Shilling for Shale

September 26, 2011

Economic blogger Tim Worstall has been getting very excited about shale gas. Cuadrilla Energy, a company set up to explore for unconventional gas in the UK, are reporting the discovery of 200 trillion cubic feet of the stuff under Lancashire. Tim is positively cock-a-hoop at the prospect of sufficient reserves of fossil fuels to allow us to without ‘damn windmills’ entirely.

I read Tim’s blog on a regular basis, for its amusing deconstruction of left-wing economic tropes, and I am disappointed that Tim hasn’t applied his usual economic rigour here. Shale gas appears to have become something of a magic bullet for certain sections of the Right, but as Tim would normally be the first to say, if your magic bullet is made of platinum and a thousand regular bullets do the same job, it’s probably not worth bothering with.

Tim appears to be putting himself in a box with some rather mad fellow travellers, like James Delingpole and Christopher Booker, perhaps to get a similar Telegraph gig. Let me try to summarise this shared position:

  • Renewables are bad, because they require space in a countryside that must be locked into a sepia-tinted version of the 1950s for the rest of time, are very clearly associated with hippies and filthy left-wingers, and above all are expensive. Tim is currently only espousing the last of these points.
  • A far better way of securing our energy sources is to rely on unsubsidised fossil fuels, which human ingenuity will guarantee cheap and plentiful supplies of for the foreseeable future.

It’s this question of cost that’s at the heart of the current debate, and rightly so – we need to decarbonise our economy, but we need to do it in the most cost-effective way possible. The key question, therefore, is how much shale gas actually costs, rather than how much Tim, James and Christopher think it costs.

To do so we’ll look at some research carried out by the Oxford Institute for Energy Studies. The OIES is partly funded by those well-known opponents of the oil and gas industry, the oil and gas industry. The paper we’ll look at is called ‘Can Unconventional Gas be a Game Changer in European Gas Markets?by Florence Gény.

The paper can be summarised as ‘No, Europe is different, and it’s not clear that shale gas is as profitable and productive in the US as its advocates claim’. The section relevant to our question here is from Chapter 4:

“Although gas production has continued to increase in 2009 and 2010 despite lower prices than in the previous years, there is a big question mark about current well economics. Many public sources estimate that the average price required for shale gas wells to be economic is around $6/mcf. Averages are a very poor measure to use in the case of shale plays, as every play is different, and within plays, core areas and non-core areas yield very different results, but the fact that by late 2010, gas prices had not reached $6/mcf for two years suggests that the commercial viability of many wells drilled, and so the financial solidity of many independents, could be very weak. We believe it is only a question of time before costs drive up prices, or drilling slows downs significantly and production falls. However many independents get financial protection against low gas prices through hedging strategies, so the cash impact of non commercial drilling is mitigated.”

The reduction in the price of gas in the US appears to have been caused by a broader range of drivers, not least the economic downturn and a significant increase in the number of gas processing plants, which convert unprocessed gas into dry natural gas suitable for injection into the gas grid. It’s not clear that shale is the primary cause of lower gas prices – or indeed whether shale gas suppliers can make money out of it when gas prices are low. Certainly, one of the strongest advocates of shale gas production in the US, Chesapeake Energy, made a significant loss in 2009, although they appear to have since climbed out of the hole, primarily by selling off shale gas assets. Cuadrilla doesn’t appear to have ever made a profit, although as a start-up that’s not really a consideration.

What does this mean for ‘damn windmills’? We can plug the $6/mcf figure into the costings report produced by Mott Macdonald for DECC last year. It models a range of gas prices. $6/mcf translates to about 37p per therm. The lower boundary of prices in the Mott Macdonald report is 34p per therm. Looks good for shale, right?

Well, no. The prices in the Mott Macdonald report are ‘burner tip’ prices – i.e. the cost to generators per therm at combustion. The $6/mcf price is the wellhead price, which is typically around $1-2 below the wholesale price. Factoring in the need for shale gas suppliers to make a profit, the burner-tip price of shale gas is going to look a lot more like DECC’s medium case. Under this case, onshore wind turbines will be the cheapest source of electricity by the end of this decade, when the carbon cost of gas is factored in. The latter won’t be a consideration for those who find the very concept of science an affront to their all-knowing egos like Delingpole and Booker, but for Tim, who acknowledges science as a worthwhile field, it will be.

If Tim had written ‘damn tidal mills’ he would’ve been correct. Different types of renewable energy generators will become economically viable at different times. A combination of onshore wind and combined-cycle gas turbines will be the cheapest way of replacing the quarter of our electricity generators that are being shut down over the course of this decade. I don’t mind admitting that, as a fervent supporter of capitalism, I’ve put my money into this solution. I too believe in the power of human ingenuity to provide solutions to our energy problems; I just don’t think it only applies to fossil fuels.

I would also point out that because of the long lead-time on making new sources of energy economically viable, subsidies can be a sensible policy option. For example, in 1980, the US Government brought in ‘The Alternative Fuel Production Credit’ to provide incentives to invest in non-traditional sources of energy. One of those was shale gas.

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