Centrica to invest £160m in UK shale gas

The fledgling UK shale gas sector receives a boost from Centrica’s £160m farm-in deal with Cuadrilla Resources

June 14, 2013

Cuadrilla Resources, the leading UK shale gas explorer with early-stage licences near Blackpool, has signed an historic farm-out deal worth up to £160m with British utility giant Centrica (CNA).

Centrica has acquired a 25 per cent direct interest in the Bowland shale exploration licence in Lancashire for £40m in cash from privately held Cuadrilla and AJ Lucas (AJL:ASX), an Australian Securities Exchange-listed engineering group which also holds a 41 per cent equity interest in Cuadrilla. Centrica will also pay up to £60m in exploration and appraisal drilling costs, followed by an extra £60m payment should it decide to move into the development phase afterward.

Centrica is the first major energy player to enter the UK’s nascent shale gas industry. Besides operating British Gas and Scottish Gas, the energy stalwart also has a rapidly growing upstream business, with assets spread across the North Sea, Norway, the Netherlands and Trinidad.

Mark Hanafin, managing director of Centrica's international upstream business, said: "This transaction presents an attractive opportunity for Centrica to explore the potential and commercial viability of natural gas from shale in the UK, while utilising its expertise as a responsible operator and developer of UK gas resources." But he cautioned that further drilling will be required to establish whether Cuadrilla’s Bowland shale gas project will be commercial. This is despite initial data suggesting there could be some 200 trillion cubic feet (Tcf) of gas in place within the licence.

According to the Daily Telegraph, the initial £60m is intended to cover the costs of a six-well drilling program. A spokesman for Cuadrilla told the Investors Chronicle that the first well in the program will likely be drilled and fracked in 2014. The company had hoped to restart drilling this year, but felt it wouldn’t have had enough time to complete an exploration well before a flock of "wintering birds" arrived. One of the stipulations in Cuadrilla's exploration permit is that it can't do any work while a specific breed of bird nests there for the winter. In the meantime, Cuadrilla will work through the lengthy community engagement and permitting processes for a handful of other sites.

Undoubtedly, this is a huge positive development for the Britain’s fledgling shale gas explorers. But we find Cuadrilla's choice of partner intriguing. Clearly, Centrica is a major player with huge financial resources, an operating upstream arm and an integrated distribution network. But it has no prior operating experience in shale gas whatsoever. As such, Cuadrilla will remain operator of the licence. We can't help but think Cuadrilla would have benefited from working with one of the many other large energy companies with technical experience extracting shale gas in or outside of the US. No doubt, many of them would have taken a look at Cuadrilla's data and initial well results, which have yet to be publicly disclosed. The company admits gas flowed from a partially fracked shale gas well in 2011, before earth tremors forced a shutdown of the operation, but has not said at what rate the gas flowed.

We continue to rate shares in the two leading UK shale gas explorers, Cuadrilla (through AJ Lucas) and IGas Energy (IGAS), as a speculative buy. We also rate Centrica's shares a buy, although we don’t see shale gas providing any meaningful contribution to its overall business for several years to come, if ever. For a roundup of all the shale gas explorers in the UK, check out our in-depth feature on fracking here.