Shale gas is a good idea – but it is too soon to count on it to save us

THE government’s gas strategy document, published alongside the Autumn Statement this week, rightly said that gas should play “a major role in our electricity mix” for decades to come. George Osborne was also right to focus on how to make private investment in new gas-fired power stations work without subsidies. But uncertainty is still a problem. To attract private investment, investors must be guaranteed reasonably predictable returns.

Engineering certainty about future natural gas prices will be the central challenge in making this policy work. The problem is illustrated by recent history. The use of gas-fired power stations in the UK has fallen over the last four years – high prices lowered returns and made gas stations less competitive than coal-fired power.

Gas-fired power stations should be able to provide lower cost electricity. But the assumption that UK gas prices will inevitably drop through a US-style exploitation of shale gas is flawed. Firstly, the US is much more advanced in its exploitation of shale gas, and it benefits from a much larger natural gas and shale gas industry. Secondly, America’s low natural gas prices are as much a reflection of its inability to export its current oversupply, as of the actual cost of producing natural gas. In contrast, the UK is part of a developed continental trading system and is unlikely to benefit from significant “stranded” gas production.

The real reason for constructing new gas-fired power stations is the expectation that the broader global supply of gas will increase – not that the UK can achieve autonomy by developing its own “unconventional” gas reserves. The number of global natural gas discoveries in recent years, coupled with developments in the technology for transporting gas to the UK, suggests that the range of sources will increase – improving the security of supply.

The security of Britain’s gas supply, however, also relies on the ability to store gas in sufficient quantity. There are currently nine commercial gas storage facilities in the UK, with total capacity of 4.4bn cubic metres. This equates to around 18 days of demand at today’s consumption levels. America, in contrast, has three times the level of cover. If natural gas is to play a greater role in the UK’s power generation needs, incentivising gas storage should be a priority. In turn, volatility in wholesale gas prices, particularly during periods of peak demand in the winter, should be dampened.

Shale may play a role. But it is too early to rely on the development of UK reserves to underpin our national energy policy. It is, however, important for the UK government to investigate whether the shale gas reserves we have are economically viable.

To achieve this, subsidies to the UK shale industry may be necessary in the short term. But they should be designed in conjunction with a royalty regime that would more than compensate the public purse in the long term if production becomes viable. And if the concept of UK shale is proved commercially, a substantial weight of private capital would likely follow. In the US, numerous international oil and gas companies have moved into the industry via the acquisition of specialised shale gas companies. The same would happen in the UK, albeit on a smaller scale.

Some have asserted that an expansion of the gas industry in the UK would be a major blow for the British renewable energy industry. We disagree. A greater number of natural gas power stations can be used to support, rather than replace, the growth of renewables. Gas plants can be operated more flexibly than coal or nuclear, and therefore bring better flexibility to the country’s overall power generation capacity. This would free up renewables to become substitutes for coal and nuclear. These can all provide baseload power, and we can rest assured that total power generation capacity will remain sufficiently flexible to cope with peaks in demand.

The government’s support for a diversified mix of energy sources, with gas taking priority, is sensible. It is finally beginning to understand that long-term direction and structural certainty are critical to attracting private investment to the sector. The gas generation strategy is a step in the right direction.

Ed Guinness is manager of the Guinness enterprise investment scheme and alternative energy funds, and Will Riley is co-manager of the Guinness global energy fund at Guinness Asset Management.