Shale Gas in Europe: Revolution or Evolution

Shale gasin Europe:revolution orevolution?

Introduction The transformative impact that shale gas had had on the outlook for US energy marketsContents has been well-documented. Driven by advances in technology, such as hydraulic fracturing and horizontal drilling, shale gas production in the US has increased at a rapid pace. The shale gas success story in the US has resulted in heightened speculation over the potentialThe US experience 1 for shale gas to transform energy markets in other regions. The spotlight is now on Europe, where exploration is underway in a number of countries.Geology — replicating the 2 However, a number of issues indicate that the experience in the US may not be replicatedUS experience? in Europe. Furthermore, the rapid growth in shale gas production has resulted in a corresponding increase in concerns about the impact of the development processes onGas demand 3 public health and the environment. Opinion on the environmental impact of shale gas and its role in the future energy supply mix has become increasingly polarized.Energy prices 6 This report looks at the potential for shale gas1 development in Europe and considers whatCompetition from LNG 8 the impact on gas markets across the continent may be. While there has undoubtedlyand pipeline gas been a shale gas revolution in the US, in this report we conclude that, in Europe, shale gas development will follow a more evolutionary path. We identify a number of factors that will 11 influence the pace and feasibility of shale gas development in Europe, including:Environmental and socialfactors • Geology and resource potential • Gas demandFiscal and regulatory 15regimes • Energy prices • Environmental and social factorsInfrastructure and service 17capabilities • Fiscal and regulatory regimes • Infrastructure and service capabilitiesEvolution rather than 20revolution 1 There are three main types of unconventional gas: shale gas, tight gas and coalbed methane (CBM). In this report we focus on shale gas, which occurs when natural gas deposits are trapped within shale rocks. For more analysis of the prospects and challenges related to CBM developments, see the Ernst & Young report, Coal seam gas: broadening the energy mix.

The US experience Driven by advances in technology, such as hydraulic fracturing and horizontal drilling, shale gas production in the US has increased at a rapid pace. According to the US Energy Information Administration (EIA), the annual average growth rate in shale gas production was 48% over the period 2006–2010. This has resulted in a situation where the country is now largely self-sufficient in natural gas. According to the EIA’s Annual Energy Outlook 2011, shale gas production is expected to continue increasing strongly. The reference case predicts an almost fourfold increase in shale gas production from 2009 to 2035. By 2035, shale gas production in the US is forecast to total 342 billion cubic meters (Bcm), representing 47% of total US production, a significant increase compared with the 16% share it accounted for in 2009. Figure 1 shows the increasingly important role that shale gas will play in the US domestic gas production mix over the next 14 years. Figure 1 — US gas production outlook Alaska Coalbed methane Lower 48 offshore Lower 48 onshore conventional Tight gas Shale gas 800 700 600Bcm per year 500 400 300 200 100 0 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 Source: EIA Alaska Coalbed Methane Lower 48 oﬀshore Lower 48 onshore conventional Tight gas Shale Gas Shale gas in Europe: revolution or evolution? 1

Geology — replicating the US experience? The shale gas success story in the US has resulted in Exploration is currently underway in several countries, heightened speculation over the potential for shale including Austria, Germany, Hungary, Ireland, Poland, gas to transform energy markets in other regions. Sweden and the UK. Reserves are believed to be The spotlight is now on Europe, where exploration is present in at least 16 countries across Europe, including underway in a number of countries. Ukraine, though no shale gas play has yet been brought into production in Europe. Over half of all estimated European shale gas European shale gas reserves are concentrated in just two countries. The largest estimated reserves in Europe potential are in Poland with 5.2 Tcm, which equates to 29% of the European total but less than 3% of global shale gas In an EIA report published in April 2011, World Shale reserves. Poland is closely followed by France, which Gas Resources: an Initial Assessment of 14 Regions has estimated resources of 5.0 Tcm, or 28% of the outside the United States, global technically recoverable European total. Only a fraction of this resource base is shale gas resources were estimated to total 185 trillion likely to ever prove commercial and be produced. cubic meters (Tcm). The report, which assessed 48 shale gas basins in 32 countries, estimated that China holds the largest shale gas resources, accounting for 19% of the global total. The US, which given its experience of shale gas production, probably has the most accurately estimated resources and accounts for 13% of the global total. Countries in Europe with known shale gas reserves collectively account for almost 10% of the global total. However, at present there is limited experience of shale gas development in Europe on which to base estimates of potential resources in place. The experience in the US may not be replicable in other countries, as the petro-physical properties of the shale vary from one rock formation to another across different regions. Even within the US, each of the gas shale basins is different and each has its unique set of exploration criteria and operational challenges. A step change in exploration and appraisal drilling activity will be required to gain a better understanding of the resource potential in Europe. Estimates of technically recoverable shale gas reserves are certain to be revised, upward and downward, over time as new information is gathered. However, even then, there is no guarantee that any confirmed deposits would be economical to develop.2 Shale gas in Europe: revolution or evolution?

