The Impact of Shale Gas on Energy Markets

Written evidence submitted by INEOS Olefins & Polymers UK (ISG 10)

1. Executive Summary

1.1 UK industry need secure supplies of competitively priced energy to survive and prosper in international markets. Similarly the petrochemicals sector requires competitively priced feedstocks.

1.2 Since the 1970’s North Sea oil and gas has provided the petrochemical industry with advantaged ethane and liquefied petroleum gases (propane and butane) feedstocks that have seen a successful petrochemical manufacturing industry grow based on a competitive olefins (ethylene and propylene) market.

1.3 This has been able to support downstream derivative manufacturing even though such products may be disadvantaged by distribution costs. UK derivatives today are exposed to global competition from low cost regions such as United States and Middle East E. The UK derivative portfolio (polyethylene, polypropylene, polyethylene vinyl chloride (PVC), ethanol, ethyl acetate (ETAC) and vinyl acetate monomer (VAM) in particular) cannot compete with low cost product unless the upstream feeds are competitive. Therefore, if feed costs into UK olefins manufacturing were to level with the rest of Europe, these derivatives would be outcompeted not only by their US and ME competitors, but also lose out against mainland European competitors who would then have similar costs but more differentiated derivatives and lower freight costs to serve the market.

1.4 Production forecasts for these advantaged petrochemical feedstocks from the North Sea show a marked decline at the end of this decade. Without a replacement advantaged feedstock the inevitable decline in UK olefins manufacturing industry, and therefore the associated downstream derivatives, is likely to follow

1.5 For many years the UK has had access to locally sourced supplies of natural gas which have provided consumers with competitively priced energy supplies. As conventional reserves have declined, however, UK import dependency has increased with ever-greater volumes of gas being sourced from Norway and through LNG. As a result UK natural gas prices have become increasingly uncompetitive on a global scale.

1.6 The Government recognises that natural gas will play a vital part in the UK’s energy mix in the medium term (for both power generation and heat) ahead of the wider development of new nuclear and renewables.

1.7 In sharp contrast to the UK , the USA has seen energy and feedstock prices fall, import facilities converted for exportation and a rapid growth in petrochemicals manufacture all due to the extraction of shale gas. Furthermore, with gas prices falling below coal prices, the United States has seen overall CO2 emissions fall significantly as power generation switches to natural gas where possible.

1.8 It is clear that the UK potentially has very significant reserves of shale gas based on the results of surveys to date. It is likely that the UK ’s shale deposits could contain higher weight hydrocarbons – essential feedstocks for the petrochemicals industry. Shale Gas deposits can contain these higher molecular-weight hydrocarbons (in addition to natural gas) that would re-invigorate the UK olefins and derivatives petrochemicals market.

1.9 INEOS believe it is this step change in advantaged feedstock for the petrochemicals market in the UK that is required and we will actively pursue both the import of such materials (in the short term) and the availability of UK supplies (in the long term) to maintain our UK manufacturing base

1.10 UK shale reserves have the potential to provide the UK with a secure, indigenous and highly competitive source of energy and hydrocarbon feedstocks – in essence providing a replacement for declining output from conventional North Sea reserves. Rather than requiring support and subsidy (like renewables), or requiring energy to be bought externally, UK shale would provide a vital source of income to UK plc.

1.11 The UK energy intensive and petrochemicals sectors require certainty that energy and feedstocks will be secure and competitive in the medium term. Without that certainty then it is likely that these sectors will decline and reducing the manufacturing capacity. However if shale develops positively then the prospects for manufacturing to build and grow on the current significant UK supply infrastructure are good.

1.12 The UK has a proven track record of technological development in oil and gas production and manufacturing. Recent reports show that shale gas is no riskier than current fuel extraction technologies and can be managed safely.

1.13 It is vital that UK government supports and encourages the responsible development of shale gas.

2. The Importance of Natural Gas and Hydrocarbon Feedstocks

2.1 For many years natural gas has been a key part of the UK’s primary fuel mix. Large indigenous reserves in the North Sea have provided the UK with a competitive source of energy for power generation.

2.2 In addition to natural gas, the North Sea provides other hydrocarbons such as ethane and propane which are vital feedstocks for the petrochemicals and plastics industry. Availability of these feedstocks has resulted in the UK having had a successful petrochemicals sector.

