September 2, 2014

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New Developments in The UK Shale Gas Sector

The shale gas sector in the United Kingdom is still in its infancy, but the UK Government has announced recently new measures and incentives to encourage its growth.  On 13 December 2012, the Government lifted a temporary suspension of drilling at the only drilling site in the United Kingdom, introduced tighter regulations to manage risk associated with hydraulic fracturing (fracing), set out new tax incentives to help accelerate the growth of the industry, and announced that it would establish a new Government office dedicated to the shale gas sector.

Background

Fracing involves the pumping of water, sand and chemicals into shale rock at high pressure, for the purpose of extracting reserves of natural gas.  Many European countries have been wary of fracing and the practice is currently banned in several countries, including France.  The French Government banned fracing in May 2011 in response to pressure from environmental groups.  Reports have suggested that exploration permits were revoked from three companies that had announced they were intending to undertake fracing activities, and seven applications for permits were rejected.  It should be noted that by the French Government has not banned the exploration of shale gas, just the practice of fracing. 

Apart from the United Kingdom, the only other European country that has allowed energy companies to undertake exploratory drilling is Poland.  Poland is said to have the largest reserves of shale gas in the European Union.  As of June 2012, it had granted over 100 licences to foreign companies wishing to undertake exploratory drilling activities in the country.  

The exploitation of onshore gas reserves has already revolutionised the energy sector in the United States, and the UK Government now hopes that Britain will be able to service some of its future gas demand through the use shale gas obtained by fracing.  Europe, as the world’s second-largest gas market, has become increasingly dependent on imported gas, which not only is expensive, but also carries with it all the risks generally associated with an imported product, including the potential for a sudden termination of supply. 

Reports on Shale Gas

The UK Government has commissioned several reports on shale gas in order to assess the potential risks of fracing.  These include, inter alia

In addition to these reports, the British Geological Survey (the BGS) conducts ongoing research into shale gas.  The BGS estimated in 2010 that if shale in the United Kingdom was as productive as shale in the United States, an estimated 150 billion cubic metres of gas could be produced.  The BGS also notes, however, that as little as 10 to 20 per cent of the full UK reserve of shale gas may in fact be recoverable.  Little exploratory drilling has so far taken place in the United Kingdom and there has been no commercial production of shale gas.

The sites with the best prospects of producing large quantities of shale gas are likely to be close to the formations that yield conventional oil and gas reserves.  In the United Kingdom these include the Upper Bowland Shale, which is currently being explored by Australian shale gas company Cuadrilla Resources, and areas near North Sea exploration sites and the English Channel Fields. Cuadrilla has estimated that there could be 5.6 trillion cubic metres of shale reserves beneath the surface of the United Kingdom, although the BGS estimates that this figure is nearer to 4.2 trillion cubic metres.  

Fracing Suspension Lifted

On 13 December 2012, Ed Davey, the UK Secretary of State for Energy and Climate Change, gave his approval to Cuadrilla to resume fracing in Lancashire in the north of England.  Exploratory drilling at the site in Lancashire started in August 2010 but was halted in May 2011 when evidence emerged that fracing may have been triggering seismic activities. 

The Government subsequently commissioned the April and June reports, which served as the basis for Mr Davey’s decision to allow fracing to resume.  Cuadrilla’s operations are currently the only fracing activities that are currently being undertaken in the United Kingdom.  The DECC, the Government department responsible for applications in relation to shale gas operations, did, however, start accepting new applications for exploratory drilling on 13 December 2012. 

Mr Davey’s support for the resumption of fracing was met with a mixed response.  Although many in the energy sector see fracing as the way forward, and an opportunity to tap into an, as yet, underexplored resource, environmentalists have suggested that increased fracing may create a “dash for gas” that will prevent the United Kingdom from meeting its climate change targets, owing to the increased carbon dioxide emissions.  A study has, consequently, been commissioned by Mr Davey to ascertain the possible impact of shale gas developments on greenhouse gas emissions and climate change. 

