Shale gas in Europe: revolution or evolution?

Introduction
Contents
The US experience Geology replicating the US experience? Gas demand Energy prices Competition from LNG and pipeline gas Environmental and social factors Fiscal and regulatory regimes Infrastructure and service capabilities Evolution rather than revolution 1 2 The transformative impact that shale gas had had on the outlook for US energy markets 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 potential 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. However, a number of issues indicate that the experience in the US may not be replicated 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 on 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. This report looks at the potential for shale gas1 development in Europe and considers what the impact on gas markets across the continent may be. While there has undoubtedly 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 influence the pace and feasibility of shale gas development in Europe, including: Geology and resource potential 15 Gas demand Energy prices 17 Environmental and social factors Fiscal and regulatory regimes Infrastructure and service capabilities

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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 20062010. This has resulted in a situation where the country is now largely self-sufficient in natural gas. According to the EIAs 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 800 700 600 Bcm per year Coalbed methane Lower 48 offshore Lower 48 onshore conventional Tight gas Shale gas

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Alaska Lower 48 oshore Tight gas

Coalbed Methane Lower 48 onshore conventional Shale Gas

Shale gas in Europe: revolution or evolution?

Geology replicating the US experience?

The shale gas success story in the US has resulted in heightened speculation over the potential 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. Exploration is currently underway in several countries, including Austria, Germany, Hungary, Ireland, Poland, Sweden and the UK. Reserves are believed to be present in at least 16 countries across Europe, including Ukraine, though no shale gas play has yet been brought into production in Europe. Over half of all estimated European shale gas reserves are concentrated in just two countries. The largest estimated reserves in Europe are in Poland with 5.2 Tcm, which equates to 29% of the European total but less than 3% of global shale gas reserves. Poland is closely followed by France, which has estimated resources of 5.0 Tcm, or 28% of the European total. Only a fraction of this resource base is likely to ever prove commercial and be produced.

European shale gas potential

In an EIA report published in April 2011, World Shale Gas Resources: an Initial Assessment of 14 Regions outside the United States, global technically recoverable shale gas resources were estimated to total 185 trillion 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.

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 regions 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 Import requirement Bcm/pa 80 60 40 20 0 -20 -40 -60 -80 -100 -120 4.500 3,750 3,000 2,250 1,500 750 0 Shale gas resources Bcm

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?

Sw ed en De nm ar k Ne th er la nd s No rw ay

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Fr an ce

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Shale gas in Europe: revolution or evolution?

The increasing import dependency has not been a major problem for European customers in the past two years as ample gas supplies have been available from a variety of sources. The supply glut in the US has meant that liquefied natural gas (LNG) cargoes destined for North America have been diverted to other destinations, including countries in Europe. In addition, many European customers took minimum contractual volumes under long-term contracts and consequently Russias pipeline supplies to Europe declined. Predicted gas demand growth will be an important consideration for oil and gas companies when considering investment in shale gas projects in Europe. The IEAs report, The Golden Age of Gas Scenario, adopts new assumptions that have the effect of creating a more positive outlook for natural gas leading up to 2035. Under this scenario, demand in Europe is forecast to be 20% higher relative to 2008 levels by 2035. This will further increase the import dependency of many European countries, which is likely to push security of supply concerns to the fore again. The issue of security of supply moved up the political agenda following the dispute between Russia and Ukraine in January 2009 that resulted in interruption of Russian gas supplies into European markets.

The availability of cheaper shale gas could lead to a switch from coal to gas for electricity generation. This might discourage investment in more expensive, but lower carbon, renewable sources of power generation. Although emissions from new gas-fired power generation would be lower than from existing coal plants, the reduction would not be sufficient on its own to meet the regions long-term emissions targets. Under this scenario, governments would need to offer enhanced incentives to companies prepared to invest in low-carbon energy technologies or reduce the competition for funding by placing a moratorium on the construction of new gas-fired power plants. Although not certain, it is probable that the European Commission (EC) would, through protective legislation, support more renewable energy usage rather than increased gas use. Nuclear power had been enjoying something of a renaissance in some European countries prior to the accident at the Fukushima plant in Japan in March 2011. Since then, a number of countries have announced reviews of the safety of existing nuclear plants or have decided not to extend their operational life. There have also been delays or overturns of earlier 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?

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

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

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Source: Thomson Datastream

Shale gas in Europe: revolution or evolution?

Competition from pipeline gas and LNG

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

Some of the proposed pipeline projects are competing with each other to secure supply commitments.