Gas demand Total combined gas production by countries in the European Union (EU) has been in decline since a peak was reached in 1996. Increased production from Norway has not been sufficient to offset the declines in other countries. At the same time, gas demand across the continent has continued to grow, albeit at a slower pace in the last couple of years due to the impact of the global recession. According to International Energy Agency (IEA) estimates, the Organisation for Economic Co-operation and Development (OECD) Europe region imported more than 260 Bcm of gas in 2010, accounting for around half of the region’s total primary gas supply. Figure 2 shows the current gas import requirements of European countries that have known shale gas resources. Figure 2 — Gas import requirement and shale gas resources by country Import requirement Shale gas resources 5,250 100 4.500Import requirement — Bcm/pa Shale gas resources — Bcm 80 3,750 3,000 60 2,250 40 1,500 20 750 0 0 -20 -40 -60 -80 -100 -120 y ce ey UK e nd y ia ia en k s ay nd ar an ar in an ar an rw rk ed la ra nm ng la rm lg m Po Tu Fr No Sw Uk er Bu Hu Ro De Ge th Ne Note: No independent assessments of the size of the shale gas resources in Hungary, Romania and Bulgaria are available. Sources: EIA, BP Statistical Review of World Energy 2011 Shale gas in Europe: revolution or evolution? 3

4 Shale gas in Europe: revolution or evolution?

The increasing import dependency has not been a The availability of cheaper shale gas could lead tomajor problem for European customers in the past a switch from coal to gas for electricity generation.two years as ample gas supplies have been available This might discourage investment in more expensive,from a variety of sources. The supply glut in the US but lower carbon, renewable sources of powerhas meant that liquefied natural gas (LNG) cargoes generation. Although emissions from new gas-fireddestined for North America have been diverted to other power generation would be lower than from existingdestinations, including countries in Europe. In addition, coal plants, the reduction would not be sufficientmany European customers took minimum contractual on its own to meet the region’s long-term emissionsvolumes under long-term contracts and consequently targets. Under this scenario, governments would needRussia’s pipeline supplies to Europe declined. to offer enhanced incentives to companies prepared to invest in low-carbon energy technologies or reducePredicted gas demand growth will be an important the competition for funding by placing a moratoriumconsideration for oil and gas companies when on the construction of new gas-fired power plants.considering investment in shale gas projects in Europe. Although not certain, it is probable that the EuropeanThe IEA’s report, The Golden Age of Gas Scenario, Commission (EC) would, through protective legislation,adopts new assumptions that have the effect of support more renewable energy usage rather thancreating a more positive outlook for natural gas leading increased gas use.up to 2035. Under this scenario, demand in Europe isforecast to be 20% higher relative to 2008 levels by Nuclear power had been enjoying something of a2035. This will further increase the import dependency renaissance in some European countries prior toof many European countries, which is likely to push the accident at the Fukushima plant in Japan insecurity of supply concerns to the fore again. The issue March 2011. Since then, a number of countries haveof security of supply moved up the political agenda announced reviews of the safety of existing nuclearfollowing the dispute between Russia and Ukraine in plants or have decided not to extend their operationalJanuary 2009 that resulted in interruption of Russian life. There have also been delays or overturns of earliergas supplies into European markets. decisions to approve new nuclear build. However, only one country, Germany, has actually closed any nuclear stations as a result of the Fukushima accident. Germany has mothballed 7 gigawatts of its oldest nuclear capacity. The uncertainty over the future of nuclear energy, coupled with cost and investment issues with renewables, could lead to a situation where gas becomes the primary energy source in Europe in the next 20 years, rather than being a transition fuel to a low carbon economy. Shale gas in Europe: revolution or evolution? 5

Energy prices The issue of cost and However, even with the higher development costs, the relatively higher gas prices that can be realized gas prices in Europe mean that shale gas projects in Europe could still be economical. As can be seen from Figure The price of gas was an important factor in the rapid 3, since 2008, gas prices in Europe have typically increase in shale gas production in the US and will be been higher than in the US. A gas supply bubble has an equally important driver of future gas demand in developed in the US from the combined impact of an Europe. Higher gas prices in the early to mid-2000s upsurge in shale gas production and a drop in demand helped support the ramp-up in development of shale during the recession. The main consequence of these gas in the US. developments has been a sharp decline in US natural gas prices. The spread between gas prices in Europe Shale gas production costs across Europe are and the US widened in 2011, as spot gas prices in likely to be higher than in the US, at least until an Europe increased as a result of the recovery in gas understanding of the geology improves and further demand after the recession-led slump. Oil-indexed advances in technology can help drive down costs. pricing is still prevalent in longer-term contracts in The IEA estimates that production costs for US shale Europe, despite the evolution of a number of spot gas range from $3/MBtu to $7/MBtu, while estimates market hubs across the continent. The most well- from a number of organizations indicate that average established and liquid spot gas market in Europe is in production costs in Europe could be between $8/MBtu the UK, which moved earlier and more decisively than and $12/MBtu. Production costs in North America other European countries to introduce competition into had declined markedly over time with advances in energy markets. There are seven other spot market technology and knowledge transfer gained from the hubs across Europe: Zeebrugge (Belgium), TTF (the experience of large-scale production. Technologies Netherlands), NCG (Germany), Gaspool (Germany), for drilling and fracking are not at a developmental PEG (France), PSV (Italy) and CEGH (Austria). The standstill. Growing recognition of the potential of shale development of additional trading hubs has been resources mean that oil and gas and oilfield services hindered by a lack of liquidity and also by infrastructure companies will invest in research and development to capacity or access issues. improve the efficiency and lower the cost of shale gas exploration and production. While the proportion of short-term, spot-traded gas in the supply mix has grown in recent years, long-term, but higher priced, imports by pipeline still satisfy the majority of Europe’s gas needs. This means that any fall in gas prices resulting from the build-up of shale gas production in Europe would not be as dramatic as in the US.6 Shale gas in Europe: revolution or evolution?

