The Impact of Shale Gas on Energy Markets

Written evidence submitted by EDF Energy (ISG 18)

Executive Summary

· EDF Energy believes that the level of technically recoverable shale gas resources around the world is potentially significant. However, based on the currently available evidence, we believe that the conclusion of the Committee's previous report in May 2011 remains correct, namely that shale gas is unlikely to be a "game changer" for the UK and that we are unlikely to replicate the production experience of the USA.

· European shale gas production costs are likely to be higher than those in the USA. Reasons include differences in regulatory, fiscal, labour and environmental regimes, as well as land and resource access issues pertaining to geology and population density.

· While shale gas may make a contribution towards the EU's energy needs, the region is forecast to be dependent on imports of gas for at least 60% of its demand by 2030 [1] . Global conditions will therefore continue to influence regional market prices. Gas prices currently remain strong despite weak gas and power demand as a result of the world recession.

· Future European gas prices are likely to be set by the marginal cost of importing gas from Norway and Russia, as well as by LNG. Although the volume of gas available worldwide may be increasing, once the costs of LNG transportation (and re-gasification) to Europe is taken into account, this may only curb the extent of price rises in the longer-term rather than drive prices down from current levels. In addition, it is likely that LNG cargoes diverted from the USA will be used to meet growing demand in Asia rather than go to Europe.

· Gas-fired generation (whether fuelled by conventional or shale gas) will play an important role in the transition towards a decarbonised power sector in the 2030s by providing the reliable and flexible backup generation required for balancing the electricity system.

· However, further investment in any unabated gas generation plant, beyond the minimum that is required to bridge the gap to the transition to low carbon technologies, would introduce significant challenges in meeting the UK’s legally-binding climate change objectives. Such investment substantially increases the risk that the UK’s long term emissions reduction targets will not be met, or at least be met in a cost-effective manner. This is either because the carbon emissions from these new assets will be ‘locked in’ or, alternatively, because it increases the risk of stranded assets.

· The carbon footprint of long distance gas transportation systems, including LNG and pipelines will have to be considered. This could be significant in some cases, as the UK starts increasingly to move away from UK Continental Shelf (UKCS) supply to a greater reliance on imported gas. We also support the Committee’s previous recommendation that adequate regulatory safeguards should be in place to monitor and mitigate some of the other environmental concerns associated with shale gas, including methane leakage.

· We believe that the largest opportunity for gas generation in the longer term will be when it is fitted with carbon capture and storage (CCS), since this could allow gas to take a larger share of the market if other low carbon options do not come forward, or if they prove to be more expensive.

· It is imperative that the Government maintains its continued momentum on Electricity Market Reform (EMR). Reform of the existing electricity market arrangements is necessary to ensure the market is capable of delivering the reliable diverse energy mix required to deliver the UK’s energy policy objectives. The Government’s proposals will provide the investment framework that is crucial for the low carbon investment that the country needs, and will keep costs down for consumers.

· EDF Energy believes that the Government’s commitment to move to a low carbon economy is likely to mean that fossil fuel plant such as CCGTs will in the future operate at lower load factors than historically has been the case. This is likely to lead to increased revenue uncertainty and this could lead to under-investment and lower levels of reliable capacity. We therefore welcome the Government’s proposal to introduce a capacity market to help address security of supply concerns, and look forward to seeing its design preference by the end of the year.

A bout EDF Energy

EDF Energy is one of the UK’s largest energy companies with activities throughout the energy chain. We provide 50% of the UK’s low carbon generation. Our interests include nuclear, coal and gas-fired electricity generation, renewables, and energy supply to end users. We have over five million electricity and gas customer accounts in the UK, including both residential and business users.

EDF Energy’s response to your questions

Q1. 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?

1. In lieu of access to primary data, EDF Energy has conducted a comprehensive review of the available literature on shale gas and other unconventional gas resources. However, no one report is viewed as a definitive reference source and most of the reports reviewed contain sufficient caveats to acknowledge that the estimates provided are liable to change.

2. The literature suggests that the shale gas volumes in place in the UK are substantial, up to 5 trillion cubic metres (tcm) [1] . However, estimates of technically recoverable reserves range between 150 billion cubic metres (bcm) [2] and 570 bcm [3] , and this represents 2-7 years of UK gas demand in 2011 [4] . As annual production volumes are likely to be small (Pöyry forecasts a maximum 4 bcm per annum [5] ), the UK will still need to import around three quarters of its forecast gas demand by 2030 [6] .