2.3 However forecasts of these fundamental advantaged feedstocks show a steep decline at the turn of the decade. It is imperative that alternatives are found to sustain UK manufacturing and exports in these sectors.

2.4 The so called "dash for gas" saw a transformation of the power generation industry with the widespread displacement of coal resulting in a significant fall in UK carbon emissions.

2.5 UK government policy is to further decarbonise the UK economy – and much of this will have to be achieved through the decarbonisation of the power generation sector.

2.6 In the medium term the UK Government recognises that natural gas will continue to play a vital role in power generation, both as a back-up for interruptible renewables and ahead of the deployment of a new generation of nuclear stations in UK (excluding Scotland) and Scottish Governments off shore wind and wave generation.

2.7 As a critical "bridging fuel" it is essential that natural gas prices remain competitive in the UK Gas prices determine wholesale electricity prices and critically important for the energy intensive sector.

3. UK and the US – Contrasting Recent History of natural gas

3.1 Following the discovery of natural gas in the North Sea, the UK for many years enjoyed the benefits of plentiful gas supplies. This resulted in gas prices which were relatively competitive. The construction of the UK to Belgium interconnector also enabled large volumes of gas to be sold and exported to the wider European market.

3.2 During the mid 2010’s UK indigenous production was seen to decline quite rapidly as field depletion exceeded new discoveries. As a result the UK has moved to becoming a net gas importer. This has resulted in prices being on average higher and exposed to external global factors.

3.3 In particular the UK is now increasingly dependent upon imports of Liquefied Natural Gas (LNG). While there is no recognised global market for LNG (as there is for oil for example) it is very clear that the price and availability of LNG is affected by the global supply and demand balance and other risk factors. For example following the global financial collapse of 2008, LNG availability kept UK prices relatively low and competitive whereas after the Fukushima nuclear incident, increased demand for LNG has seen a significantly tightening of the LNG market and prices increasing.

3.4 This tightening of the LNG supply/demand balance has caused UK prices to rise significantly. (Price evolution is shown in Addendum 1).

3.5 Natural gas prices have now risen above the equivalent cost of coal for the generation of power. This has resulted in power generators increasing power generation on coal stations and reducing generation on gas stations. With coal stations emitting more carbon dioxide per unit of power generated, this has resulted in UK emissions increasing (we estimate that UK CO2 emissions increased by around 25 million tonnes in 2011 alone).

3.6 The gas price is critical in determining the price of wholesale electricity. Increasing wholesale gas prices have caused wholesale electricity prices to increase. With the UK generation mix being more dependent on gas than most of other European markets, this has resulted in UK wholesale prices rising to highly uncompetitive levels. When tax policy is taken into account the situation in the UK is even worse. (Electricity price comparisons are shown in Addendum 2).

3.7 In the United States the situation is nearly the complete reverse. In the late 2010s the US expected that it would need to import large quantities of LNG and as a result a number of import terminals were built.

3.8 At the same time, advances were made in the recovery of shale gas. Development was so rapid that by the time terminals were constructed, US shale gas production had grown enough that imports were simply not required and the new terminals remained very largely unused.

3.9 The growth of shale gas also pushed prices down very significantly – far more than many had predicted. The contrast is now stark with the US enjoying natural gas prices which are around 30% of the levels we see in the UK.

3.10 In addition to the extraction of natural gas (methane), large quantities of larger hydrocarbon molecules are being extracted (ethane and propane). This advantaged feedstock has helped to drive a resurgence in US olefin production and the downstream olefin-derivative industries. The next few years will see the US bring on line olefin production based on shale gas, and will see the US challenge the Middle East for the title of low-cost producer of olefins and therefore olefin-derivatives.

4. Impact of Shale in the US

4.1 The growth of shale gas in the US has had profound impacts.

4.2 The increased availability of chemical feedstocks has seen investment increase significantly in ethane crackers announced. For example on 1st June 2012 ICIS Heren reported that "US-based ExxonMobil Chemical’s announcement of a new 1.5m tonne/year cracker in Texas by 2016 brings the tally of new US ethylene capacity announcements to 33% of existing capacity".

4.3 US natural gas prices have fallen dramatically and are now around the lowest in the world – certainly of the transparent liquidly traded markets.

