Baker Study on Geopolitics of European Shale Gas Fails to Rise
By Michael LaBelle
The potential of shale gas to alter the geopolitical landscape of energy is becoming too important to ignore. The recent report by researchers from the James A. Baker III Institute for Public Policy at Rice University determines that Russia will become a shriveled supplier to the European market by 2040. According to the report, Russian exports will only comprise 13% of the European gas mix, compared to 27% in 2009. The dramatic impact, as determined by the researchers, will be the scrapping of South Stream and altering the supply sources for Nabucco.* Europe will thwart Russia's energy weapon by utilizing the increased liquidity in the European and global gas markets. The findings suggest that the overall impact on Europe, of exploited shale gas plays, will be a more independent continent with a reorientation towards the foreign policies of the United States. However, this perspective overlooks fundamental realities about the geopolitics of gas in Central and Eastern Europe and how US foreign policy should respond.
The study
First, it must be stated that the authors do a robust job of developing a global model that accounts for the impact of gas extracted from shale formations. The model and the scenarios do well to demonstrate the impact on energy markets until 2040. In addition, expanding the analysis to consider the geopolitical ramifications is commendable. However, despite using a robust model that can adjust for regional differences, they fail to be more effective at setting up the scenarios and to account for present and future regional market conditions. This failure leads to false assumptions that may erroneously influence US foreign policy in relation to promoting shale gas technology and undermine support to the Nabucco gas pipeline project.
At the start of the report the researchers caution of the regulatory and environmental hurdles that may reduce the assumed output in the model. However, in the model they ignore these hurdles, despite the obvious importance to a geopolitical analysis involving shale gas. In addition, political support for shale and pipeline gas should not be underestimated. After all, it was the Polish government that in 2010 signed a new gas supply agreement with Russia and Gazprom. Some commentators warned this threatens to dilute the viability of the country’s LNG terminal. The politics of gas rest in diversification but not exclusion.
My criticism of the report rests on three areas. 1) The clumping together of Europe and presenting it as a single gas market, 2) ignoring technical and regulatory aspects of shale gas, and 3) ignoring political and commercial support for the Southern Corridor. Accounting for these aspects will lead to a more effective assessment of how shale gas will not liberate regions of Europe from Russian gas dependency. Consideration of these aspects also means Europe will not become friendlier towards US foreign policy – as the authors claim.
The ‘single’ European gas market
There are three scenarios the researchers provide that demonstrate the impact of shale gas on the geopolitics of energy. In my own words these are:
- Everything global, shale gas is exploited from all countries globally.
- Life in 2005, US shale gas from 2005 discoveries are used and no shale gas is exploited outside the US.
- Limited US/Everything global, US environmental regional restrictions limit US output but not globally.
Developing US foreign policy advice based on these limited and constrained scenarios only extends the distorted/neglected picture that US policy makers have on Europe, and more specifically Central Eastern Europe (CEE) and South East Europe (SEE). This is where my criticism lies. If the researchers are able to account for regional variations in the US, then they can also develop a scenario where regional variations in Europe are accounted for. The reliance on Russian gas is regional. As demonstrated by the chart based on Gazprom’s 2010 data, by Ian Wyatt writing for TheStreet. The use of Russian gas varies across Europe, with dependency quickly rising above 50% for most countries in the CEE/SEE regions. Those countries that have less dependency have access to alternative supplies and domestic production (such as in Romania and Poland).
Painting Europe with a single brush obscures the regional variations in gas dependency that can generally be summarized as between new and old EU member states (Western and Eastern Europe).* For this reason, the location of shale gas is also important to consider. Shale gas is expected to fuel local markets. Thus, if a recent report by the United States Energy Information Administration is considered shale formations exists in Poland with a high probability in Bulgaria, Hungary, Romania and Slovakia. The countries that are highly dependent on Russian gas also have the potential to significantly reduce their reliance on Russian sourced gas. However, the current high dependency in the CEE/SEE region, even after utilizing shale gas, may still remain relatively high in comparison to older EU member states. Dependency on Russian gas will remain high for the following two reasons: technical and regulatory constraints and the political realities that are infused into European gas markets.
Source: http://www.eia.gov/analysis/studies/worldshalegas/
Technical and regulatory assumptions
The “Hype and Reality” of shale gas, as explored by Paul Stevens in a 2010 Chatham House report, demonstrates that it is more than just potential that drives the amount and speed of gas extracted. Local factors will play an important role. These factors are based on getting to know the local geology, legal frameworks, size and scalability of the local technical know-how, NIMBY, environmental concerns along with the local environment’s ability to support extraction techniques.
