Unconventional Gas in Europe - Opportunities & Risks
Bullish predictions are being made about a revolution in unconventional gas in Europe; yet, Europe’s threshold for larger-scale shale gas development still remains uncertain, with a range of obstacles – from environmental concerns to economic viability - balancing out the various incentives to move forward. Unconventional gas, such as shale and tight gas, has had a dramatic impact on the US gas market, increasing energy security and steering prices downward as production and resources have headed in the opposite direction.
By 2008, shale alone accounted for 9.5% of all US gas production and by 2009, according to some estimates, 20% of US gas supply came from this source. Following these successes, Europe is now being aggressively explored for its suitability in terms of unconventional gas production as it hopes to follow in the footsteps of its transatlantic partner. There has been a significant uptick in activity and dealmaking focusing on European shale in just the last six months.
However, the picture in Europe is very different from the United States and, from an economic perspective, the play may not bear fruit. This article assesses both the opportunities and risks for European shale as producers in the region attempt of follow in the footsteps of North America.
Resource Opportunities in Western Europe
With the backing of investors and expertise from some of the world’s major hydrocarbon organizations, unconventional gas exploration is now underway. Investment bank, JP Morgan estimates that EU shale gas production is set to grow to nearly 30 Bcm/year by 2015, and four times that amount by 2020, with large deposits identified across the entire spectrum of Europe.
Specifically, Western Europe is home to substantial quantities of unconventional gas, including a large area linking the Netherlands and Germany to the East of England. Moreover, France has ample opportunity for investment with substantial pockets in the Paris Basin as well as in Languedoc Roussillon, the Cevennes Mountains and the Savoie region. In Scandinavia, Sweden has deposits in its southern regions that Shell is currently exploring and Norway’s Statoil has acted in alliance with US shale giant Chesapeake Energy in pursuit of wider European opportunities.
Towards Eastern Europe, ExxonMobil, Falcon, MOL and Austria’s OMV have flirted with unconventional sources in Hungary and Poland. OMV is also planning to resume drilling in the Vienna Basin that it pursued in the 1980s while Shell is active in exploring Romania. ConocoPhillips, ExxonMobil, Talisman Energy, Chevron and Marathon are all showing interest in the Baltic Basin of North Poland, as ConocoPhillips, ExxonMobil and Chevron have also expressed interest in Poland’s south-eastern Lublin and Podlasie Basins. Further east still, Turkey and the Ukraine have substantial unconventional reserves and Shell has pursued preliminary exploration in the latter. Europe’s geological map is clear in this sense. Unconventional gas is present and exists in significant quantities. By the estimates of the US National Petroleum Council in 2007, there may be as much as 539 Tcf (shale); 2 to 3 times more than Europe’s proven level of conventional gas reserves.
Risks Particular to the European Market
Given the industry excitement over the prospects of unconventional gas resources in Europe, it is important to understand the related risks as well. Broadly speaking, there are risks associated with the regulatory makeup of the European market, the environment, the role of Russia, and those concerning the economic viability of the European unconventional gas market. Many of these risks are the same for shale gas the world over, but particularly on the regulatory and economic viability side, they are particularly acute in Europe.
EU Market/Regulations
The laws and regulations covering oil and gas exploration and development in Western Europe are underdeveloped in terms of managing unconventional gas; so much so that current regulations do not even make reference to these types of resources. This lack of regulatory framework may create a real obstacle to Europe’s unconventional gas exploration. Take, for example, the technical definition of a ‘gas field’; normally defined territorially by the gas/water contact. In unconventional gas fields there is no such contact point and therefore no definable ‘field’ under the current legislation. Hence, the European market will require regulatory adjustments before unconventional sources can be fully optimized. By contrast, environmental legislation, principally at a local level, is much tougher and more specific in Europe than in the United States. Thus, hydraulic fracturing (hydrofracking) will be even more seriously challenged there than it has been in the US, for reasons which will be explained below.
