FW moderates a discussion focussing on shale gas in the UK between Elizabeth Shepherd, an environment partner at Eversheds, Robert Hodges, a director at EY, and Nick Grealy, director of No Hot Air.
FW: The UK shale gas market has received plenty of media coverage in recent months. What are the prevailing issues surrounding general activity and development in the sector?
Shepherd: Current drilling activity remains constrained due to the need to navigate the still novel hurdles presented by environmental, planning and permitting regulation and public order issues. This inevitably slows development, although the authorities are taking steps to make the process more transparent and user friendly. At the same time, we are seeing high levels of activity preparing for the 14th licensing round and a number of high profile farm-ins to existing licences have recently occurred.
Grealy: Geologists are very confident that the resources are extremely prospective. But we can’t talk the gas and oil out of the ground, we need to explore for it. The UK government has turned around completely at the national level, but this has to be translated into local action. The number one issue is planning. The government has to walk the talk and allow people permission to carry out exploration to confirm flows. If the present system is allowed to continue, I would recommend against putting even a penny into the sector, given the multi-year wait.
Hodges: The UK shale gas industry is still at an early stage of development. Companies that are investing in the sector need to appraise the quality of the shale in the UK to determine if the safe production of shale gas will be commercially viable. Progress has been slower than anticipated and only a handful of exploration wells have been drilled so far. As mentioned, this is largely the result of the lengthy planning and permitting process that companies need to follow before exploration work can begin. In addition to planning and permitting, there are a number of factors that will influence the eventual speed of development and evolution of the industry. These range from macro issues, such as the regulatory and fiscal regime, social acceptance and supply chain capability, through to technical issues relating to geology and the results of exploration activity. Ultimately, however, it will be the economic viability of projects that will determine the pace of development. Activity will accelerate if it is demonstrated that shale gas in the UK can flow at rates that make it economic.
FW: What steps has the UK government taken to encourage the development of the shale gas market? What affect do you believe the new government tax allowances will have on future activity?
Grealy: The tax allowances aren’t important, and I’m not sure that any one asked for them. It’s planning, planning, planning. We’re asked to wait literally years to drill even the simplest borehole which would take less than a week to actually drill.
Hodges: I disagree with this - a significant amount of capital is needed to establish the commercial viability of shale gas in the UK. By reducing the level of tax payable on early profits, the proposed onshore allowance will increase a company’s after-tax return on capital investment. The allowance should therefore influence decision-makers when they are considering committing exploration and appraisal costs during this nascent phase of the industry. Investors will draw confidence from this move and the broader support that the UK government has demonstrated for the industry. The Office of Unconventional Gas and Oil has been established to coordinate regulatory effort. Planning guidance has been issued that clarifies the interaction of the planning process with the environmental and safety consenting regimes.
Shepherd: The government has continuously and publicly reaffirmed its commitment to shale gas exploration and exploitation. By bringing in a tax regime that is regarded as the most generous in the world, investment in the UK has clearly been incentivised. It is however worth noting that there is widespread mis-reporting by the media of the practical operation of the tax allowances as an across the board lowering of the industry’s corporation tax rate. The UK government has also focused on clarifying the shale gas regulatory regime and, in December 2013, produced a Regulatory Roadmap as a “first point of reference” for those interested in shale gas development.
FW: What impact do you predict the recent Strategic Environmental Assessment (SEA) report – including its draft licensing plan and zoning permits – will have on the shale gas market?
Grealy: The question is whether we need to have a SEA for each well or well pad. If so, I think a more profitable return would be to take several million pounds and bury it in a hole in the ground. Assuming of course, one could get planning permission to do so.
Shepherd: The draft licensing plan offers licences that cover more than 37,000 square miles of currently unlicensed areas, resulting in greater scope for investigation and development of shale resource. The combination of growing knowledge about a greater shale potential and improving technology is resulting in increased interest in the 14th licensing round. The SEA report should narrow the scope for challenge as individual schemes are progressed, but care will be needed to ensure compliance with the strategic assessment.
Hodges: Consultation on the SEA report represents an important milestone ahead of the next UK oil and gas onshore licensing round expected later this year. The report provides scenarios which show how shale gas can have a positive impact for UK economy. It also considers the likely significant effects on the environment of the licensing proposals. It plays an important role in establishing the social licence to operate for the shale industry in the UK. The opening of additional onshore acreage for oil and gas exploration could pave the way for further study of the country’s shale resources. This might mean that the resource potential and commercial viability of shale extraction in the UK could be confirmed more quickly. However, the award of a licence does not confer the right to start drilling. Companies would still need to apply for the necessary permissions before beginning exploration activity.
FW: Environmental concerns are a major cause of opposition to shale gas exploration and extraction. In what ways are shale gas operators addressing general criticisms, environmental issues and safety concerns?
