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UK leads Europe’s shale pack

Government backing, generous tax breaks and world-class reserves should make the UK a major unconventional gas producer

After a difficult beginning, the UK’s shale-gas sector has emerged as the most attractive place in Europe to invest. Strong government support and eye-popping reserve estimates have underpinned the change in fortunes. Still, if they are to thrive, drillers will have to convince the public and local planning committees to tolerate hydraulic fracturing.

There are certainly few doubts about the geological potential. A recent study by the British Geological Survey (BGS) claims the UK’s Bowland basin, in northwest England, could hold a vast shale-gas resource of as much as 2,281 trillion cubic feet (cf). By comparison, the UK’s conventional gas reserves stand at just 8.7 trillion cf, according to Cedigaz.

Cuadrilla Resources, one of the firms hoping to drill the reserves, reckons there could be 200 trillion cf of gas even within its Bowland licence alone. “Those are world-record numbers,” Andrew Quarles, Cuadrilla’s exploration director, told Petroleum Economist.

The quality of the resource is also high. Quarles says the energy density is “huge”, and the shales are 1,000 metres thick or more – about five times thicker even than the shales of the Eagle Ford and Barnett, two US shale plays that have been a bedrock of that country’s recent energy revival. “It’s going to get a lot of attention from a lot of people,” says Quarles.

But above-ground conditions are spurring just as much enthusiasm. A robust regulatory regime, strong government support and existing infrastructure make a compelling combination when you throw in the vast resource potential, says John Blaymires, chief operating officer at IGas, another hopeful driller. “The advantage we have there is infrastructure, a market and a high gas price,” Blaymires says. “So you’ll have a high cost base initially but that will be supported by a high gas price.” The difficulty, he confesses, will be around the “socio-economic aspects” of drilling. “The real issue is how to unlock it at a local level.”

The story on that front has been mixed so far. In 2011, the UK government placed a moratorium on fracking after Cuadrilla’s drilling caused two small earth tremors near Blackpool, a coastal resort in England’s northwest. The moratorium was formally lifted last year, but further exploration was put on hold for 18 months while the UK government carried out environmental impact studies and parliament debated the merits of shale gas.

Fracking’s favour

Since then, things have shifted back in the sector’s favour. UK domestic gas production is at its lowest level in fourteen years, North Sea reserves continue to decline and soaring retail energy costs – average household bills have risen by 40% in the past three years alone – have made their own case for shale-gas supplies.

Without it, UK gas production, which fell by 14% last year to 40.9 million tonnes of oil equivalent amid rapid decline in the North Sea, is likely to keep tumbling. It brings worries about energy security. Years of renewable energy subsidies, meanwhile, have added to the energy cost inflation, while doing little to improve the supply outlook.

UK natural gas supply and consumption

Supporters say shale offers the best solution. Production could bring other benefits, too, supporting a value-added petrochemicals sector, as well as providing jobs and tax revenue.

In the US cheap gas feedstock has spurred a surge in the country’s petrochemicals industry, offering a marked contrast to the UK’s downstream. In October, the 200,000 b/d Grangemouth refinery and petrochemicals plant in Scotland almost closed, partly because it struggled to compete with cheaper operating costs in the US. “At Grangemouth they wanted to invest in a terminal to import US ethane from shale gas,” notes Quarles. “We hope we can have a positive impact on that.”

Another positive shift has come from London in the shape of tax breaks. The government plans to cut corporation tax from 22% now to 21% next year and to 20% in 2015. New shale-gas projects could also be eligible for funding of up to £3 billion ($4.5 billion) as part of a major infrastructure regulation overhaul starting in 2015.

That amendment would extend the so-called ring-fence expenditure supplement, the amount by which companies can offset expenditure against losses, from six to 10 years for shale-gas projects. The government was to release more details on 5 December.

The fiscal push seems to be working. Proving the commerciality of UK shale will take some time – but juicy tax breaks and supportive signals from the government have helped to lower investment risks.

This is encouraging bigger players to swoop in, part of a process that should help speed development. In June, Centrica bought a 25% stake in Cuadrilla Resources’ shale-gas acreage in Lancashire. In October, GDF Suez signed an agreement with Dart Energy to buy a 25% stake in 13 licences located in Cheshire and the East Midlands, overlying the Bowland Shale. “In the UK the thing they’ve done that’s been really helpful is on the tax side providing incentives,” says Kamlesh Parmar, chief executive of 3Legs Resources, another shale-gas focused firm. “What industry really needs is an incentive to spend more money. The UK has done very well with that approach.”

Public support

The government has also pledged community benefits as a sweetener to get the public to support the developments. In the US, private landowners can negotiate directly with drillers seeking access to their lands – a process that has made some acreage holders in shale sweet spots wealthy.

But land-ownership rules are different in the UK, where most of the land is in the hands of the crown. To get around this, the government proposed that drillers hand local communities £100,000 per fracked well and 1% of revenues once production starts.

That could amount to a lot of cash. But Cuadrilla, for one, has endorsed the plan, saying it is “right” that locals reap the benefits. That is sensible, because shale drillers still need to win over a suspicious public, and an array of issues could still stymie plans. The companies will have to satisfy planning officers that the shale can be extracted without damaging the environment.

The UK is densely populated, too. So negotiating access to drilling sites will need some patience. Opponents also worry about truck noise and the destruction of the landscape. The firms will need to show they can frack away without doing much of either.

Although UK bureaucracy doesn’t plumb the depths of some countries, red tape will still present a hurdle. Prospective developers often need nine or 10 permits from different government agencies before drilling can start. Operators may also have to carry out an environmental impact assessment for sites to gain approval even though it is not a legal requirement.

