Shale Gas

Memorandum submitted by the Office of Gas and Electricity Markets (Ofgem) (SG 13)


· There is consensus that unconventional gas production from within Europe is unlikely to make a significant contribution to gas supply until 2020 at the earliest. Estimates put European unconventional gas resources at around 35tcm (trillion cubic meters, annual demand in GB is around 90billion cubic meters), which gives an unconventional supply figure of around 1.75tcm based on an extraction rate of 5% (this is equivalent to 19 years of current GB annual gas demand).

· Levels of unconventional gas production from outside Europe (excluding Australia and North America) are also highly uncertain although significant resources exist in Asia. Resources in North America and the Asia Pacific area are estimated at 233tcm and 274tcm respectively.

· Production of shale gas in Europe is likely to be significantly more challenging than in North America. Key challenges include planning (including access to land), water availability, stricter environmental regulations and availability of support services for drilling operations.

· Large scale unconventional gas production in the UK could displace some imports whilst large scale foreign production could free up conventional gas supply for alternative destinations, potentially improving UK/European security of supply.

About Ofgem

Ofgem is the Office of the Gas and Electricity Markets. Protecting consumers is our first priority. We do this by promoting competition, wherever appropriate, and regulating the monopoly companies which run the gas and electricity networks. The interests of gas and electricity consumers are their interests taken as a whole, including their interests in the reduction of greenhouse gas emissions and in the security of the supply of gas and electricity to them. As part of meeting our duties and functions Ofgem actively monitors the energy market and this includes looking at range of issues such as the impact of new energy sources on the market

1. Background

Ofgem is monitoring closely the development of unconventional gas due to the impact of production from these sources on global and UK energy markets. The rapid development of unconventional gas has already had a profound impact on gas production in the US. The resulting reduc tion in demand for both imports of pipeline gas (from Canada and Mexico) and LNG (liquefied natural gas) has release d incremental LNG supply to other markets and means that the US is unlikely to present a significant source of additional demand for LNG in the medium term (although the US still imports a large volume of LNG – 12bcm in 2010). In our work on project Discovery (published in October 09) we assumed a further expansion of unconventional gas in the US under all but one of the four scenarios modelled .

In this note we have attempted to provide material we hope the committee will find useful. The material has largely been drawn from publically available sources. The note firstly sets out forecasts for unconventional gas resources and outlines a range of technical factors relating to the extraction of unconventional gas. The note also considers the economics of shale gas production, presents estimates of potential unconventional gas production in Europe and outlines a number of barriers to large scale production in Europe/UK. Section 7 responds to specific questions raised by the committee where these are not addressed in other sections.

In this note we have focused on unconventional gas more generally. Shale gas is considered to be a type of unconventional gas which also includes coal bed methane (CBM) and tight gas [1] .

2. Unconventional resources

The chart shows that the total volume of global unconventional gas in the ground is estimated to be around 921tcm. In comparison conventional resources at the end of 2008 were estimated at 184tcm. However, the majority of this is difficult to extract. If we assume that 5% is recoverable (based on US experience), this gives a supply of around 46tcm compared to total global consumption of gas in 2009 of 2.9tcm.

Source: IEA

It took around 20 years of development to reach current levels of shale gas production in the US, with production increasing from 7bcm in 2000 to 87bcm in 2009 (14% of consumption) and is forecast to rise to 368bcm in 2035 or around 55% of current consumption (recently the EIA has doubled its forecasts of US shale resources from 13.6tcm to 23.4tcm). Replicating this level of increase in other markets is likely to be challenging although, the know-how and technology developed during this period can be utilised in other markets. However, other barriers exist in reaching similar levels of production (see below).

In Western Europe the key areas that are thought to contain unconventional gas deposits are Poland, Germany, Hungary, Turkey and parts of the UK. The chart on the next page shows the most promising areas for shale gas exploration in the UK.

Source: British Geological Survey

3. Technology

This section outlines a range of technological factors important in producing unconventional gas. Shale gas is extracted using a process known as hydraulic fracturing or ‘fracking’ where water/chemicals are injected at high pressure into a well to fracture rocks to release trapped gas.

Typically around 15-16 wells have to be drilled before finding the ‘sweet spot’ (an area within a shale gas region that contains a high concentration of gas). Average extractions rates are between 4-6% as shale gas is not evenly distributed across a given area (based on US experience). This means that a greater number of wells are required compared to conventional gas production.