Shepherd: Industry acknowledges that the development of any shale reserves must be undertaken in an environmentally and socially responsible way, and many of the guidelines included in the Recommendation recently issued by the European Commission reflect established industry good practice. Industry also recognises that the best way to address criticisms and concerns is to provide the facts necessary for people to develop a true understanding of shale gas exploration and extraction. This includes the community engagement which is actively pursued by shale gas operators, and dissemination of information relating to operations. For example, industry promotes voluntary public disclosure of the substances in hydraulic fracturing fluid on a well-by-well basis in the EU on the website NGS Facts. Members of the public can search for well sites that have been hydraulically fractured and find out what substances were used in the fracturing fluid.
Hodges: I agree. Shale gas operators must be focused on their environmental and legal obligations as well as their stakeholder communication strategy – managing the relationships with local communities is particularly important. The government and shale operators have important roles to play in helping the public understand the risks and benefits of shale gas development, and local residents need to be reassured about the safety of shale exploration. UKOOG has developed a community engagement charter for its members, which provides a robust framework for shale operators working alongside local communities. Innovation and advances in technology throughout the supply chain are also helping to reduce the environmental impact of shale gas operations. Innovations such as single pad drilling, where multiple wells can be drilled from one pad, will help reduce the surface footprint of shale development. Research is also being directed at ways to find new, more environmentally conscious types of drilling fluids, as well as to recycle drilling waste and flowback water. We are also starting to see increased use of natural gas as a fuel in drilling operations, displacing some diesel fuel, with significant emissions benefits.
Grealy: Public information campaigns at the local level are effective. The number one response from locals is often “Is that all there is to it?” But we have a national press constantly looking to create ‘controversy’ where none exists. UK journalists generally don’t have the time or knowledge to investigate or research, and feel their readers, even in the alleged ‘quality’ press, can’t understand science that takes more than two sentences. But UK journalists at all levels, predominantly rely on cheat sheets and PR releases from a huge army of environmental ‘activists’ who are not interested in cutting carbon, but talking about it or pushing their technology. If the government realised that few outside of Whitehall take newspapers seriously any more, it would solve a lot of problems. Having said that, it is notable that the debate does change when we get on the business and politics pages and out of the energy and environment ghetto.
FW: How have developments in the shale gas space impacted upon the conventional energy market in the UK? What contribution do you expect shale gas to make to the UK energy mix as the industry becomes more established?
Hodges: Gas plays an important role in the UK energy mix, both as a fuel for power generation and for domestic heating purposes. Indigenous North Sea production has been in decline for the last ten years, resulting in the UK becoming a net gas importer. Domestic shale gas resources, if they can be developed cost effectively, could help compensate for this decline in the longer-term. Technology is not at a standstill and new technologies will be developed as the industry matures. This will boost output by lowering the cost of shale gas extraction and improve the efficiency of development and production activities. Production from domestic shale gas resources is unlikely to make the UK energy self sufficient but it will help diversify the supplier base and could be a key contributor to UK consumption.
Grealy: Prices have already stabilised, and once US LNG starts to spill into world markets next year, we’ll see at least a potential for lower prices. One thing is certain: European wholesale prices won’t go up from present levels. Ever. As regards the impact, it’s not so much a matter of how much gas do we have, but how much do you want?
Shepherd: Shale gas has not yet been extracted in commercial volumes in Europe and the US has not yet started exports of shale gas in high volumes. As a result, the conventional energy market in the UK has not been obviously impacted, with oil prices remaining largely stable over the last three years and gas prices continuing on a slight upward gradient. If confidence grows that shale gas will take off in the UK there is the potential for downward pressure on future pricing. However, gas demand may also increase as gas fired electricity generating stations are seen as a natural complement to intermittent generation from onshore and offshore wind.
FW: Shale gas has become an economic success story in the US. Do you believe that the same levels of success can be replicated in the UK? Which areas of the country are poised to provide lucrative returns for operators and investors?
Grealy: The success of the US can only be replicated if we want it, and only if we decide what outcome is desirable and how quickly we want it. If the present planning system continues, we’ll probably see shale gas from France and Ireland before the UK. The macro economic impact is important, but again, the government appears happier to sooner abolish the monarchy than change the planning system, so any benefits are academic.
Shepherd: It is often stated that the UK is very different from the US – there are differences in geology, population density and mineral property rights. The first two of these differences may, to a large extent, be reduced over time by improving technology and the third can be addressed by appropriate remuneration strategies for local landowners and communities. A further, and significant differential is the relative costs of drilling and availability of drilling rigs between the two jurisdictions.
Hodges: Building on these points, in the US there was a unique combination of factors that supported the rapid growth of the shale industry. These facilitators are not present in the same combination in any other country. It will take time to develop sufficient depth in the UK onshore supply chain. Additionally, the UK is closely integrated with other energy markets across Europe and so shale gas development is unlikely to have as dramatic impact on UK gas prices. The British Geological Survey (BGS) estimates that the total volume of gas in place in the Bowland shale in northern England is approximately 1300 trillion cubic feet. This assessment of shale gas resources suggests that the Bowland Shale could be the largest and most attractive onshore UK shale basin. However, further exploration and appraisal activity is needed to determine the extent to which the gas will flow and whether it will be commercial to produce.
