Grzegorz Pytel, Futurisk LLP, UK, provides an overview of the challenges faced by the shale industry as efforts continue to spread the ‘revolution’ to Europe.
A few years ago when the US ‘shale gas revolution’ was mentioned very few people realised what it would lead to. Sceptics, including some of the largest and most powerful oil and gas companies such as Gazprom, were dismissing the significance of the revolution limiting it to the US and to the effect on the market there. Enthusiasts, also including some of the largest private companies, believed that the revolution could be replicated in Europe. Two sides of the argument had one thing in common and, despite the fact that they were arriving at different conclusions, were making the same mistake: looking at the European shale gas prospects through the US lens. Somehow it did not occur to either side that the natural resources industries in Europe and the US operate in different business and regulatory environments.
The US: steaming ahead
Not only did the US shale gas revolution result in making the US the largest natural gas producer in the world, independent from other countries, but also market competition resulted in cheap gas lowering the costs of energy and the price of gas as a feedstock. This made energy intensive and petrochemical industries start returning to the country. Quietly the US has been undergoing a re-industrialisation, which at the time of economic crisis and increased economic competition from Asian countries plays a key role in putting the US economy back on track.
What made the US shale gas industry so successful? When it all started a couple of decades ago the US onshore oil and gas industry was going through a decline. However, whilst large oil and gas companies started looking into new or risky frontiers, deep offshore, Arctic, Russia, West Africa, Brazil and Australia, the local US oil prospectors knew that they had to find something new in the US or die. And the market for local onshore services, always very competitive, was becoming even more competitive. This, coupled with the US government tax incentives in the early 1980s (originally designed to foster tight gas and CBM production) and increasing gas price, brought the price of oilfield services to a commercially acceptable level to consider the development of shale gas resources (which, in business terms, is a quest to maximise production from very unproductive wells). Therefore at the outset, the US had a large, competitive and vibrant local market for onshore oilfield services, which faced an ultimatum: try something new or die.
There is a short phrase to describe this US phenomenon in general: a strong ‘just do it’ attitude. However this would not have been enough if there had not been access to shale gas resources in the US on realistic terms. Essentially, in the US mineral rights belong to private landowners. This has two implications: by and large it is in their immediate private interest to maximise the profit from the land ownership. Despite some controversies and even protests, private landowners are generally keen to do deals with private natural resource prospectors. Furthermore if in the future, with the benefit of hindsight, the deal does not look that good for the private mineral rights owner this is a private matter. Good or bad: it is business between private companies or individuals. It does not touch upon the explosive political issue of corruption and the passing of national wealth into private hands, which is hotly debated whenever a state owns mineral rights and licenses these rights to private prospectors. In democratic countries this can be a minefield.
The success of shale gas developments in the US resulted from a number of factors: the US onshore oil and gas industry had to find ‘something’ new or die, the oilfield services industry was very competitive and under pressure to offer good prices and take some risks or face a decline, the government provided tax incentives, mineral right ownership was private and available to private prospectors on a competitive basis, the natural gas price was on an upward trend. Last, but not least, the US economy in general is the most productive and innovative in the world, and the oil and gas industry is a part of the most productive and competitive sector of the economy: private companies from small and medium size to multinational enterprises.
Europe: the reality check
Last year a very senior executive of a large multinational, which operates globally, observed at a diplomatic dinner: “When it comes to onshore oil and gas exploration, Europe remains a little bit of a basket case.” His words summarised succinctly the current status of shale gas developments in Europe and expressed the exasperation in the industry. What stops Europe from repeating the US shale gas success story? Whilst the technologies developed there are not immediately applicable in other parts of the world, they proved that shale gas could be produced at very competitive rates. The technological know-how base developed in the US is significant and given the technological and engineering depth of oil and gas companies, a commercial production of shale gas in Europe should be a matter of not too distant future. A number of European countries such as Poland, France, Germany and now the UK are considered to have very significant shale gas resources, each of them of the order of 3 - 5 trillion m3.
However, it is not as straightforward as one would have hoped. To start with, the European onshore oil and gas industry is very small and uncompetitive. This is in sharp contrast to its offshore counterpart, which was developed so successfully in Norway and in the UK. Whilst there are around 2000 land drilling rigs in the US, in Europe the number is only around 100. The onshore service industry in Europe is uncompetitive: the services are expensive if there is any surge of demand. This is a significant barrier in a risky greenfield exploration.
In Europe, state authorities control the licensing of exploration acreages: mineral rights are publicly owned. As a result there is no immediate incentive, like there is in the US, to derive profits from those rights. The benefits for individual landowners and local communities are dependent on central government decisions on taxation and redistribution. Therefore, typically for local communities the developments are simply not worth a hassle. This perception is exacerbated by the fact that private companies exploring for oil and gas are seen as the main potential beneficiaries, greedy, belonging to ‘fat cat’ directors and shareholders. Generally local communities believe they will be exploited, and receive very little in return.
