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American shale gas boom spells trouble for Eurozone Recovery

Posted in Finance Articles, Total Reads: 4249 , Published on May 21, 2013

The shale gas boom in North America has led to a fall in natural gas and electricity prices in the United States. However, natural gas export restrictions in the US have prevented a similar fall in prices in the Eurozone. This price discrepancy will reduce the competitiveness of European manufacturers compared to their American counterparts, resulting in lower corporate profits and slower growth in the Eurozone. Moreover, Europe’s inability to successfully tap its own shale gas reserves will leave it with no choice but to suffer from the fallout of an extended recession.

The shale gas boom in North America is causing a persistent and growing discrepancy in the prices of natural gas between the United States and Europe. This trend threatens to derail the nascent recovery of the Eurozone by making European exports less competitive in international markets.

According to the U.S. Energy Information Administration, shale gas accounted for less than 1% of US domestic gas production in the year 2000. By 2010, however, this share had grown over twentyfold. The resulting supply glut caused natural gas prices in the US to drop sharply from $15.78 per million British thermal units (mBtu) in 2005 to less than $2 per mBtu in 2011. As natural gas accounts for over 25% of all electricity generation in the United States, there has been a significant knock on effect on electricity prices as well.

The drop in natural gas and electricity prices has been a boon for US companies in energy-intensive industries such as metals, chemicals and manufacturing. According to a December 2011 Price Waterhouse Cooopers report titled “Shale Gas: A renaissance in US manufacturing”, shale gas will reduce energy expenses for US manufacturers by $11.6 billion annually through 2025. These cost savings will make US manufacturing exports more competitive in the international markets.

Lower energy costs are also attracting new investments in energy-intensive industries in the US. Companies such as Nucor, the largest steelmaker in the United States, and Dow Chemicals have planned large investments in new manufacturing plants to capitalize on the cost advantages presented by shale gas. Even non-US companies including Taiwan’s Formosa Plastics and India’s Essar Steel have US investments in the pipeline (Pittsburgh Post Gazette, 2 Jan 2012). These new investments will provide a much-needed boost to the US economy, further improving prospects for US businesses.

However, cheaper natural gas prices in the US have not found their way to European and Asian countries yet. According to the Europe Energy Portal, European companies pay, on average, 4 to 6 times as much as their American counterparts for natural gas. The primary reason for this price discrepancy is that the US government restricts the export of natural gas. A combination of concerns, including the environmental impact of shale gas extraction, and the possibility that natural gas export can drive up domestic prices, have led to these export restrictions. These concerns will not disappear anytime soon and therefore, we can expect the price discrepancy between the US and Europe to persist for the foreseeable future.

As a result, European manufacturing companies will continue to suffer from a significant energy cost disadvantage to their US counterparts. "European energy prices were up to five times as high as prices in the US and as a result Europe’s industrial competitiveness is suffering", said Harald Schwager, executive director at BASF, a large German chemical company, in an interview with the German media (ICIS News, 5 Jul 2012). Germany and the UK, Europe’s two largest natural gas consumers, would be the most affected by this trend. The fact that manufacturing accounts for over 28% of Eurozone GDP makes this a matter of grave concern for those who hope for a swift Eurozone recovery. In addition, Germany’s plans to phase out nuclear power in the next 10 years could make things worse by making the country more dependent on natural gas for generating electricity (New York Times, 30 Jun 2011).

The energy cost disadvantage can also drive manufacturing investment out of Europe and into the US. In fact, a number of large European industrial companies have already announced plans to set up plants in the US. Germany’s Bayer is reported to be in discussions with potential partners to set up a large ethane cracker facility near the Marcellus shale basin in the US. Shell Oil has already started construction on a new refinery in the Appalachians. Each of these investments represents a blow to the Eurozone’s ability to grow its way out of the current recession.

