The Real Problem of Shale Gas in Europe: Financing

While the European Union continues to finance roads and railways - low investments in gas storage facilities remain a problem. Natural Gas Europe had the pleasure of speaking with Gilles Darmois, expert and author of a report about shale gas in France and Europe.

We spoke about the mistakes made by European countries and institutions, future opportunities and possible challenges. According to Darmois, Donald Tusk’s proposal to create one single European gas buyer is the optimal solution, but it could find resistance from several companies, whose preference is to negotiate gas contracts with Gazprom because “the only interesting thing when you are in a gas company is to negotiate contracts.” The French expert also said that European institutions should not forbid fracking, but they should simply define an appropriate legal framework. However, according to Darmois, fracking has no future in Europe - and the reason is not political, but economic. He also said that infrastructure and cohesion are the two solutions in the hands of Europeans, while enthusiasm for US LNG will soon run out of steam. 

You write that Europe requires a real gas policy - what mistakes have been made thus far? 

The question for me started when we had the Crimean problem, when Russia annexed Crimea and people started thinking about sanctions. Everybody said it is too bad because we cannot impose sanctions against Russia because we need Russian gas. These events led me to take back a report I wrote back in 2009, in which I suggested to promote a grouping at a European level, a central buyer for European gas. At that time, Europe was the only good client of Gazprom. And by good client I mean that Europe paid in hard currency. 

So you are basically saying that a very different situation occurred 5 years ago and that a reaction at the moment would have been more effective. Effectively, Europe would have had stronger bargaining power back then?

Yes, but the problem is also that, as it stands today, it is not possible to effectively move gas around Europe. You cannot move gas from the West towards the East in quantities that can face the eventual disruption of one source. There is no gas safety. We have to be much more serious about building high pressure transportation infrastructures that can move gas from the LNG terminals on the Mediterranean Sea or Atlantic Ocean towards the Eastern part of Europe. And similarly, if you have problems in the West, you could use the same infrastructures to ship gas from the East to the West. In my work I propose to remove all the congestions within Europe. This requires European policies and States cannot be left on their own because the main transportation pipes have to be across states.

To recap -  two main European mistakes are a lack of understanding of the situation and a late answer to the problem. In a sense, you say that the answer from the European Union arrived too late, with national interests prevailing on the common mission. 

Well, not only that. The European Union has been focusing on competition policies and not on an energy policy. In that competition policy, the idea was that you should have as many actors as possible and that you should leave the decisions to the market. The problem is that the market will never build safety infrastructures because there is not a return for this kind of investment. The markets will not pay this price, the safety infrastructures have to be fostered through political decisions taken at a European level. 

Are European politicians able to cope with such a mission? In other words, do you think European politicians are able to understand the situation and finally take strong and fast decisions to foster this kind of safety infrastructure?

If you look at the proposal made by the Polish Prime Minister Donald Tusk, you see that there is some form of understanding. He said that there must be one single European actor to buy Russian gas. At least, Donald Tusk is ready for this sort of approach. The point is that we are weak actors in front of a seller, but if you group these actors in one agency that will buy the gas, this new agency will be very strong. At the moment, everybody goes to Gazprom and Gazprom thinks that they are a must, but that should not be the case. Gazprom is now launching new routes toward Asia, but that will require a lot of investments. It cannot be anything but a long long long process. In this context, some people start understanding the problem and that we need a central buyer. 

What about safety infrastructures?

For what concerns infrastructures, Europe has been spending billions of euros to build roads and railways, but not enough has been poured on energy infrastructures. Of course, this is another signal of the fact that Europe has not any form of energy thinking. Europe has a focus mainly on competition and transportation, but no energy at all. 

You said that a single purchaser of gas in Europe would strengthen the bargaining power of Europeans. Do you think this is possible, considering national interests? Austria seems to be increasing its clout supporting the South Stream project, running against Brussels' position. Germany is taking advantage of the situation as well, signing good contracts with Russian companies. Spain’s Repsol is consolidating its position in Russia as well. Italy is trying to capitalise on its presence in Algeria. Norway clearly voiced its intention to influence European policies. Are all these facts compatible with a single purchaser of gas?

Speaking with people from the industry, I realised that the only interesting thing when you are in a gas company is to negotiate contracts. So, if you leave these negotiations to some agency, it becomes very boring for companies and their employees. So that is the main reason why it is so difficult to have this idea coming through. I speak about something that is objective and, if we want natural gas to play a role in the energy mix in Europe, we must create a safety network. If you don’t want this single buyer of gas, there still remains the transportation, which comprises getting rid of all the congestions so to be ready to gas disruptions of 60 to 90 days from single suppliers. If you speak with gas companies, they say that they cannot fund gas storage facilities because they are too costly. But when it had been decided that we would have had 90 days of oil storage to face disruption, everybody reacted saying that it would have been too costly. But at the end people agreed on the fact that it was a necessary measure to improve the supply of oil. If we want to seriously go into gas, we must give to the gas safety the same level of importance granted to oil safety. The problem here is that there is a seasonality in the gas consumption, but I am speaking about gas storage in addition to the inter-seasonal storage. 

Are the same considerations/points valid for your other arguments? You said that it would be important to create a European operator responsible for developing and managing infrastructures and storage facilities to increase the efficiency of transmission facilities - correct? Is this compatible with national interests?

There are two things here. Firstly, there is less and less connection through direct ownership between the States and the oil and gas operators. Secondly, I think that companies would be interested in having these infrastructures because it would put them in the condition to sell any form of imported gas on the Western coast to any place inside Europe. I think these infrastructures are a pre-requisite for having a really unified gas market in Europe. If you cannot move the gas around, you cannot have a single gas market. All the companies should be interested here, but they would not build these infrastructures because they don’t have the strong incentive to do it. That is why there should be another kind of intervention.

