage facilities.

"One of the biggest challenges for the UK is probably going to be the population density. The UK is much more densely populated than the US making the management of movements more challenging.

"The sharp influx of logistics activity during the drilling and fracking phases can have a significant impact on the local community. Increased traffic congestion, damage to local roads, noise and air pollution are among the most commonly cited concerns."

Ms Stark pointed out that fracking is extremely water intensive, requiring around 5m gallons per well. Although the UK is not a water stressed area, she pointed out that in certain areas in certain years, industrial water use can be restricted. Also the waste water from fracking needs to be transported off the site and treated or injected into wells deep underground. She said the UK will have to find disposal sites or build enough treatment works.

"As the volume grows, the question is can the used water treatment works keep up?"

In anticipation of substantial opposition, the government is preparing to remove planning control for fracking from local municipalities:

Under new laws, Government ministers, rather than local authorities, could have the final say on more "nationally significant infrastructure" projects, including onshore gas extraction. Proposals in the Growth and Infrastructure Bill would would exempt shale gas plans from some local planning procedures and consultations. The laws are aimed at stopping local blockages in the planning system to fast-track infrastructure and boost economic growth. Campaigners, who warn that fracking could cause "major damage" to the landscape, could have less opportunity to challenge unwanted developments.

Vague promises of 'community benefits', particularly if these come in the form of "voluntary contributions by developers to an area where their business has a long–term impact on local resources and the environment" are unlikely to appease anyone. However, if proposals to share business rates with local councils are, in fact, enacted, then councils, which a very squeezed financially, and set to become far more so, could effectively be bought off.

Apparently over 60% of England is currently under 'license block' consideration for the development of shale gas, much of it under the Home Counties. It is ironic that Conservative Party politicians are the most ardent champions of shale gas development, yet the land that would be affected is home to much of their key powerbase.

This does seem to be an obvious form of political suicide, and the fact that the present government seems blind to that is a measure of the level of concern over Britain's energy future. The powerful impulse to deny reality in order to cling to business as usual is understandable, but terribly misguided.

Under such circumstances, it is natural human behaviour to look for a saviour. Given our ghastly choices, it wouldn’t be surprising if we were susceptible to false dawns….With the West on its economic uppers, and losing power relative to the rest of the world, a home-grown energy bonanza sounds appealing…

When the big energy companies and Western governments push in the same direction, they can, for a while anyway, create any conventional wisdom they like, even one with little regard for the facts.

Unfortunately for proponents of the appealing fantasy, reality wins in the end. We are not destined to see the geo-strategic map redrawn in favour of the West as a result of shale energy. Instead, we are going to be facing some very hard decisions on rationing scarce resources for the foreseeable future, and we are going to be doing it in a time of deepening financial crisis. Britain will be critically short of both money and energy, and sadly those twin deficits can be expected to aggravate each other significantly.

Shale gas is a Faustian bargain meant to kick the energy can down the road, but it amounts to nothing more than a cruel deception.

By Raul Ilargi Meijer
Website: http://theautomaticearth.com (provides unique analysis of economics, finance, politics and social dynamics in the context of Complexity Theory)

© 2012 Copyright Raul I Meijer - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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