Hamish McRae: Fracking buys time but doesn't fix the problem

  • @TheIndyBusiness

Does fracking change the fundamentals of the energy market, and if so in what ways? The debate here in the UK about the extraction of oil and gas from shale has focussed on the environmental issues it raises. That is understandable and perhaps inevitable. But whatever we do or don't do will not make a material difference to what the world does and so from a broader economic perspective the big issue is whether the world will see a reversal of the ever-tighter markets for oil and gas.

We know that global demand for energy will carry on increasing. We know that oil and gas are more convenient and relatively cleaner fuels than coal, and that gas is more abundant than oil. But what we don't know is whether fracking will make gas supplies so competitive as to reverse the prospect of ever-tighter markets and hence the long-term upward trend in prices.

So many predictions about energy markets have been proved wrong that you have to take everything with a pinch of salt. Lewis Strauss, the American physicist and proponent of nuclear power, said in 1954 that it would become so efficient that it would produce electricity that would be "too cheap to meter". But we can say with some confidence that demand for energy from the emerging world will increase rapidly for another generation at least and we know that China has already become the world's largest emitter of carbon – as well as the world's largest producer of passenger cars.

We also know that while the price of oil is close to its previous peak, the price of natural gas in the US is the lowest it has been for more than two years – and that is largely the result of additional supplies from fracking.

I suppose the core economic issue is to what extent the world's recoverable reserves of oil and gas have been increased by this technology. There have been no official estimates of the change, but the world has for the past generation been running roughly level with both oil and gas: some 40 years of oil left at present consumption levels and some 60 years of gas. So we have been finding the stuff about as fast as we use it.

My guess is that fracking pushes this a bit further forward: we will gain a few years' supply but it will not make a radical step change in the outlook. In other words we could see it as the equivalent of the exploitation of deep-sea oil and gas.

Will we see a cut in prices globally, as has occurred in North America? No, because what has happened in North America is the coming together of a number of exceptional factors and because gas cannot be so easily and cheaply transported as oil.

But fracking, like offshore oil, will have political consequences. Just as the discovery of oil and gas in the North Sea reduced Europe's dependence on imported fuel, so the development of Canadian and US reserves will reduce North America's dependence. The Middle East and Russia will remain hugely important as a result of their abundant supplies, but at the margins their influence will lessen.

There is one obvious further issue. From a conservation perspective any increase in supplies of oil and gas will tend to hold down the price and insofar as price has been the main spur to greater energy conservation, that spur will be less sharp. But that can be countered by countries using taxes to offset any decline in energy costs, if they want to. (They may not: one effect of falling energy costs in the US has been to give a spur to manufacturing, not something any government would wish to discourage.)

In addition, the costs of alternative sources of energy, particularly solar power, have been falling rapidly too. My instinct is that the momentum behind conservation is strong enough to carry on for a while, particularly since the increased supplies of oil and gas only buy a limited amount of time.

With inflation on the rise once more, our real incomes are squeezed again

The falling trend of inflation was broken in March, with the CPI at 3.5 per cent, an overshoot that can no longer be blamed on the increase in VAT, nor on a fall in sterling. The effect of the VAT increase in January has now moved through the system and the pound is the highest it has been for more than a year.

The practical effect for all of us is that real incomes continue to be squeezed: money wages are up less than 2 per cent year-on-year so most people are seeing an annual cut in incomes of more than 1 per cent.

What this will mean for policy is unclear. The so-called "doves" on the Bank of England's Monetary Policy Committee will feel uncomfortable, particularly the arch-dove, Adam Posen, who a year ago predicted that inflation would fall to 1.5 per cent by the middle of this year. He added: "If I have made the wrong call, not only will I switch my vote. I would not pursue a second term."

But this is not really about people; it is about policy. Another bout of quantitative easing now looks most unlikely.