Shale gas in Europe: revolution or evolution?

LNG imports
Since 2005, 24 new LNG trains have been commissioned, bringing the total number of LNG trains in operation across the globe to 94 at the end of 2010. There is a significant amount of additional LNG liquefaction capacity coming online between 2011 and 2012 that was sanctioned based on expectations that the US would become a major import market. The shale gas boom in the US has rendered a number of LNG import terminal facilities idle, and some operators are seeking approval to convert their facilities so that they can export LNG. Over the last three years, LNG volumes that were initially intended to supply the North American market have been diverted to other markets, including Europe, due to depressed North American natural gas prices. LNG supplies at spot prices were, at times, considerably lower than the oillinked price of contracted natural gas supplies delivered to Europe by pipeline. All of this additional LNG supply coming onstream will have to find new destinations, with Europe, the Middle East and customers in Asia competing for Atlantic and Pacific Basin supplies. In 2010, countries in Europe imported a combined 60 million tons of LNG. New LNG import capacity is being added in Europe at sites in Italy, Spain, Portugal and Poland. The Swinoujscie terminal in northwest Poland is projected to become operational in 2014. In 2009, Poland signed a deal with Qatargas for gas deliveries for 20 years, starting in 2014, at an annual rate of 1.5 Bcm. The contract is expected to fulfill one-third of Polands total gas needs. The projected increase in LNG supplies over the next 10 years and the installation of additional LNG import capacity in Europe could reduce the need for significant volumes of additional gas from shale deposits in many countries.

Shale gas in Europe: revolution or evolution?

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Shale gas in Europe: revolution or evolution?

Environmental and social factors

Mounting concern as production rises
With the increase in shale gas production brought about by the application of fracking techniques, there has been a corresponding increase in concerns about the potential impact of the process on public health, drinking water and the environment. Hydraulic fracturing, commonly referred to as fracking, is the process of creating fractures or fissures in underground formations to allow natural gas to flow. During fracking, water, sand and other chemical additives are pumped under high pressure into the shale formation to create fractures. These fractures are held open by sand, allowing gas to flow freely to the surface via the wellbore. In the US, which now has had several years of shale gas production experience on which to base assessments of its impact, the issue has become increasingly contentious. The key issue in the debate is the potential impact of fracking on drinking water supplies. In response to public concern, the US Congress directed the United States Environmental Protection Agency (EPA) to conduct research to examine the relationship between hydraulic fracturing and drinking water resources. The EPA announced in March 2010 that it would conduct a research study to investigate the potential impacts of hydraulic fracturing on drinking water resources. Initial research results are expected by the end of 2012, with a full report targeted for 2014. In March 2011, the US President directed the Secretary of Energy to form a subcommittee of the Secretary of Energy Advisory Board, the Shale Gas Production Subcommittee (Subcommittee), to recommend, within 90 days of its first meeting, immediate steps that can be taken to improve the safety and environmental performance of fracturing. In its 90-day report, the Subcommittee listed nine recommendations to address concerns on possible water pollution, air pollution, disruption of the community during production of shale gas and the potential for adverse impact on communities and ecosystems. With the increased development pressures and the widespread adoption of new technologies, continued monitoring is necessary to determine whether the recommendations included in the report may be included in future legislation. The Subcommittee is scheduled to issue a final report in November 2011. In August 2011, the US state of New Jersey passed a bill that imposes a one-year moratorium on hydraulic fracturing while studies into the environmental impact of fracking are ongoing. The controversy arising over shale gas development in the US is likely to have some impact on government and public attitudes to shale gas exploitation on the other side of the Atlantic. Before production has even started, public opposition to shale gas exploration in a number of European countries has been growing, attracting increasing media attention along the way. Governments will expect a certain amount of public opposition to shale gas development. However, there will be a tipping point, which will vary 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.

