Skip to content

UK Government: ‘We Now Understand That Natural Gas Is A Destination Fuel’

“We used to regard gas as a transition fuel. We now understand that it is in fact a destination fuel,” British energy minister Charles Hendry MP said recently.

Enormous potential: The areas marked in red show locations where it would be possible to extract shale gas


Unnoticed by the powerhouses of the British media, the economy of the United States is rebounding on the back of a manufacturing-led boom fuelled by cheap gas. The American revival is in its early stages, but already manufacturing is being repatriated from China: an astonishing development after decades of offshoring.

The factor that above all separates the US energy market from those in Europe and Asia is the enormous increase in gas production and reserves brought about by the shale gas revolution. Which prompts the question: why are British politicians and industrialists not interested in promoting shale potential at home?

In recent years the gulf between open market gas prices in North America and the rest of the world has widened dramatically. The reason — as is now generally understood — was the development in the US of massive gas reserves trapped in previously inaccessible shale rock formations. The benchmark price at Henry Hub in Texas fell from a pre-shale peak of nearly $13 per million British thermal units (BTU) in mid-2008 to as low as $2.71 in January this year. Since January 2011 the US price has averaged less than $4 while the British National Balancing Point (NBP) price has averaged more than $9.

Open market gas prices on either side of the Atlantic roughly tracked each other for 13 years from mid-1995 until mid-2008, when they abruptly separated.

Initially many observers thought the market divergence would be shortlived. Some believed the US bonanza would evaporate, that once the easy gains had been made the marginal costs would rise, new production would be harder to bring on, and prices would return to higher levels. So far this has not happened: the typical marginal costs of new shale gas production are now around $3 per million BTU. In 2011 shale gas accounted for a quarter of US natural gas production.

The impact on reserves has been equally dramatic. In 2000, US dry natural gas resources were estimated by the Energy Information Administration at 1,500 trillion cubic feet, almost entirely in conventional reservoirs. By 2012 estimated reserves had risen by 67 per cent to more than 2,500 trillion cubic feet, of which a third was accounted for by gas in shale formations.

There is a longer-term prospect that North America will begin to export liquefied natural gas (LNG) to the rest of the world, helping to restore a global pricing equilibrium. To do this, American LNG import terminals which were constructed a few years ago to cope with an anticipated domestic shortage of gas are being reconfigured to handle exports. However, no gas has yet been exported, and there are already rumblings within the US that the country should not allow its sudden good fortune to be dissipated by sharing it with foreigners.

Great bulwark of free enterprise it may be, but the US has a long history of energy protectionism, from oil import quotas in the 1950s, wellhead price controls in the 1970s and a refusal to allow exports of Alaskan oil in the 1980s. But even if the US refuses to licence LNG exports, Canada, whose own traditional export markets south of the border have been hammered by the shale revival, will certainly look to sell LNG to the world.

Meanwhile the US has begun to benefit from significantly lower energy costs. Industrial output looks like growing at 4-5 per cent this year and next. Power generators are switching to gas from more expensive and dirty coal, and this trend is forecast to increase dramatically over the next quarter-century. Americans’ perennial sense of insecurity, most recently voiced by President Obama, about over-reliance on energy imports, looks like evaporating. The technological advances that have given the US its abundant shale gas will also provide crude oil from shale.

One simple example: cheap gas will encourage the US petrochemical industry to invest $30 billion in new plant over the next five years, according to the Chevron Phillips Chemical Co. Plastics producers will get a double boost from cheaper feedstock gas — the raw material for their product — and lower electricity costs. This will further increase the American advantage over competitors in Western Europe and Asia whose usual feedstock is oil.

Thus shale gas has changed the game and not only in terms of hydrocarbons supply: it has provided the US with a chance to launch an economic recovery based on manufacturing and exports.

Americans have largely taken all this in their stride, even though as shale exploration moves into liberal north-eastern states a degree of nimbyism becomes apparent. How very different from the reaction in Britain where the prospect of a large new source of energy and exchequer revenue has either been ignored or treated with suspicion.

A lot of nonsense is talked about the prospects for shale gas in Britain, both for and against. Advocates claim that there are gigantic reserves just waiting to be tapped, and that the North American phenomenon could easily be replicated here. Opponents — and they are in the vocal majority — say that fracking (hydraulic fracturing)poisons the water supply and causes earthquakes; they also worry that renewing Britain’s search for hydrocarbons will divert investment away from renewables.

