See also FOI's reveal Lord Brown tried to water down fracking regulations
In all the light and heat (not least on these pages) about the impact of shale on bills one report is often quoted - a report by energy consultants Poyry on the impact of the Lancashire shale.
Also in this series:
Who owns the rights to drill in the UK?
Where are drilling licenses issued? and which seats are included?
What's happening in Balcombe (Part 1)?
FOI documents reveal how the regulations were made (Part 1)
Fracking and Naturally Occuring Radioactive Materials (NORM)
The report argued that shale gas could be economically useful in a range of ways - including balance of payments and receipts for the treasury, but it is what the authors said on bills which has been most debated - so we got in touch with them to get to the bottom of it.
First, the assumptions
First, it’s always good to start with the assumptions. Every report must make assumptions in order to answer a specific question. Poyry made four important assumptions, one of which came from Cuadrilla. All of them are fair, but also debatable, and it's important to make them clear.
Firstly it used estimates provided by Cuadrilla for shale gas production and their own estimates of global shale gas production, from their ‘central case’ in a report for Ofgem on the impact of shale gas. This case has been updated but has not, we’re told, significantly changed in this analysis.
That assumption is important because the impact of UK shale on wholesale prices will depend on the price sensitivity of the market as a whole. Poyry are assuming that a relatively tight gas market is relatively sensitive to any new sources of supply - or indeed - demand.
Then, for the UK, Poyry uses Cuadrillas production estimates which require an assumption about Geology.
Because the UK currently only has a ‘resource’ estimate for shale and because we do not yet know how much can actually be extracted, much less, how much can be extracted at a profit this is a ‘what if’ scenario based, presumably, on the kind of production Cuadrilla would like to see in it’s patch. That does not make it wrong, simply indicative.
There is, therefore, an important second assumption here - that shale gas in the UK can be produced at lower cost than the prevailing market cost at the time of production. Others such as Bloomberg, the IEA, the US Energy Information Agency and Ernst and Young have produced cost estimates for shale gas in Europe which generally range from below current prices to above them.
As Bloomberg put it “Our cost range of $7.10 to $12.20/MMBtu is similar to the range of market prices for natural gas seen in the UK during the course of 2012.This suggests that even proven shale gas resources in the UK might struggle to secure finance.” Cuadrilla and the Institute of Directors, on the other hand, expect the economics to be far more favorable.
Pöyry used its own cost estimates based on those given in the European Commission's JRC scientific and policy report published in 2012 to ensure that there was no bias in the cost assumptions compared to other gas sources. That estimate puts the cost of production between 32-76p/therm. The current gas price is around 65p/therm, a level which Poyry expect will continue or rise.
The future of shale gas therefore depends on a third assumption - that the global gas price will justify extraction in the UK. Poyry tend to forecast a rising gas price but not everyone does.
Navigant, in a report for DECC, produced a range of scenarios depending on the level of global gas production. In one scenario shale gas production in China makes the world’s largest economy almost independent in gas - shifting exports from the US and elsewhere to Europe and lowering prices.
Perhaps more interestingly the International Energy Agency (IEA) have forecast that global action to reduce the risk of serious climate change (to about 50%) would result in a lower gas price in Europe than we have today by 2030.
Even with a global switch from coal to gas the IEA predict the world has so much that the price will fall if we move to limit carbon emissions, they also argue over half of the world’s proven gas supplies should stay in the ground.
This stuff matters, as the IEA explains, because it means that relatively high cost investments in new oil and gas reserves risk becoming stranded. Not every well turns out to be economic, many don’t, just look at Exxon’s experience in Poland or Shell’s with US shale oil - economics is very much an assumption, not a given. However it is a slight tangent on this article - if the economics don't stack then that is because it cannot influence bills.
Two to four percent
The Poyry report concluded that, based on these assumptions production in Bowland basin would reduce wholesale gas prices in the UK by between 2 and 4% between 2020 and 2034.
That is to say that if UK shale gas meets around 21% of demand (the production assumption from Cuadrilla) in the 2030’s it will reduce gas prices by 2-4% compared to what what would happen in a ‘no UK shale’ case.
To extrapolate this to bills, it is also important to be careful with one’s assumptions.
First the Poyry report does not say that bills will fall by 2-4%, simply that gas prices will be 2-4% lower than they would otherwise be without shale gas. In it’s report for Ofgem Poyry’s central assumption was that gas prices would still rise, though that - of course - depends (see above).