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Environmental concerns
Subsurface impacts
The primary environmental concern seems to be the risk of contamination of drinking water supplies by the chemicals used in the hydraulic fracturing process. Fracking fluid is typically 98% water and sand, with fracturing chemicals comprising only 2%3% of the fluid. Fracking fluid formulas vary slightly among production sites in accordance with the unique requirements of each sites geology. Some commentators have called for increased transparency and disclosure on the chemicals used in the fracking process. Shale producers contend that the composition of fracturing fluids is proprietary information and that fracturing fluids are physically separated from the water table by cement and steel casings. There is, however, the risk of groundwater pollution from improperly constructed wells. The EPA has stated that proper well construction is essential for isolating the production zone from underground sources of drinking water. A 2011 Duke University study found no evidence of drinking water supplies being contaminated by fracking fluids, although researchers from the US institution did find significantly higher concentrations of methane in wells located within a kilometer of active fracking sites. However, there is no pre-drilling data available so it is uncertain whether the methane was linked to the fracking process or whether it was present before shale drilling commenced. Many European countries have a one-time opportunity to undertake studies or data gathering before shale gas drilling begins. These results could then be compared with post-drilling results to gain greater understanding of the impacts. Disposal of the water that flows back to the wellhead after fracturing is another concern the industry is facing. Wastewater has to be stored, treated for 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.

The EPA recognizes that there are important potential research areas related to hydraulic fracturing other than those involving drinking water resources. These include potential effects on air quality, ecosystem impacts, seismic risks, public safety concerns, occupational risks and economic impacts. Environmental concerns related to shale gas drilling may well be even greater in more densely populated Europe. Drilling activity by Cuadrilla Resources at a site near Blackpool in the UK was temporarily suspended in late May 2011 while investigations took place into whether shale gas extraction work triggered a small earthquake. The independent study commissioned by Caudrilla Resources concluded that it is highly probable that the hydraulic fracturing of the Preese Hall-1 well did trigger a number of minor seismic events. The report further concluded that the seismic events were due to an unusual combination of geology at the well site coupled with the pressure exerted by water injection as part of operations. The authors of the report noted that the combination of geological factors was extremely rare and would be unlikely to occur together again at future well sites. The UK government is currently studying the report although it has indicated it has no current plans for new legislation of the shale gas industry. The report did not appease opponents of shale gas drilling in the UK who have called on the government to introduce a moratorium on development of the resource. As yet though, there is no conclusive evidence of the extent to which fracking could impact the rock shelf and cause seismic events or subsidence. Land subsidence has been shown to occur in areas where mineral extraction activities take place, as the removal of material causes overlying surface rock to sink or collapse. However, this could happen with conventional oil and gas production or mining activities and is not unique to shale gas exploitation. Subsidence can also result from fluid withdrawal in areas where soft subsurface materials like sand and clays are present.

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Shale gas in Europe: revolution or evolution?

Surface impacts
The physical footprint associated with shale gas exploration and production is significantly larger than that for the exploitation of conventional hydrocarbons. Access to land and land usage is likely to become an increasingly important issue in densely populated Europe. The typical well pad needs to be of sufficient size to accommodate the drilling 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-well pad system allows wellheads to be clustered together and enables the drilling of multiple horizontal wells from a 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 social costs 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 stress on the local water supply. The drilling and hydraulic fracturing of a horizontal shale gas well typically requires more water than conventional oil and gas developments. Water used in shale gas exploration mainly comes from surface water sources but can also come from groundwater, private water sources, civic water supplies, recycled produced water and sea water. There are significant regional variations in precipitation levels across Europe, and in regions where levels are relatively low, there is already periodic pressure on water supplies. The water needs of shale gas development should be balanced with existing regional requirements for water. However, the issue of water usage by the energy sector is not limited to shale gas development. Competing or alternative energy sources can also have large water needs. Hydroelectricity is an obvious example, but crop-based biofuels also require water for irrigation, and nuclear plants rely on water for cooling systems.

Shale gas in Europe: revolution or evolution?

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Social acceptance
In addition to environmental issues, there is the issue of the social acceptance of the shale gas industry in Europe. Compared with the US, there is a higher population density in Europe and more stringent environmental regulations. Issues like noise pollution, which has so far been less of a concern in the US than some of the other issues, might be more of a problem in densely populated regions of Europe. Governments need to promote public confidence in the regulation of shale gas activity, and operators need to demonstrate that their operations are properly managed and sustainable. There has been widespread media coverage of the growing public backlash against shale gas development based on concerns over its impact on the environment. In Bulgaria, the decision by the government to award shale gas permits has been 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. Polands national gas company, Polskie Grnictwo 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.

In a poll conducted in August 2011 by Polands Centre for Public Opinion Research, 74% of Poles questioned supported the exploitation of shale gas in the country. However, a smaller majority (56%) of respondents supported the development of shale gas deposits situated near their homes. Moreover, 41% of respondents said it was hard to say whether shale gas production is environmentally safe, and 45% expressed the same uncertainty on the question of whether shale gas production is safe for peoples health. This highlights the challenges that operators will face in gaining public support in Europe. Environmental concerns are likely to bolster public support for a strengthening of the regulatory regime governing shale gas development. The European public will be waiting for the results of US studies on the environmental impact of shale gas production to emerge before fully accepting its development in their own countries.