The truth as usual lies somewhere between. The geological potential is certainly large, though the recoverable element of the gas in place has not yet begun to be assessed. A fundamental difference between Britain and the US is that in Britain mineral rights belong to the Crown, while in America they belong to the freeholder, which inevitably means British developments will take longer to initiate, even without political pressure from greens and local interests.

The impact on the water supply will inevitably remain a matter for concern, because of the tiny amounts of chemicals dissolved in water injected to fracture the source rock. The techniques themselves are constantly being refined and, compared to the early days in the US, the chemicals used now appear innocuous. Hydraulic fracturing does, according to the US Geological Survey, cause small but harmless earthquakes, although the recycling of waste water into deep wells can cause perceptibly larger quakes. It should be noted that most subterranean activities, such as coal mining, can cause subsidence or earthquakes.

There are several shale gas exploration sites around Britain but the most significant is Cuadrilla Resources’ initiative on the Fylde coast of Lancashire. Cuadrilla is backed by Lord Browne, lately the boss of BP. Last September Cuadrilla announced that it had identified reserves in place of 200 trillion cubic feet — roughly 20 times the proven reserves of conventional natural gas in the North Sea. Even assuming only a 10 per cent recovery rate — very conservative by North American standards — this one find potentially trebles Britain’s gas reserves, and provides George Osborne and his successors at the Treasury with an enormous opportunity.

The reaction to this good news has been, at best, muted. The BBC, inevitably, reported the story as an environmental disaster in the making. The Financial Times, preoccupied with rescuing the euro, paid it scant attention. Ofgem, which in recent years has dwindled from an effective regulator of competition to an alternative delivery vehicle for government green energy policies, reissued an old report by some tame consultants insisting that shale gas held little promise for the UK. The formal reaction from a Department of Energy and Climate Change (DECC) spokesman was discouraging: “Any development must sit with our plans for a strong portfolio of energy sources as we move to a low carbon economy, including renewables, nuclear and clean coal and gas.” This unenthusiastic line was repeated by the hapless Chris Huhne during his last months as Secretary of State at DECC, notably in a Guardian interview in which he repeated the demonstrable nonsense that shale drilling could lead to gas flames spurting from domestic water taps.

So, how much might this unwanted and embarrassing Fylde gas discovery be worth to the British economy? Cuadrilla is planning to bring the field up to full production by about 2020. Privately they believe they will be producing 1 trillion cubic feet, or 28 billion cubic metres a year. That is about half of current UK gas production from the declining North Sea fields.

At today’s prices that amount of Fylde gas would be worth about £4.2 billion a year to the Exchequer early in the next decade. It would also improve the balance of payments by £7 billion, and go a long way to restoring Britain’s energy independence. Tens of thousands of real jobs would be created in a depressed English region. What’s not to like?

The problem is the Coalition’s energy policy, which is really a climate change policy inherited from the previous Labour government and designed to appease environmental activists by forcing ordinary consumers to subsidise ineffectual and expensive wind energy. As I have argued previously in Standpoint, such policies will merely inflate energy costs — much of the increase ending up in the pockets of large utilities and wealthy wind farm investors — while actually increasing the reliance on natural gas to cover the gaps when the wind fails to blow.

There are some reasons for optimism. Ministers have begun to acknowledge the importance of gas: “We used to regard gas as a transition fuel. We now understand that it is in fact a destination fuel,” Charles Hendry MP said recently. They have also begun to take a more active interest in where the gas comes from: David Cameron has discussed with Vladimir Putin the possibility of extending the Russo-German Nordstream pipeline across the North Sea to Britain. But they have done little so far to encourage more exploration, least of all for shale gas.

The political difficulty is obvious: even with opposition to wind power growing increasingly forceful and articulate, it will be embarrassing to row back from an ineffectual policy whose consequences the government clearly did not understand.

But there is the heart of the matter. Wind power will require larger and larger amounts of gas generation to keep the lights on when the wind doesn’t blow, which is 70 per cent of the time on a good day and 90 per cent on a bad day. Once this has been accepted, the choice between buying more imports and encouraging the development of potentially huge domestic reserves becomes less difficult.

Unfortunately, by the time this happens the UK will be many years off the economic pace being set by the American shale bonanza. Just one more reason to pray — one cannot expect that British governments will one day again be prepared to leave these sorts of decisions to the market, and not to the vagaries of well-intentioned but ill-understood state interventions.

Standpoint Magazine, April 2012