Figure 3 — Uncontracted gas prices in Europe and the US US-Henry Hub Price UK-NBP day ahead price DJ Zeebrugge price 20 15US$/Mmbtu 10 5 0 2007 2008 2009 2010 2011 Source: Thomson Datastream Shale gas in Europe: revolution or evolution? 7

Competition from pipeline gas and LNG Pipeline gas There are plans, at varying stages of approval and development, for the construction and start-up of a Shale gas will need to compete with existing energy number of new supply pipelines to Europe. The Nord sources in Europe, where investments in infrastructure stream gas pipeline, running via the Baltic Sea directly have already been made. Russia stands to be to Germany, is set to be fully operational before the particularly challenged by the shale gas boom. Along end of 2011 and will allow Russian gas destined for with other Atlantic Basin gas suppliers, Russia now Europe to bypass Ukraine and Belarus. The proposed finds that the prospects for a strong mid-to-long- term South stream gas pipeline, which is planned to run market for LNG imports into North America are greatly from Russia to Bulgaria via the Black Sea and then diminished. Therefore, it is not surprising that Russia split into two branches supplying southern and central has been publicly airing doubts about the viability of Europe, is targeted for start-up in 2015. The EU- shale gas. supported Nabucco pipeline project is envisioned to carry gas from the Caspian region and the Middle East At present, Russia is the major supplier of pipeline gas to Europe via Turkey. However, the project has been to Europe and will continue to fulfill this role in the hit by a number of setbacks. In October, the Nabucco short to medium term. However, pipeline supplies from gas pipeline consortium announced that the pipeline’s Russia are not without their own challenges. These planned start date has been pushed back by two years, challenges include the distance of some reserves from to 2017 and that it would cost more than originally the market and political issues around cross-border gas expected and also be about 20% longer in length than transit. Further challenges include the harsh conditions initially planned. The Shah Deniz gas field offshore in some locations — which means that work may not Azerbaijan is expected to serve as the main source of be possible year-round — the scale of investment in the initial gas supply for Nabucco. development of new reserves, and how quickly these reserves can be brought to market. Additionally, to However, some of the proposed pipeline projects underpin the development of gas fields in the more are competing with each other to secure supply remote regions of East Russia, gas producers will commitments. Azerbaijan’s state-owned SOCAR set be targeting customers in Asian markets that are in a 1 October 2011 deadline for the submission of closer proximity to the supply source. New investment technical and commercial bids for construction of a will also be required to put in place the infrastructure southern corridor gas pipeline for Shah Deniz gas. The required to facilitate the development of fields in more consortium behind the Nabucco pipeline submitted remote regions. their proposals to Azerbaijan for shipping gas from the Caspian state to Europe, although it is likely that rival pipeline projects, Trans-Adriatic Pipeline (TAP) and Interconnector-Turkey-Greece-Italy (ITGI), will Some of the proposed pipeline also have submitted bids. Furthermore, in September, the EU authorized the EC to conduct negotiations projects are competing with with Turkmenistan and Azerbaijan on construction each other to secure supply of the trans-Caspian gas pipeline (TCP). Not all of the proposed pipelines to supply gas to Europe will be commitments. sanctioned, but those that do get built will have to compete with domestic shale gas production in the battle for market share.8 Shale gas in Europe: revolution or evolution?

LNG importsSince 2005, 24 new LNG trains have beencommissioned, bringing the total number of LNGtrains in operation across the globe to 94 at the endof 2010. There is a significant amount of additionalLNG liquefaction capacity coming online between 2011and 2012 that was sanctioned based on expectationsthat the US would become a major import market. Theshale gas boom in the US has rendered a number ofLNG import terminal facilities idle, and some operatorsare seeking approval to convert their facilities so thatthey can export LNG. Over the last three years, LNGvolumes that were initially intended to supply theNorth American market have been diverted to othermarkets, including Europe, due to depressed NorthAmerican natural gas prices. LNG supplies at spotprices were, at times, considerably lower than the oil-linked price of contracted natural gas supplies deliveredto Europe by pipeline. All of this additional LNG supplycoming onstream will have to find new destinations,with Europe, the Middle East and customers in Asiacompeting for Atlantic and Pacific Basin supplies.In 2010, countries in Europe imported a combined 60million tons of LNG. New LNG import capacity is beingadded in Europe at sites in Italy, Spain, Portugal andPoland. The Swinoujscie terminal in northwest Polandis projected to become operational in 2014. In 2009,Poland signed a deal with Qatargas for gas deliveriesfor 20 years, starting in 2014, at an annual rate of1.5 Bcm. The contract is expected to fulfill one-third ofPoland’s total gas needs. The projected increase in LNGsupplies over the next 10 years and the installation ofadditional LNG import capacity in Europe could reducethe need for significant volumes of additional gas fromshale deposits in many countries. Shale gas in Europe: revolution or evolution? 9

