The economics of fracking

It’s difficult to ignore the hype surrounding hydraulic fracturing – this, assures the government, is going to help revolutionise the energy industry in much the same way as has happened in the US. Gone will be the dark days of energy dependence on Russia. But do the economics stack up?

On May 23, the government came forwards with new rules that will make it easier for companies to get access for fracking on land. This coincided with a report from the British Geological Survey (BGS) that suggests there is a great deal of shale oil locked away in the southeast of England.

Some think that now might be the time for a dose of American-style frackonomics – understanding the key figures, both in terms of costs and benefits, behind all the rhetoric.

Earlier this year, Ben van Beurden, CEO of Dutch-British oil company Shell, admitted that “some of our exploration bets [on fracking] have simply not worked out”. The company admitted that it had lost a chunk of the $80 billion that it had invested in the industry in the US.

Shell has developed its own actuarial models on the value and risks of fracking, according to company insiders, although it is keeping such models close to its chest.

The problem is that there are so many intangibles when it comes to fracking that it is difficult to put a price on either the costs or the benefits.

Hiscox, one of the largest specialist insurers in the UK, is prepared to underwrite damage from earthquakes – not a particularly common occurrence in Britain – but not if those are caused by fracking, largely because an insufficient amount of data makes the risk difficult to price.

But Ed Dolan, an economist and visiting professor at the Stockholm School of Economics in Riga in Latvia, argues that it is important to get a handle on some of the economic costs, as well the benefits in fracking, if only to make sure the public does not end up footing the bill.

“I don’t think a knee-jerk ‘for’ or ‘against’ makes sense,” he said. “You have to look at this from an economic perspective, and it is possible to isolate and study certain criteria.”

He points out that things like water quality before and after fracking, the rise in local pollution and health hazards can all be measured.

Some studies have been attempted in the US, which Dolan argues can help understand the British situation, but there is one important proviso: little research has so far been carried out in places as densely-populated as parts of the UK are.

It is one thing to study the environmental cost in the middle of Texas – a state that is twice as big as the UK, with less than half the population – and quite another to study the impact of a site in Lancashire. Even where fracking has been attempted in more densely-populated places in the US – such as Pennsylvania or New York State – there have been few studies done.

But there are signs of a growing awareness in the UK.

Susan Christopherson, a professor at the Department of City and Regional Planning at Cornell University in the US, says that conversations she has had with people during a recent lecturing tour of the UK, shows that people in government are finally starting to appreciate the need for a clear valuation of the economic costs and benefits of fracking.

A House of Lords Committee is currently looking at the implications of fracking across the UK, with the intention of selling the benefits of shale gas to a sceptical British public. Christopherson says that it won’t be able to do that with more robust economic figures, noting that recent studies show that support for fracking in the country has slipped below 50%.

But the costs involved in fracking may turn out to be a moot point if, as suspected, the hype around fracking turns out to be a speculative bet, fuelled by cheap debt.

“We’ve seen this in the US for the past 200 years,” said Christopherson. “Oil is discovered, industries move in to exploit the natural resource. When they move out, the communities are worse off than they were before – smaller populations, more income inequality and less diversification.”

Low-interest rates could be driving the speculative nature of fracking exploration, since companies can fund new wells relatively cheaply.

Deborah Rogers, head of the Energy Policy Forum, a think tank, and former financial analyst, says that new wells are being drilled to service the debt used to fund previous wells.

When interest rates rise, as they are expected to at some point next year, signalling the end of cheap debt, things could come to an ugly end.

“The important thing is to look at what might be lost, not just what will be gained,” said Christopherson. “If you start fracking in Tunbridge Wells and the area is damaged as a tourist site because of perceived industrial activity, you would lose tourism jobs and, if fracking turns out to be a short-term boom, you will have to rebuild the ‘Tunbridge Wells’ brand. That should not be overlooked.”

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