As protests grow against fracking in the UK and elsewhere in Europe, should investors be concerned?

A detailed look at the complex debates around hydraulic fracturing.

The recent high profile protests in Balcombe, West Sussex, in the UK have seriously raised public awareness of hydraulic fracturing, or “fracking”. Local residents and environmental activists have been shown in the media holding up euphemistic banners such as “Get the frack off our land” near the entrance to a test drilling site by Cuadrilla, the UK gas company that owns licences to prospect around the country. But in fact the fracking process has been used in the UK’s oil and gas industries for many years. So what has changed, and should investors be concerned about it now? Shale fracking and fracking are actually two different activities. The latter generally results in no more than the arrival of fairly familiar ‘nodding donkey’ well pumps on the landscape. But local communities are becoming concerned that drilling for oil in the UK could start to resemble the scale of operations seen in the US, where there is widespread fracking for shale gas; 25,000 wells are being drilled in America every year to be fracked. In comparison, there are just over 2,150 inland wells in the UK and according to the Department of Energy and Climate Change, around 200 of these have been fracked. Fracking has revolutionised the US energy market and the energy industry is anticipating a similar transformation in the UK. Gas and oil discoveries in shale rock in the US have given rise to a boom in gas and oil production and have dramatically reduced gas prices. The International Energy Agency (IEA) estimates that the US will overtake Russia as the world’s biggest gas producer by 2015, and Saudi Arabia as the world’s biggest oil producer by 2020. In the UK, fracking has been used historically to crack rock to maintain production and has occurred on a small scale, but there is now the possibility of a significant expansionin the amount of drilling and fracking. Until recently, fracking for shale gas would not have been economically viable, but changes in technology have potentially made it cost effective. A significant development has been horizontal drilling which means firms are able to access a larger area. Cuadrilla has already drilled wells in Lancashire in the north of the UK and calculates it has 200 trillion cubic feet of gas in the Bowland Shale licence area. This suggests the overall volume for the region may be more than 400-500 trillion cubic feet in total. UK firm IGas says there could be up to 170 trillion cubic feet of gas in the areas it is licensed to explore in northern England. The UK’s annual gas consumption is 3 trillion cubic feet, so there is a long-term potential benefit for investors that are willing to embrace this technology. Despite this, fracking remains controversial, as the recent protests have shown. It has been blamed for causing earth tremors and there are concerns about water contamination, property insurance coverage and the large volumes of water required. Friends of the Earth described fracking as “dirty and unnecessary”, arguing that the UK should focus on investing in renewable energy. UK scientists have carried out research into quakes caused by human activity ranging from mining to oil drilling; only three could be attributed to hydraulic fracturing. Most fracking events released the same amount of energy as “jumping off a ladder”. The integrity of well bores drilled for fracking is of much greater concern, with some potential for leaks. The amount of gas that can be extracted will become clearer once a significant number of wells have been drilled and gas flow rates tested. In a report published earlier this year, the Energy and Climate Change Committee
cast doubt on the value of shale gas extraction. Although it argued that shale gas in the UK could help secure domestic energy supplies, it also warned that it may not reduce prices. The shale gas industry is in its infancy in the UK and significant investments in the equipment and infrastructure needed to make it viable will be required. The UK’s shale gas developers will face technological uncertainties too with different regional geologies to contend with. And public opinion may also be more sceptical. The UK is a more densely populated landscape than the US and shale gas operations will be closer to urban and village areas as a consequence. Operators may have to overcome potentially tighter regulations. The extent of recoverable resources in the UK is also unknown, so it is too soon to say whether shale gas will achieve US-style levels of success. That said, when looking at the effect on the likely direction of energy policy, the UK would need to increase its nuclear capacity four-fold or its wind energy 20-fold to decarbonise heavy industry. Both these targets appear to be some way off, so the government is most likely to continue to give gas a central role in its energy strategy. Successful investment in shale gas will reduce dependence on imports and increase tax revenues, but there is a downside. If it takes off, shale gas emissions will likely have a very negative impact on the UK’s statutory climate change targets, unless the government can move faster on carbon capture and storage. Many investors have expressed support for greenhouse gas reductions, so face a challenge in reconciling their carbon ambitions with the promise of a decent return from fracking. The UK Onshore Operators Group (UKOOG) has said that the industry’s view is that stakeholder engagement is key to public acceptance of shale gas exploration. It said communities should share in the possible benefits of development, a view shared by the April report from the Energy and Climate Change Committee. Research from Sustainalytics shows that community engagement and stakeholder outreach is anarea where only around half the companies in the oil & gas sector have solid policies in place. Transparency is going to be key in delivering public acceptance of the shale gas industry. For an investor it is important to know what tools operators have at their disposal in order to improve community acceptance. UKOOG has established a set of Shale Gas Guidelines on industry best practice. They address two major issues at the core of social resistance:

  • The guidelines suggest that companies should carry out baseline studies on the presence of methane on groundwater reservoirs. Such a study will help generate acceptance and will assist the company in avoiding uncomfortable litigation in the future.
  • The guidelines provide a registry that companies can use to disclose fracking chemicals. Lack of transparency in this regard remains one of the main areas of resistance to shale gas development.

With new incentives from the Government announced in the budget to boost the recovery of shale gas, it seems highly likely that fracking will grow rapidly in the UK. If so, this would have implications for the entire nation, judging by how widespread shale gas deposits are to be found across the country. Gas extraction in the North Sea tends to be out of sight, out of mind. But once it arrives on your doorstep, some local action can be expected as UK citizens voice their opposition to lorries, noise, dust and pollution. Indeed, fracturing the rock is only one of the processes involved in the extraction of shale gas. For example, the migration of fluids from the remaining well reservoir is a significantly unexplored risk. Investors need to think about all the implications in the shale gas production chain. West Sussex is somewhat smaller than Texas: there is nowhere for an oil company, or investor, to hide.

Andy White is Associate Director of the Advisory Services Team at Sustainalytics.