10 Shale gas in Europe: revolution or evolution?

Environmental and social factorsMounting concern as In March 2011, the US President directed the Secretary of Energy to form a subcommittee of the Secretaryproduction rises of Energy Advisory Board, the Shale Gas Production Subcommittee (Subcommittee), to recommend, withinWith the increase in shale gas production brought 90 days of its first meeting, immediate steps that canabout by the application of fracking techniques, be taken to improve the safety and environmentalthere has been a corresponding increase in concerns performance of fracturing. In its 90-day report, theabout the potential impact of the process on public Subcommittee listed nine recommendations to addresshealth, drinking water and the environment. Hydraulic concerns on possible water pollution, air pollution,fracturing, commonly referred to as “fracking,” disruption of the community during production ofis the process of creating fractures or fissures in shale gas and the potential for adverse impact onunderground formations to allow natural gas to flow. communities and ecosystems. With the increasedDuring fracking, water, sand and other chemical development pressures and the widespread adoption ofadditives are pumped under high pressure into the new technologies, continued monitoring is necessaryshale formation to create fractures. These fractures are to determine whether the recommendations includedheld open by sand, allowing gas to flow freely to the in the report may be included in future legislation. Thesurface via the wellbore. Subcommittee is scheduled to issue a final report in November 2011.In the US, which now has had several years ofshale gas production experience on which to base In August 2011, the US state of New Jersey passed aassessments of its impact, the issue has become bill that imposes a one-year moratorium on hydraulicincreasingly contentious. The key issue in the debate fracturing while studies into the environmental impactis the potential impact of fracking on drinking water of fracking are ongoing. The controversy arising oversupplies. In response to public concern, the US shale gas development in the US is likely to have someCongress directed the United States Environmental impact on government and public attitudes to shale gasProtection Agency (EPA) to conduct research to exploitation on the other side of the Atlantic. Beforeexamine the relationship between hydraulic fracturing production has even started, public opposition to shaleand drinking water resources. The EPA announced in gas exploration in a number of European countries hasMarch 2010 that it would conduct a research study been growing, attracting increasing media attentionto investigate the potential impacts of hydraulic along the way. Governments will expect a certainfracturing on drinking water resources. Initial research amount of public opposition to shale gas development.results are expected by the end of 2012, with a full However, there will be a tipping point, which will varyreport targeted for 2014. from country to country, where the tide of public opposition will be difficult for a government to ignore from a political standpoint. The public clamor for government action could result in moves to regulate or limit the exploration and production of shale gas. Shale gas in Europe: revolution or evolution? 11

Environmental concerns The EPA recognizes that there are important potential research areas related to hydraulic fracturing other than those involving drinking water resources. These include Subsurface impacts potential effects on air quality, ecosystem impacts, The primary environmental concern seems to be the seismic risks, public safety concerns, occupational risks risk of contamination of drinking water supplies by the and economic impacts. Environmental concerns related chemicals used in the hydraulic fracturing process. to shale gas drilling may well be even greater in more Fracking fluid is typically 98% water and sand, with densely populated Europe. fracturing chemicals comprising only 2%–3% of the fluid. Drilling activity by Cuadrilla Resources at a site near Fracking fluid formulas vary slightly among production Blackpool in the UK was temporarily suspended in late sites in accordance with the unique requirements of May 2011 while investigations took place into whether each site’s geology. Some commentators have called for shale gas extraction work triggered a small earthquake. increased transparency and disclosure on the chemicals The independent study commissioned by Caudrilla used in the fracking process. Shale producers contend Resources concluded that it is highly probable that the that the composition of fracturing fluids is proprietary hydraulic fracturing of the Preese Hall-1 well did trigger information and that fracturing fluids are physically a number of minor seismic events. The report further separated from the water table by cement and steel concluded that the seismic events were due to an casings. There is, however, the risk of groundwater unusual combination of geology at the well site coupled pollution from improperly constructed wells. The EPA with the pressure exerted by water injection as part of has stated that proper well construction is essential operations. The authors of the report noted that the for isolating the production zone from underground combination of geological factors was extremely rare sources of drinking water. and would be unlikely to occur together again at future A 2011 Duke University study found no evidence of well sites. The UK government is currently studying the drinking water supplies being contaminated by fracking report although it has indicated it has no current plans fluids, although researchers from the US institution for new legislation of the shale gas industry. The report did find significantly higher concentrations of methane did not appease opponents of shale gas drilling in the in wells located within a kilometer of active fracking UK who have called on the government to introduce sites. However, there is no pre-drilling data available a moratorium on development of the resource. As yet so it is uncertain whether the methane was linked to though, there is no conclusive evidence of the extent the fracking process or whether it was present before to which fracking could impact the rock shelf and cause shale drilling commenced. Many European countries seismic events or subsidence. Land subsidence has have a one-time opportunity to undertake studies or been shown to occur in areas where mineral extraction data gathering before shale gas drilling begins. These activities take place, as the removal of material causes results could then be compared with post-drilling overlying surface rock to sink or collapse. However, this results to gain greater understanding of the impacts. could happen with conventional oil and gas production or mining activities and is not unique to shale gas Disposal of the water that flows back to the wellhead exploitation. Subsidence can also result from fluid after fracturing is another concern the industry is withdrawal in areas where soft subsurface materials facing. Wastewater has to be stored, treated for like sand and clays are present. chemicals and disposed of appropriately. Operators are currently exploring ways to use and recycle the water produced from hydraulic fracturing. The use of recycled water could significantly reduce the demand for surface water withdrawal and wastewater treatment or disposal.12 Shale gas in Europe: revolution or evolution?