Environmental Concerns
Chemicals used in hydraulic fracturing have proved controversial in the Northeastern US due to the potential hazardous effect they can have on water supply aquifers by way of contamination. This concern has manifested itself most clearly in efforts taken by New York Governor David Paterson (D) to place a moratorium on new permitting for shale gas development. After vetoing a more stringent bill coming out of the State Assembly earlier this month, the Governor offered an executive order which would ban high-volume, horizontal hydraulic fracturing until July 1, 2011.
This high profile case has been closely watched in Europe along with incidents like the contamination of an aquifer in Dimock Township, Pennsylvania. Both cases have boosted fears in Europe where sensitivity to the issue is acute due to its high population density and the proximity of shale ‘plays’ to urban centers such as the Paris Basin, and the water supplies of Paris. Should a shale gas water contamination incident affect the water supplies of one of Europe’s major urban areas, the fallout for the budding industry would be enormous.
Russia’s Role
Moscow is also closely watching shale developments in the United States and Western Europe. With unconventional sources helping the US to pass Russia in terms of gas production in 2009 (for the first time since 2001) and Russian output also taking a hit due to a declining EU market, shale gas has hit a nerve in Moscow. Consequently, Russia, and particularly Gazprom, has been busy criticizing the prospects of unconventional sources in Europe. Highlighting the environmental doubts over unconventional sources, Gazprom’s head of export, Alexander Medvedev, commented “Every American housewife is aware of shale gas, but not every housewife is aware of the environmental consequences of the use of shale gas. I don’t know who would take the risk of endangering drinking water reservoirs.” While it is doubtful that Russia is actually concerned by the environmental effects, it has clearly used the hype surrounding the environmental issue as a strategic pretext designed to dampen enthusiasm for what is a major competitor to its own conventional-gas export market.
The economic viability of non-conventional sources has also been attacked in Russia. A Gazprom spokesman went on record to describe shale’s margins as a joke, commenting that there was no way unconventional sources could match the prices of conventionally-produced gas. While Russia’s concerns may not be shared by others in Europe, it is clear that Russia is intent on playing the part of the ‘spoiler’ in Europe’s exploration for unconventional sources.
Economic Viability
Even bigger than these other risks, economic viability is, indeed, a major one. The profitability of unconventional gas in Europe is not nearly as clear cut as it is in the US. The US experience benefited substantially from an existing onshore service industry of which there is no comparable entity in Europe. As of April 2010, there were only around 100 active land rigs in Europe, compared to 2,515 in the US (of which 1,491 were gas). Moreover, Europe lacks the distribution infrastructure and the skilled manpower to make a major launch into the unconventional market viable.
This critical lack of infrastructure could, of course, be remedied by investment if resources provide an attractive enough pull (albeit a colossal cost in itself); yet, costs in Western Europe are likely to be high and margins slim, for a number of reasons, which could well act as a disincentive. First, the geological makeup of the European market will serve to draw out the costs. Deposits in Europe are deeper, lower in terms of materiality and in smaller basins. Additionally, European ‘plays’ are more fragmented in comparison to US ‘plays’ and its shale richer in clay, making these deposits less workable by fracturing. Second, only Hungary currently has any tax incentives for unconventional gas production providing a further disincentive for investment. Third, the European market is highly fragmented in comparison to the US market. And fourth, some of Europe’s most prominent unconventional deposits are offshore; an avenue which has yet to be explored or assessed due to the significant costs involved.
Given Europe’s Tight Supplies, Perhaps an Inevitable Risk Worth Taking
On the whole, unconventional gas development in Europe will be more challenging than in North America, but its added risks should not be a deterrent to investors with the capital and expertise. Far more than the US, where the supply issues are actually far less pressing, EU countries are in need of a comprehensive energy revolution, or they will continue to suffer from a lack of adequate supplies and high prices during this significant continental economic downturn. It is hard to see a way that Europe can address its supply issues without substantially more unconventional gas coming online. Energy security through unconventional gas may well be the incentive to overcome the obstacles, though significant, of regulations, environmental concerns, and economic viability, detailed above.
Alexandros Petersen is Director of Research at the Henry Jackson Society
This article is reprinted with the kind permission of the Henry Jackson Society