3. The estimates for the amount of shale gas in Europe are also wide-ranging, and range from 16 tcm [7] to 157 tcm [8] . Within this, technically recoverable gas is estimated at around 3.8 tcm [9] to 17.7 tcm [10] , and commercially recoverable volumes up to 4.4 [11] tcm. In the most optimistic scenario, shale gas will offset the decline in EU domestic gas production, leaving a need to import at least 60 per cent of gas demand by 2030 [12] . This is likely to come from Norway and Russia, or by diverting LNG cargoes away from Asia.

4. The USA has made the greatest advances in fulfilling the potential of shale gas, and has seen shale gas production increase from 28 bcm in 2006 to 140 bcm in 2010. However, despite having 30 years experience in shale gas extraction, the true size of potentially extractable shale gas reserves remains uncertain and is still being discovered. The range of technically recoverable shale gas reserves are estimated at between 13-50 tcm [13] , out of total resources of 109-202 tcm [14] .

5. With regard to the rest of the world, although shale gas resources appear to be abundant across the globe, the most significant are in China with recoverable reserves estimated at 1.6 [15] -36 [16] tcm (albeit with relatively few studies available). However, it is important to note that the most promising area, the Tarim basin, is located in an arid region and therefore does not have easy access to the large volumes of water required during the hydraulic fracturing process.

6. EDF Energy believes that the level of technically recoverable shale gas resources around the world is potentially significant. However, based on the currently available evidence, it is our view that the production experience of the USA is unlikely to be replicated elsewhere because there are still considerable obstacles that must be overcome. Besides the ongoing need to address a number of wider environmental concerns associated with hydraulic fracturing (such as groundwater contamination), the commercial viability of extraction is variable across countries because it is dependant on specific local issues, including access to land, environmental constraints, technological knowledge and expertise, cost of production, access to market and fiscal terms. Public support, and ultimately social acceptability, will also remain key factors that will have to be considered.

Q2. Why are the estimates for shale so changeable?

7. Although the presence of unconventional gas resources have been known for decades, the shale gas industry is still in its relative infancy, and this is reflected in the uncertain nature of the data and forecasts available. We would expect the quality of the forecasts to improve as further exploration and drilling proceeds. This has been reflected in the general global upward trend in shale gas resource estimates over the last two decades as the quality of data available from actual production experience (as opposed to modelling and inference) improves.

8. A recent report by the European Commission Joint Research Centre (JRC) [17] highlights some of the difficulties involved in making accurate estimates and the subsequent variability in estimates. This includes a "lack of comprehensive and independently corroborated data on geology, the results of exploration drilling and the long term production levels of wells". The report also suggests that "industry practice is evolving so rapidly that ultimate recovery rates and unit costs of produced unconventional gas are moving targets with some forecasts predicated on the anticipation of future technological progress".

9. The JRC also notes differences in the resource assessment methodologies (e.g. bottom-up analysis of geological parameters or extrapolation of production experience) and assumptions used by the various sources. We agree that it is likely that such lack of consensus will contribute to the large variation in estimates. For example, the report highlights the inconsistencies in the definitions used for commonly used terms in the available literature. This makes it difficult to compare different estimates (e.g. ambiguity over the definition for "technically recoverable resources"). The authors also point out that, bar the US Energy Information Administration (EIA), there are few organisations that provide resource estimates for unconventional gas on a regular basis. This also makes comparison between estimates difficult, given the general assumption that the most recent report represents the most accurate information available.

10. All the relevant sources that we reviewed stated that European shale gas production costs are likely to be higher than those in the USA, with the most commonly stated prediction being around 50 per cent higher [18] . Reasons include differences in regulatory, fiscal, labour and environmental regimes, as well as land and resource access issues pertaining to geology and population density. It is also important to highlight that the low gas price in the USA (~18p/therm versus ~61p/therm in the UK) is due to current overproduction and oversupply, and partly driven by the fact that shale gas is being extracted as a by-product from shale oil production. The current price is perceived by several market analysts to be below break-even and unsustainable for dry (i.e. non-oil associated) shale production, and this has likely contributed to the recent $5.5bn write down in value of shale gas assets by a number of major energy companies [19] .

Q3. Should the UK consider setting up a wealth fund with the tax revenue from shale gas?

11. EDF Energy is aware of the use of Stabilisation Funds in countries around the world (such as Norway) to control the revenue stream resulting from commodity sales. The aim is to smooth out the effect of windfalls and shortfalls caused by fluctuations in commodity prices. The Funds help governments try and stabilise their expenditure over time so that during boom periods, the excess revenue is not spent and instead can be drawn upon during leaner times. As a result, Government spending does not have to be cut during such austere periods. This also has the additional benefit of helping check inflationary pressures.

12. We believe that this is an option that the Government may wish to consider in the future, once the forecasts of UK shale gas production and its impact on UK and European gas prices (and hence actual tax revenue) are more certain.

Q4. What have been the effects of the shale gas on the LNG industry?