Surface impactsThe physical footprint associated with shale gas exploration and production is significantly larger than that forthe exploitation of conventional hydrocarbons. Access to land and land usage is likely to become an increasinglyimportant issue in densely populated Europe. The typical well pad needs to be of sufficient size to accommodate thedrilling rig equipment, wastewater ponds, storage and pipeline infrastructure, and facilities for staff and contractors.In the US, companies have sought to reduce land use through the development of “superpads.” The multi-wellpad system allows wellheads to be clustered together and enables the drilling of multiple horizontal wells froma single pad. This is a more expensive option, but it helps reduce the geographical footprint of shale operations.For example, it reduces the need for new transport infrastructure and minimizes the additional traffic on roads.Moreover, the additional cost may be the price that has to be paid to allay concerns over the economic and socialcosts associated with land use and to win public acceptance.There are also concerns that the large volumes of water required for hydraulic fracturing may place undue stresson the local water supply. The drilling and hydraulic fracturing of a horizontal shale gas well typically requiresmore water than conventional oil and gas developments. Water used in shale gas exploration mainly comes fromsurface water sources but can also come from groundwater, private water sources, civic water supplies, recycledproduced water and sea water. There are significant regional variations in precipitation levels across Europe, andin regions where levels are relatively low, there is already periodic pressure on water supplies. The water needsof shale gas development should be balanced with existing regional requirements for water. However, the issueof water usage by the energy sector is not limited to shale gas development. Competing or alternative energysources can also have large water needs. Hydroelectricity is an obvious example, but crop-based biofuels alsorequire water for irrigation, and nuclear plants rely on water for cooling systems. Shale gas in Europe: revolution or evolution? 13

Social acceptance In a poll conducted in August 2011 by Poland’s Centre for Public Opinion Research, 74% of Poles In addition to environmental issues, there is the issue questioned supported the exploitation of shale gas of the social acceptance of the shale gas industry in the country. However, a smaller majority (56%) of in Europe. Compared with the US, there is a higher respondents supported the development of shale gas population density in Europe and more stringent deposits situated near their homes. Moreover, 41% of environmental regulations. Issues like noise pollution, respondents said it was hard to say whether shale gas which has so far been less of a concern in the US production is environmentally safe, and 45% expressed than some of the other issues, might be more of a the same uncertainty on the question of whether problem in densely populated regions of Europe. shale gas production is safe for people’s health. This Governments need to promote public confidence in the highlights the challenges that operators will face regulation of shale gas activity, and operators need in gaining public support in Europe. Environmental to demonstrate that their operations are properly concerns are likely to bolster public support for a managed and sustainable. There has been widespread strengthening of the regulatory regime governing shale media coverage of the growing public backlash against gas development. The European public will be waiting shale gas development based on concerns over its for the results of US studies on the environmental impact on the environment. In Bulgaria, the decision by impact of shale gas production to emerge before fully the government to award shale gas permits has been accepting its development in their own countries. attacked by opposition socialists and green groups, who have started a campaign against the drilling. At the same time, some communities in Europe are actively embracing the shale gas potential. Poland’s national gas company, Polskie Górnictwo Naftowe i Gazownictwo (PGNiG), has started the “Flame of Hope” campaign. Its purpose is to collect the largest possible number of votes in support of an appeal to Members of the European Parliament (MEPs) to refrain from activities aimed at stopping shale gas exploration and production. The campaign was launched on 29 September 2011, and press reports indicate that more than 16,000 signatures were collected in the first month.14 Shale gas in Europe: revolution or evolution?

