Shale of the century – the future for fracking in Ireland

Hydraulic fracturing, or “fracking” as it has become universally known, is a technique for extracting reserves of oil and gas that would be otherwise impossible or uneconomic to extract. The technique, which involves injecting rock with a mixture of water, chemicals and sand, has become one of most contentious issues in British and Irish politics. Advocates of fracking say that more widespread use of the technique could bring cheaper energy and reduce reliance on (not always friendly) foreign suppliers. Opponents point to a range of potential harmful impacts on the environment, associated possible risks to human health from polluted groundwater, and even an increased risk of earthquakes due to increased seismic activity.

Locally, it is unlikely that there will be much fracking activity any time soon.  The Australian company Tamboran, who were granted a licence in 2011 to look for shale gas in County Fermanagh, had their licence revoked in September 2014 with no drilling having taken place. Scotland announced a moratorium in January 2015, and there has been no activity in the Republic of Ireland.

The United States has seen a significant amount of fracking activity, and as a result natural gas prices in the US have fallen precipitously. However, attempts to recreate the shale gas boom in Europe have failed miserably. Poland, which was considered to have the largest reserves of shale gas in Europe and was the best shot of a viable European fracking industry, has had estimates of reserves slashed, and the industry is in disarray.

Ireland has far less favourable geology, with a complex system of shallow aquifers meaning that the risk of calamitous pollution affecting drinking water is much higher. If a viable fracking industry has not been able to sprout in Poland, then the prospects for one in Ireland are even dimmer. There is also a simple matter of economics. The excellent blog, The Gas Man Cometh!, estimates that fully loaded breakeven costs for Fermanagh shale gas would be in the order of $14 per million thousand cubic feet. This would not have been profitable even at the peak of the market for local gas prices, which was $12.01 per million British Thermal Units (BTUs), or $12.30 per million thousand cubic feet on the 4th of December 2013. At the time of writing, the ICE index that the price of British and Irish gas tracks is $7.58 per million BTUs. It is apparent that there is currently no economic argument for fracking in County Fermanagh.

So why the interest in fracking for shale gas in Fermanagh in the first place?  To understand this, it is necessary to look at how the market for oil and gas are intertwined with each other, and what has happened in the oil market over the last decade or so. The graph below shows how the price of crude oil (West Texas Intermediate) has moved since 1986. Prices were broadly stable and predictable until 2003, when a change to the rules by which banks operate would prove to have significant repercussions. The Central Bank of the United States, the Federal Reserve or Fed, decided to allow banks to trade physical in commodities such as oil, metals, and even food. This means that physical commodities begun to be traded as if they were intangible, financial assets. This marked the start of increased volatility and a “boom and bust” cycle in markets such as oil.

Oil WTI

The price of crude oil rocketed until the financial crash in 2008, when prices fell down to close to their historical level. However, a new intervention by the Federal Reserve then started to have a big impact on oil prices. Rounds of quantitative easing, effectively the central bank creating money out of thin air, meant that yields on financial instruments such as bonds collapsed. As such, people trying to generate a return on capital shifted out of financial assets and into tangible assets, such as oil. The three rounds of quantitative easing by the Fed pumped up the price of oil again. With the end of quantitative easing in the US, and the expectation of higher interest rates, capital is flowing back out from commodities and into financial assets. Oil has been uncoupled from its original purpose as something to heat your house, or fuel your car, and instead acts as if it was an intangible asset, and this is the principal reason why prices have soared.

However, the market interpreted this signal (a hike in the price of oil) as an increase in demand for energy, and began to explore alternative sources. Traditionally, the price of gas and oil was closely linked. However, the high price of oil encouraged new technology and innovation in areas such as fracking. The fracking boom led to a vast increase in the supply of gas in the United States, and it is for this reason that gas prices in the US have stayed stable, whilst the price of oil-linked gas in Europe increased.

The graph below shows how natural gas prices in the UK and the US, on the left axis, have moved in comparison to the price of crude oil on the right axis (all UK gas prices were converted to US dollars at the daily spot rate). It can be seen how the financially driven increase in the price of oil drove the price of natural gas higher and higher, whilst the large amounts of fracked gas in the US kept prices low. It now makes sense why it may have appeared to make sense to frack in Europe.

You said oil was cheap, you were the sale of the century

What looked like increased demand for energy led people to believe that there may be money to made from $14 gas. But the increase in the oil price was not, in the main, demand led, it was the result of perverse incentives arising from distortions due to American Central Bank policy. It is incredible how, in our interconnected and globalized world, how obscure changes in banking regulation rules, and the monetary policy of foreign countries, can lead to a situation where it can seem like a good idea to carry out manifestly insensible schemes, such as injecting the lakelands of County Fermanagh with chemicals in order to extract gas.

The future is, as ever, uncertain, but there are various reasons why it is unlikely that there will be much fracking taking place in Ireland any time soon. Firstly, it is quite possible that oil markets will fall further. Currently oil prices are being propped up by those embarking on contango, literally where traders are buying oil at one price and then simultaneously selling it in a year’s time for a higher price, meaning that if you have the means to store oil then you are guaranteed a profit, as if you could fill up your tank with home heating oil for £500 and then agree to sell it for £700 in a year’s time. But this trade requires having somewhere to store your oil for a year, and inventories of oil are swelling. Eventually people will run out of places to store oil for their contango trades, and given the current deflationary outlook for the world economy, this opportunity will disappear and the price of oil could start to fall once more.

Another factor is that the gap between the price of natural gas in the US and in Europe is likely to shrink, as technological improvements make it cheaper to convert gas into liquid and ship it to where it is needed. There is no shortage of shale gas in America, and it is therefore likely that gas prices in Europe will fall as the gap between European gas and American gas closes.

The artist behind this excellent piece of political graffiti, as seen in Pottinger’s Entry in Belfast, need not worry. Nobody sensible is likely to want to frack in Ireland for some time to come.

Ban Frackin

 

Edited 2nd March 2015: As pointed out by The Gas Man Cometh, I had mistakenly referred to “million cubic feet” when I should, in  fact, have said “thousand cubic feet”. Also, as alluded to by Melanie Brown and Nevin in the comments, it was remiss of me to discuss fracking in Northern Ireland without discussing the situation on the north coast. You can read more about what is happening on the north coast here.

A qualified accountant and data analyst, interested in politics, economics and data. Twitter: @peterdonaghy

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