Encouragement, or discouragement, can occur at the national and local level. At a recent shale gas conference in Hungary, a Polish participant disputed the findings of the Chatham House report with the author himself. And while Poland’s encouragement and significant backing of the technology should not be overlooked, these concerns must be considered in a regional CEE context to understand if a dent can be made to gas supplies from Russia.
Disputed or contentious energy regulatory environments, which are common in the CEE/SEE region, may also dissuade potential investors. Risks increase in inconsistent regulatory environments; these will feed into any evaluation of the costs of investment in a country, even if incentives exist.
Political realities
The political support for shale gas exists in the CEE/SEE region. It also exists for transit pipelines through Europe’s Southern Corridor shipping gas from Russia, the Caucasus, Central Asia, and the Middle East. Governments and companies have already invested and committed money to these projects. Significant political capital has also been spent. The need for a gas pipeline, either Nabucco or South Stream, is justified from a security of supply perspective. This is not to say a southern transit pipeline is either 100% economically or politically justifiable, however enough of both reasons are present in the concepts to support an alternative European supply route.
The study discounts the business case for South Stream and alters it for Nabucco.* There are significant question marks hanging over both pipelines in terms of costs and supply sources. The assumption is that Nabucco cannot achieve 50% capacity utilization over 20 years, to make it economically justifiable. Included in this assessment is the methodological assumptions that gas from the Caucasus meant for Nabucco will be diverted to higher priced Asian markets, while conventional Iraqi gas, when it comes on-line at high capacity, fills this void. However, this assumption is based on unimpeded lower priced European shale gas production, which does not correspond to a realistic scenario.
Constraints on shale gas production in Europe need to be considered because these will influence European shale gas prices. In addition, there are significant security of supply justifications for pipeline gas. Just as shale gas will need strong political backing, including financial incentives, to make it a reality so too does the gas through the Southern Gas Corridor. Labeling gas from Central Asia and the Caucasus as too expensive compared with tax incentivized shale gas is unfair. The same considerations should be applied for Southern Corridor gas.
The largest hurdle may come from vested state business interests in a southern transit pipeline. State ownership or investments held in companies supporting Nabucco and South Stream also mean there will be competition for direct or indirect state economic support. Austria, Bulgaria, Hungary, and Romania all have financial interests in the pipelines. The Baker Institute authors assume that shale technology will quickly surpass and undermine support for Nabucco, rendering it a white elephant; to avoid this Iraqi gas should be used to achieve US geopolitical aims. However, there remains the likelihood that Nabucco will be built before shale technology is significantly deployed. This could undermine the political (and possibly economic) justification for shale gas.
Conclusion
The model’s authors seek to offer shale gas as a geopolitical game changer (as I have outlined elsewhere, this is not the case). Energy independence, the authors’ assume, can liberate Europe from Russia and bring European countries more closely to US policy positions. However, the existing regional divisions in European energy markets are not presented and the all or nothing assumptions further divorces the findings from regulatory, technical and geopolitical realities.
Revising the model to account for more realistic assumptions, or even a mid-way scenario will provide policy makers with an effective analytical tool. The authors provide a solid foundation, and robust model, to account for alterations in the global and regional variation of energy infrastructure. Therefore, they should account for the building of one southern transit pipeline and two LNG facilities in Central Eastern Europe, along with more robust interconnector capacity. An energy infrastructure survey on the impact of the Southern Corridor indicates this as a likely scenario for future developments in the infrastructure in the region. The costs may be higher than ‘rational’ market prices, but security of supply and gas do not always conform to true market pricing. Providing effective policy advice in the area of geopolitics of energy requires fuller accounting of regional variations and the realities of technological progress.
Basing US foreign policy on an “energy independent Europe” born from shale gas, leads to erroneous support for a US technology. This false support undermines more effective avenues of cooperation between the US and Europe, such as in Nabucco. The assumption that shale gas will increase European support for US international initiatives that Russia opposes, lends almost a vassal status to the countries in Eastern Europe. In addition, the almost total reliance of these countries on Russian oil is ignored, as is the political and economic benefits of on-going engagement with Russia. Washington should become re-engaged in Europe, and specifically the CEE/SEE region, but basing re-engagment in the region on shale gas fosters mistrust and will impede true transatlantic cooperation.
*The original version of this article said the Nabucco pipeline could be cancelled because of the impact of shale gas. After a discussion with the report’s authors, it was identified that Nabucco could remain a viable US supported project by using Iraqi gas after 2020, as stated in the report. The authors point out that the robust model accounts for regional variations in Europe, but the presentation of this data was not included in the final report. In addition, the model was developed to account for some of the identified criticisms in this article and this is a multi-part study that will later examine some of these criticisms.
Michael LaBelle is a research project manager at Central European University. He is also an independent consultant for his company Limax Energy. His blog can be found at www.energyscee.com