Friday, June 11, 2010

Shale gas and EU energy security

by Katinka Barysch

Will unconventional gas solve Europe’s energy security problem? Many EU member-states rely a lot on Russian gas; in the case of some Central and East European countries the dependence is total. What if these countries suddenly discovered that they themselves sit on huge gas reserves? They should not hold their breath. Unconventional gas will make a big difference to the EU’s energy security – but perhaps not in the way that shale gas enthusiasts expect.

Unconventional gas (UG) is gas trapped in rock formations. The technology now exists to get this gas out. It involves drilling into the rocks and then blasting in water mixed with chemicals to extract the gas. In the US, the new technology has been a ‘game changer’. US production of shale gas (one form of UG) tripled in 2004-08, allowing America to overtake Russia as the world’s biggest gas producer. The US is now self-sufficient – which has enabled it to mothball its terminals for importing liquefied natural gas (LNG, gas that is frozen to liquid form and transported by tankers).

Is something similar about to happen in Europe? Some energy experts estimate that Europe’s UG reserves could be several times bigger than its conventional gas reserves. The likes of Exxon, Chevron, Shell and ConocoPhilips have already snapped up land plots in places that look promising for UG exploration, most notably in Poland, Sweden and Germany.

Should the EU scrap expensive and complicated diversification plans, such as the proposed Nabucco pipeline to import Caspian gas, and simply wait for the UG boom to happen in Europe? At a recent energy security conference in Vienna, gas experts, geologists and industry representatives urged caution.

* Estimates of European UG reserves are based on geological surveys that were not carried out with UG in mind. Only drilling holes in the ground will show whether the geology is indeed suitable for producing and commercially exploiting UG. So far, there has been very little drilling in Europe. A couple of wells in Hungary have been abandoned as unpromising. In southern Sweden, environmental concerns may make gas extraction impossible irrespective of whether the geology proves suitable. In Poland, the country considered most promising, not a single well has been drilled so far.

* In the US, it was small, technology-savvy energy companies that made the shale gas boom possible. The giant international oil companies have only recently joined the fray by buying up smaller companies with the right technology and know-how. Europe’s energy markets are still dominated by national champions. There are few nimble, innovative players. Expertise and infrastructure for UG development is scarce. Engineers are being flown in from Texas or Pennsylvania. In the whole of Europe, there are only 67 land rigs (the structures used in drilling for UG), compared with thousands in the US.

* US legislation tends to be rather kind to oil and gas companies. For example, the law that regulates the safety of drinking water has an intentional loophole that excludes ‘fracking’, the technology used to blast water and chemicals into rocks. Only now, with the shale gas boom in full swing, are environmental concerns mounting in the US. In Europe, by contrast, exploration starts with these concerns already being widely discussed. UG production needs huge amounts of water and, more importantly, uses chemicals that seep into the ground (usually at a depth of several thousand metres but that could store up problems in later years). Some UG drillings have made the earth shake near-by.

* Big UG sites require lots of space (they consist of scores of rigs close together), as well as new roads, reservoirs and pipelines. Planning restrictions in Europe are often tight, partly because the continent is more densely populated: typically 250-400 people live on each square kilometre in EU countries compared with 80 in the US.

* In the US, whoever owns a plot of land owns the resources beneath it. In EU countries, the resources below surface usually belong to the state. There will be no ‘poor farmers to shale gas millionaires’ stories in Europe. If only big energy companies gain, UG production could be less socially acceptable. Moreover, those companies looking for UG in Europe complain that local regulators and environment ministries have no experience with awarding the necessary licenses. Progress can be frustratingly slow.

* The US shale gas boom happened at a time when gas prices were rising and most analysts predicted steadily growing gas demand for years ahead. The situation is very different now. The European market is over-supplied at the moment, prices on the 'spot' market for short-term gas contracts have fallen significantly, and the medium-term outlook is highly uncertain. “High prices allowed us to make lots of mistakes when building up the US shale gas industry,” says one gas expert. “With depressed prices and demand in Europe, we have to be profitable straight away.” Because of the smaller scale of production and the dearth of infrastructure and expertise, it will probably cost two to three times as much to produce UG in Europe than in the US. So it is not clear whether European UG will be able to compete with LNG and pipeline gas.

