Shale gas could frack up our manufacturing
Fracking won't help our industrial base, if the Dutch disease is anything to go by.
Among the many extravagant claims made by supporters of fracking, perhaps the most absurd is that it will lead to a renaissance in British manufacturing. George Osborne picked up this theme last week when he argued that cheap energy was leading manufacturers to return to the US and he wanted to see this happen in Britain. A revival in the fortunes of our hard-pressed industrial regions would be warmly welcome, but sadly fracking will not deliver this. Even if all the major obstacles to extracting large amounts of UK shale gas could be overcome, our manufacturers are unlikely to benefit from much cheaper gas. To make matters worse, they could even suffer a big loss of competitiveness, as they did in the late 1970s when the discovery of North Sea oil pushed up the value of the pound.
The obstacles to major shale gas production in the UK are well known. To start with there are uncertainties about the geology. The estimate of UK shale gas reserves in the north of England was recently revised up substantially to 1300 trillion cubic feet and it is often suggested, based on US experience, that it might be feasible to extract 10 per cent of these reserves. Yet given that there are differences in the geology between the US and UK, no-one really knows whether it will be economically viable to extract anything like this volume of gas.
Even if the economics of extraction turned out to be viable, there are a multitude of environmental concerns and substantial political opposition. Unlike the US, where fracking can take place in the wilderness, we live in a crowded island. Developing our shale gas reserves will inevitably bring substantial local and national opposition that will make it much harder for the industry to take off in a big way.
But as many commentators have already pointed out, even if these substantial obstacles could be overcome, it may not mean cheap gas for our manufacturers. Unlike the US which has little capacity to export its newly found gas reserves, the UK is heavily integrated into the European energy market and our gas prices are set at the European level. Extra gas production from UK shale gas is unlikely to be large enough to lead to major reductions in European gas prices.
But what has been overlooked is that the discovery of a natural resource should lead to an appreciation of the exchange rate, which makes the manufacturing sector less competitive. The most celebrated example of this happened in the Netherlands after the discovery of a large gas field in 1959 which led to the term the “Dutch disease”.
There is also an example closer to home when the UK made the discovery of North Sea oil in the 1970s and sterling became a "petro-currency". Interestingly, if the claims of proponents of fracking are to be believed, the scale of shale gas reserves in the UK could be of a similar magnitude to the discovery of North Sea oil. If 10 per cent of the estimated northern shale gas reserves were accessible, this would be equivalent to around 3250 million tonnes of oil which is almost exactly the same as UK offshore oil production since 1975.
And the precedents from when the UK discovered it had large offshore oil reserves in the 1970s are hardly encouraging. Despite an almost perpetual economic crisis, the real effective exchange rate of sterling rose by nearly 30 per cent in the six years after the first North Sea oil was landed in 1975. Over this period gross output of UK manufacturing fell by over 22 per cent and unemployment rose sharply.
That’s not to say that no-one benefits from exploiting natural resources. The companies extracting shale gas could take on more workers and may generate higher profits for their owners. There may also be additional tax revenues for the government if they are not squandered on excessive tax breaks to stimulate the industry in the first place. But the beneficiaries will not include UK manufacturers. Even if one ignores all the practical, political and environmental obstacles to exploiting our shale gas, the argument that it will lead to a renaissance in UK manufacturing does not stack up. It is unlikely to significantly reduce our energy prices and is more likely to push up sterling and erode the competitive position of our manufacturing firms.