Fiscal and regulatory regimesEuropean government Germany’s relatively modest estimated shale gas resources are unlikely to have a significant impactattitudes to shale gas on the country’s heavy dependence on imports from Russia and Norway. Despite this, public opposition toNational energy policy considerations, which include the development of shale gas in Germany has beensecurity of supply concerns, emissions targets and gathering momentum. The German state of Northstate support for competing energy sources, will all Rhine Westphalia (NRW) has announced that it willshape individual countries’ attitudes to shale gas grant no further permissions for exploratory drillingdevelopment. This, coupled with a lack of consistent projects using hydraulic fracturing until the summerevidence on the impact of fracking on the environment of 2012, when it expects to receive the findings of aand citizens’ health, has resulted in a situation where study it has commissioned into the environmental risksopinion on shale gas development in Europe has associated with shale gas.become polarized. Poland, conversely, is probably the European countryThe wide spectrum of opinion is illustrated by the that is, at least publicly, most supportive of shale gasdiffering stances of Poland and France, which have development. The east European nation’s shale gassimilar levels of estimated technically recoverable shale resources, if proven to be commercially viable, wouldgas resources. On 30 June 2011, France became the help the country become self-sufficient in energy andfirst country in Europe to enact a ban on hydraulic also provide wider economic benefits. Poland currentlyfracturing. The French Senate voted by 176 votes to depends on coal for over 90% of its power generation.151 to impose a permanent ban on the use of fracking Poland would like the EU to adopt legislation to supportin shale gas and oil projects due to concerns about shale gas development. The Polish governmentthe impact of the process on the environment. The plans to introduce special regulations for shale gaspermanent ban replaces a temporary suspension of production in its own country, including new fees orshale drilling activity put in place earlier in the year. even mandatory participation of the state in order toOperators with shale gas acreage in France opposed the safeguard its budgetary interests, a deputy treasuryban, claiming that, while alternatives to fracking exist, minister said on 8 September 2011.they may not be economically viable. In early October Most European countries have taken a less firm stance2011, the French government canceled three shale gas and appear to be adopting a “wait and see” approachexploration permits because the holders did not commit to shale gas development. In May 2011, a UK Houseto not use fracking processes to explore these permits. of Commons Energy and Climate Change CommitteeOther operators that have committed to not using report was released. The report concluded that shalefracking technologies have retained their permits. gas resources in the UK were unlikely to be a “game changer” but recognized that it was important for the UK to monitor the development of the shale gas industry in Poland, in terms of both the UK’s prospects and the evolution of national and EU regulation in reaction to the development. The report’s authors did not support a moratorium on the use of hydraulic fracturing in the exploitation of the UK’s hydrocarbon resources. Shale gas in Europe: revolution or evolution? 15

Pan-European regulation In 2009, EU member states agreed to commit to reduce energy usage and set a target to reduce In March 2011, the EC published a roadmap for moving emissions by 20% by 2020. However, the energy toward a competitive low-carbon economy by 2050. efficiency target is voluntary and not legally binding on This energy roadmap did not mention shale gas, but a member states. Some MEPs have raised concerns that revised version is scheduled to be published later this CO2 emissions from unconventional gas production year that may shed some light on the EC’s stance on could be higher than from conventional production shale gas development in Europe. due to the energy required to power equipment and issues with equipment and water transport. The issue In the US, fracturing is largely regulated by individual of methane escape has been put forward as another states, although some would like to see the federal reason why shale gas development in Europe should government impose overarching regulations. At be more tightly regulated. This could become a more present, the EC does not have jurisdiction over significant issue if methane emissions are included in sovereign states’ subsoil laws or resource development future phases of the EU Emissions Trading System (EU programs. Existing hydrocarbon regulation in Europe ETS). The system is a cornerstone of the EU’s policy to was drafted by individual countries for conventional combat climate change and its key tool for reducing exploration and production (E&P) activities and may industrial greenhouse gas emissions. The ETS now not apply to the development of shale gas deposits or operates in 30 countries, the 27 EU Member States cover the new processes and technologies involved plus Iceland, Liechtenstein and Norway. The EU ETS will in its exploration and extraction. The EC is currently be further expanded to the petrochemicals, ammonia examining whether existing EU environmental and aluminum industries and to additional gases in legislation would apply to shale gas production but is 2013, when the third trading period will start. not planning to bring forward any new legislation in the immediate future. In October 2011, the EC put forward a directive on fuel quality that sets minimum environmental standards Some oil companies may desire common pan-European for a range of fuels to enable suppliers to identify the regulation to make it easier for them to operate most carbon-intensive options. The Commission has across borders. At present, for example, the transfer proposed that oil sands and oil produced from shale of equipment between countries may be hindered by rocks should be ascribed a greenhouse gas value that different national standards and safety requirements. is higher than that for conventional oil. Shale gas is However, gaining unanimity among member states not included in the directive, but the principle that of the EU on shale gas regulation is likely to be an fuels must meet minimum environmental standards almost insurmountable feat. Poland is likely to veto makes it more likely that it could be included in future any attempt to limit shale gas development through legislation. new EU-wide regulation. To get agreement on common standards, they may have to be watered down to such an extent that makes them less stringent than those already in place in some individual member states.16 Shale gas in Europe: revolution or evolution?

Infrastructure and service capabilities The lack of oilfield service sector capacity, suitable equipment and a skilled labor force have been highlighted as potential bottlenecks preventing the faster development of shale gas in Europe. This is one of the challenges that countries in Europe will need to address to develop their unconventional resource potential. The service level intensity for shale gas development is typically higher than for more conventional oil and gas developments. In the US, the oilfield services sector has grown and developed to support the shale gas industry. Many of these oilfield services companies are now looking to export the techniques they have used successfully in North America to international markets. Typically, Europe has less than 50 onshore rigs actively exploring for or developing oil and gas at any one time, compared with up to 2,000 in the US. Figure 4 shows the number of active rigs operating onshore and offshore across Europe over the last 10 years. Although the number of active land rigs in Europe has increased over the course of 2011 to more than 70, a higher number than operating offshore, there is still a shortage of suitable rigs for shale gas exploration and development in Europe. The US land rig fleet is already fully utilized and would not be relocated to Europe unless there was a firm work commitment. However, equipment from other regions may not be suitable for use in Europe where the geology is different. Moreover, the equipment may not meet mandated local standards, which could delay the import process. The transport of equipment across European borders might be hindered by differing regulatory requirements and health and safety standards among EU member states. If new, high-specification equipment needed to be built for shale gas operations in Europe, significant capital expenditure and firm commitments from operators would be required. Figure 4 — European rig counts Land rigs Offshore rigs 80 70 60 50Number of rigs 40 30 20 10 0 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Source: Baker Hughes Shale gas in Europe: revolution or evolution? 17

