Analysis

The shale gas revolution

In the first of a two part series on the major issues surrounding shale gas extraction in Central and Eastern Europe, Andrew Ryan summarises how these new sources will be exploited differently to US reserves.

Fracking in Krynica, Poland.Image licensed on Creative Commons by Karol Karolus.

Fracking in Krynica, Poland.
Image licensed on Creative Commons by Karol Karolus.

Unconventional gas has been recorded since the nineteenth century. However, our story doesn’t really begin until the 1980’s, when the Arab-Israeli Oil Crisis and a genuine fear about the security of energy supplies overlapped with rising prices and dwindling conventional reserves. It also coincided with the USA reaching an onshore energy resource maturity in both natural gas and oil, resulting in the exodous of many major oil companies either to different countries, or to offshore drilling sites. This meant that remaining resources, many of them seemingly unviable, were left to small and medium sized enterprises (SME’s). Of these, shale gas (one of four unconventional gases) is extracted using a technology called hydraulic fracturing, which, through a reduction in cost base price has recently become economically viable. The USA has ruthlessly exploited this resource leading to huge increases in output and a rapid fall in prices.

Understandably, countries everywhere are attempting to repeat the USA’s shale revolution.  These aspirations are particularly acute in Eastern Europe, notably in Poland and Ukraine.  The nature of natural gas transit combined with a socialist legacy and the subsequent existence of state-owned companies, leads to the creation of powerful regional monopolies such as Gazprom. With service suspensions in Ukraine still fresh in many people’s memories, the stakes appear significantly higher in Eastern Europe.  Large unconventional reserves and excitement about this fuel of the future therefore make this region seem like the perfect opportunity to experiment.

Few people then would dispute that shale gas will be exploited at some point in the future. The real question that arises is whether shale gas will be a competitively priced substitute to current supplies. This is not just a question of reservoir quality or technological capacity, but of the institutional ability to exploit these reserves. To help us understand this, we need to turn to our only known example of economically viable extraction – the US.

Compared to America, the biggest stumbling block for Central and Eastern Europe thus far seems to be the marked absence of SME’s. Instead, the challenge will probably be taken up either by international Oil Companies (IOC’s) or national giants, such as PGNiG and Naftogaz. Neither of these entities have the qualities that made shale gas so successful in the US: a constant drive to grow, being structurally nimble and a willingness to take risks.

The inherent problem of shale gas is the constant need to find new sources and ‘sweet spots’, while at the same time reducing the cost base, through either technological innovation or greater geographic understanding. These are activities that lumbering state-owned energy giants, or to IOC’s who are still heavily invested in conventional and offshore reserves, are not best placed to undertake.  Indeed, with an increasing number of IOC’s departing Poland, PGNiG in particular has a seemingly insatiable appetite for licenses.  With the market vulnerable to the potential of artificially low priced liquefied natural gas (LNG) from the USA and massive conventional reserves in Russia, it is hard to believe that the shale gas revolution will be that revolutionary.

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4 thoughts on “The shale gas revolution

  1. Might foreign SMEs catch the opportunity? I think I cannot form a decent opinion, I am not knowledgeable enough to form an opinion. It would be nice to hear the opinion of the writer.

    I came up with some thoughts though, and institutional issues are central to these thoughts.

    From the side of growth-starved foreign SMEs I do not see why the option of launching new operations and drilling new fields in Eastern Europe should be off the table from start.

    From the government side, licensing drilling operation to foreign SMEs seems to me a very politically sensible issue.

    On one side governments might be eager to fully value revenues from gas extraction. If foreign SMEs have superior technology and higher willingness to bear business and exploration risks, they might be willing to bid for the licenses unrivaled by big regional players. At least in Poland, where the common market offers legal protection to SMEs which are target of unfair treatment in public tenders or retaliations from big corporations.

    In addition, the regional market would see Eastern European countries less dependent and with more bargaining powers in negotiations with state-owned monopolies like Gazprom.

    In such a scenario though I do not see but long term political returns and very high risks meanwhile. Why should Polish and Ukrainian government push such an agenda when regional monopolies could just pull the plug six months from now? Let alone the political pressure that could mount in countries like Ukraine.

  2. Thanks for the comments Giacomo,

    “From the government side, licensing drilling operation to foreign SMEs seems to me a very politically sensible issue.”

    It does seem a very sensible opportunity. And I think your right it does seem odd. But I think the issue coalesces around a desire to keep resources nationalised and ensure investment in the economy, something which state giants and IOC’s can respectively offer. That said, I do think it’s an interesting idea that people have been dismissive of.

    However, there are a couple of points which I omitted from this due to space constraints. Firstly, there are most certainly foreign SME’s operating in Poland. Take a look at this for the breakdown (http://polishshalegas.pl/en/shales-in-poland/other-licensees). However, Poland’s mining law in particular seems to be inching ever closer towards the state exerting strong control over its own resources for example any companies wishing to operate there have to apply for permits in Polish and have to, I suppose, kind of ‘outsource’ their E and P work to Polish companies. So you get companies like “Chevron Polska Energy Resources Sp” or “lane energy Poland”. This is ‘collaboartion’ is probably going to be further intensified by the intermediary powers of NOKE (National Energy Minerals Operator). All in all I see it as unlikely that international or domestic SME’s will have much effect.

    Ukraine on the other hand seem to, and have very recently signed a massive deal with Royal Dutch Shell for production. Seemingly they see IOC’s as having sufficient financial clout to begin something like shale gas from almost scratch. There perhaps was the potential for SME’s to develop these resources, but IOC’s are so keen to not miss out on the energy bonanza that it was left out on in the USA. I imagine its difficult to turn these massive sometimes highly diversified companies down. Particularly when they have the resources (and the lobbying power) to guarantee to invest $400 milliion

    “Why should Polish and Ukrainian government push such an agenda when regional monopolies could just pull the plug six months from now?”

    I’m not sure what you mean here: if you are suggesting why Gazprom don’t simply say “well you can have your shale gas we’ll keep all our gas” then that’s fairly simple. They aren’t at all freighted about it, and as I see it, they’re probably right. Google “Gazprom shale gas” and they have barely paid attention to it – they know they have the largest conventional reserves in the world: with proper deregulation and exploitation of newer resources it should lower costs even more significantly. Especially if they follow the model of private exploitation of reserves which the oil industry used.

  3. Thanks for sharing your thought. My last assertion was more on this stream

    “Ukrainian minister: pushing energy independence through an aggressive/competitve shale drilling might pay out in 10 years; political pressure/commercial retaliation toward us from those unfavorable to such an agenda takes no time.
    Why bother with such a risky bet? I just want to win the next term. Heat up those old buildings with conventional gas from abroad so we catch out some more supporters…”

  4. Poland and Ukraine are not the biggest headache for Gazprom (which I wouldn’t call a ‘regional monopoly’, since it’s only monopolist in Russia and solely in terms of exports), nor their primary objective.
    Gazprom demonstrated by embarking in highly economically unsound projects (Nord Stream and South Stream) that their main concern is to export the – little, we should add: the optimistic plan for 2020-25 is to reduce (!) gas exports – gas that they have left directly to Western European consumers.

    As much as Poland and Ukraine are excited by shale gas and their energy revolution, I agree with Andrew on the many pitfalls for the possibility of success. Also the plan shows little compliance with the EU’s 20:20:20 plan.

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