Shale gas: Britain’s saviour?

Shale gas: time for us to pile in?

We’ve made a right mess of energy policy in this country.

Energy heats our homes, powers our factories and keeps our office lights on. Alongside food and shelter, it’s a country’s most basic need. And despite all of this, in the UK we seem to be stuck with ever-rising energy bills. The risk of blackouts is growing alongside our bills. And we did it all to ourselves.

Shooting ourselves in the foot

Since 2007, the average British electricity bill has gone up by a whopping 40%. That’s 21% more than inflation, at a time when household incomes are severely squeezed. And at first glance, it isn’t obvious why that’s happened. The price of crude oil has been stable for a few years now. In fact, at $106 per barrel, it’s a lot lower than the pre-crisis spike of $150. Natural gas prices have fallen over time, too. The devaluation of sterling accounts for some of the increase in bills, but ultimately, the chief culprit is our drive to cut carbon emissions.

13% of British electricity is currently generated from renewables. EU law requires that, over time, this figure rises to be closer to 30%. That pressure is what’s driving desperate measures like the building of offshore wind farms. Power companies are guaranteed £155 per megawatt hour from those sea windmills, a staggering three times the current wholesale electricity price. And where do these subsidies come from? Your pocket, and mine.

But wait, you might say: there are zero-carbon, non-renewable alternatives. What about nuclear? Well, the first new nuclear power plant for 20 years, Hinkley Point in Somerset, will still cost us twice the going rate for the electricity it will generate.

The debate on prices mainly revolves around domestic utility bills, which is understandable. That’s where people feel the hit. However, we are hardly going to create many manufacturing jobs in this country by jacking up the cost of energy and reducing our competitiveness, are we? Ironically, the most vociferous supporters of a ‘re-balancing’ of the economy – that is, away from services and towards manufacturing – are often those arguing loudest for high-cost energy policies.

The other reason behind rising prices is the government’s policy of shutting down cheap but dirty coal-fired power stations. The upshot of this has been a dramatic shrinking of our spare generating capacity. A couple of years ago we had over 15% spare, but Ofgem forecasts this cushion will be a slim 2-5% just two years from now. It seems a bizarre position to put ourselves in, doesn’t it? As someone who remembers doing their homework by candlelight during the power cuts, and the three-day week of 1973, it makes for a dismal prospect.

Fracking: The new American dream

But wait: we may have just been handed a lifeline. Natural gas isn’t a renewable energy source, but it’s far cleaner than coal. If we were able to unlock the huge reserves trapped in shale formations under large parts of this country, our energy costs and emissions would both fall significantly. The technique for releasing this gas, as I’m sure you know by now, is hydraulic fracturing, also known as ‘fracking’. Horizontal drilling technology gives us access to the reserves, then the natural gas is released by pumping water and chemicals under pressure into the well.

The impact of shale oil and gas in the US has been dramatic. Natural gas production is up 30% since 2008 and its price has fallen by 66%. Energy security has ceased to be the big issue it once was, and the country now produces more oil than it buys in. Low gas prices have even helped halt the long-term decline of American manufacturing. That’s all resulted in jobs being created, as energy-intensive industries have once again become competitive in the global marketplace.

Environmental concerns overruled

So could ‘fracking’ be coming to a field near you? It might be a step closer following the news that French oil major Total is to take a stake in two prospective shale gas fields in Lincolnshire. David Cameron followed this news up by offering local authorities a bigger slice of the taxes that would be generated if shale gas development goes ahead. So the government is keen to promote it – and if enough money finds its way into local communities, I suspect much of the opposition will fade away too. That said, there’ll always be some opposition to drilling for gas.

I must admit I’m not a fan of siting industrial plants in the countryside. But if we are going to do it, I’d prefer it to make economic sense. Shale gas makes sense. The two main environmental objections to fracking are the risks of groundwater contamination and the possibility of earth tremors. The first should be controllable by regulation and engineering. Regarding the second, tremors and subsidence are common by-products of mining operations, but they weren’t often put forward as reasons to shut down coal mines. Given the ultimate size of the potential reserves, we’d be mad not to try to exploit them.

Fracking’s investment potential

Share prices of shale gas licence owners have reacted very positively to the Total news. Over the last ten days IGas (IGAS) has jumped by 40%; the smaller Egdon Resources (EDR) has quadrupled. So is it time for us to pile in? There are a couple of obvious things to think about first.

As with most natural resource projects, it’ll take a long time for companies to start making money. The planning process could well be lengthy and controversial – despite government support. Test wells will have to be drilled to understand the underground geology and the technology needed to extract gas efficiently. So there is the risk that returns will be stretched out into the future.

Then there is also the risk that these returns will be lower than hoped. The huge success of fracking in the US has dramatically reduced gas prices which has been great news for the economy and for consumers. However, it has been less good for the producers. If UK shale were to generate the sort of volumes hoped for, we could see a similar effect over here.

I doubt shale will be a short-term fix. But I do believe that it has the scope to make a big contribution to Britain’s long-term energy security and bills, and that, over time, it can provide other economic gains in terms of jobs and tax revenue.

That still leaves us with the current mess: the one-two punch of high energy prices and tight generating capacity. This is a legacy of poor planning in an industry with long lead times. What I’d really like to see is a coherent energy policy that is firmly planted in the real world. Something that is affordable, as well as what is clean and green.

And shale could well play the leading role.

This article is taken from our FREE penny share investment email Penny Sleuth.
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