Extraction rates and cost of production depend on a range of factors such as the quality of the play (an area containing shale gas resource), the technology employed and the quality of the well operator. For instance:

· Production is significantly higher in dry gas areas than oil/wet gas areas (wet gas contains some liquids such as oil).

· Production is higher where horizontal drilling extends further out.

· Operator performance varies significantly, with the best operators producing significantly more than less efficient operators holding all other relevant factors constant.

· Deeper shale gas is harder to access but provides better flow rates due to higher pressure.

It is possible to apply horizontal drilling techniques used in unconventional gas extraction in improving flow rates from poorly performing conventional gas wells. For example, using this technology in Saudi Arabia has increased volumes from a conventional gas well from 0.5mcf/d to 30mcf/d. This could improve the economics of existing conventional gas wells that are either currently uneconomic and/or are coming to the end of their useful lives. It is also possible to improve/maintain extraction rates from existing unconventional gas production wells by further re-fracturing wells.

4. Economics of shale gas

Global gas prices play an important role in determining the economics and hence overall levels of unconventional gas production. The chart below shows estimated costs of European shale gas production versus other new sources of supply in 2020.

Source: Oxford Institute for Energy Studies. The current $/£ exchange rate is 1.55 and the cf to cm conversion factor is 0.028. This gives a p/therm for Poland Shale (base case) of 56p/therm.

The chart shows that European shale gas is likely to have a higher cost of production compared to other gas supply sources. The long run cost for current shale gas projects in the US have been estimated to range from 12.5p/therm to 40p/therm. Current Henry Hub (a pricing point for gas trading in the US based in Louisiana) prices are around 25p/therm whilst GB prices are around 65p/therm.

In North America, government has provided assistance to unconventional producers. This has included tax breaks (e.g. the crude oil windfall profit tax act) and R&D support. The US is also offering to help other countries realise their unconventional gas resources through their Global Shale Gas Initiative launched in April 2010.

5. Forecasts of European and UK unconventional gas production

The charts on the next page show that European gas demand is unlikely to recover to 2008 levels until 2013. The second chart shows that unconventional gas is unlikely to make a significant contribution in meeting gas demand in UK by 2020 (in both base and high case scenarios) although other European countries have the potential to produce around 5-10bcm by 2020 (in the high case scenario).

Source: Woodmac

Cuadrilla Resources, the first company to drill for shale gas in the UK, have recently obtained promising results from the UK’s first shale gas well in Lancashire. Based on this data they estimate that shale gas could ultimately meet 5-10% of UK gas demand although they do not give a time frame for this view. They are hoping to start the extraction process in early 2011.

In terms of coal bed methane, according to Reach CSG, the UK has potentially large deposits that could be exploited. They estimate that CBM has the potential to provide up to 20% of UK gas production in 2020.

6. Factors that may restrict the development of unconventional gas in Europe

A number of factors may restrict the extent to which unconventional gas resources can be exploited in UK/Europe compared to volumes observed in North America. These include:

- Availability of sites. Some sites containing potential unconventional resource are protected by national or European law.

- Geology of sites. Many European sites are smaller, with shale gas deposits deeper and further away from each other.

- Service sector. A lack of a flexible, readily available service sector in Europe to support unconventional gas operators. However, current operators in North America are commercial firms and as such are likely to offer their services in other markets where demand exists.

- Local opposition. Concerns about the impact of drilling on the local community, in particular concerns over drinking water contamination.

- Water utilisation/scarcity. Concern whether there is adequate infrastructure to transport water to the drilling sites, disposing of waste water and competition with other uses, e.g. drinking. Some positive developments in this area including using saline water for fracking (rather than drinking water) and recycling a high proportion of the water used.

- Environmental restrictions. These are often more stringent in Europe than in the US (particularly when compared to the large shale gas producing states).

- Less uninhabited/available land. Population density in Europe is 100 to 200hab/km2 compared to just 30hab/km2 in the US. The US model of ‘factory drilling’, where hundreds of wells are drilled across a specific play to indentify a ‘sweet spot’, is therefore unlikely to be appropriate for most European markets. Instead a target approach is more suitable, where detailed R&D takes places to identify sweet spots more accurately. This method is consistent with the traditional exploration and production method that the large European energy firms are familiar with. In the US drilling is often in sparsely populated areas but even where it is in more heavily populated areas, the public is accustom to drilling activity due to a history of onshore oil drilling.

