Interactive Investor

Is the UK set for a shale gas revolution?

30th July 2013 09:39

Julie Fisher from interactive investor


Share on

Shale gas has hit the headlines recently, with the discovery of a potential 1,300 trillion cubic feet (tcf) of gas in north-west England spurring talk of the UK mimicking the US shale boom.

But who would be the winners and losers of such a boom and how can investors cash in on it?

What is shale gas?

This is gas trapped between layers of shale rock, which, as Miton Group fund manager George Godber explains, was unavailable to us until "technology altered the outlook".

Extraction takes place by means of horizontal drilling and hydraulic fracturing - also known as fracking. The process involves drilling down into the rock, turning the drillbit sideways and forcing water, sand and chemicals into the wellbore to create small fractures in the shale through which the trapped gas can escape.

The benefits

One of the main benefits of shale gas is a plentiful supply of cheap gas for the countries in which it is found.

The Department of Energy and Climate Change's fossil fuel price projections, published on 17 July, predicts successful exploitation of shale gas could lower UK gas prices by more than 25% by 2030.

"Low-cost energy revolutionises countries," says Godber, adding that a cheaper gas price could have a huge impact on energy bills for households and businesses alike.

He also points to the possibility of "an enormous employment boom", not just in the areas surrounding the shale gas licences, but also in companies which provide drilling technology and engineering services.

The risks

The main issues raised in connection with shale drilling are environmental.

There are concerns the chemicals used in fracking could end up in the water table, and that the process increases the probability of earthquakes.

"Any form of energy has risks versus rewards."

For instance, UK-based fracking company Cuadrilla Resources had to cease operations in Lancashire for 18 months while connections between fracking and earthquakes were investigated, but VSA Capital analyst Malcolm Graham-Wood dismisses the tremor, which had a magnitude of less than one on the Richter scale [classifying it as a 'micro' earthquake], as being similar to "a bus or a lorry passing".

Godber echoes this sentiment, adding: "Any form of energy has risks versus rewards."

US shale revolution

Shale gas first gained importance in the US when the Department of Energy subsidised the development of horizontal drilling in Texas in the early 1990s. Between 1996 and 2006 shale gas production in the US tripled and by 2008 the New York Times was reporting a "gas rush", as companies scrambled to get involved in its extraction.

According to the Energy Information Administration Agency of the Department of Energy, the US now has 665 tcf in estimated recoverable resources. Only China, Argentina and Algeria have larger shale gas reserves.

And this has had a material impact on the energy market.

"The US has gone from being the biggest energy importer in the world to being almost entirely self-sufficient in energy," says Godber.

In fact, the US has so much shale gas that its natural gas prices fell to a 10-year low of less than $2 (£1.31) per million British thermal units (mBtu) in 2012, down from more than $15 per mBtu in 2005.

"Just five years ago we were talking about importing [liquefied natural gas] and bringing that in from overseas and now [the US is] looking at self sufficiency for the next 100 years in natural gas," says Peter Brett, the manager of Royal Dutch Shell's onshore well operations in the US.

Can the UK replicate the US experience?

The British Geological Survey estimated in June that the UK has 1,300 tcf of shale gas reserves.

Put into context, that is twice the size of US reserves; and just 10% of this would be enough to meet the gas needs of the UK for more than 40 years. The UK currently imports 80% of its gas.

A recent report published by the Institute of Directors estimated that investment in shale could peak at £3.7 billion a year, supporting 74,000 jobs. A boom could also "generate significant tax revenue" for the government.

Corin Taylor, the report's author, says: "Shale gas could be a new North Sea for Britain, creating tens of thousands of jobs, supporting our manufacturers and reducing gas imports."

But the potential problem is not with the existence of the reserves, but whether they can be accessed. Jan Stuart, head of energy reserves at Credit Suisse in New York, explains that extracting shale gas "is not as straightforward in many parts of the world as it has proved to be in the US".

"Shale gas could be a new North Sea for Britain, creating tens of thousands of jobs, supporting our manufacturers and reducing gas imports."

The US was a big oil producer before the shale boom and as such, already had the infrastructure to exploit its shale resources. It also has a low population density in big shale sites such as Texas and North Dakota.

According to US census data, Texas had a population density of 96.3 people per square mile in 2012, while North Dakota had just 10 per square mile.

In contrast, in the areas surrounding the shale gas licences in north-west England, the Office for National Statistics estimates that there are over 1,300 people per square mile. Therefore any negative effects of shale gas drilling, including potential contamination of water and earth tremors, would affect far more people in the UK than they have in the US.

There has been little detail as to what the consequences for homeowners in areas surrounding shale gas licences might be, but the Petroleum Act 1998 allows for compulsory purchase of land in order to drill for oil and gas. If production takes off, people could also be relocated to make way for new infrastructure.

The World Energy Council also suggested in a 2010 report that European shale gas reserves are likely to be deeper than those in the US, making them more costly and difficult to access.

However, Chancellor George Osborne recently announced plans to cut the tax on shale production to 30% from 62%, in an attempt to encourage the extraction of shale gas. This tax cut will significantly reduce costs for the companies involved, allowing for investment in the necessary infrastructure.

Firms had hopes of a UK shale boom even before Osborne stepped in. On 3 June, for example, IGas Energy announced a 172.3 tcf shale gas discovery that it said had the "potential to transform the company and materially benefit the communities in which we operate".

Ten days after IGas's announcement, Centrica purchased a 25% stake in the Bowland exploration licence in north-west England. Mark Hanafin, managing director of Centrica's international upstream business, explained: "With North Sea gas reserves declining and the UK becoming more dependent on imported gas supplies, it is important that we look for opportunities to develop domestic gas resources, to provide affordable sources of gas to our customers and to develop broader economic benefits to the UK."

How to trade

Graham-Wood says his most important advice to anyone unsure about investing is: "If you think [a shale boom] might happen you've got to have a go at it."

For him the "obvious" investment opportunities on the London Stock Exchange are IGas and Centrica. He is backed up by Harold Hutchinson, an analyst at Investec, who agrees Centrica is a definite 'buy', describing shale gas as "a very interesting option for them".

A less obvious play is Alkane Energy, a British energy company with its main portfolio in coal mine methane sites. But, according to Graham-Wood, "it also has shale acreage which it will have to do something with in due course".

  Current share price (p) 52-week low (p) 52-week high (p) Price/earnings ratio (x)
IGas Energy 121.25 65.30 154.70 -11.25
Centrica 377.20 308.80 395.41 15.39
Alkane Energy 37.99 18.33 41.40 17.55

Get more news and expert articles direct to your inbox

Sign up for a free research account to get the latest news and discussion, and create your own virtual portfolio.

Free Sign Up