Executives from Chevron have indicated that the Cross-border pipeline connections would need to earliest that pilot production could take place in be improved if shale gas production reaches a level Poland is 2013. Most observers, however, are more that makes it possible for some countries to export cautious and do not expect to see production reach gas for the first time. However, all of the shale gas commercial levels for at least another 10 years. Given produced in Europe is likely to be consumed within the the lead time to first production and the likelihood that region, as the forecasted increase in LNG supplies, developments will evolve more slowly, this will give the including potential exports from the US, is likely to be service industry the breathing space needed to gear more than sufficient to meet demand needs in Asia up to meet the requirements of the shale gas industry and the Middle East. In September 2011, the Prime in Europe. It will also give operators the opportunity Ministers of Poland and the Czech Republic opened a to assemble a skilled workforce through targeted Polish-Czech gas interconnector in Cieszyn, southern recruitment and training programs. Poland. The new interconnector could form part of an enhanced north-south gas corridor that may If Europe’s shale gas potential is proven, this will be required if Poland’s shale gas production could provide tremendous opportunities for the oilfield support exports. The infrastructure requirements services sector in Europe, which in recent years has associated with shale gas development are not limited focused on more substantive opportunities in other to pipeline transportation capacity. Requirements markets, such as the Middle East. However, it is unlikely would potentially include new access roads for site that there will be a headlong rush to invest in new traffic, access to water supplies, wastewater treatment capacity until the results of initial exploration and and processing facilities, gas storage capacity and development efforts provide more evidence about the amenities for onsite personnel. Greater availability potential for commercial shale gas extraction in Europe. of potentially cheaper natural gas will also be an Some government support may be provided to help important consideration in decisions made about the service sector adapt to the needs of the shale gas investments in future power generation capacity. sector. The state-owned Polish bank, BGK, has agreed to lend 15 million euros to Nafta Pila, a subsidiary of PGNiG, for the purchase of a new drilling rig and supporting equipment. The limited supply of drilling rigs that meet regulatory requirements is one of the factors slowing the exploration for shale gas in Poland. Infrastructure issues present another potential barrier to the efficient development of Europe’s shale gas potential. Significant investment may be required in the gas transmission infrastructure in some countries to upgrade the network so that it is able to cope with increased gas flows. Access to most natural gas transmission pipeline capacity in Europe is still mainly controlled by the large national utility companies and governed by national-level regulations. Furthermore, suppliers may have existing capacity tied up under long-term capacity reservation contracts.18 Shale gas in Europe: revolution or evolution?

The operators Over the last 12 months, there has also been an increase in the number of partnerships announcedCompanies own shale gas acreage across more between some of the oil majors and the independentthan a dozen countries in Europe, but most activity players to jointly explore for shale gas in Poland andis currently focused on Poland. While not all are other European countries. 3Legs Resources plc, whichactive, around 20 companies currently hold shale listed on the UK’s Alternative Investment Market ingas acreage in Poland. The acreage holders include a June, and its subsidiary, Lane Energy, are workingnumber of North American and Europe-based small with ConocoPhillips in the Baltic Basin. UK-basedto mid-cap independent players, with the oil majors Hutton Energy announced in August that it hadrepresented by ExxonMobil, Chevron, ConocoPhillips, agreed to a farm-in deal with ExxonMobil to take aTotal and Eni. There are likely to be a number of other 49% interest in four of the US company’s shale gasentrants, as some of the companies with experience exploration areas in Poland. Some wider industryfrom the shale gas boom in the US are actively collaboration is also taking place. Gas Shales in Europeevaluating opportunities in Europe. The notable (GASH) is the first European interdisciplinary shaleabsentees are the Europe-based majors, BP and Royal gas research initiative. The project, which started inDutch Shell, which were also later entrants to the US 2009 with the first phase to run for three years, isshale gas market. Shell in particular has significant sponsored by Statoil, ExxonMobil, Gas de France SUEZ,shale gas interests in other regions such as China and Wintershall, Vermillion, Marathon Oil, Total, Repsol,South Africa, where there is a moratorium currently Schlumberger and Bayerngas. GASH focuses on thein place on shale gas drilling operations, and Shell shale gas potential in Europe, especially on the Alumis in the early stages of assessing potentially major Shale (Denmark) and the Posidonia and Carboniferousresources of shale gas in Sweden. Shales in Germany. The organization is leading the development of a European black shale database.Large reserves in place, drilling successes, earlydevelopment and sustainable economic levels of The burgeoning cooperation between companies isproduction are among the factors that will shape the being mirrored at the state level. There is greaterfortunes of the small to mid-cap companies that are inter-country cooperation on evaluating and exploitingfocused on shale gas exploitation. Early successes global shale gas resources. The US governmentcould prove to be transformational for the companies agreed in February 2011 to finance the survey ofthat are centering their development efforts on the Ukraine’s shale gas deposits amid speculation that thenascent shale gas industry in Europe. It is likely that country may have some sizable deposits. In Spain, athe successful companies will attract the attention of regional government is partnering with two US-basedlarger potential acquirers. Chinese companies have companies in a joint venture to explore unconventionalalready bought into shale gas companies in the US natural gas deposits in Basque Country in northernand may also turn their sights to Europe. In the US, a Spain. The Basque government will invest 40 millionnumber of the independent players that were active euros in the project, while the two privately held USin the early development of shale gas have either companies will invest 60 million euros. Two wells arebeen acquired or have farmed out stakes in projects to to be drilled initially to see if extraction is technicallybetter-capitalized players. feasible and economically viable. The increased collaboration is likely to help drive down costs and improve the ability of projects to attract funding. Shale gas in Europe: revolution or evolution? 19