Whether and when Europe’s first UG projects will become profitable is still anyone’s guess. One manager who runs a UG project in Poland says that in a best case scenario his company would need around three years to drill exploratory wells, another three to determine whether resources are commercially viable and yet more time to figure out how to get supplies to customers. One person involved in the Swedish exploration says he would expect commercialisation in around ten years.

“In Europe, unconventional gas is not a game changer,” concludes one executive of a big EU gas company. UG will most likely develop in Europe, but a repeat of the US shale gas boom is doubtful. The good news is that regardless of UG developments in Europe, the shale gas boom in the US is changing the global, and European, gas market.

Scores of new LNG terminals are being constructed in the Gulf, Africa and elsewhere. But the US LNG market has disappeared almost overnight. Other than Asia, that only leaves Europe as a destination for rapidly growing amounts of LNG. Already, market prices for LNG have collapsed in Europe, which, in turn, has forced pipeline gas suppliers such as Norway’s Statoil and Russia’s Gazprom to re-negotiate contracts with their biggest European customers. LNG imports mean more competition in a market hitherto dominated by 30-year contracts with fixed volumes and prices linked to the international oil price. That system is crumbling. Gazprom and other suppliers will have to make a bigger effort to be cheap and reliable – and that before even a single molecule of unconventional gas has been produced on the European continent.

Katinka Barysch is deputy director of the Centre for European Reform


Andrey A.Konoplyanik said...

Excellent article! My congratulations to Ms.Barysch! This is an excellent analysis - the best one among those on shale gas that I have read/heard in the meantime. I have the same view as the author on the prospects of the shale gas in Europe and worldwide - this gas will definitely find its competitive niche in the energy balance, different in different regions and much smaller in Europe than in US, as the author has shown with good persuasive argumentation. Current eiphoria and exagerration regarding as if its future dominance in the energy mix and expectation that it will substitute traditional gas, including puipeline gas supplies to Europe from Russia, is very much emotional and is not based on fair economic justification of its future role. I do fully in agreement with Katinka that revolutionary role of shale gas need to be found out not in the current or future structure of energy balances, but in this "domino effect" that it has pushed forward and stipulated changes in contractual structures and pricing mechanisms in the international gas markets, including and first of all in Europe. I do agree with the author that without US shale gas this adaptation, that has started already, of contractual structures and pricing mechanisms in European gas market will be at least postponed for some indefinite future. I do agree that it was, in effect, US shale gas that stipulated Gazprom to adapt in long-term contracts to make them more flexible and more competitive within this new environment at the European gas market. My congratulations to Katinka! Very well done!
Dr.Andrey A.Konoplyanik, Consultant to the Board, Gazprombank, and Professor, Russian State Oil & Gas University n.a.acad.I.M.Gubkin, both Moscow, Russia

Nick Grealy said...

Drs Konoplyanik and Gubkin naturally have a somewhat negative view on shale in Europe. I think it would make more sense for Russia to start with their own shale reserves that tower over those in Europe.
Much of Ms Barysch's analysis makes sense, especially on LNG's impact. It is an analysis not unfamiliar to readers of .
However given the market dynamics of Europe, it would not take much shale to have a significant impact. It will come and sooner than one thinks, but at that point we will have shale being exported from Texas directly to Europe in the form of LNG. Shale is accessible, affordable and despite what many in Gazprom would like us to believe, far more environmentally friendly than some would make out. Shale production would sit on our doorstep where we can keep an eye on how it is produced. I somehow would have more trust on the green footprint of shale techniques in Europe than conventional gas produced in Kovykta or Sakhalin or Yamburg or Urengoy to name just a few!

Anonymous said...

Mr Grealy,

Dr Gubkin was not a co-author of Dr Konoplyanik. Gubkin is simply part of the name of Mr Konoplyanik's place of work. Too bad the chap is no longer with us, I would be very much interested to hear his opinion on the issue.