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