Shale gas discovery in the US has had some perverse consequences


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Consequences in financial markets can sometimes be unexpected and occasionally perverse. Take, for example, the respective fortunes of coal and gas over the last few years – back in 2008, huge global demand led by China and its power stations had seen coal growing more and more expensive while, in relative terms at least, gas was cheap.

In the intervening period, however, the introduction of new technologies such as ‘fracking’ have allowed the us to tap into its vast shale oil and gas reserves, with the result that it is pretty much self-sufficient in energy terms. Obviously this has some pretty exciting consequences for the world’s largest economy – and some odder ones for the commodities sector and indeed the rest of the world.

Taking the commodities angle first, the laws of supply and demand would suggest that, if huge reserves of gas are discovered, the price of gas should fall.  What actually happened was the price of coal went down. This was partly due to the fact the us no longer needed the coal it or any other country was producing and this new surplus flooded any market that still had an appetite for the resource.

Meanwhile, on the opposite side of the equation, the Fukushima nuclear disaster in March 2011 led to Japan suspending its nuclear programme and increased suspicion of nuclear power elsewhere around the world. With gas a cleaner way of producing energy than coal, the price of the former therefore remained high while the latter’s plummeted.

As for the US, shale gas means its future is looking rosy. In 2013, for example, consensus estimates have us GDP growing by some 2% – with about a quarter of that attributable to shale gas. That is great for the US but what about the rest of the world? In nuclear-free Japan, gas costs an expensive $15 (£9.25) per unit while in the European Union it is $11.80. In the US, it is $3.80 per unit.

Shale gas is a difficult substance to transport but not impossibly so – if the powers that be in the US wished, they could sanction the building of the requisite terminals and other infrastructure to liquefy the gas and then ship it around the world to a hungry market. The question is, however, why would they?

There would be some short-term uplift but nothing compared to the potential gains from, first, building the necessary infrastructure at a domestic level and, second, bringing back home – or ‘onshoring’, as it is now known – a number of energy-intensive industries that had previously been the modern-day preserve of countries such as China.

In other words, the question of whether the US should sell the energy that would allow other countries to remain global leaders in, say, chemical production or use its newfound cost advantage to produce chemicals domestically and become a global leader itself only has one answer. As we noted earlier, the short-term boost to the US economy from shale gas will be meaningful but the long-term one could be enormous.

An interesting twist to all this is the US is by no means the only country sitting on substantial reserves of shale gas but it is the only one so far to allow itself free rein in tapping those reserves. Here in the UK, for example, the government has only just lifted the moratorium on fracking that was put in place after two minor earthquakes in Lancashire in May 2011. Recent consultation has found that developing the UK’s shale gas reserves should make a “meaningful” contribution to the country’s energy situation.

Back in 2008, it was believed by some that fossil fuel was a dying resource, energy prices would only ever go higher and industry could only now thrive in the emerging markets. A few years on, not only is the world finding more sources of energy, it is also growing better at getting it out of the ground while the us is enjoying an undreamt-of structural cost benefit across a number of industrial sectors.

As we never tire of saying, the future is uncertain and tough to predict. Investors would do well to resist the temptation to extrapolate the future from how things stand and instead recognise the possibility things can change materially going forward.


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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