Manufacturing and the shale gas 'boom'

The shale gas debate has dominated the news agenda in recent months, further fuelling the debate surrounding the UK’s energy policy. The Government’s approval for hydraulic fracturing ‘fracking’ has divided opinions. Some commentators are hailing the potential ‘shale gas boom’ as a catalyst for the UK economy, while others are justifiably concerned with the possibly serious environmental risks that are considered to be related to hydraulic fracturing as a means of extraction.

With growing concerns of possible future energy shortages as fears of demand outstrip supply there are clear economic benefits to the large scale commercialisation of alternative energy sources in the UK. Shale gas is considered to be an easily extractable and abundant resource which could significantly help to fill the void in the medium term.

The opportunity

The US has a relatively well-developed shale gas industry that has received strong support from Government and continues to be in the forefront in the development of extraction engineering technology. The country is now considered to be the premiere shale gas producer in the world. 

Recent reports from the British Geological Survey and Department for Energy and Climate Change contain estimates that indicate substantial shale gas reserves, particularly in the North of England which potentially hold over 1,300 trillion cubic feet of natural gas. Nevertheless, in the UK, the processes for shale gas extraction are not being significantly applied.

While there has been much discussion concerning the potential impact that significant production of shale gas may have on the UK’s energy security, energy industry and national economic health, little has been said of its impact on the manufacturing sector.

 Manufacturing demand

In the short term, the increase in drilling activity will raise demand for capital goods and related inputs goods, particularly those engineering products used in both drilling and power generation; this will be reflected also in benefits throughout the UK supply chain.

There are also a number of notable British industrial companies that have already benefited from the shale gas boom. These include FTSE-listed pump-maker Weir Group, and Rotork, the world’s largest producer of valve actuators and control systems. The former increased its involvement in the industry at the end of last year following its acquisition of Mathena, the US equipment supplier to the onshore oil and gas drilling sub-sector, and the latter recorded a 15 per cent jump in its order book since December to £208 million.

Lowering energy costs

The most significant impact on the manufacturing sector could come in the form of lower energy costs, which some commentators have identified as one of the factors behind the manufacturing renaissance in the US where natural gas prices has fallen from $12 mbtu (million British Thermal Units) in 2008 to just $3 mbtu in 2012.

For a manufacturing sector under persistent margin pressure and with its competitive advantage being eroded by low cost emerging markets, the prospect of cheaper energy is welcome news. The increased availability of cheaper gas, whether imported and / or locally sourced as a result of domestic shale gas production, will help lower energy costs for businesses across the country.

This could further drive the on-shoring of manufacturing, from the Far East, which is presently being driven by  rising transportation costs and wage inflation, amongst other reasons. This trend is already evident in the US with Boeing and General Motors being two large and important corporations moving ‘home’ some of their manufacturing requirements.

 From petroleum to gas

The energy intensive and gas and oil feedstock reliant chemicals industries could be significant examples of manufacturing sub-sectors that will benefit from the development of a domestic shale gas industry. The confluence of lower feedstock costs and energy prices could provide a boost for the industry similar to the US chemical subsector, which has seen a significant increase in investment. 

For the UK steel and automotive sectors which are directly and indirectly energy intensive, a fall in prices would help improve the nation’s competitive stance in a growing global economy.

The catch

However, it is still relatively early to arrive at a decisive verdict concerning the impact of domestic shale gas production on the manufacturing sector. Notwithstanding the ongoing environmental concerns and the pressing need to continue to look to long-term renewable energy, there remains much uncertainty over the potential quantity of gas that can be retrieved safely and effectively in the UK.

While theoretically the argument is strong for the support of shale gas extraction in the UK, we should be careful when comparing the UK with the US industry. The US benefits from the location of sites in areas that are relatively sparsely populated, with reserves of easily extractable gas.

In the UK and Western Europe, where drilling is restricted or not possible in densely populated urban areas and with challenging geography, the cost of extraction will certainly be higher than in the US, and hence the exact cost-benefit of UK shale gas remains unclear at this time and will require careful analysis.

Therefore, even if the UK shale gas market does not take off, the opportunity to benefit from competitively priced, foreign shale gas is significant and underlines the need to develop the appropriate infrastructure for its import into the UK.

While it is still in its infancy, shale gas potentially presents an enormous opportunity for UK manufacturers yet the environmental concerns will be a major consideration for energy companies considering developing shale gas. Businesses leaders will therefore be watching the continued development of the US market closely before making their own judgements.

James Buckle is a Director in the Manufacturing and Chemicals sector team at Lloyds Bank Commercial Banking, Global Corporates