Energy and Climate Change CommitteeWritten evidence submitted by the Department of Energy and Climate Change (DECC) (ISG 01)

Introduction

1. This Memorandum sets out some general information relevant to the Committee’s inquiry and responds to the specific questions posed by the Committee in their call for evidence.

Shale gas and the UK energy markets policy

2. In the UK, as elsewhere in Europe, shale gas development is still at a very early stage. The technical and economic prospects for production are uncertain, and the scale of potential production equally so. Shale gas clearly does have the potential to contribute to the diversity of our energy supply, and Government therefore aims to facilitate exploration work to properly delineate this resource, while ensuring that extraction can be carried out safely and with all proper protection for the environment. But it is still too early to come to firm conclusions on whether shale gas production in the UK or elsewhere in Europe is likely to have a significant effect on overall UK energy production, security of supply and prices.

3. Since our 2009 unconventional gas Call for Evidence, the Department has continued to monitor developments in the UK, Europe and globally in order to assess the potential impacts on the gas markets. We have considered a range of studies produced recently on this subject (by the IEA, Poyry, Wood Mackenzie) and have commissioned further analysis (see contract notice http://www.contractsfinder.businesslink.gov.uk/Common/View%20Notice.aspx?site=1000&lang=en&NoticeId=618713). We will continue to consider the implications of shale gas development in the coming months as we develop our gas generation and energy security strategies.

Global Unconventional development

4. Large scale global development of unconventional1 gas would improve an already benign global gas supply picture. The IEA has described the global gas resource base as “vast and widely dispersed geographically”, estimating that conventional recoverable resources are equivalent to more than 120 years of current global consumption, and added that the total recoverable resources (conventional and unconventional) could sustain today’s production for over 250 years.

5. The US boom in unconventional production was supported by favourable geology, low population density, a competitive supply industry which has developed significant advantages of scale, variable levels of environmental regulation, and strong development incentives for landowners. With the possible exception of the geology, these factors do not, at least for the time being, obtain elsewhere. Various analysts estimate serious exploitation in the EU to be a decade away. In addition, global gas demand is forecast to rise dramatically (by 55% by 2035, according to IEA).

6. The combination of high levels of shale gas production and a lack of export infrastructure has pushed US wholesale gas prices to levels much lower than those in the UK. If proposed US export facilities do develop this will put downward pressure on UK and global gas prices, and will improve the economics of further shale gas production in the US, but there are constraints on developing capacity.

Implications for gas markets, prices and decarbonisation strategy

7. The development of shale gas in the US has helped depress UK and global spot wholesale gas prices since 2009 by reducing the US need for LNG imports. Since then, however, gas markets have tightened with UK wholesale prices increasing due to growing demand from emerging economies such as China (and more recently Japan, following the nuclear shutdowns). However, the impact of low US gas prices on other markets has been more limited than might be expected in large part due to a lack of US export infrastructure.

8. There is great uncertainty associated with predicting the effects of unconventional gas globally on UK and EU gas prices and markets. Consensus forecasts suggest prices will go up over the coming decades, but increases in unconventional gas production make it likely that this growth will be more moderate than in the absence of unconventional gas and it will also increase the chance of falling gas prices.

9. At least for the next decade, and due to the range of constraints set out in paragraph 5, EU shale gas production is not expected to have as great an impact on EU gas prices as has been the case with US shale gas production on Henry Hub prices. EU gas prices influence UK prices strongly due to our physical connection to European gas markets through the IUK interconnector.

10. Lower gas prices would reduce the overall costs of our energy supplies. They would necessitate higher incentive payments to make nuclear and renewable generation and renewable heat competitive, but reduce the incentives needed for gas CCS. Low gas prices would also encourage switching from coal.

11. Shale gas could have a beneficial effect on global emissions where it displaces coal, and does not lead to a weakening of policy support for, and investment in, lower carbon options such as renewables and nuclear. The IEA in its recent report on shale gas concluded that the net effect on emissions would be positive.

Responses to the Committee’s Questions

What are the estimates for the amount of shale gas in place in the UK, Europe, and the rest of the world, and what proportion is recoverable?

12. See table at Annex A for estimates from the US Energy Information Administration of proved natural gas reserves and of technically recoverable shale gas in the UK, Europe and other regions of the world.