4.4 Rather than being a net importer, the US is now expected to be a net gas exporter, with a number of major liquefaction projects announced (in part using the terminals that were constructed to import gas). Thus, rather than exporting money to buy gas, the US will have a large new revenue stream.

4.5 Lower gas prices have resulted in a lowering of electricity prices, giving a massive competitive advantage to the US electro-intensive industries

4.6 Natural gas is now more competitive than coal for power generation in the US – so gas has displaced coal in the power generation sector. As a result the US has seen a significant reduction in CO2 emissions.

4.7 There are a number of other reports that show the impact of shale gas is having on the US manufacturing sector which is now clearly growing. Selections of these are quoted in Addendum 4.


5. Shale Gas Potential in the UK

5.1 Shale gas in the UK has the ability to be transformational in delivering secure and competitive energy and feedstock supplies which are vital for the energy intensive and petrochemicals sectors.

5.2 It is apparent, albeit on limited surveys that the UK has significant and world class shale deposits. The Bowland shale for example is reported to be 5 times the thickness of the Marcellus shale in the US.

5.3 Technically, there are reports from respected bodies that shale extraction can be achieved with no greater risk than current extractive technologies. Indeed the UK has well established arrangements in a wide variety of industries for responsibly managing environmental and other risks. The US has demonstrated the technology which should be readily transferable. Indeed, shale gas extraction has been undertaken in Germany for many years without technical or environmental issues.

5.4 Furthermore, the UK has a very strong track record when it comes to putting new infrastructure in place. The development of a massive oil and gas production and transmission infrastructure was achieved in a relatively short period in arguably a much more challenging environment. There is no reason to suggest that given the right climate that this could not be replicated for shale gas production.

5.5 The UK should be looking to achieve "first mover" advantage. With an established gas and petrochemicals infrastructure already in place we only require a competitive source of supply to replace dwindling indigenous North Sea reserves to sustain our remaining energy intensive and petrochemicals sectors.

5.6 The benefits to industry are only part of the story with many wider spin-off benefits, which seem certain to enhance the prospects of the UK manufacturing and wider economy.

6 Conclusions

1.14 6.1 UK olefins manufacturing in the UK is sustained by advantaged feedstock pricing from North Sea gases (ethane, propane and butane) that provides support to the associated UK olefins derivatives manufacturing base (that are disadvantaged by greater transportation and freight costs to the inland European market). If feed costs into UK olefins manufacturing were to level with the rest of Europe, these derivatives would be outcompeted not only by their US and ME competitors, but also lose out against mainland European competitors who would then have similar costs but more differentiated derivatives and lower freight costs to serve the market. New sources of advantaged feedstock are required to maintain a UK olefins and derivatives manufacturing base.

6.2 UK energy prices are already uncompetitive. The UK’s energy tax and policy framework indicate that the competiveness gap is only set to increase.

6.3 For energy intensive manufacturers, such as olefins and derivatives producers, energy is a major component of productions costs: accessing competitively priced energy is simply business critical.

6.4 Shale gas offers an opportunity that must not be rejected if the UK is to remain a competitive location for energy intensive industries.

6.5 INEOS strongly supports the responsible development of shale gas in the UK. We consider it vital to the long-term success of our manufacturing operations in the UK.

6.6 We encourage UK Government to support the development of shale gas. Unlike renewables and new nuclear, this support will not need to be financial. Rather the need will be in areas such as licensing and planning. Indeed, UK plc will reap massive financial benefit from a successful shale gas industry.

7 Responses to Questions

In response to the questions raised by the Committee we have provided comments below (where we feel it is appropriate to comment).

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?

We are not experts in this area and only have access to information that has been made publically available.

In the UK it is apparent that information on reserves is evolving as test drilling is required in order to gather concrete information on shale quality. It is apparent that views are changing rapidly but generally new information is leading to ever more optimistic forecasts.

The proportion of recoverable reserves is also uncertain. However, assuming conservatively that just 10% of reserves are recoverable then we estimate that the Bowland Shale has the capacity to produce 30% of the volume of gas that has been extracted from UK conventional fields since 1970. In view of this we think it is reasonable to say that extracting shale gas would be comparable to rediscovering the North Sea.

Globally, new information is published on a near daily basis indicating that massive shale deposits lie across the planet. China, for example has the largest reserves, and with a gas market of similar size to the UK, reserves to demand ratios are around 250 years.

