The Impact of Shale Gas on Energy Markets - Energy and Climate Change Contents

5  Impact on energy market and prices

48.  Shale gas is one part of a wider global gas industry. The US shale gas revolution has seen gas prices fall from around $12 to $3 per million British thermal units (Btu) over a short period of time.[137] This has led many to speculate about what impact shale gas might have on other gas prices around the world and in the UK. [138]

Box 2 - Markets and trading

Unlike oil, gas is not currently a globalised market. Historically there have been three regional markets (US, Europe and Asia) with relatively little trade between them. This is because unlike oil, gas tends to be transported by pipeline, which makes inter-regional trading of gas difficult and expensive (although liquefied natural gas - LNG - can be shipped).

Most gas is traded using long-term contracts. This is because gas is difficult and, therefore, expensive to move around requiring long-term commitments from buyers and suppliers. The use of long-term contracts can prevent buyers and sellers from determining a spot market price of gas.

Long-term contracts for gas are often indexed to the price of oil (generally referred to as oil-indexation) which is easier and cheaper to move around. This is especially the case in mainland Europe and Asia. In practice, indexing gas prices to oil prices means that if the price of oil goes up, so does the price of gas, and if the price of oil goes down, so does the price of gas.[139] In general though, oil-indexed prices are considered to be more stable than spot or hub prices for gas.

The majority of liquefied natural gas (LNG) is also traded using long-term contracts (which are also indexed to oil prices). However, an increasing proportion is being traded on the spot market.[140] In the US and the UK, for example, the price of gas is determined using wholesale trading hubs known as the Henry Hub price and the Net Balancing Point (NBP) respectively. These determine the price of gas based on gas-to-gas competition (i.e. market forces). The combination of long-term contracts, spot markets and the limited trade between regions has created price differences across these regions.

Impact of foreign shale gas on UK gas prices

49.  There are two main ways in which cheap US gas prices could affect UK gas prices: changes to the way gas is traded and development of exports from the US.

Changes to the way gas is traded

50.  The price of gas in the US is based on gas-to-gas competition (often referred to as a spot market). This makes it easier to determine a market price for gas compared to a rigid mechanism of determining gas prices indexed to the price of oil (see box 2). Countries in Europe and Asia where the price of gas tends to be index linked to oil prices are now looking at gas prices in the US and questioning the high price they are paying by comparison. Professor Bradshaw of UK Energy Research Centre (UKERC)suggested, for example, that Japan's attitude towards paying for gas was changing.[141] Dr Bros of Société Générale told us that Asian buyers were increasingly unwilling to use oil-indexation as a basis for purchasing long-term contracts and were looking for new ways to price gas. [142] Similarly, in Europe, companies were seeking to renegotiate the terms of their long-term gas contracts with suppliers to reflect the lower prices available on spot markets.[143] According to Oil and Gas UK, this has been something the European Energy Department is actively encouraging.[144] Dr Bros suggested that as a result oil-indexation was, in his words, "going to fade".[145] However, because in Europe the volume of gas currently traded using oil-indexed prices, delivered through pipelines, is significantly larger than spot traded LNG the fading of oil-indexation will take a long time.[146]

51.  Increased gas-to-gas competition does not necessarily mean that low gas prices will result. In fact, spot prices tend to be more volatile. It is preferred by some because it helps to determine a market price of gas.

52.  We conclude the shale gas revolution in the US has the potential to influence the nature of gas markets around the world. In particular, it could stimulate greater use of gas-to-gas competition in spot markets to determine gas prices rather than oil-indexation. However, this would not necessarily guarantee that the price of gas will fall.

Exports of US gas

53.  The price of gas is also affected by the cost of transporting it. In the case of LNG liquefaction, shipping and regasification of the gas all have significant costs. According to the Chemical Industries Association:

"The necessary export terminals with liquefaction facilities, specialised shipping with pressurised, cooled containment and import terminals with re-gasification and storage capacity are all expensive investments".[147]

54.  According to Professor Stevens of Chatham House and Dr Bros of Société Générale transporting gas from the US to the UK could add ~$6 per million Btu to the original price of gas in the US (~$3 per million Btu).[148] Whether this price is higher or lower than the UK price (roughly ~$8-10 per million Btu) will determine whether it is economic to import gas from the US. If it is economic, Mr Crotty of INEOS Olefins & Polymers Europe suggested that the UK was, "extremely well placed" to exploit any potential benefits arising from the impact of shale gas on gas markets because the UK has the infrastructure to continue to import gas.[149]

55.  The US shale gas "revolution" also saw the US withdraw from the LNG market. LNG that was expected to be imported by the US was subsequently made available to Europe and Asia creating a "short-term glut" in the market and therefore reducing the price of gas and making it attractive to import. However, most of this LNG was subsequently absorbed by Japan following the Fukushima nuclear incident, bringing an end to these price reductions.[150] The withdrawal of the US from the LNG market, combined with the future export potential of its shale gas could exert further downward pressure on gas prices. It is uncertain whether this will outpace rises in the level of demand, particularly from Asia, which could limit any potential future price reductions.

56.  We conclude that if the US were to begin exporting its shale gas as LNG, the UK might find it economically attractive to import some of this gas. However, the significant transportation costs associated with shipping LNG, combined with expected demand for LNG from Asia, means that the price for this gas in the UK is likely to be significantly higher than that experienced in the US.

Impact of domestic shale gas on UK gas prices

57.  Some believe that developing a UK shale gas industry could reduce the risk of gas prices being determined by the price of imported gas (whether as LNG or by pipeline).[151] It could also enable the UK to enjoy the energy security benefits of domestically produced gas (as discussed further in chapter 7). A key question is how much shale gas production in the UK is likely to cost and, therefore, whether the cheap gas prices experienced in the US can be replicated in the UK.