Global estimates

13. Based on data from several sources, the IEA2 estimate that remaining ultimately recoverable resources of shale gas worldwide amount to 208 tcm, coalbed methane (CBM) 47 tcm and tight gas 76 tcm.

REMAINING TECHNICALLY RECOVERABLE NATURAL GAS RESOURCES BY TYPE AND REGION (END 2011)

14. The IEA assessment for its June 2011 publication Are we entering a Golden Age of Gas?3 covered 48 shale gas basins in 32 countries and put technically recoverable shale gas resources in those countries and in the US at 187 tcm; China was seen as having the biggest resources (36 tcm), followed by the US (24 tcm), Argentina (22 tcm) and Mexico (19 tcm). More than half of the world’s proven reserves are concentrated in Russia, Iran and Qatar in large conventional gas fields. North America and Europe are at the lower end of the proven reserves, even though North America has benefitted from substantial additions of unconventional gas. Unconventional gas now accounts for nearly one-quarter of the total North American proven gas reserves. The IEA highlighted that the extent to which countries exploit their unconventional resources will be a key determinant of future global gas supplies.

Source: IEA

UK estimates

15. In 2010 DECC commissioned the British Geological Survey (BGS) to carry out a survey of landward shale gas potential. In that context, the BGS provided a first estimate of the production potential for shale gas in the UK, based on a simple analogy with US shales, of up to 150 bcm (5 tcf). This estimate compared the production per area of a possibly analogous play in the US to the area of the UK shales under consideration. The Carboniferous Bowland shale in northern England is thought to be the most promising, but intervals in the Jurassic in the Weald and Wessex basins of southern England are also considered to be prospective. Deeper shales occur widely in the subsurface, but their potential is largely unknown.

16. In April 2011, the US EIA estimated that there is 20 tcf of Technically Recoverable Resources in the UK (http://www.eia.gov/analysis/studies/worldshalegas/). (See below on the meaning of Technically Recoverable Resources).

17. DECC has commissioned the BGS to provide a better estimate of the Bowland Shale resource (ie, the gas in the rocks). Study of the prospectivity of other shales will be considered after this work is published towards the end of 2012.

18. However, until commercial UK shale gas development can be proven, and the production profiles can be compared to other producing basins, any estimate of the amount of gas which could potentially be produced is subject to substantial uncertainties (see the answer below to your question on why the estimates are so changeable).

EU estimates

19. Poland, as the EU Member State which seems to have the most significant prospectivity, is the most advanced as regards exploration of unconventional gas reserves and have a very active programme of drilling. They are also reinforcing the regulatory framework for exploration and production of both conventional and unconventional gas (and oil) reserves which may alleviate some of the environmental concerns in that country. In other Member States there remains significant concern over impacts of shale gas exploration and exploitation with some Member States either having a moratorium or de facto moratorium in place.

Why are the estimates for shale gas so changeable?

20. The first major reason is a frequent confusion between reserves and the total resource. Some reports cite estimates of how much gas is in the ground and some of how much might be extracted. The latter will be much smaller than the former, particularly if the estimate is of economically rather than technically recoverable reserves.

21. In discussing estimates, several different terms are used to describe the volume of gas present. These differentiate the various methods according to how much information is available, technical assessment of how much might be producible and finally if it is commercially viable to do so.

Total Resources (gas-in-place): the total volume of gas estimated to be present for a particular accumulation.

Technically Recoverable Resources: the estimated volume of gas that might be recovered from the total resource, by reference only to the technical feasibility of recovery.

Reserves: the fraction of the potentially recoverable resources that are deemed to be commercially recoverable. This can be further sub-divided into proven, potential and possible reserves based on the confidence that reserves will be recoverable. Proven reserves are considered almost certain to be recoverable. Reserves may thus be discussed with a much greater level of certainty than potentially recoverable resources. (see DECC website for detail http://og.decc.gov.uk/en/olgs/cms/data_maps/field_data/uk_oil_gas_res/uk_oil_gas_res.aspx)

22. As noted earlier, a 2010 report prepared by BGS for DECC estimated shale gas production potential by a simple analogy: “The UK Carboniferous (Upper Bowland Shale) shale gas play, if equivalent to the Barnett Shale of Texas, could potentially yield up to 150 bcm (5 tcf) shale gas.”