Germany also has significant reserves and with shale extraction having been undertaken for many years, we anticipate that shale development will see further growth.

Why are the estimates for shale gas so changeable?

We are not experts but exploration to date is limited. As exploration continues it is apparent that shale deposits are large, tend to surpass expectations and are globally diverse.

It is clear that other countries are likely to pursue shale development (as the US has done) and we see it as essential that the UK, with a strong track record on gas production and an existing good infrastructure that we seize early mover advantage.

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

We have no particular view on the relative merits of off-shore versus on-shore shale gas extraction. However, in either case we think it essential that UK Government support the development of the industry particularly through the granting of exploration and development licences.

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

We have no strong view on the merits of setting up specifically a wealth fund. However, it is apparent that the UK economy will boosted significantly if we continue to produce (and potentially export) indigenous gas rather than import supplies from other parts of the globe at higher and uncompetitive prices.

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

As already discussed, the US will become a gas exporter of natural gas. Others will follow. Better that the UK is an early mover.

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

Potentially shale could improve the prospects of a global gas market developing. However, if we do not embrace indigenous shale gas extraction we will remain a large importer forced to accept prices and exposed to geo-political risk.

Further, local gas production has the very clear potential to grow local industry through production and providing competitive energy and feedstock supplies for energy intensive and petrochemical sectors.

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

The development of shale gas should be seen as providing the bridge to a lower carbon economy. UK carbon emissions were reduced massively in the period known as "the dash for gas". We have already noted that with gas prices currently higher than coal, carbon emissions in 2011 were higher than they would otherwise have been.

Further, it is clear that the deployment of significant levels of low carbon generation infrastructure remains many years away. Renewables will inevitably require back-up generation and any new nuclear seems very unlikely before 2020. Gas will be required to provide the bridge in the short to medium term – and shale gas can provide this without the need for expensive economic support mechanisms.

In the long term, whether gas will affect the deployment of new nuclear and renewables will have to be determined by policy and economic views. For example, will cheap gas combined with Carbon Capture and Storage provide a more economic, secure and acceptable source of power generation?

Predicting the future is without question uncertain. However, shale gas can offer another route to secure, competitive and lower carbon energy – and it should not be ruled out of the energy mix at this stage

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

Again the US offers a view of potential benefits. We note two examples.

First, shale gas has lowered prices such that natural gas is now the preferred fuel for power generation. As a result US carbon dioxide emissions have fallen massively. Increased use of shale gas in the UK or ROW has the ability to reduce coal burn provided it is cheaper than coal.

Secondly, gas is already being used as an alternative to liquid hydrocarbon fuels, offering reductions in emissions.

Thus, greater use of shale gas can provide a route to lower carbon emissions by displacing use of fuels with higher carbon intensity.

Of course shale gas is not carbon free. While Carbon Capture and Storage is still to be proven on a commercial scale, it would be an obvious partner to shale gas in providing a zero carbon but secure energy supply in the longer term.

Addendum 1 – Wholesale Gas Price Comparisons

The chart below shows the evolution of UK and US natural gas prices since 2006.


Addendum 2 – Wholesale Electricity Price Comparisons -2015

(Source: INEOS)

The chart below shows our view of delivered electricity prices (for a very large user) in 2015.