13. The increase in unconventional gas production in the USA over the last decade has had a knock-on effect on LNG imports into the country, and together with the global economic recession has led to a global surplus of LNG capacity. However, according to Chatham House [20] , some of the surplus LNG capacity has been absorbed by an increase in Japanese demand for gas to replace the loss of generation capacity as a result of the tsunami and earthquake in March 2011.

14. In the last decade, US domestic gas production was originally forecast to decline. This led to a surge in LNG re-gas capacity investment in the USA, with corresponding investment in those countries, such as Qatar, that were looking to export gas. However, as a result of increased shale gas production, the USA actually only imported 13 bcm of LNG in 2009 (out of a LNG re-gasification capacity of nearly 150 bcm [21] ). There are now plans for US producers to add export capabilities, and the EIA forecasts that the USA will become a net exporter of LNG in 2016.

15. With this new dynamic, the JRC forecasts that it is likely that Europe will replace the USA to become the second largest regional market after Asia for LNG in terms of import/re-gasification potential. The International Energy Agency (IEA) [22] predicts that the trend in liquefaction (i.e. export) growth will continue to grow for the foreseeable future with overall capacity expected to grow by 50% between 2008 and 2013.

Q5. Could shale gas lead to the emergence of a single, global gas market?

16. The rapid growth of liquefaction and re-gasification LNG capacity around the world, and corresponding global LNG trade volumes over the past decade, have helped break down the regional and fragmented nature of gas markets. However, it is too early to suggest that this growth, along with current developments in shale gas, is likely to lead to a global gas market in the foreseeable future. Even if a global gas market were to develop, significant price differentials between the US, European and Asian markets would persist as the costs of producing, shipping and re-gasifying LNG are significant. We believe that a move away from traditional oil-indexed gas contracts, as is starting to emerge in the EU, will help because as the JRC notes, "a weaker [oil-gas price] link implies greater potential for shale gas to induce a significant growth of gas use in [LNG] transportation".

17. It will be important to consider the carbon footprint of long distance gas transportation systems, including LNG and pipelines. This could be significant in some cases, as the UK starts increasingly to move away from UK Continental Shelf (UKCS) supply to a greater reliance on imported gas.

18. Based on the currently available evidence, we believe that the conclusion of the Committee's previous report in May 2011 remains correct, namely that shale gas is unlikely to be a "game changer" for the UK. While shale gas may make a contribution towards the EU's energy needs, the region will continue to be dependent on imports of gas. We believe that global conditions will continue to influence regional market prices. Gas prices currently remain strong despite weak gas and power demand as a result of the world recession.

19. In the short to medium term, Europe is likely to be caught between downward pressures through LNG cargoes diverted away from the USA (and the development of LNG supply from Qatar and Australia), and upward pressure from growing demand for gas from Asia. However, although the volume of gas available worldwide may be increasing, it is important to note that, once the cost of transportation to Europe is taken into account, this may only curb the extent of price rises in the longer-term rather than drive prices down from current levels.

Q6. What are the effects on investment in lower-carbon energy technologies?

Please see our response to Question 7.

Q7. What is the potential impact on climate change objectives of greater use of shale gas?

20. EDF Energy is committed to delivering affordable, secure, and low carbon supplies based on a diverse energy mix, including nuclear and renewables. As part of this, we believe that unabated gas fired generation (including that from shale gas) will play an important role in the transition towards a decarbonised power sector in the 2030s by providing the reliable and flexible backup generation required for balancing the electricity system.

21. In addition to its role in electricity generation, gas also plays a significant role in heating, with 81% of home heating [23] fuelled by this source. However, we support DECC’s ambitions to move away from fossil fuel heating. EDF Energy has long supported early action on renewable heat, as we believe that this is a sector which can make a significant and cost effective contribution to the UK meeting its 2020 renewable energy target, especially through the use of heat pumps.

22. Further investment in any unabated gas generation plant (whether fuelled by conventional or shale gas), beyond the minimum that is required to bridge the gap to the transition to low carbon technologies, would introduce significant challenges in meeting the UK’s legally-binding climate change objectives (as set out in the Climate Change Act 2008). This is because while gas fired generation has lower carbon dioxide emissions than old coal fired generation, without carbon capture and storage (CCS) it is still a significant source of carbon emissions in its own right.

23. Such investment in unabated gas generation plant substantially increases the risk that the UK’s long term emissions reduction targets will not be met, or at least be met in a cost effective manner. This is either because the carbon emissions from these new assets will be ‘locked in’ or, alternatively, because it increases the risk of stranded assets.

24. As recognised in the Committee’s previous report, we note that there is a large divergence in opinion with regard to the lifecycle greenhouse gas footprint of shale gas (including direct and indirect emissions of both carbon dioxide and methane), and the issue of such leakages will need to be investigated further.