Additionally, since mineral rights are publicly owned and the existing very small onshore oil and gas industry is either state-owned or controlled (as in Poland) or is dominated by national champions (as in Germany), the licensing of shale gas exploration acreages to foreign, private companies is seen as giving away national wealth. It is a very emotive situation: resource nationalism is rife in Europe.
There is also a productivity twist in the structure of the onshore oil and gas industry in Europe. Overall, European economies are less productive than the US. Whilst in the US the oil and gas industry belongs to the most productive part of the economy – private companies – the onshore oil and gas industry in Europe is dominated by state owned or controlled companies or by national champions, which are the least productive parts of the economy. The productivity gap between the oil and gas industry in the US and in Europe is significant. Productivity matters a lot in risky ventures: it is an additional uplift on expected profits, which allows more risky projects to be taken on.
This litany of business woes is underpinned by uncertainty surrounding future EU policies, which are likely to affect the viability of shale gas development, such as: market liberalisation, renewable energy targets, expensive environmental regulations and Brussels bureaucrat-led safety standards.
A need to re-think
Some years ago Goldman Sachs published research on above ground risks versus below ground risks in the oil and gas industry at large. In summary, above ground risks constitute about 75 - 80% of all investment risks. As shale gas developments in Europe are planned mainly in densely populated areas and the local communities are politically aware and perceptive to the ongoing anti-fracturing campaigns, these risks still significantly higher, around the 90% mark. As Poland’s experience showed, even if private operators can obtain an exploration licence, they cannot be certain about the future tax demand of the host governments. They cannot be certain about being accepted by the local community. Opposition can lead to prolonged protests or extended periods of obtaining permits. Even if prospectors eventually start exploration work, the oilfield services are not easily available and expensive. In the meantime the EU regulations may change in a way that they will render any shale gas developments sub-commercial. All these summarise the level of above ground risks in Europe.
It seems that companies got into shale gas exploration in Europe on the assumption that if the gas is in the ground, as it appears to be, the rest could just be ‘sorted out.’ However, as Poland’s example showed, it was a very long shot. The governments in Europe do have experience on working with large private oil and gas exploration companies and investors. The problem is that governments do not understand the decision-making process or that they are a big part of a risk equation. On the other side, companies do not understand that the governments do not understand them. Companies also approach community relations in a naïve manner with PR campaigns such as TV and media adverts explaining how eco-friendly and generally great they are. This fosters resentment since local communities cannot afford to fund their campaigns on a similar scale. It also breeds a culture of payments being claimed from companies upfront: ‘if they can afford such expensive self-serving and cheesy PR campaigns, then surely they can offer millions when they come in?’ Oil and gas companies make themselves easy targets for financial demands before they see any return on their investment. They put very little, if any, effort to work through local businesses. However, to be fair, governments do not facilitate such approach either.
At present, in Europe there is a need to ‘frack’ the brains of politicians, policy-makers, community leaders and indeed company executives in order to release business- and common-sense before any shale fracturing can take place.
The UK and France: potential vanguard
Two countries in the EU may actually reverse this gloomy trend: the UK and France. It is clear now that the UK shale gas geological prospects look very good indeed. There are significant technical and technological challenges, but the UK government has vast experience dealing with private oil and gas companies in a risky offshore environment. The situation is not that different from some 40 years ago, when offshore oil and gas technologies from the US were adopted and improved in the North Sea. There is also very little resource nationalism in Britain and the government, and the opposition, try to create good business conditions. The shale gas services industry is likely to develop on a competitive basis like its offshore conventional counterpart. In fact the latter may be the base for it. The only significant unknown is social acceptance (e.g. fear of fracturing, changing of the character of the countryside, etc.). If communities in the areas rich in shale gas, which used to be industrial heartland in Britain, begin to see their future, and the future of their children, as one where they work in, and with, the oil and gas industry, there could be a real breakthrough. However, this is quite a long shot at present.
France also has large shale gas, as well as shale oil, resources. The current ban on fracturing may not last that long. France needs cheap energy, plenty of new jobs and high-tech developments. Its national champion, Total, is at a risk of lagging behind the world oil and gas leaders. Therefore it looks increasingly likely that the French government, and the public, will see the value in its vast shale oil and gas resources. If developments start, they are likely to take the shape of a national project such as the development of the nuclear power stations or the fast trains network, rather than on an open market basis.
It is hard to see any other country in Europe showing the way. Poland had its ‘15 minutes of fame’ a couple of years ago. Whilst this ended in disappointment, it did allow others to see and learn from the challenges. Hopefully, one day Poland will seize its opportunity again. Generally, the challenges in Europe are significant and mainly above the ground: they are in the minds of people, rather than in the vast shale reservoirs below.
Adapted by David Bizley
Read the article online at: https://www.oilfieldtechnology.com/exploration/28012014/shale_gas_in_europe_a_bumpy_road_ahead/