Secondly Poyry assume, reasonably, that the 2-4% reduction will impact both on gas prices and on wholesale power prices, which are generally (though not always) set by the highest marginal cost of production, which is normally gas. Gas does not make up most of our power generation, or even the largest chunk (that is coal) but it has historically set the price.
What that means is that the wholesale power element of the bill will be reduced by 2-4% by gas between 2020 and 2035.
The wholesale gas/power element of an average dual fuel bill is just under half the total cost (£635), so a reduction of 2-4% is a reduction of £12-25 a year compared to what would otherwise have been the case.
That is to say an impact on bills (as opposed to prices) of between 0.8% and 1.7%. Bills will still be higher if global gas prices are higher and lower if they are lower.
But dates are important here. 2-4% of wholesale gas prices today will have a different impact on bills both in absolute and percentage terms to 2-4% of the wholesale price in 2020 and in 2030.
That’s because efforts to decarbonise the power sector could reduce (though not eliminate) the price setting role of gas (because so much of the power sector will be on fixed price ‘contracts for difference’) and efforts to improve home efficiency could reduce the overall importance of gas to bills. The former would affect electricity bills, the latter heating bills.
The Committee on Climate change have calculated the wholesale costs for consumers of electricity and gas will reduce by around £150 over the next 7 years, for example, although implementing this depends on their assumption that the costs of delivering renewables will be much lower in 2020 than they are today and the roll out of energy efficiency.
Indeed, reducing the exposure of households to changes in the price of gas is part of the point of the government’s energy reforms. A report by Oxford Economics for the Department of Energy and Climate change argued that decarbonising the power sector would reduce the impact of gas price volatility on bills by 50% by 2050.
On the other hand a scenario which assumes we merely switch from coal to gas, but that efforts on efficiency and renewables fail (despite established government policies), would see gas retain it’s importance to household bills.
There is also the question of the impact beyond Europe. Poyry assume the UK to be connected to a North Western European gas market, so you would expect the 2-4% impact on the wholesale gas price to translate to a reduction in that market, though this reduction would be mitigated by transportation costs.
Poyry calculated these impacts in their model - but didn’t publish them but it’s important to be clear, we are talking about the North Western gas market here, not Spain or Italy.
What does this mean for bills?
The study shows that based on Poyry’s model and Cuadrilla’s geological and economic assumptions the Lancashire shale will moderate gas prices by 2-4% and so have an impact on bills of 0.7 -1.8% if the production came on stream today though this may be reduced by 2030.
It doesn’t show it will put bills down on where they are now - because it doesn’t make that kind of prediction. Nor does it show that if we frack outside Lancashire there will, or won’t, be a greater impact.
Greater UK production than Cuadrilla forecast may lead to a greater impact - though not necessarily in a linear way. However it is worth noting that a report by the US Energy Information Agency (EIA) suggested most shale in the south of the UK is tight oil, not shale gas, so extrapolations about entirely different fossil fuels should be handled with some care.
If we assume the UK acts as advised to by it’s Independent climate advisors to decarbonise the power sector and improve efficiency the impact of a reduction in the wholesale cost of gas on bills would be lower - so below 0.7-1.8%.
It is not useful to extrapolate from this study to the impact of shale in Europe as a whole. Poyry’s ‘no shale’ scenario against which they make their comparison is a trifle misleading, meaning - as it does - no shale in the UK but shale in other countries. There is, therefore, no need to ‘imagine’ this impact, as Poyry have already modelled it to various scenarios. Their central scenario does not see EU prices falling if shale gas is developed.
Cuadrilla’s own PR man was recorded claiming the research showed the impact on bills would be “basically insignificant”, whilst Poyry have said shale gas will ‘not lead to a collapse in prices’. Both seem to us reasonable interpretations.
Others have suggested it shows that Lancashire shale, if extracted at scale, will have an impact on European gas prices and that the small impact on each bill - when multiplied by the number of consumers - amounts to a large amount of money, this is also true. It normally is and it’s a point Poyry themselves make.
Similar arguments could be made about the discovery of a new gas field in the North Sea. The South Morcambe field, for example, supplies 6% of the UK’s gas demand.
But above all the assumptions of the study should be remembered. This is not a study about, for example, whether we can extract shale gas or whether it is economic. It assumes those things and simply asks if we do - at a particular level - what will be the impact.
It is also not actually a study which answers the question 'What is the impact on bills?' - as that depends on multiple subsequent assumptions. The answer appears to be not a great deal, but it really does depend on your assumptions.