23. This cannot be compared to the 2011 Cuadrilla estimate of 200 TCF of total resource (gas-in-place) on their licence. The Cuadrilla estimate does not indicate how much they think they may actually be able to recover, nor take into account the development costs, and whether the deliverability and gas price are high enough to justify drilling all the wells which would be needed to produce the gas, nor consider which gas is in areas which cannot be accessed.

24. DECC does make estimates of undiscovered resources for conventional hydrocarbons, which are published on our website, but those estimates do not to date include any estimate of UK shale gas, because of the absence of data on the production performance of UK shales.

25. The second major reason for the variability is that reserves estimates for shale gas are subject to greater uncertainty than estimates for conventional oil and gas. The US EIA estimates Technically Recoverable Resources for areas across the world by multiplying the risked gas-in-place by a shale gas recovery factor, which incorporates a number of geological inputs and analogues that are appropriate to each shale gas basin and formation. But for most areas of the world outside North America, the information available for such analyses is much more limited, or absent, and the uncertainties correspondingly greater.

26. There is also a methodological issue. The recovery factor methodology, which has developed over a century or so to enable reserves estimates to be made for conventional oil and gas resources, does not seem to apply with equal success to shale gas, shale oil and coal bed methane. These unconventional resources are more extensive than conventional oil and gas resources, which have the character of accumulations in a specific and relatively limited space. The unconventional resources, however, are very extensive spatially, with more significant variations of properties across that area (the phenomenon of “sweet spots”).

27. The US Geological Survey, which has the most experience in estimation of petroleum reserves, has developed a different methodology for reserves estimation in these extensive petroleum resources, based on a reservoir performance model of wells, which predicts the capability for the summation of these wells with variable deliverability to produce gas. When sufficient drilling and production data is not available, information from analogous accumulations is used. The USGS describe their technically recoverable resource estimates as a work in progress, changing as more production experience becomes available and as new technologies are applied to extract these resources. The development of USGS estimates using this new methodology has led to substantial reductions in previous US estimates, notably for the Marcellus shale.

28. DECC has now commissioned a BGS team to provide a more detailed analysis and estimate of the entire Bowland Shale gas total resource potential (gas-in-place) to better understand the potential future contribution to the UK energy mix. This work is due to be completed towards the end of 2012 and will provide an independent assessment of the total resource. However this work will not produce a reserve estimate, that is, how much of this gas will be technically and economically viable to produce. Until there is shale gas production in the UK, any estimates of recoverable reserves must be considered as highly uncertain. It can take many years to establish real decline curves and trends across wells in a given play and so even after several years of production, estimates will still be prone to large fluctuations.

What are the prospects for offshore shale gas in the UK Continental Shelf?

29. Offshore costs are many times that of onshore and that unless there are significant changes in technology, costs and gas price it is difficult to see how offshore shale gas might become a real prospect within the next few decades. Some shale gas under the sea however might be accessible from land-based operations.

30. At the present time there is no known offshore exploration activity for unconventional gas anywhere in the world. The EIA excluded offshore portions of assessed shale gas basins, and shale gas basins that exist entirely offshore, from their World Shale Gas estimates. If shale gas development can be proven to be technically and commercially viable onshore, it is possible that the industry may look to the offshore for future exploration, and further study could be merited at that time.

Should the UK consider setting up a wealth fund with the tax revenue from shale gas?

31. The Treasury has made no recent estimate of potential tax revenues from shale gas. As a general principle, tax revenues flow to the Consolidated Fund.

What have been the effects of shale gas on the LNG industry?

32. The majority of unconventional gas production is located in United States and Canada. IEA data suggests that 14% of global gas production came from unconventional sources in 2010 with 90% of this produced in the US or Canada. As a result, the major impacts of unconventional gas have come about due to increases in the availability of gas in these countries.

33. As recently as 2008, it was widely expected that import requirement for LNG in the United States was likely to increase over the coming decades. However, the “shale gas revolution” in North America has made the US the world’s largest gas producer (overtaking Russia) and has turned the US from being a gas importer to becoming virtually self sufficient. This unexpected growth reduced the US need for LNG imports and freed up LNG in the global market. This has increased supply and has put downward pressure on oil-linked contracts, resulting in the renegotiation of some contracts, particularly in Europe. Some commentators argue that increased availability of LNG cargoes also accelerated an increase in the proportion of global LNG sold on the spot market.