Proposed Regulatory Regime

Shale gas drilling is covered by the UK regime for all oil and gas exploration and development activities.  In his statement, Mr Davey announced that all new fracing operations will also be subject to new controls to mitigate risks associated with fracing.  These include, inter alia, a more thorough assessment for seismic risk and the installation of a “traffic light system,” under which operations will be stopped automatically under certain conditions.  The threshold for tremors in fracing activities is lower than for industries such as coal mining or construction. 

The controls are, at this stage, yet to be defined, but will be reviewed, as experience develops, to ensure they are proportionate to the risks. 

Measures to Encourage Fracing

The UK Government intends for shale gas to become a major part of the United Kingdom’s gas supply in the long term.  In order to encourage the development of shale gas reserves, the DECC will set up an Office for Unconventional Gas and Oil (the OUGO) and the UK Government will consult on appropriate tax regimes for fracing activities.

The OUGO, together with other UK Government departments, will provide a single point of contact for investors and will ensure a simplified and streamlined regulatory process.  It will be led by the DECC and is intended to help encourage investment in the shale gas sector.

The UK Chancellor of the Exchequer, George Osborne, announced on 5 December 2012, in the Government’s Gas Strategy, that the Coalition Government will launch a consultation on tax incentives for the emerging shale gas industry.  The Chancellor said that the industry would be excluded from the existing North Sea fiscal regime, where tax rates are between 62 and 81 per cent.

European Regulation

The European Parliament rejected a ban on shale gas on 21 November 2012, but asked the European Commission to consider new laws to regulate the sector. 

The Parliament’s decision to regulate the shale gas sector is based on three new studies on shale gas, published by the Commission on 7 September 2012.  The studies look at the potential effects of shale gas on energy markets, the potential climate impact of shale gas production and the potential risks shale gas developments may present to the environment.  There have already been calls, however, to avoid having a single regulatory regime covering the whole of the European Union, given each country’s particular sensibilities to the practice.

The Commission launched a consultation on shale gas and other unconventional fossil fuels on 20 December 2012, inviting comments on the risks and benefits associated with fracing.  The consultation will help the Commission determine whether the existing regulatory framework can manage associated risks effectively, or whether additional regulatory safeguards should be put in place.  The consultation will close on 23 March 2013.

Differences for Operators Between The United States and The United Kingdom

The shale gas industry might not become as profitable in the United Kingdom as it is in the United States.  One of the factors causing concern is excessive use of water in fracing, given that water resources in many parts of the United Kingdom are already under pressure. 

In addition, shale gas reserves are more diffuse than conventional gas sites and productivity at each well falls relatively quickly.  The United Kingdom is populated far more densely than the United States,  which means it will be harder to continually find new drilling sites.

Furthermore, in the United States landowners own the mineral rights beneath their homes, whereas in the United Kingdom the mineral rights are owned by the Crown.  This means there is not the same economic driver to encourage exploratory activities. 

Conclusion

The UK Government expects new estimates for Britain’s shale reserves, which are to be published by the BGS within weeks, to be revised upwards.  If exploratory drilling proves positive, shale gas production might commence in earnest in 2015.  It is clear that the Government is taking the steps required to encourage the expansion of fracing activities, and introducing measures to make it more financially viable. 

© 2014 McDermott Will & Emery

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About this Author

David Birchall, McDermott Will Emery law Firm, Environmental Attorney
Partner

David Birchall is a partner in the law firm of McDermott Will & Emery UK LLP, based in its London office.  His practice focuses on corporate energy deals, energy trading (including carbon), renewables and clean tech projects, energy projects, regulation and waste, in particular waste to energy schemes.

+44 20 7570 1403
Associate

Simone Goligorsky is an associate in the law firm of McDermott Will & Emery UK LLP, based in its London office.  She is a member of the Energy & Commodities Advisory practice where her practice focuses on advising banks, financial institutions, corporate institutions, hedge funds, energy companies and utility groups on a variety of matters, including cross-border regulatory and compliance matters.

During her training contract, Simone completed a six month secondment to the Firm’s Paris office, and also completed a secondment to the commodities legal desk of a...

+44 20 7577 6985