Some may argue that the discrepancy in natural gas prices is only temporary and that the prices can be expected to converge as soon as Europe starts generating natural gas from its own shale deposits. However, there are a number of key challenges that will prevent Europe from successfully tapping its shale deposits. Firstly, the geological profile of the European shale gas fields is not as favorable as that of fields in the US. This makes it more difficult and more expensive to extract natural gas from the European shale gas fields. Secondly, shale gas supporters in Europe face stiff resistance from environmentalists who have raised concerns about water body contamination during shale gas drilling. While such environmentalists are there in the US as well, the ones in Europe have much stronger political support. France and Bulgaria, for example, have already banned “fracking” – the process used to extract shale gas – due to environmental concerns.  Another key difference between the US and Europe is in terms of ownership rights to natural resources. In the US, the owner of land has rights over any resources that lie below the land. Therefore, they are usually willing to overlook environmental concerns and allow their lands to be used for shale gas drilling in return for a share of revenues. In Europe, on the other hand, the resources belong to the state. The European landowners, therefore, do not see any immediate benefit for themselves from shale gas extraction on their land. Instead, they oppose fracking anywhere near their land in fear of the environmental consequences. Due to these challenges, it will be a while before Europe is able to produce its own shale gas in quantities sufficient to bring down the prices.

The transatlantic discrepancy in natural gas prices is a real threat to the recovery of the Eurozone. And given the US export restrictions and the challenges in extracting shale gas in Europe, there may not be much that they can do to avoid it.

The article has been authored by Prashant Sarkar, IIM Ahmedabad

Natural gas price dips below $2 (Financial Times, 11 Apr 2012) http://www.ft.com/intl/cms/s/0/2ff80096-83ee-11e1-82ca-00144feab49a.html#axzz2HhVv81yM
The ‘Shale Gas Revolution’: Developments and Changes (Chatham House briefing paper, Aug 2012) http://www.chathamhouse.org/sites/default/files/public/Research/Energy,%20Environment%20and%20Development/bp0812_stevens.pdf
What is U.S. electricity generation by energy source (U.S. Energy Information Administration, Frequently Asked Questions) http://www.eia.gov/tools/faqs/faq.cfm?id=427&t=3
Natural Gas Statistics (U.S. Energy Information Administration) http://www.eia.gov/naturalgas/
Shale-gas revolution spurs wave of new U.S. steel plants (Pittsburgh Post Gazette, 2 Jun 2012) http://www.post-gazette.com/stories/business/news/sale-gas-revolution-spurs-wave-of-new-us-steel-plants-668673/
Europe’s Energy Portal http://www.energy.eu/
Shale Gas: A renaissance in US manufacturing? (PWC, Dec 2011) http://www.pwc.com/en_US/us/industrial-products/assets/pwc-shale-gas-us-manufacturing-renaissance.pdf
Germany: New Ban Approved (New York Times, 30 Jun 2011) http://www.nytimes.com/2011/07/01/world/europe/01briefs-Germany.html
Should Europe be fracking? (Project Syndicate, 4 Oct 2012) http://www.project-syndicate.org/commentary/a-us-model-for-shale-gas-production-by-daniel-gros
Shale: Can the US experience be repeated? (The Economist, 13 Sep 2012)  http://www.economist.com/blogs/buttonwood/2012/09/energy
Shale of the century (The Economist, 2 Jun 2012) http://www.economist.com/node/21556242
Shale gas: Terminal decline no longer (The Economist, 23 Apr 2012) http://www.ft.com/intl/cms/s/0/a5053c50-8d2b-11e1-9798-00144feab49a.html#axzz2HhVv81yM
The coming US boom and how shale gas will fuel it (Financial Times, 23 Apr 2012) http://www.ft.com/intl/cms/s/0/09fbb2ac-87b8-11e1-ade2-00144feab49a.html#axzz2HhVv81yM
BASF eyes shale gas potential in Germany and Argentina (ICIS News, 5 Jul 2012) http://www.icis.com/Borealis/Article.asp?p=1&q=BCBDCEDDCABDDCC7D0DFC099AFCFD185B8E7BBC6DF6DDCBDCEDDC6B7DCB8D48DBCDF6ECADBD9AEE5B8D4E1&id=B28398A29D7AA6

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