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Shale gas in Europe: revolution or evolution?

Fiscal and regulatory regimes

European government attitudes to shale gas
National energy policy considerations, which include security of supply concerns, emissions targets and state support for competing energy sources, will all shape individual countries attitudes to shale gas development. This, coupled with a lack of consistent evidence on the impact of fracking on the environment and citizens health, has resulted in a situation where opinion on shale gas development in Europe has become polarized. The wide spectrum of opinion is illustrated by the differing stances of Poland and France, which have similar levels of estimated technically recoverable shale gas resources. On 30 June 2011, France became the first country in Europe to enact a ban on hydraulic fracturing. The French Senate voted by 176 votes to 151 to impose a permanent ban on the use of fracking in shale gas and oil projects due to concerns about the impact of the process on the environment. The permanent ban replaces a temporary suspension of shale drilling activity put in place earlier in the year. Operators with shale gas acreage in France opposed the ban, claiming that, while alternatives to fracking exist, they may not be economically viable. In early October 2011, the French government canceled three shale gas exploration permits because the holders did not commit to not use fracking processes to explore these permits. Other operators that have committed to not using fracking technologies have retained their permits. Germanys relatively modest estimated shale gas resources are unlikely to have a significant impact on the countrys heavy dependence on imports from Russia and Norway. Despite this, public opposition to the development of shale gas in Germany has been gathering momentum. The German state of North Rhine Westphalia (NRW) has announced that it will grant no further permissions for exploratory drilling projects using hydraulic fracturing until the summer of 2012, when it expects to receive the findings of a study it has commissioned into the environmental risks associated with shale gas. Poland, conversely, is probably the European country that is, at least publicly, most supportive of shale gas development. The east European nations shale gas resources, if proven to be commercially viable, would help the country become self-sufficient in energy and also provide wider economic benefits. Poland currently depends on coal for over 90% of its power generation. Poland would like the EU to adopt legislation to support shale gas development. The Polish government plans to introduce special regulations for shale gas production in its own country, including new fees or even mandatory participation of the state in order to safeguard its budgetary interests, a deputy treasury minister said on 8 September 2011. Most European countries have taken a less firm stance and appear to be adopting a wait and see approach to shale gas development. In May 2011, a UK House of Commons Energy and Climate Change Committee report was released. The report concluded that shale 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 UKs prospects and the evolution of national and EU regulation in reaction to the development. The reports authors did not support a moratorium on the use of hydraulic fracturing in the exploitation of the UKs hydrocarbon resources.

Shale gas in Europe: revolution or evolution?

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Pan-European regulation
In March 2011, the EC published a roadmap for moving toward a competitive low-carbon economy by 2050. This energy roadmap did not mention shale gas, but a revised version is scheduled to be published later this year that may shed some light on the ECs stance on shale gas development in Europe. In the US, fracturing is largely regulated by individual states, although some would like to see the federal government impose overarching regulations. At present, the EC does not have jurisdiction over sovereign states subsoil laws or resource development programs. Existing hydrocarbon regulation in Europe was drafted by individual countries for conventional exploration and production (E&P) activities and may not apply to the development of shale gas deposits or cover the new processes and technologies involved in its exploration and extraction. The EC is currently examining whether existing EU environmental legislation would apply to shale gas production but is not planning to bring forward any new legislation in the immediate future. Some oil companies may desire common pan-European regulation to make it easier for them to operate across borders. At present, for example, the transfer of equipment between countries may be hindered by different national standards and safety requirements. However, gaining unanimity among member states of the EU on shale gas regulation is likely to be an almost insurmountable feat. Poland is likely to veto any attempt to limit shale gas development through 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.