34. US LNG exports would put further price pressure on the Atlantic market. One project, the Sabine Pass in Louisiana, has been granted all the permits required to export LNG from the US. Cheniere Energy, the developers, took Final Investment Decision on the project on 30 July and expect to commence operations by 2015 with a target of c. 20 bcm/y by 2017–2018. Seven further projects await Department of Energy export approval, totalling in excess of 120 bcm/y of capacity.

35. Elsewhere in North America, Canada (endowed with large unconventional gas resources of all three types and formerly an exporter of gas to the US) has approved two LNG export projects in British Columbia, amounting to around 9 bcm/y. Given the projected growth in demand from for natural gas in China and India, and assuming that some of Japan’s nuclear capacity remains offline, it is likely that demand for natural gas will outpace the incremental supply.4

Could shale gas lead to the emergence of a single, global gas market?

36. While trade in natural gas is generally expected to increase, the impact of unconventional gas production on trading patterns is unclear. Russia and the Middle East account for the majority of the remaining reserves of conventional gas, while significant gas discoveries have recently been made in other parts of the world (for instance in East Africa). However, unconventional gas resources are more evenly spread. As a result, it is possible that large scale production from unconventional sources could decrease inter-regional trade by reducing the need for imports. In the IEA’s Golden Rules Scenario, the total volume of inter regional trade increases by almost 50% out to 2035. However, this is 15% lower than compared to the baseline case.

37. For the moment, production of unconventional gas is still overwhelmingly a North American phenomenon. Virtually all of the world’s existing shale gas production currently takes place in the US and Canada. According to the IEA,5 in 2010 76% of global unconventional gas output came from the United States (360 bcm) and a further 13% from Canada (60 bcm). Beyond North America, the largest contribution to unconventional gas production came from China and Australia, producing around 10 bcm and 5 bcm of coalbed methane, respectively.

38. Future uncertainties make it difficult to predict how the global unconventional resource will be developed in the coming years, and therefore the extent to which it will shape the global gas market. Prohibitions are currently in force in parts of Europe. In parts of Canada, the United States and Australia moratoria have been placed on hydraulic fracturing, pending the results of additional studies on the environmental impact of the technology. The IEA notes that if these concerns are not addressed, the lack of public acceptance in some countries could mean that unconventional production is slow to take off. See Annex B for assessments on the potential impact of unconventional development on the global market by the IEA and Wood Mackenzie.

What are the effects on investment in lower-carbon energy technologies?

39. If there were to be a significant increase in the supply of shale gas and if this led to low wholesale gas prices in the European market, the impact would be the same as if low gas prices came about through another scenario.

40. From the energy efficiency perspective, for an individual consumer (either a firm or a household) lower energy prices reduce the incentive to invest in energy efficiency. However, the wider benefits of energy efficiency would be maintained: companies would still benefit from lower costs, and greater productivity from investing in energy efficiency, and households from lower energy bills and greater comfort from insulated homes. Energy efficiency could still be cost-effective in terms of carbon abatement so would still be good for society to pursue energy efficiency (for example, insulation measures would save on carbon emissions) and these societal benefits could be more important if the gas itself is cheaper as gas demand would increase.

41. Exploitation of unconventional gas is expected to lower the price of gas relative to those of other fuels, including renewables. This will increase demand for gas as well as increasing the relative cost of switching to alternative renewable heat and electricity technologies (although for some technologies which use electricity as a fuel source (such as heat pumps) a fall in gas prices would also lead to a reduction in the electricity costs (assuming gas CCGT is the marginal generation technology).

42. As CCGT plant set the wholesale electricity price for much of the year in the UK, lower wholesale gas prices would lead to lower average wholesale electricity prices. However, as explained below, with low carbon generation supported by the new FIT with CfD mechanism, investment in low carbon plant would not be expected to be very significantly affected by changes in wholesale electricity prices.