Despite prime minister David Cameron’s public backing for shale gas, local poobahs will hold just as much sway over the approvals process. “There’s a difference between what the government approves and what the planning committee approves,” Hamish McArdle, an energy lawyer at Baker Botts, told Petroleum Economist. “People on the planning committees have to answer to their constituents and they will want to see it. Cuadrilla’s attempts to be more transparent have set a precedent for other companies.” He added that potential delays to drilling operations, whether from anti-shale protests or at a local planning level, could add around 5% to a company’s drilling costs.

The rest of Europe, where pockets of shale promise have yet to yield any development, will be watching all this. Success in the UK, believes Blaymires, will be a catalyst for other European countries to speed up their own shale exploration. “If the UK can demonstrate it can be done safely and environmentally responsibly I think Poland will adjust its fiscal terms and that will encourage more investment. It will put enormous pressure on France and Germany to lift the moratoriums,” Blaymires says. McArdle added: “If other countries start to see it getting a competitive advantage, due to cheaper fuel, that will hit home.”

Whether full-blown shale-gas output will deliver cheaper energy – a key plank of the government’s argument in support of it – remains unknown, however. “I think it would be misleading to say we can bring prices down,” says Blaymires.

More likely is that shale gas puts a cap on those prices, he thinks. Cuadrilla’s Quarles isn’t promising cheap gas either. Rather, the main benefits for the UK will come in tax revenue, jobs and balance of payments.

A recent study by Deloitte, an accountancy, claimed that shale-gas production from the UK’s Bowland basin alone could reach 297 billion cf per year (cf/y) by 2020, cutting the country’s imports by 14% over the next seven years. But with UK gas demand forecasts of 2.8 trillion to 3.5 trillion cf/y by 2020, shale-gas output is unlikely to put much pressure on gas prices. What it could do is reduce the UK’s gas-import bill and free up some supplies of liquefied natural gas for the rest of Europe. 

Investor’s guide to UK shale

Promising acreage:

• The British Geological Survey (BGS) estimates shale-gas reserves in the Bowland Shale formation, the area between Wrexham and Blackpool in England’s west, and Nottingham and Scarborough, in the east, range from 822 trillion cf to 2,281 trillion cf;

• Dart Energy holds 14 licences in the Bowland Basin and estimates gas in place of 110 trillion cf;

• Cuadrilla Resources says there could be 200 trillion cf of shale gas beneath just two wells in its Bowland basin acreage;

• IGas says its licence area in northwest England could hold over 170 trillion cf of shale gas;

• The BGS is working on a study of the Weald Basin in Southern England. IGas says it could contain shale oil as well as shale gas;

• The UK could also have vast offshore shale-gas reserves but very few studies have been done. The BGS has offered “a tentative resource estimate” of 1,000 trillion cf for the east Irish Sea basin alone; and

• In January 2014 the UK government will detail which new blocks will be on offer in the next oil and gas licensing round. It is expected to issue new onshore licence regulations specifically for shale gas.

Land access:

• Under UK planning law operators must obtain a licence from the crown and inform landowners of their intention to drill under their land even at depths of 800-2,800 feet;

• UK landowners have no rights to the oil or gas under their land but access rights have to be negotiated with landowners;

• Drillers need landowners’ permission if horizontal wells pass beneath their land or they risk being liable for trespass;

• Activist group Greenpeace has been trying to exploit this land-ownership loophole by launching a legal block on fracking in the UK. The UK government is in discussions with drilling companies to close the loophole; and

• It has suggested that drillers offer local communities £100,000 per well fracked and 1% of revenues to garner support for shale gas development.

UK drilling license application process:

• The UK’s Department of Energy and Climate Change (Decc) auctions acreage in licence rounds granting exclusivity to operators in the licence area. However the licences do not give consent for drilling or any other operations;

• When an operator wants to drill an exploration well, it must negotiate access with landowners for the drilling-pad area and the surface under which any drilling extends. Permission must also be obtained from the Coal Authority if the well encroaches on coal seams;

• Then the operator needs to seek planning permission from the Minerals Planning Authority (MPA) or the local planning authority in Scotland. The operator must obtain the appropriate environmental authorisation permit from the Environment Agency (EA) in England, Natural Resources Wales (NRW), or the Scottish Environment Protection Agency (SEPA) in Scotland;

• The MPA will determine if an environmental impact assessment (EIA) is needed;

• If an EIA is needed it must be completed by the applicant and submitted to the MPA before it decides on planning permission;

• An environmental permit from the appropriate environmental regulator may also be needed. At least 21 days before drilling is planned, the HSE must be notified of the well design and operation plans to ensure that major accident hazard risks to people from the well and well-related activities are properly controlled;

• HSE regulations also require examination of the well design and construction by an independent person;

• Notification of an intention to drill has to be served on the EA under S199 of the Water Resources Act, 1991;

• Decc will check that the EA, SEPA and HSE have no objections before allowing drilling operations. If fracking is intended, Decc will require a fracking plan to mitigate the risk of induced seismicity. It will review this plan before these operations are permitted;

• If the operator wishes to drill an appraisal well or start production operations, it must start again with the process described above; the landowner’s permissions and planning consent, which may require an EIA, EA, NRW or SEPA consultation and HSE notification, and finally a decision from Decc; and

• The Office of Unconventional Gas and Oil (OUGO) has been set up to co-ordinate all the UK regulatory bodies and departments. OUGO aims to devise regulation which encourages growth whilst protecting the environment.

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