Evolution rather than revolution While there has undoubtedly been a shale gas revolution in the US, in Europe shale gas development will follow a more evolutionary path. As discussed earlier, a number of factors will influence the pace and feasibility of shale gas development in Europe; these factors are summarized in Figure 5. Figure 5 — Shale gas in Europe: revolution or evolution? Evolution Revolution Geology and resource potential • Disappointing well results • Early exploration success • Reserves found to be uneconomical to • Reserves potential proven to be greater develop than expected • Unsustainable production rates • Rapid ramp-up in production Environmental and social factors • Results of studies into environmental • Studies show that fracking is safe to impacts lead to restrictions/bans on use public health and the environment of fracking • Public desire for lower energy prices • Increased public pressure on governments to halt development activity until impact is known Fiscal and regulatory regimes • Potential EU-wide regulations on shale • Incentives provided by individual gas development countries to shale gas developers • Inclusion of shale gas in EU fuel quality • Expedited approvals process for and emissions legislation developments • Government support for shale gas R&D Energy prices • Competition from LNG and pipeline gas • Deregulation of gas markets from Russia and the Caspian region • Long-term, oil-indexed contracts not • Limited spot market liquidity renewed • Improved interconnectivity between markets Gas demand • Slower growth due to measures to • Increased demand for gas as a fuel for support development of low-carbon power generation economy • Gas positioned as a transition fuel to a • Weaker Eurozone economy low-carbon economy Infrastructure and service • Limited supply of suitable equipment or • Oilfield service industry is fast to adapt capabilities skilled personnel to industry needs • Lack of funds available to invest in new • Technology developments that drive gas supply infrastructure down costs Source: Ernst & Young analysis20 Shale gas in Europe: revolution or evolution?

The impact of shale gas is unlikely to be transformational for the European energy market as a whole, but it couldprove to be significant for individual countries by helping reduce their dependence on imports. The impact is likelyto be most significant in Poland, which has a greater reliance on imports and larger potential shale gas resourcesthan a number of other countries. Advocates of shale gas development in Europe put forward improved energysecurity as one of the key benefits, helping countries become more self-sufficient. Security of supply could alsobe achieved through diversity of supply sources. A shale gas boom in Europe could, in practice, weaken energysecurity in Europe through over-reliance on a single energy source.There is no consensus across Europe on shale gas development and government attitudes vary, in some casesmarkedly, as exemplified by the positions of Poland and France. Public opinion on the issue is similarly divided,adding to pressure on governments to take action to either support or restrict shale gas development. At present,most countries in Europe appear to be adopting a “wait and see” approach on the issue. European countries withsizable shale gas resources are closely monitoring the situation in Poland and will hope to replicate any successachieved there in their own countries. There will, however, be setbacks along the way — in September, UK-basedAurelian Oil and Gas announced what the Chief Executive described as “disappointing” initial results from itsTrzek-3 unconventional gas well in Poland, which was producing higher levels of water and lower rates of gas thaninitially expected.The impact that shale gas will have on energy markets will vary widely from one country to the next, dependingon the country’s national energy strategy, degree of import dependence, projected growth in gas demand andthe cost and social acceptance of alternative and competing supply sources. The impact could, however, betransformational for the small to mid-cap independent companies that are focused on the nascent shale gasindustry in Europe. There will also be opportunities for service companies to carve out new revenue streamsand gain an early foothold in shale gas development activity in Europe. Research is not at a standstill, and newtechnologies will be developed that will help drive down the cost of shale gas extraction and improve the efficiencyof development and production activities.The shale gas debate has become increasingly contentious, but there is no denying the economic benefit thatthe evolution of a shale gas industry could bring to individual countries in Europe. The increase in governmentrevenues from taxes on shale activity, and private sector job creation would be especially welcome in these timesof fiscal austerity. Most of the issues used by opponents to call for restrictions on shale gas development are notexclusive to shale gas activity, but environmental concerns are likely to bolster public support for a strengtheningof the regulatory regime governing shale gas development. Any risks that are shown to be linked to shale gasdevelopment need to be balanced with its potential contribution to energy security and economic development.Many hope that the experience in the US can be replicated in other countries. This experience also needs toinclude learning the lessons from studies underway on the environmental and public health impacts of shale gasdevelopment in the US and using them to shape appropriate regulation where necessary in Europe. Shale gas in Europe: revolution or evolution? 21

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