43. Investment in renewable electricity is currently driven by the Renewables Obligation (RO), which will remain open to new projects until 2017. From 2014, the new FIT with CfD mechanism will drive investment in low carbon generation. Unlike investment under the RO (where projects are remunerated with a relatively fixed top-up to the wholesale price), investment in renewables and nuclear plant under the CfDs will be largely unaffected by changes in the wholesale price, as project revenues would only be affected during the period of the remaining operational lifetime after the end of the CfD contract. These later years are heavily discounted in investment decision-making.

44. However, the amount of revenue support for low carbon generation required in addition to the wholesale price, ie the CfD support cost, would be affected by lower gas prices. The total price consumers pay for low carbon renewable and nuclear generation (during the terms of CfD contracts) would not be affected, just the amount they pay relative to the wholesale price. This CfD support cost for nuclear and renewables would rise under a low gas price scenario.

45. The impact of lower gas prices on investment in gas CCS plants will depend on whether the terms of their CfD contracts include a linking of the strike price to wholesale gas prices. If there is such a link, then lower gas prices would be expected to have no impact on investment in gas CCS. If, on the on the other hand, there was no link, then lower gas prices might lead to more investment in gas CCS until such time as the strike price on offer for new plants was reviewed and lowered in line with the lower gas prices, ie only for a few years at most.

46. As the strike price for new plant ultimately falls in either case, the total cost to consumers of supporting gas CCS will decrease. The CfD support cost would also be expected to fall slightly, due to the lower efficiency of gas CCS plants compared to unabated CCGT. This means that gas forms a greater proportion of CCS plant costs than unabated plant costs, and so a fall in wholesale gas prices would allow gas CCS strike prices to fall by more than the long-run marginal cost of CCGT falls and hence by more than average wholesale prices more. A smaller gap between the wholesale price and the gas CCS strike price equates to a reduction in CfD support costs.

47. The dispatch of low carbon generation will not be affected by low gas prices as long as the low gas price does not change the ordering of plants in the merit curve, which is determined by plants’ marginal revenues and marginal costs. With their CfD revenue support and low short-run marginal costs, wind and nuclear generation would generally always be expected to dispatch ahead of CCGTs. Similarly, with RO and/or CfD support for biomass generation, it would take some combination of high biomass prices and low gas/carbon prices for biomass and CCGTs to switch places in the merit curve.

48. As noted above, gas CCS plants incur additional fuel costs related to the CCS technology compared to an unabated CCGT plant, and hence the gas CCS plant’s short-run marginal cost falls relatively more as a result of lower gas prices than that of unabated CCGT, and if gas CCS is the marginal plant in the future then wholesale prices would fall as a result. Whether gas CCS or unabated CCGT dispatches first will depend largely on the level of CfD strike prices and carbon prices. In any case, investment in gas CCS on CfDs would not be affected by low gas prices, regardless of the impact on wholesale prices, if the strike price on the CfDs is indexed to the gas fuel price. Without such indexation, gas CCS investment would look more attractive in a low gas fuel price world.

49. Finally, it is perhaps worth noting that as long as unabated CCGT is assumed to set wholesale prices as the marginal plant, a low gas price scenario would not necessarily lead to more investment in unabated CCGT as their revenues would reduce in line with their lower fuel costs.

What is the potential impact on climate change objectives of greater use of shale gas?

50. The IEA estimates that, provided methane emissions from shale wells are minimised by using appropriate technology, shale gas will have well-to-burner emissions that are 3.5% to 12% higher than the equivalent for conventional gas. However shale gas should have a greenhouse gas footprint significantly below coal over a 100 year time horizon. Shale gas could therefore have a beneficial effect on global emissions where it displaces coal, and does not lead to a weakening of policy support for, and investment in, lower carbon options such as renewables and nuclear. Its greater use in these contexts, particularly where coal is the only realistic alternative, should therefore be welcomed. The IEA concluded that the net effect on emissions would be positive.

51. In the UK, we will be required to include any methane emissions from unconventional gas exploration and production in the UK’s greenhouse gas inventory, which is used to meet both our international and domestic reporting obligations, and compliance with greenhouse gas targets under EU legislation and UK Carbon Budgets. This means that any increase in emissions from greater use of shale gas would require greater emission reductions to be delivered elsewhere.

