Tuesday 6 January 2015

Fracking and Fantasizing

As we've often discussed, cheap fossil fuel is a dagger in the heart of the green agenda, which tries so desperately to trade under the false flags of security of supply and lower long-run cost.  The sophistry with which DECC argues that its policies will result in "lower energy bills than they would otherwise have been" would delight a Jesuit wrangler or medieval schoolman.  The tortuous counterfactuals are mind-boggling.

With coal already dirt cheap (and I do mean dirt), oil at $50 or so, and gas following them down, the hollowness of this rhetoric sounds louder than ever.  And since (a) the government's new subsidy of choice - the Contract-for-Difference - settles against market price*, and (b) there is an overall £bn cap on the amount paid out, an awful lot of would-be renewables projects are looking increasingly fanciful (not to mention Hinkley C, which must surely now be cancelled - surely?).

Amusing, then, to hear loud whistling-in-the-dark from the direction of the Grauniad's Environment section:
Plummeting oil price casts shadow over fracking's future
The price of oil has dropped to around $55 per barrel, but fracking companies need prices of $60-100 to break even.
Hold tight fellahs, before you get your hopes up: let's just watch and see what happens. First thing will be, yes, a reduction in CO2 emissions, haha!, as even more coal gets displaced by cheaper natural gas.  Funny, eh?  

But no, the US fracking industry will not implode.  US onshore drilling is one of the most price-sensitive things known to man so, sure enough, the number of new wells drilled will fall.  This happens every cycle and is called The Laws of Supply and Demand, nothing unusual there.  But the Sunk Costs phenomenon will also be at work; and a shale producer with debt to service has nothing to do except keep producing, at whatever price, right down to his marginal cost of production (rather lower than "$60-100 oil eqivalent").  If he goes bust,  as some will, one of the big boys will gladly relieve him of his assets.

I still wonder when someone somewhere well to the east of the US shale industry with access to high explosives will take matters into his own hands.  Barring that, settle down for a big disappointment for our greenies, plus the usual surge of cost-cutting innovations the price-slump will certainly engender, facilitating the next round of new developments.


* I acknowledge that the Energy Act gives DECC the power to rig the market price of electricity.  However, they'd probably find it hard to do more than give it a bit of a nudge before serious repercussions came their way 


BE said...

Retail electricity prices in Norway are something like twice or three times those in the UK.

The Danes are generating a third of their electricity from wind.

We won't mention the Germans. OK we will, I read a headline recently that said that so many people had bought those domestic batteries, you reported on a while back, that the price of energy "storage" had halved in 2014.

Do not underestimate the ability of governments to really screw over their citizens...

Mark Wadsworth said...

There was a most interesting reader's letter in today's FT which said that oil and gas producers have high sunk costs but low marginal costs.

(Let us assume this is correct, it might be nonsense).

Therefore, in the medium term when oil and gas prices fall, then as long as they are still above marginal costs, even those with high sunk costs and high total costs will try to produce more rather than less.

Which is the neat book-end to the theory that if prices are high and expected to rise, the best strategy for somebody with an oil or gas field is to simply do nothing at all. Just leave it in the ground. (again this might be nonsense, but it's a good theory).

Nick Drew said...

high sunk costs but low marginal costs

yes, frequently true, at least in the short- / medium-term - and what's more, some of the main variable costs are often not cash, but energy itself, e.g. pumps, compressors and processing plant, fueled by the oil/gas being produced

(what's even more, sometimes the marginal cost is negative!)

as to rational extraction strategies, there is a load of textbook theory on this, often in conflict with other textbook theory

for example, some hold that unless there is backwardation (forward prices lower than spot price) no-one would ever produce, they'd leave it in the ground

then there's the Hotelling 'rule' ...

sadly for the theorists, there are plentiful real-life counter-examples to all of them

Jer said...

I say old chap - no call for using American spellings, we shouldn't sink to their level!

James Higham said...

Most interesting to see the fracking progress now and whether Russian oil goes back up. Keep us up to speed, Nick.

Nick Drew said...

Jer - when it comes to fracking we should most certainly sink to their level ...

(sorry about that)

rwendland said...

> Retail electricity prices in Norway are something like twice or three times those in the UK.

That's not what the Eurostat data says - pre-tax Norway is fractionally below the EU average, and quite a bit lower than the UK. 2013 pre-tax domestic electricity costs in Euros/kWh for medium sized households, and the % difference from UK price, were:

0.1752 +5.7% Spain
0.1658 0.0% UK
0.1498 -9.7% Italy
0.1493 -10.0% Germany
0.1376 -17.0% EU-27
0.1373 -17.2% Norway
0.1333 -19.6% Netherlands
0.1155 -30.3% Poland
0.1007 -39.3% France

Some coutries have very high taxes on electricity, so post-tax data does not give a good indication of generation and distribution costs in a country.

As you can see, the UK has close to the highest underlying leccy generation and distribution costs of the large EU countries. Partly due to the UK beginning to run short of North Sea gas. Low prices in France and many East European countries are largely due to their electricity companies inheriting many power stations at well below fair capital cost.

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