In 2009, EU member states agreed to commit to reduce energy usage and set a target to reduce emissions by 20% by 2020. However, the energy efficiency target is voluntary and not legally binding on member states. Some MEPs have raised concerns that CO2 emissions from unconventional gas production could be higher than from conventional production due to the energy required to power equipment and issues with equipment and water transport. The issue of methane escape has been put forward as another reason why shale gas development in Europe should be more tightly regulated. This could become a more significant issue if methane emissions are included in future phases of the EU Emissions Trading System (EU ETS). The system is a cornerstone of the EUs policy to combat climate change and its key tool for reducing industrial greenhouse gas emissions. The ETS now operates in 30 countries, the 27 EU Member States plus Iceland, Liechtenstein and Norway. The EU ETS will be further expanded to the petrochemicals, ammonia and aluminum industries and to additional gases in 2013, when the third trading period will start. In October 2011, the EC put forward a directive on fuel quality that sets minimum environmental standards for a range of fuels to enable suppliers to identify the most carbon-intensive options. The Commission has proposed that oil sands and oil produced from shale rocks should be ascribed a greenhouse gas value that is higher than that for conventional oil. Shale gas is not included in the directive, but the principle that fuels must meet minimum environmental standards makes it more likely that it could be included in future legislation.

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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 80 Offshore rigs

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Shale gas in Europe: revolution or evolution?

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Executives from Chevron have indicated that the earliest that pilot production could take place in Poland is 2013. Most observers, however, are more cautious and do not expect to see production reach commercial levels for at least another 10 years. Given the lead time to first production and the likelihood that developments will evolve more slowly, this will give the service industry the breathing space needed to gear up to meet the requirements of the shale gas industry in Europe. It will also give operators the opportunity to assemble a skilled workforce through targeted recruitment and training programs. If Europes shale gas potential is proven, this will provide tremendous opportunities for the oilfield services sector in Europe, which in recent years has focused on more substantive opportunities in other markets, such as the Middle East. However, it is unlikely that there will be a headlong rush to invest in new capacity until the results of initial exploration and development efforts provide more evidence about the potential for commercial shale gas extraction in Europe. Some government support may be provided to help the service sector adapt to the needs of the shale gas 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 Europes 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.

Cross-border pipeline connections would need to be improved if shale gas production reaches a level that makes it possible for some countries to export gas for the first time. However, all of the shale gas produced in Europe is likely to be consumed within the region, as the forecasted increase in LNG supplies, including potential exports from the US, is likely to be more than sufficient to meet demand needs in Asia and the Middle East. In September 2011, the Prime Ministers of Poland and the Czech Republic opened a Polish-Czech gas interconnector in Cieszyn, southern Poland. The new interconnector could form part of an enhanced north-south gas corridor that may be required if Polands shale gas production could support exports. The infrastructure requirements associated with shale gas development are not limited to pipeline transportation capacity. Requirements would potentially include new access roads for site traffic, access to water supplies, wastewater treatment and processing facilities, gas storage capacity and amenities for onsite personnel. Greater availability of potentially cheaper natural gas will also be an important consideration in decisions made about investments in future power generation capacity.

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Shale gas in Europe: revolution or evolution?

The operators
Companies own shale gas acreage across more than a dozen countries in Europe, but most activity is currently focused on Poland. While not all are active, around 20 companies currently hold shale gas acreage in Poland. The acreage holders include a number of North American and Europe-based small to mid-cap independent players, with the oil majors represented by ExxonMobil, Chevron, ConocoPhillips, Total and Eni. There are likely to be a number of other entrants, as some of the companies with experience from the shale gas boom in the US are actively evaluating opportunities in Europe. The notable absentees are the Europe-based majors, BP and Royal Dutch Shell, which were also later entrants to the US shale gas market. Shell in particular has significant shale gas interests in other regions such as China and South Africa, where there is a moratorium currently in place on shale gas drilling operations, and Shell is in the early stages of assessing potentially major resources of shale gas in Sweden. Large reserves in place, drilling successes, early development and sustainable economic levels of production are among the factors that will shape the fortunes of the small to mid-cap companies that are focused on shale gas exploitation. Early successes could prove to be transformational for the companies that are centering their development efforts on the nascent shale gas industry in Europe. It is likely that the successful companies will attract the attention of larger potential acquirers. Chinese companies have already bought into shale gas companies in the US and may also turn their sights to Europe. In the US, a number of the independent players that were active in the early development of shale gas have either been acquired or have farmed out stakes in projects to better-capitalized players.