52. However, increased use of gas will not by itself be enough to put the world on course for 2°C, as recognised in the IEA’s recent report on shale gas. While our modelling suggests that unabated gas could retain a significant role in electricity generation through the 2020s, potentially still producing up to two thirds of today’s generation levels in 2030, and highlights that unabated gas may still be needed for back up even in 2050, it would need to be combined with increased use of low carbon generation including renewables and nuclear energy. Gas could also be combined with CCS to make a greater contribution to emissions reductions in the long term.

Summary and Way Ahead

53. As indicated in the evidence above, Government considers that it is still too early to say whether shale gas production in the UK, Europe and globally will be economic on any significant scale (other than in the US), and therefore what impact it will have on the energy markets. Even if economic reserves are confirmed, there are reasons to think that the development of shale gas in the UK, and in Europe, will be slower to develop and more constrained than in the US: the supply industries are much less well-developed, population densities are higher and land use patterns typically more diverse, and environmental regulation is generally tighter.

54. Nevertheless, we consider that unconventional gas could play a positive role in economic, energy security and sustainability terms. Government therefore aims to facilitate exploration work to properly delineate this resource, while ensuring that extraction can be carried out safely and with all proper protection for the environment. To this end, Government aims to reach a conclusion as soon as possible on the future of fracking activity for shale gas

55. The Government is committed to publish a new gas generation strategy in the autumn of 2012. This will focus on the role of gas in the electricity market, and will take account of the latest information on gas supply prospects, including any prospective contribution from unconventional supplies.

Annex A

EIA World Shale Gas Estimates (bcm), April 2011
	Proved Natural Gas reserves	Technically recoverable shale gas
Europe
France	6	5097
Germany	176	227
Netherlands	1388	481
Norway	2039	2350
UK	255	566
Denmark	59	651
Sweden		1161
Poland	164	5295
Turkey	6	425
Ukraine	1104	1189
Lithuania
Others	77	538
North America
United States	7716	24409
Canada	1756	10987
Mexico	340	19284
Asia
China	3030	36104
India	1073	1784
Pakistan	841	1444
Australia	3115	11213
Africa
South Africa		13734
Libya	1549	8212
Tunisia	64	510
Algeria	4502	6541
Morocco	3	311
Western Sahara		198
Mauritania	28
South America
Venezuela	5066	311
Colombia	113	538
Argentina	379	21917
Brazil	365	6400
Chile	99	1812
Uruguay		595
Paraguay		1756
Bolivia	750	1359
Total of above areas	36064	187512

Source: The Impacts of Unconventional in Europe, A Report to Ofgem

Poyry, June 2011

Annex B

IEA AND WOOD MACKENZIE VIEWS ON THE IMPACT OF SHALE GAS ON THE GLOBAL MARKET

Wood Mackenzie6 said that an increase in indigenous unconventional supply in Europe, combined with the increased availability of LNG to the Atlantic (in the high case they modelled) would put pressure on the major piped suppliers. Their assessment is that the impact of unconventional gas on the European gas market dynamics is more likely to be incremental rather than disruptive, particularly over the next 15 years. This would increase competition among suppliers and could result in lower hub prices in Europe, renewed pressure on traditional levels of oil-indexation and a drop in the uncontracted gas price both in Europe and in the linked Pacific market, but is not likely until after 2025.

Globally, Wood Mackenzie consider that an unconventional production profile in line with their high case would also make an incremental impact on global gas market dynamics, rather than a disruptive change. They estimate that in the Pacific basin additional unconventional gas production of 100 bcm in 2030 in the high case would displace 50 bcm of more expensive LNG imports. The additional Chinese and Indian unconventional gas in their high case would reduce the requirement for LNG in the Pacific basin in the longer term and increase LNG availability to the Atlantic.

Even in the IEA Golden Age of Gas Scenario,7 which models significant production, natural gas markets would become more global and regional prices are expected to show signs of increased convergence, but the market does not become truly globalised. Pricing mechanisms are likely to become more reflective of market conditions, including the prices of competing energy sources, such as coal, other gas supplies, and in some cases oil. The pace and extent of this change will hinge to some degree on how long the overcapacity in global gas supply persists. North America would remain largely self-sufficient and is therefore likely to be essentially isolated for inter-regional trade. However, there are pressures and uncertainties about the level of future exports from that country which will affect the impact the US can have on the global gas market.

October 2012