Are you saying that Europe should fund this kind of infrastructure?

Not necessarily to fund them, you can identify the region, looking at the flows and the congestions, before making a call for tender. These people who will manage this infrastructures agency will say: well, I need this capacity to be built between this point and that point, what are your offers, what would be the price and sort of return on investments do you require? Then the agency would choose. So, it would be private funding, private companies and then the repayment would be made  over the years by some fee paid by the agency managing the infrastructure. 

To change the topic slightly, you write that American gas prices are set to increase over the next years.

Yes.

Do you think that this increase would weaken the argument of European shale enthusiasts? In other words, do you expect that an increase in US gas prices would have an impact on European policies as well?

I also said that European policies should not change because of American gas prices. Europe should not wait for American gas to replace Gazprom. Europe should not wait for free or cheap gas from the US. When the US will start exporting its gas, it will not be cheap, because the demand will be increasing and the supply will not increase that much. Right now in the US they are developing a Compressed Natural Gas system for trucks. That is developing and it will increase the demand for gas. They have the Petrochemicals based on ethane that will increase demand as well. You have some manufacturing going to the US because of cheap gas. This will equally translate into higher demand. Then you have 3, 4, 5 LNG plants that are going to export gas. That will also increase the demand.  If you look at this additional demand, you see that the price will go back to what it was before. So you will not have competitive LNG. The American Liquefied Natural Gas will not be cheaper than Russian or Qatari gas. 

When will it happen? When will we see a rise in gas prices?

Also today, the gas price does not pay for the well in the US. If you look at all the impairments made by the companies, you can easily notice that gas prices are set to increase if you want to keep demand on the same levels. Right now, the price does not pay for the drilling or the completion of the well. So the CAPEX is not paid back. Therefore, the prices are set to go up. Soon.

Some experts also foresee some small US shale producers going bankrupt when interest rates increase. In your understanding, is this a relevant factor to consider while designing a grounded European gas policy?

I think the prices are so low at the moment because of destruction of equity. Several billions destroyed between Shell and ExxonMobil are very visible. That is due to the fact that small players have been selling to large players some shale acreage at really high costs, expecting higher gas prices. But the prices are not high enough. If you want to have a stable production of shale gas in the US, you must have higher gas prices. And this would decrease the potentials of American to become an exporter of natural gas, especially to Europe. When LNG facilities will be ready to export, gas prices will be not 4 dollars, but more 6, 7 or 8 dollars.

Do you think that energy-intensive manufacturers that previously thought about setting up plants in the States are considering this change in prices? In other words, are there some European and Asian companies anticipating these increases? Do you think the relocation trend will continue?

As far as the anticipation of an increase in prices, my answer is no. The fact that shale gas wells’ production declines very quickly and the fact that you have to drill constantly are two aspects that petrochemical companies don’t understand. However, companies may prefer paying less than their competitors, but they are satisfied as long as they don't pay more. If you think that the US has low gas prices, then you move to the US. But if American gas prices go up, it goes up for everybody present in the US.

Are you saying that European companies are not going to relocate over there because of a likely increase in gas prices in the US?

I think that some companies still believe in the so-called miracle of shale gas. They might move. They will therefore become an additional force pushing up demand and increasing the US price. But as I said, it will be OK as long as they do not pay more than their competitors. The main purpose of the gas consumers is to pay low prices. If they can’t pay low prices, they want at least to pay the same price paid by competitors. If they just can get more expensive gas, they will not be able to compete. 

You said that Europe should not openly help shale gas explorers and that it has to avoid granting public assistance, subsidies or feed-in-tariffs. Do you think that a European shale gas industry could survive without public help?

I think there is no future for shale gas in Europe. The first reason is that the gas belongs to the states and it is not owned by individuals. So you cannot drill 1,000 wells at the same time. This is not possible. 

What is the other reason?

There are much more people in Europe than in North America.. The density of population is much higher. A lot more people will be against giving drilling permits in their back yard. 

Do you see any other difficulties?

There is no infrastructure. You cannot bring the rigs from the US because there they are working full time. You would need to build another 1,000 rigs. That requires know-how, but also steel and other materials. You also need to train drillers, you have to train people doing the completion. In other words, it would require huge and long investments.

So what is your message?

What I say is that it should not be the state to forbid fracking. States’responsibility should be to write the rules for fracking to respect the environment. So the first step would be to authorise fracking after the rules have been written together with the companies who claim to have the answers to clean drilling. Then the industry will try to work and that stage will prove that they cannot make it. I think that the question of shale gas in Europe should be solved trying and seeing if it is economic. I would be surprised if it was economic, but if it was, that would be good news. If it will be not economic, it will then be dropped. But at least the current political buzz will fade away. No more political bickering. 

What about the UK and Poland? They seem quite in favour of substantial support to shale gas explorations. 

Yes, but Poland has not been very successful. Exxon drilled and left, Chevron drill a few wells, they are still there, but at very different conditions. So Poland did not really succeed. In the UK, if companies want to go for shale gas, the onus is on them, to prove that it is possible to drill respecting all the environmental requirements. 

But it is clear that companies will receive subsidies, in one way or another. 

I think there should not be subsidies because of a political reason. The first hurdle for shale gas is environment. If you support it, you will create enemies. Also the industry says that they don’t need state subsidies. Maybe after a while, they might say they need feed-in-tariffs, as they do for Coal Bed Methane in Northern France, but in general they don’t ask for any support. All in all, I think that the markets will not solve the problem, but that states cannot ban it and that companies have to make their way without any subsidy. That is also to avoid the current political buzz.  

Sergio Matalucci