FW: The EU recently stopped short of introducing regulation on fracking, although it did produce a number of non-binding ‘recommendations’ concerning environmental impacts. To what extent do you believe the industry will commit to these recommendations?
Shepherd: While the recommendations are not binding, their efficacy and application will be reviewed in 18 months’ time and the creation of binding legislation will be considered again at that time. It is therefore in industry’s best interests to commit to and apply the recommendations, as the alternative is the potential inflexibility and delay of binding legislation. It should be noted that the recommendations are broadly similar to already existing guidance such as the UK Onshore Operators Group (UKOOG) Guidelines, and DECC’s Onshore Oil and Gas Exploration in the UK: Regulation and Best Practice Roadmap. The potential for binding legislation and the fact that the recommendations do not stray far from already existing, and accepted, guidance suggests that the industry can and will commit to the recommendations.
Hodges: Individual countries have interpreted EU environmental legislation in different ways and some are developing specific rules covering shale development. The EU recommendations should provide a level playing field for operators across member states that choose to develop unconventional resources. The UK already has an established and robust regulatory and oversight regime in place to ensure that exploration and production activities are conducted in a way that safeguards the environment and public health. In many cases the provisions of the UK regime go beyond what is required under the minimum EU recommendations. As mentioned, UKOOG and DECC have both published guidelines covering best practise for shale well operations in the UK and I agree that adherence to these industry leading standards is critical in preserving a company’s social licence to operate.
Grealy: The industry would probably prefer stronger regulation to weaker. The gas industry overall welcomes carbon targets and thinks we can help not only meet 2030 targets but to exceed them. We don’t think technology targets help, as we see from the success of coal in Germany based on renewable subsidy.
FW: Overall, what key issues should operators and investors consider before committing to the UK shale gas space?
Hodges: Public acceptance will be one of the key enablers of shale gas exploration and production in the UK. Higher population density means that close engagement with communities is required and this will add to the lead time required before projects can go-ahead. A stable regulatory and fiscal regime, particularly during the high cost exploration phase, is also an important consideration for potential investors in the UK shale gas industry. The industry needs to work with the government and relevant authorities to ensure that proposed regulation is fit for purpose. Given the upfront costs and risks involved, access to capital is critical. The tax regime is one factor here and that is where the onshore allowance and government’s wider signalling will play an important part. Companies may also want to consider partnering with players that have experience in the shale space or are able to fund work programmes.
Grealy: If it’s only about money, there are a huge range of opportunities worldwide. The UK may well miss the boat and by the time anyone got permission to drill in the UK, we would be swamped by cheap imports of gas from multiple locations. So we’ll get the benefit of low gas prices and supply security, but we’ll continue to export money to others. It’s like importing bread or eggs. Why should we do it? The answer appears to be that job preservation in the planning system is more important than anything else. Finally, everyone thinks this is about gas. It’s also about oil, and maybe even greater than gas in some parts of the UK. We could have several hundred thousand barrels of oil produced in the UK too. But that isn’t a good story for Greenpeace and Fiends of the Earth, so journalists ignore it, despite the macro implications of almost wiping out the current account deficit, geo politics, and so on.
Shepherd: Consideration of the length of time development of shale gas will take is important before commitment is made. Operators and investors need to give careful thought to the need for flexibility and change because the planning system isn’t designed to accommodate the dynamic requirements of the oil and gas industry. The regulatory and permitting requirements remain cumbersome but we expect this to improve over time with the goodwill of the government behind it. A unique opportunity presents itself for potential operators to help shape the regulations on a practical level.
Elizabeth Shepherd is environment partner at Eversheds. She advises operators, service companies and others in the shale gas value chain on current regulation concerning shale gas, as well as developments across the EU or in specific Member States which will inform their shale strategy. She is closely involved with industry initiatives, including NGS Facts, the template for public disclosure of chemicals used in hydraulic fracturing on a well by well basis. She also works with Shale Gas Europe on issues affecting stakeholder and public perception of shale gas across the EU. Ms Shepherd can be contacted on +44 (0)845 497 8215 or by email firstname.lastname@example.org.
Robert Hodges is a director in EY’s Energy tax team in London. Mr Hodges has over 13 years’ experience advising clients on UK and international taxation with a particular focus on the oil and gas sector. He has recently been advising early investors in UK shale in relation to their investments, future plans, and the Government’s consultation on the introduction of the onshore tax allowance. Mr Hodges can be contacted on +44 (0) 20 7951 7205 or by email: email@example.com.
Nick Grealy is director of the energy consultancy No Hot Air. A graduate of New York University, Mr Grealy’s US-based career included working for utility Con Edison, Chase Manhattan Bank North African Finance and the City of New York Home Energy Assistance Program. On returning to the UK he started a career in the UK energy industry at London Electricity, Total Gas Marketing, Energy Quote and Utilities Specialist for the Department of Health. Today he is one of the leading advocates of shale gas in Europe, and has appeared in front of UK Parliamentary Committees to discuss the topic. Mr Grealy can be contacted on +44 (0)7818 640 211 or by email: firstname.lastname@example.org.
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