Low gas prices mean a £110 carbon tax

Shale gas changes everything. One leading industry consultant said recently that natural gas extracted from shale formations may multiply world availability by between ten and hundredfold. This means we will be awash with the stuff everywhere around the globe.

The price of gas is low today, will probably remain at these  low levels and, perhaps more importantly, worries over the security of supply will disappear.  Any rational electricity generator will replace old power stations with new combined cycle gas turbines, ignoring fancy new lower carbon technologies such as wind and nuclear unless the carbon price is sufficiently high to block the use of natural gas. The UK’s objective of near-decarbonisation of electricity generation by 2030 becomes impossible without a very high penalty levied on the use of gas to generate power.

Today’s (May 20th 2010) announcement of the plans for the new UK coalition suggest that a guaranteed minimum carbon price is now an explicit government objective. What carbon price will be required to keep nuclear power as a viable alternative to using cheap gas for generation? My calculations suggest a minimum figure of at least £110 per tonne of CO2.Shale gas

Shale is a geologically common sedimentary rock, found all around the world. It contains methane (natural gas) in large amounts as a result of the rotting of organic matter encased in the rock as it formed. Until a few years ago this gas was seen as not commercially exploitable because it did not exist in sufficient density inside the rock. Technological advances, some brought about as a result of the very high gas prices of 2007/8, have made shale gas much cheaper to extract. These developments, which include the ‘fraccing’ (fracturing) of the shale to let out the gas, mean that shale is cost competitive with conventional sources of methane. It is now being produced in large quantities in North America.

We cannot know precisely by how much the advent of shale gas has multiplied the world’s usable reserves of hydrocarbons. But many analysts see the impact as hugely important to the structure of the global gas market. Not only is potential production increased, the wide distribution of shale means that no single country (such as Russia) can hope to exert control over availability. The US has shale, China has shale, even the UK has shale. Drilling is already planned or occurring in Lancashire.

Shale gas extraction *may* pollute water supplies and cause local subsidence. It seems to use potentially toxic chemicals, although the drilling companies are unclear on this point. They do admit to having to drill hundreds of wells across each field because of the relatively low density of gas compared to conventional gas domes.

The impact

Gas is a relatively low carbon way of generating electricity. New gas turbines are efficient, needing less than 2 kwh of raw material to generate 1 kwh of electric power. Methane and propane, the primary constituents of gas burn to water (H20) and CO2, but the amount of carbon dioxide is less than half what a coal-fired station generates for the same amount of electricity. So a swing away towards greater use of gas in electricity generation will cut the UK’s CO2 emissions, but still not allow us to meet the core target of generating a lot more electricity for electric cars and heat pumps and making that electricity with minimal carbon dioxide.

Today’s wholesale price of gas for delivery in the next few weeks is approximately 1.3 pence per kilowatt hour.  Turning that in electricity in a power station roughly doubles the price to about 2.5 pence of gas per kilowatt hour of power. Add in the generator’s capital charges and gas power stations need to obtain 3.5 pence per kilowatt hour from their customers to turn a reasonable profit. (You won’t be alone in wondering why the domestic retail price of electricity remains well above 10 pence per kWh. Even adding in the costs incurred by the retailer doesn’t justify the gap).

Shale  gas, which has already clearly pushed down world gas prices, will probably continue to stabilise what had been a very volatile market in recent years. Generators who might have worried that gas power stations would be subject to sharp spikes in the fuel cost are almost visibly relaxing. Three years ago UK gas prices and availability were adversely affected by the need to bid against the US east coast terminals for ship-borne liquid gas (LNG) but he concern that this might happen again is fading. So although we may see more planned delays in gas power station construction, following on from SSE’s announcement this week, the fuel of choice for generators will probably be gas.

The key question facing the new UK government’s energy policy is what the low and probably more stable price of gas means for energy policy. Decarbonisation requires the coalition to penalise fossil fuel generation (gas or coal) to a sufficient extent to oblige generators to choose low carbon technologies. With today’s low gas prices, what will the penalty have to be to incentivise generators to prefer nuclear?

My calculations have to be approximate but I think the numbers are nevertheless worth presenting. I believe that the Areva EPR design for a 1.6 GW nuclear reactor will cost about £4.5bn in the UK. (This is slightly lower than earlier figures on this blog (here) because of the 10-15% rise in the value of the pound against the Euro since these numbers were calculated). At this level I believe that while generators need  a wholesale price of 3.5p/kWh to be profitable for gas they require a price of 6.5p/kWh for nuclear. In order to push the electricity companies towards nuclear, the carbon price would therefore have to add at least 3p to the cost of each gas-fired kWh. I suggest that to provide a sufficient and clear incentive the government will actually need to impose a burden of perhaps 4p per kilowatt hour on gas.

The carbon emissions of a gas fired power station are about 0.36 kg of CO2 per kilowatt hour. So the minimum carbon tax needs to be about £110 per tonne to push the operators towards nuclear. (Calculation: at .36 kg per kWh, the power station will generate 2,778 kWh for each tonne of CO2 emissions. To penalise each kWh by 4 pence, the carbon price per tonne will have to be 2,778 times 4p, or £111.11)

This is about ten times today’s rate for CO2 within the European trading system. Does the government really think it can achieve this? Since the same economic logic applies to offshore wind – perhaps about as expensive as nuclear – does the coalition believe it can get the electricity industry to invest billions on Dogger Bank off the eastern coast of the UK without a carbon price of about this level? The reduction in the long-term expectations for the gas price have forced up the required carbon tax to levels no-one appears to really contemplate. As I said in the first sentence, shale gas changes everything.