Hamish McRae: Gas, in all forms, is our best fuel option

Economic View

It is going to be a "dash for gas" in Britain. There is one quick way of closing the potential electricity generating gap that the UK faces and that is to build more gas power stations.

Click here to view the graphic

Given the financial and political uncertainties about new nuclear plants and the physical uncertainties about wind power, it is pretty clear that the only way through is to build more thermal power stations and, of the three possible fuels, gas is the only sensible one – oil is too expensive and coal too dirty.

So that is what is going to happen. But what we do is a tiny element of the global energy market, for we account for less than 3 per cent of the world's primary energy use. The interesting question for the world is how much time the changed outlook for gas production buys for its economy. What we will do will be pretty much the same as everyone else.

Some perspective: there have been many studies of energy demand and supply in recent months but they all tend towards the same broad conclusions. These are that energy demand will continue to climb in pretty much a straight line for the next couple of decades, notwithstanding improved conservation; that virtually all the additional demand will come from the emerging world; and that most of the additional supply will come from fossil fuels.

You can see one set of estimates in the graph on the right, taken from BP. As you can see the three bottom segments, coal, oil and gas will still be providing about 80 per cent of global primary energy in 2030. Renewables (including biofuels), nuclear and hydro are projected to gain share but they start from such a small base that they cannot hope to make more than a marginal impact on the total supply.

Actually, we have become increasingly aware of the limits of nuclear and biofuels recently and even these projections may be an overestimate. Both Japan and Germany have turned their back on nuclear power, while the mood on biofuels has shifted rapidly as it has become clear that increasing the supply has had a damaging impact on the price of food.

I have been cross-checking the BP estimates with those of the International Energy Agency, which earlier this year did a special report on the impact of unconventional gas. The broad conclusions, which run forward to 2035, are pretty much the same. Oil will remain the largest single source of primary energy but output will rise modestly. Coal will grow too, but will be displaced as the second biggest source by gas, which will grow by more than one-third. Renewables will double, but because of the lower base they will still be much smaller than any of the fossil fuels. And nuclear will grow, but again from a low base.

The particular focus of the IEA paper was the extent to which we will be able to rely on unconventional gas. There are three main sources of this. Shale gas, which has received most publicity, is the largest, and is gas trapped in shale rocks. But there is also what is called tight gas, which is a sub-form of shale gas. And there is coal-bed methane, which coal mines had to get rid of as it was extremely dangerous, but which is now seen as fuel in its own right.

Unconventional gas is controversial. Some feel that the environmental risks are so great as either to preclude its extraction or at least to require higher safety standards than are being applied. Others feel these risks can be managed and the advantages of access to gas that does not have to be imported justifies the development. The environmental concerns will not go away, but the IEA has set out some "golden rules" for higher standards that increase the cost of the gas but cut the risks. Its projections for growth of output assume these rules are applied.

Shale gas certainly changes the US energy outlook. As you can see from the right-hand chart from the Institute for Energy Research, it is transforming the US gas market. Instead of facing declining supplies the US is increasing them and has the prospect of further rises for the next 20 years and beyond. Indeed there are projections that it will become a net exporter of gas rather than an importer.

For Western Europe it looks most unlikely that we will be able to transform ourselves from being net gas importers. The IEA projections suggest Europe excluding Russia will import even more than it does now. There are shale reserves in Western Europe, including the UK – Scotland had a shale oil industry in the 19th century – but this is not going to be anything like sufficient to meet Europe's growing needs. Remember we have to cope not only with growing electricity demand but the fact that Germany seems likely to shut its existing nuclear power stations.

But shale gas does improve energy security because of the diversification of supplies, a point made by the IEA. Aside from the US, Australia, Latin America and Africa are all set to increase output. Thus Africa is projected to become a bigger gas exporter than the Middle East by 2020.

So how should we react to all this? As far as the UK or, indeed, any developed country is concerned, secure electricity is vital. Power cuts are a catastrophe, not just in economically but in environmentally. If we hit the situation seen in much of the emerging world, where there are frequent interruptions to supply, there would be a surge in standby generators. Even the most efficient of these are less efficient than grid power stations.

We also have to accept that if the UK is to boost manufacturing, this will increase our demand for power. Generally, making things needs more power than making services. So while we can achieve a great deal by sensible conservation, it would be naïve to think that will be enough. At some stage new technologies will come along to reduce the world's dependence on fossil fuels. We should do all we can to hasten that but, meanwhile, we have to manage as best we can.

Nobel Peace Prize could be Europe's integration turning point

In financial markets you always look for signals that mark a turning point. The sale of Foxtons, that most aggressive of the London estate agencies, by Jon Hunt in 2007, signalled the top of the house price boom.

The bid by Royal Bank of Scotland for ABN Amro a few weeks later signalled the top of the banking boom.

Gordon Brown’s sale of most of the UK gold reserves between 1999 and 2002 signalled the bottom of the gold market – actually a 20-year low.

I am fretting at the moment for the “sell” signal for US Treasury securities, for they have enjoyed a 30-year boom. That market must turn soon, pushing up longterm yields around the world and mark the start of a generational bear market. But what will it be? The presidential election?

But the award of the Nobel Peace Prize to the European Union is surely a candidate for a “sell” signal there? I don’t mean that Europe will go to war again.

No, my thought is that the award has come just at the time when inter-European tensions have started to climb. You don’t need to buy Angela Merkel’s view that “if the euro fails, Europe fails”, to be aware that the euro’s current travails may mark a high point of European integration.

It is worth noting too that the prize is awarded by the Norwegian Nobel Committee, for Norway has demonstrated how it is possible to be a successful European nation while not joining the EU.

The key question the presentation raises is whether the EU, as presently constructed, is pulling Europe together or pushing it apart? On balance most people would accept that for much of the post-war period the EU and its predecessors have been a force for European unity. It has been a club countries wanted to join.

But at some stage Europe will reach a peak of integration from which it cannot proceed any further and from which some countries, not just the UK, will choose to step back. Put it this way: this may not be a sell signal for the EU but I could see it turning out to be one for the euro.

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