- Getting gas to market. Grid density varies considerably, with a gas grid (km)/area (1000km2) of 62 and 45 in the US and UK respectively but only 1 in Sweden. One solution could be to convert extracted unconventional gas into electricity and transmit the power where electricity transmission is more readily available than gas.

- Compensation to land owners. In the US legislation provides owners of above ground land rights over underground resources. In almost all European countries underground resources is owned by the state. However, European drilling companies have said that they have not found it difficult to obtain access by negotiating directly with land owners. However, this may change as the level of drilling increases.

- Lower prices in 2009/10, due in part to high levels of production of unconventional gas in the US, reducing the NPV of European projects, although gas prices are currently rising in Europe.

Whilst European players are less experienced than their North American counterparts there is a greater preference for partnerships and joint ventures in Europe, with energy majors with unconventional gas extraction experience partnering up with smaller outfits. This is due in part to higher costs of developing European plays (~£200m from development to production).

7. Questions posed by the committee

What are the prospects for shale gas in the UK, and what are the risks of rapid depletion of shale gas resources?

As the analysis above shows, there is considerable uncertainty over the likely levels of unconventional gas production (including shale gas) in the UK and across Europe more generally. There are a number of barriers that need to be overcome before significant production levels can be achieved. Based on current forecasts, significant volumes of UK unconventional gas production are unlikely before 2020.

The level of recoverable gas from an unconventional gas play sets the overall production limit. As noted above various factors including geological and technical determine the level of recoverable gas. In terms of the rate of depletion of shale gas wells, experience from the US indicates that although unconventional gas wells deplete faster than conventional wells production levels can be improved by re-fracturing of wells.

What are the implications of large discoveries of shale gas around the world for UK energy and climate change policy?

Large scale discoveries of shale gas resources do not necessarily mean large scale production will follow due to technical and economic factors, particularly in Europe. However, if we assume large scale production occurs this will increase overall gas supply, which is equivalent to large discoveries of conventional gas. Thus, an increase in shale gas production is likely to have the same impact on energy policy as an increase in gas production from conventional sources.

Large scale unconventional gas production in the US has already had a significant impact on global, European and UK energy prices. The significant rise in US indigenous production has reduced its LNG import requirement freeing up cargoes for alternative destinations. It is difficult to isolate the impact of increasing shale production on global gas prices from other factors such as demand reduction due to the recession and the increase in LNG liquefaction capacity. However, it is likely to have played a role in reducing gas prices.

Large unconventional gas production (as with any increase in gas supply) is likely to have an impact on the UK energy policy. For instance, everything else equal, it is likely to improve the security of supply outlook, both if large scale UK indigenous unconventional production is realised which then displaces imported gas or if large scale unconventional gas production in other countries occurs freeing up gas for international markets. Our view is that impact on security of supply for the UK is likely to be neutral to positive. However, a number of factors complicate the picture, for instance how quickly global demand will recover, in particular the speed of energy demand growth in China and India.

Finally, it may be new regulations, particularly environmental, may be need to manage the environmental impact of unconventional gas drilling, in particularly relating to usage and disposal of water.

How does the carbon footprint of shale gas compare to other fossil fuels?

Work on understanding the environmental impact of unconventional gas production is still at an early stage. However, environmental impacts are likely to include impact on water resources, concerns on contamination of the water table and the possible leakage of methane.

The Environmental Protection Agency in the US has launched a study into the impact of hydraulic fracturing, used in shale gas production, on the environment including drinking water. The study will publish its results in 2012 (please see the following link

A paper published by Robert Howarth at the University of Cornell calculated that if methane leakages from hydraulic fracturing are including, along with emissions from forest clearing and water transport the carbon footprint of shale gas is slightly worse than coal. However, the paper notes that the assessment is highly uncertain and the numbers should be treated with caution (

I hope that you consider this information useful.

January 2011

[1] Unconventional gas is largely made up of methane, i.e. the same as conventional gas. However, it is harder and/or less economic to extract than conventional gas . Gas that is currently considered unconventional could become conventional as technology develops and costs fall . CBM is found in coal seams and is methane gas that has either been absorbed onto the coal or is dispersed into pore spaces around the coal seam. Tight gas is gas trapped in usually impermeable and non-porous rock.