25. It is imperative that the Government maintains its continued momentum on Electricity Market Reform (EMR). Reform of the existing electricity market arrangements is necessary to ensure the market is capable of delivering the reliable diverse energy mix required to deliver the UK’s energy policy objectives. The Government’s proposals will provide the investment framework that is crucial for the low carbon investment that the country needs, and will keep costs down for consumers.

26. The Government’s commitment to move to a low carbon economy is likely to mean that fossil fuel plant such as CCGTs will in the future operate at lower load factors than historically has been the case. This is likely to lead to increased revenue uncertainty and this could lead to under-investment and lower levels of reliable capacity. We therefore welcome the Government’s proposal to introduce a capacity market to help address security of supply concerns. A well designed capacity market will deliver a higher reliability standard in a sustainable and cost effective way. It is vital that the capacity market is designed to provide adequate capacity to ensure security of supply and we look forward to seeing the Government’s design preference by the end of the year.

27. The potential emergence of large volumes of shale gas reinforces the need to establish a credible and enduring carbon price signal so that investors are able to make well-informed investment decisions. It is commonly accepted that the current EU ETS price is not providing the long-term signal to make the relevant investments in low carbon generation. While the introduction of the carbon price floor in the UK helps restore the long-term price signal that the EU ETS was expected to achieve, it does not remove the need for reform of the EU ETS at the European level.

28. EDF Energy therefore supports initiatives that would help remedy some of the defects of the EU ETS at the European-wide level, and would encourage the Government to pursue these. For example, we agree with the Government that the UK should work with its EU partners to arrive at a robust agreement for domestic carbon dioxide reductions across the EU, including a more ambitious reduction target for 2020 relative to 1990 levels.

29. In addition, as the supply side of the EU ETS is totally inelastic, we believe a supply response mechanism, based on transparent and objective criteria, and resulting in a minimum level of scarcity, would help UK industry avoid any unnecessary differential competitive impacts and help address carbon leakage concerns. The EU ETS cap should be able to adjust to compensate for the impacts of other EU energy policy initiatives (e.g. renewable and energy efficiency targets), resulting in cuts in emissions, to ensure that carbon price signals are not undermined.

October 2012


[1] IHS CERA, Breaking with Convention, 2011

[1] Ibid.

[2] British Geological Survey, The Unconventional Hydrocarbon Resources of Britain’s Onshore Basins , Shale Gas, 2011

[3] EIA, World Shale Gas Resources: An Initial Assessment of 14 Regions Outside the United States , April 2011

[4] BP Statistical Review of the World 2012 states 2011 UK gas consumption at 80.2 bcm

[5] Pöyry, The Impact of Unconventional Gas on Europe , June 2011

[6] IHS CERA, Breaking with Convention, 2011

[7] EIA - World Shale Gas Resources: An Initial Assessment of 14 Regions Outside the United States , April 2011

[8] IHS CERA, Breaking with Convention, 2011

[9] Wood Mackenzie total unconventional resource

[10] EIA, World Shale Gas Resources: An Initial Assessment of 14 Regions Outside the United States , April 2011

[11] IHS CERA, Breaking with Convention, 2011

[12] Ibid.

[13] IEA, EIA, IHS CERA and Advanced Resources International Estimates

[14] EIA, World Shale Gas Resources: An Initial Assessment of 14 Regions Outside the United States , April 2011

[15] European Commission Joint Research Centre, Unconventional Gas: Potential Energy Market Impacts in the European Union, September 2012

[16] EIA, World Shale Gas Resources: An Initial Assessment of 14 Regions Outside the United States , April 2011

[17] European Commission Joint Research Centre, Unconventional Gas: Potential Energy Market Impacts in the European Union, September 2012

[18] Pöyry, The Impact of Unconventional Gas on Europe , June 2011

[18] IEA Golden Rules for a Gold Age of Gas and EU Commission, Unconventional Gas: Potential Energy Market Impacts in the European Union, p129. “cost estimates are in line with current break-even costs for shale gas production in Europe of … $5-12/MBtu” which is approximately 50% higher than the $3-6/MBtu quoted for the US on page 191.

[19] http://www.arcticgas.gov/2012/companies-write-down-value-shale-gas-assets

[20] Chatham House, The ‘Shale Gas Revolution’: Development and Changes Briefing Paper, August 2012

[21] European Commission Joint Research Centre, Unconventional Gas: Potential Energy Market Impacts in the European Union, September 2012

[22] IEA, Medium-Term Oil and Gas Markets, 2010

[23] DECC, The Future of Heating: A strategic framework for low carbon heat in the UK , March 2012

Prepared 14th November 2012