Nafeez takes a look at the unfolding story of doubts about the reliability and durability of US shale gas reserves which have been “inflated” under new Security and Exchange Commission (SEC) rules introduced in 2009. The new rules allow gas companies to claim reserve sizes without any independent third party audit. This is very much the case here in the UK right now. The overestimation of reserve sizes is being used to obscure the dodgey economics of fracking.

The first problem is production rates, which start high, but fall fast. Nafeez cites eminent authorities who have noted that production at wells drops off by as much as 60 to 90 percent within the first year. It is, however, something that any undergraduate geologist would readily understand and expect. This makes long-term profitability difficult, even in the UK context in which the gas markets will not allow any significant drop in gas prices even with greater supply. (I will explain this later). The industry has run into a crisis because it borrowed to finance the set up and production costs on the basis of its fanciful estimates of what it could extract from reserves of essentially uncertain size and accessibility. Prices are therefore rising fast again to save the companies bacon!

Nafeez neatly sums up the lesson we need to learn fast:
“Rather than ushering in a new wave of lasting prosperity, the eventual consequence of the gas glut could well be an unsustainable shale bubble, fuelling a temporary economic recovery that masks deeper structural instabilities. When the bubble bursts under the weight of its own debt obligations, it could generate a supply collapse and price spike with serious economic consequences.”

Returning to the differences between the US and UK gas markets.

Because of the way the wholesale gas market works in the UK, shale gas production (even at the most optimistic estimates) will have little impact on the price consumers pay.
See: http://www.publications.parliament.UK/pa/cm200708/cmselect/cmberr/293/29305.htm

Key points:

• Natural gas is bought and sold in the UK by a number of means, e.g. On the spot market, through forward and futures trading, and under off-market contracts
• The daily spot price of gas serves to balance real-time supply and demand
• At their present level, wholesale gas prices are already significantly higher than supply costs
• Gas trading in the UK takes place via the National Balancing Point (NBP), which provides a virtual trading location for buying and selling into and out of the UK transmission system – essentially off-market contracts whereby normal market mechanisms do not operate
• Since the opening of pipelines connecting the UK to the European gas market, Continental gas prices have had a much greater influence on UK prices. The impact of increased supply in the UK would be spread across Europe
• One of the key characteristics of the European gas market is the indexing of long-term gas contracts to the price of oil, usually with a lag of 3 to 9 months. This exists largely for historical reasons, but persists because the gas market in Europe is not sufficiently liquid to allow producers to use it to index long-term contracts.

The upshot of all this is that there these mechanisms are skewed to ensure that UK consumers will see negligible benefits from shale gas, but the producers will have potentially huge profits. The opposite has been the case in the USA. The Shale Gas boom has seen their wholesale gas price plummet, but this has hit profitability of the producers causing many out of production after just 2 or 3 years.

In conclusion – the economics are dodgey ofr the producers; the benefits to the consumer will be negligible; and we all know the environmental consequences will be dire. I strongly suspect that once we get past the speculative phase that tin-pot companies like Coastal Oil & Gas/UK Methane are ankle deep in at the moment, the serious players will realise that the whole escapade simply does not add up – especially on crowded little islands with passionate activists on their case every step of the way. They are not usually that stupid – unlike someone I could name:

A few other dimensions/perspectives can be found in this excellent piece from Damian Carrington:

http://www.guardian.co.uk/environment/damian-carrington-blog/2012/sep/28/shale-gas-fracking-uk-carbon-energy