Over the last 12 months, there has also been an increase in the number of partnerships announced between some of the oil majors and the independent players to jointly explore for shale gas in Poland and other European countries. 3Legs Resources plc, which listed on the UKs Alternative Investment Market in June, and its subsidiary, Lane Energy, are working with ConocoPhillips in the Baltic Basin. UK-based Hutton Energy announced in August that it had agreed to a farm-in deal with ExxonMobil to take a 49% interest in four of the US companys shale gas exploration areas in Poland. Some wider industry collaboration is also taking place. Gas Shales in Europe (GASH) is the first European interdisciplinary shale gas research initiative. The project, which started in 2009 with the first phase to run for three years, is sponsored by Statoil, ExxonMobil, Gas de France SUEZ, Wintershall, Vermillion, Marathon Oil, Total, Repsol, Schlumberger and Bayerngas. GASH focuses on the shale gas potential in Europe, especially on the Alum Shale (Denmark) and the Posidonia and Carboniferous Shales in Germany. The organization is leading the development of a European black shale database. The burgeoning cooperation between companies is being mirrored at the state level. There is greater inter-country cooperation on evaluating and exploiting global shale gas resources. The US government agreed in February 2011 to finance the survey of Ukraines shale gas deposits amid speculation that the country may have some sizable deposits. In Spain, a regional government is partnering with two US-based companies in a joint venture to explore unconventional natural gas deposits in Basque Country in northern Spain. The Basque government will invest 40 million euros in the project, while the two privately held US companies will invest 60 million euros. Two wells are to be drilled initially to see if extraction is technically 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?

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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 Reserves found to be uneconomical to develop Unsustainable production rates

Early exploration success Reserves potential proven to be greater than expected Rapid ramp-up in production Studies show that fracking is safe to public health and the environment Public desire for lower energy prices

Environmental and social factors

Results of studies into environmental impacts lead to restrictions/bans on use of fracking Increased public pressure on governments to halt development activity until impact is known

Fiscal and regulatory regimes

Potential EU-wide regulations on shale gas development Inclusion of shale gas in EU fuel quality and emissions legislation

Incentives provided by individual countries to shale gas developers Expedited approvals process for developments Government support for shale gas R&D

Energy prices

Competition from LNG and pipeline gas from Russia and the Caspian region Limited spot market liquidity

Deregulation of gas markets Long-term, oil-indexed contracts not renewed Improved interconnectivity between markets

Gas demand

Slower growth due to measures to support development of low-carbon economy Weaker Eurozone economy

Increased demand for gas as a fuel for power generation Gas positioned as a transition fuel to a low-carbon economy Oilfield service industry is fast to adapt to industry needs Technology developments that drive down costs

Infrastructure and service capabilities

Limited supply of suitable equipment or skilled personnel Lack of funds available to invest in new gas supply infrastructure

Source: Ernst & Young analysis

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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 could prove to be significant for individual countries by helping reduce their dependence on imports. The impact is likely to be most significant in Poland, which has a greater reliance on imports and larger potential shale gas resources than a number of other countries. Advocates of shale gas development in Europe put forward improved energy security as one of the key benefits, helping countries become more self-sufficient. Security of supply could also be achieved through diversity of supply sources. A shale gas boom in Europe could, in practice, weaken energy security 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 cases markedly, 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 with sizable shale gas resources are closely monitoring the situation in Poland and will hope to replicate any success achieved there in their own countries. There will, however, be setbacks along the way in September, UK-based Aurelian Oil and Gas announced what the Chief Executive described as disappointing initial results from its Trzek-3 unconventional gas well in Poland, which was producing higher levels of water and lower rates of gas than initially expected. The impact that shale gas will have on energy markets will vary widely from one country to the next, depending on the countrys national energy strategy, degree of import dependence, projected growth in gas demand and the cost and social acceptance of alternative and competing supply sources. The impact could, however, be transformational for the small to mid-cap independent companies that are focused on the nascent shale gas industry in Europe. There will also be opportunities for service companies to carve out new revenue streams and gain an early foothold in shale gas development activity in Europe. Research is not at a standstill, and new technologies will be developed that will help drive down the cost of shale gas extraction and improve the efficiency of development and production activities. The shale gas debate has become increasingly contentious, but there is no denying the economic benefit that the evolution of a shale gas industry could bring to individual countries in Europe. The increase in government revenues from taxes on shale activity, and private sector job creation would be especially welcome in these times of fiscal austerity. Most of the issues used by opponents to call for restrictions on shale gas development are not exclusive to shale gas activity, but environmental concerns are likely to bolster public support for a strengthening of the regulatory regime governing shale gas development. Any risks that are shown to be linked to shale gas development 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 to include learning the lessons from studies underway on the environmental and public health impacts of shale gas development in the US and using them to shape appropriate regulation where necessary in Europe.

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2011 EYGM Limited. All Rights Reserved. EYG no. DW0123 WR no. 1110-1302057
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