Can the UK replicate US fracking success?

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Commodities - May 2013

Improvements in technology to unlock unconventional oil and gas sources locked in shale have triggered a so-called energy revolution in the US, where gas prices have dropped significantly. The UK now looks keen to follow in the US’s footsteps.

In his March Budget George Osborne, the chancellor of the exchequer, announced a series of proposals to support the fledgling UK shale gas industry, including a “new shale gas field allowance” and an extension of “the ring-fence expenditure supplement from six to 10 years for shale gas projects”.

In the past five years US natural gas production has risen 25 per cent, driven primarily by shale gas production. According to an IHS Global Insight report, shale gas currently accounts for approximately 37 per cent of total natural gas production in the US compared with just 2 per cent in 2000.

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Fracking uses a mixture of, primarily, sand and water and some chemicals to create pressure inside the drilling well that cracks rock and allows oil or gas to flow to the surface.

But concerns surround the significant amounts of water needed for the process. Furthermore, environmentalists have complained that the chemicals used in fracking contaminate groundwater and there is the suggestion that the process can lead to seismic complications.

The UK, which is still in the exploratory phase of shale gas drilling, only recently lifted a temporary moratorium on fracking following small earth tremors near Blackpool in April and May 2011 caused by drilling operations by Cuadrilla.

Frances Hudson, global thematic strategist at Standard Life Investments, says: “As a global phenomenon it is in the early stages. In the US it has changed the energy equation without a doubt. They don’t have energy security issues, so it has boosted the recovery prospects for the US.”

But she notes that the US’s shale gas companies are not necessarily making a profit; instead the beneficiaries are the big energy consumers such as the petrochemical companies.

Eric Gordon, energy analyst at Brown Advisory, adds: “It would be easy to assume that more oil would lead to more profits for oil companies and, in turn, higher returns for investors. That theory held true in 2010 but fell apart during 2011 and 2012 when the US oil-delivery supply chain drowned under the surge in production.”

Mr Gordon says the key lesson the UK could learn from the US relates to infrastructure. “To sustain increased production, the infrastructure needs to be in place,” he says. “From the producers that discover and develop prospects and sell the raw product to the refiners that take the commodity and convert it to marketable products.”

But Poppy Allonby, co-manager of the BGF World Energy and BGF New Energy funds and the BlackRock New Energy Technology trust, points out that while the UK might have the right geology to allow the economic exploitation of these resources, that may not be enough to guarantee success.

She explains: “The US also had a number of other things going for it. One, landowners shared in the industry’s success [landowners earn a royalty that is not the case in the UK] – this incentivised development of these assets. Two, there is an established, well-funded and flourishing independent exploration and production sector that drove the initial investments in shale. Three, there is an established and extremely well equipped oil service industry. Four, there is existing infrastructure, and five, the US had a history of onshore oil production.