Addendum 3 – Ethylene Cracker Investments

Company

Project

Capacity

Location

Cost

Start-up

ExxonMobil Chemical

New cracker

1.5 tonnes

Baytown, Texas

NA

2016

Chevron Phillips Chemical

New cracker

1.5m tonnes

Cedar Bayou, Texas

NA

Q1 2017

Dow Chemical

New cracker

World-scale

US Gulf Coast

NA

2016-2017

Shell

New cracker

World-scale

US Northeast

NA

2016-2017

Formosa Plastics

New cracker

800,000 tonnes

Point Comfort, Texas

$1.7bn

2016

Dow Chemical

Restart

390,000 tonnes

St. Charles, Louisiana

NA

end 2012

Westlake Chemical

Expansion

108,863 tonnes

Lake Charles, Louisiana

NA

H2 2012

Williams

Expansion

272,158 tonnes

Geismar, Louisiana

$350m-$400m

Q3 2013

INEOS

Debottleneck

115,000 tonnes

Chocolate Bayou, Texas

NA

end 2013

Westlake Chemical

Expansion

113,399 tonnes

Lake Charles, Louisiana

NA

2014

LyondellBasell

Expansion

386,000 tonnes

La Porte, Texas

NA

2014

Considered expansions

Sasol

New cracker

1.0m-1.4m tonnes

Lake Charles, Louisiana

$3.5bn-$4.5bn

NA

Indorama Ventures

New cracker

1.3m tonnes

NA

NA

2018

LyondellBasell

Expansion

NA

Channelview, Texas

NA

NA

SABIC

New cracker

World-scale

US

NA

NA

Braskem

New cracker

NA

US

NA

NA

Occidental Chemical

New cracker

NA

Ingleside, Texas

NA

NA

Aither Chemicals, Renewable

New cracker

NA

US Northeast

$750m

2016

(Source: CIA)

ANNOUNCED ETHYLENE EXPANSIONS BASED SHALE GAS 

Addendum 4 – US Economic Benefits

The quotes below from recent reports and US media give an indication of the positive effect that shale gas has had on the US economy and petrochemical sector.

U.S. energy supplies have been transformed in less than a decade, driven by advances in technology, and the economic implications are only beginning to be understood. U.S. natural gas production will expand to a record this year and oil output swelled in July to its highest point since 1999. Citigroup estimated in a March report that a "reindustrialization" of America could add as many as 3.6 million jobs by 2020 and increase the gross domestic product by as much as 3 percent.

Bloomberg

Chemical companies from around the world are flocking to the Houston area to lay down millions, and sometimes billions, in investments to take advantage of vast amounts of cheap natural gas, which is used as a chemical feedstock.

Thousands of jobs have been proposed in the Houston area from recently announced plants and expansions from chemical companies such as Irving-based Celanese Corp. (NYSE: CE) and The Dow Chemical Co. (NYSE: DOW), based in Midland, Mich.

Houston Business Journal

[L]low and stable gas prices in the U.S. are contributing to a 10 percent reduction in electricity costs to consumers and a 1.1 percent increase in the level of 2012 GDP. Perhaps more importantly, it is encouraging manufacturers to expand operations in the U.S., building new production facilities, or reopen plants that were shuttered during the recession.

In its 2012 study, the IHS found that shale gas production alone will contribute $332 billion to U.S. gross domestic product (GDP) by 2035

CNBC

The increase in US gas production has also led to the rebirth of the domestic chemical and manufacturing sectors, Ken Bromfield, North American commercial director with Dow Chemical, said.

"We have an unprecedented opportunity with shale gas to push the reset button on the US energy economy," he said.

"Manufacturing is back," he added, saying industry has announced plans to build about $80 billion of projects in the next five years, as a result of reasonably priced natural gas. Dow alone has announced $4 billion of new manufacturing projects, Bromfield said.

Platt’s

Access to vast, new supplies of natural gas from previously untapped shale deposits is one of the most exciting domestic energy developments of the past 50 years. After years of high, volatile natural gas prices, the new economics of shale gas are a "game changer," creating a competitive advantage for U.S. petrochemical manufacturers, leading to greater U.S. investment and industry growth.

America’s chemical companies use ethane, a natural gas liquid derived from shale gas, as a feedstock in numerous applications. Its relatively low price gives U.S. manufacturers an advantage over many competitors around the world that rely on naphtha, a more expensive, oil-based feedstock. Growth in domestic shale gas production is helping to reduce U.S. natural gas prices and create a more stable supply of natural gas and ethane.

American Chemical Council

Unconventional gas activity is having a dramatic impact on employment and economic growth across the US lower 48 states and the District of Columbia, in terms of jobs and its contribution to gross state product (GSP) and, by extension, US gross domestic product (GDP).

In 2010, unconventional gas activity supported 1 million jobs; this will grow to nearly 1.5 million jobs in 2015 and to over 2.4 million in 2035.

By 2015, unconventional gas activities will contribute nearly $50 billion in federal, state and local government tax and federal royalty revenue; between 2010 and 2035, continued development of unconventional gas will generate a cumulative total of nearly $1.5 trillion in federal, state, and local tax and royalty revenue.

IHS

September 2012

Prepared 25th October 2012