58.  We have heard that shale gas is "not necessarily cheap gas".[152] It is generally agreed that it is more expensive to produce than conventional gas. The low prices experienced in the US are a consequence of a unique set of factors (as discussed in the background section) which differ markedly to the UK. A recent report by Wood Mackenzie suggests that the commercial viability of the UK's shale gas resources are yet to be proven and the key determinant will be the quality of the shale and the performance of the wells. They concluded:

"Commercially viable UK shale gas development will only be possible if the subsurface is as good as the very best shale plays in North America. Wood Mackenzie's economic assessment shows that due to higher costs in the UK, average performing plays would need gas prices in excess of US$9 per thousand cubic feet (mcf) to break even."[153]

59.  It is not yet clear whether the UK regulatory system will be more costly than in the US. Higher population densities may impose greater environmental obligation but will also reduce transport/pipeline costs to market. The Wood Mackenzie report identifies several necessary steps required to make developing the UK's shale gas industry is economically viable:

"Creating a transparent, streamlined regulatory system that satisfies both a concerned public and operators; carrying out further work on the Strategic Environmental Assessment (SEA), necessary for the 14th Onshore Licensing Round, and enabling a wider range of operators to become involved in assessing the potential of the shales; and designing a fiscal system that makes future investment worthwhile.".[154]

60.  There has been speculation that some US shale gas companies are actually making a loss because the cost of production is higher than the market price of gas which has collapsed as a result of oversupply (see background section).[155] As a result many shale gas companies are also producing shale oil because it currently commands a higher price than shale gas.[156] It is not yet known whether the UK has any shale oil reserves. Mr Smith of the British Geological Society (BGS) told us that no estimates have been made of shale oil potential in the UK but that this is something they were looking at.[157] The Geological Society reported:

"It is very probable that there are shale oil resources in the UK, particularly in the East Midlands and in the Scottish Midland Valley. However, given the difficulty and cost of extracting shale oil, the likely environmental and social constraints, and the relatively extensive shale gas resources available, it seems very unlikely that these will be considered worthwhile to explore.".[158]

61.  We conclude that it is too early to say whether domestic production of shale gas could result in cheaper gas prices in the UK. It is unlikely that the US experience will be directly replicated in the UK because of differences in geology, public attitudes, regulations and technological uncertainties. Shale oil is likely to be present in the UK but it remains uncertain whether industry will consider shale oil economically worthwhile to explore.

Impact of foreign and domestic shale gas on UK gas markets

62.  UK gas prices are generally determined by the spot price of the Net Balancing Point (NBP) (see box 2). As UK production of natural gas declines the UK will become increasingly dependent on imported gas either as LNG or via the gas pipeline interconnector to mainland Europe. [159] Pipeline imports are, and are likely to remain, much larger than LNG imports so the price of gas in the UK is more likely to be influenced by the price of gas in Europe than the price of LNG imports from other parts of the world.[160]

63.  According to EDF Energy the development of shale gas will, "only curb the extent of price rises in the longer-term rather than drive prices down from current levels."[161] WWF highlighted their view that this will increase the UK's exposure to "volatile global fossil fuel prices.".[162] The Minister told us, "the likely impact from widespread exploitation of shale needs to be measured against the consensus of forecasts, which suggests that the gas price will continue to be tight.".[163]

64.  We conclude that there remains substantial uncertainty about the impact shale gas will have on gas prices, both internationally and domestically, and it is by no means certain that prices will fall a result of foreign or domestic shale gas development It would be wrong for the Government to base policy decisions at this stage on the assumption that gas prices will fall (it is possible that they will rise) in the future. However, if large quantities are found they will either bring down prices in the UK, or generate substantial tax revenues, or both - and will certainly reduce imports with benefits to our balance of payments and energy security. For all these reasons the Government should encourage exploration to establish whether significant recoverable reserves exist.

137   Q 231 [Mr Parsons; Mr Pibworth]; Q 293 Back

138   Ev 68 Back

139   Ev 111 Back

140   Q 136 [Mr Tiley] Back

141   Q 87 [Professor Bradshaw] Back

142   Q 75 [Dr Bros]; Q 87 [Dr Bros] Back

143   Ev 124 Back

144   Ev w45 Back

145   Q 75 [Dr Bros]; Ev 72 Back

146   Ev 72 Back

147   Ev w6  Back

148   Q 75 [Professor Bradshaw; Dr Bros] Back

149   Q 219 [Mr Crotty] Back

150   Q 72; Q 87 [Professor Stevens]; Q 136 [Mr Tiley] Back

151   Q 137 [Mr Egan] Back

152   Q 231 [Mr Parsons] Back

153   Wood Mackenzie press release, UK Shale Gas - fiscal incentives unlikely to be enough', 20 December 2012, Back

154   Wood Mackenzie, Press release, UK Shale Gas - fiscal incentives unlikely to be enough', 20 December 2012, Back

155   Q 6 [Mr Smith]; Q 23 [Professor Davies]; Q 61 [Dr Bros]; Q 160 [Professor Anderson]; Ev 136 Back

156   Q 6 [Mr Smith]; Q 23 [Professor Davies]; Q 30; Q 61 [Professor Bradshaw]; Q 252 [Mr Parsons] Back

157   Q 25 Back

158   Ev 94 Back

159   Q 64 Back

160   Q 64 Back

161   Ev 87 Back

162   Ev 136 Back

163   Q 322 Back

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© Parliamentary copyright 2013
Prepared 26 April 2013