Shale Gas – from America with Love?

The shale gas revolution has fundamentally changed the energy market in the U.S. Now the whole world is waiting for its expansion – Russia anxiously, Europe with hope. Can shale gas go global? Much will depend on the improvement of extraction technology, investment frameworks and U.S. global energy strategy.

US production of natural gas and crude oil from shale formations is transforming energy markets and geopolitics.  The dramatic rise in US natural gas production has led to a rapid and sustained decline of US domestic gas prices, a revival of US manufacturing, a global glut of displaced liquefied natural gas (LNG) and a subsequent erosion in the linkage between crude oil and natural gas prices in Europe.  Global gas markets are becoming more competitive and Middle East dominance of oil markets is increasingly challenged by the US and Canada.  Shale formations are ubiquitous, so technologies that can produce them economically can democratize access to energy.  Countries historically dependent on a single supplier, or on imported gas or coal, can access indigenous supply if the right economic framework is in place.  So far, only a few countries have created such frameworks.

The US experience

Since 2008, when the production of shale gas first garnered widespread attention in the United States, the US has experienced positive benefits with regards to price, climate and industry growth. US shale gas production rose from 2.25 trillion cubic feet (Tcf) in 2008 to a projected 8.6 Tcf in 2013.  The US is poised to become a net exporter of natural gas by the end of this decade.  Today, natural gas prices in Europe average more than twice the average US price, while Asian gas importers pay roughly three times as much for gas. The US Environmental Protection Agency announced in October 2013 that carbon dioxide emissions from power generation declined by ten percent between 2010 and 2012 largely as a result of natural gas replacing coal as the power generation fuel of choice.

Impact on global markets

European markets began to see price improvements in 2008, when the US began producing enough shale gas to lower its imports of LNG, freeing up those LNG cargoes to go elsewhere, including Europe. Gazprom was forced to decide between adapting to new market realities or cede some of its market share. In 2012, a number of gas companies in Western Europe renegotiated long-term gas contracts with Russia’s Gazprom, including Poland’s PGNiG, Italy’s Eni, and Germany’s E.ON; some renegotiations resulted in retroactive price reductions.

US LNG exports are likely to grow, albeit slowly. The US is poised to become a net exporter of natural gas by the end of this decade, with some analysts projecting LNG exports of as much as six to eight billion cubic feet per day (bcf/d) by the end of this decade.  So far, one export project has received final export authorization from the US government for 2.2 bcf/d and is currently under construction, while four additional applications, totaling 4.57 bcf/d, have received export approval conditional upon technical and environmental approval.  The US Department of Energy expects to issue new conditional approvals every two months, but final approvals can come up to eight months after conditional approvals, and if these projects reach final investment decision (not a certainty), construction can also take two to three years. It is safe to say that there will be LNG exports from the US, but the volume will be determined by market prices and the pace of development of competing LNG projects elsewhere in the world.  As additional supplies of natural gas become available, whether as a result of US LNG exports or production of shale gas in Europe, Europe’s negotiating power will continue to grow.

Growing US oil production from shale impacts global oil markets.  US production has helped to replace supply lost from Libya, Iraq, Sudan and Nigeria.  US oil supply growth has helped lower the cost of security cooperation on Iran to China, Japan and Korea.  The potential impacts of shale oil and gas development are enormous, particularly if the phenomenon can go global.

Can the shale gale go global?

In spite of the positive market impacts to date, the benefits of shale oil and gas continue – so far – to be limited primarily to the US. Shale formations are ubiquitous, with resources being identified in Europe, Asia, Africa and South America.  While Russia, China, the US and Argentina are among the largest resource holders for both shale gas and shale oil, there are sizable gas resources in European countries including France, Poland and Ukraine, as well as Romania, Bulgaria and Lithuania.

The US success is the result of the right configuration of geology, economics, technology, industry experience and policy. In 2008, natural gas prices in the US were relatively high, the resource plays were known, and the technological advancements in horizontal drilling and hydraulic fracturing made development economic. The domestic oil and gas service industry was robust, technically capable and reputable. The US had in place an investment framework that helped to assure companies that they would see a return on their investment. And last but not least, the policy framework in the US, which included a stable regulatory regime and land/mineral ownership rights helped companies take the risk of investing.  The scale of success in the US was dependent on all of those factors, and that success will be difficult to replicate.

Public confidence

While US production has not been without controversy, the existence of sound environmental laws on drilling safety, water usage and emissions allowed US production to rise rapidly. Even so, many states created new laws on fluid disclosure, community impacts, water recycling and well bore integrity to address public concern over the scale of development.  In Europe and Latin America, shale oil and gas can be developed safely and successfully, but governments have to create policy frameworks to ensure safety and protect investment. Rules need to be robust and include rigorous enforcement mechanisms to engender public confidence. Numerous reputable organizations, not least of which include the International Energy Agency and Resources for the Future, have done work to outline how shale oil and gas can be developed safely, and their reports can help to provide a blueprint for designing sufficient regulatory frameworks. While safety and environmental protection are often the primary focus of regulatory efforts with regards to oil and gas development, governments also need to consider the issue of local benefits, which can be addressed through policies like revenue sharing or severance taxes. Additionally, development can be harder when there are entrenched interests that support the status quo in the energy sector, whether with regard to the fuel mix or supply hegemony.  Governments can combat these interests by promoting the diversity of supply and fuel types.

Investment frameworks

Economics matters.  Decisions to invest are driven by risk and reward. The cost of developing shale formations varies greatly depending on geology and the availability of infrastructure. Tax and regulatory costs must incentivize exploration in early stages, as the risk of failure can be high. Unfortunately, some of the initial enthusiasm for shale gas development in Lithuania and Poland has waned, largely because the resources are proving to be too small or too costly to develop at current natural gas prices.  In Central and Eastern Europe, oil and gas development can be particularly costly because there is limited existing infrastructure both for drilling and for delivering gas to markets. Given the numerous opportunities for natural gas development globally (including, but not limited to, unconventional gas), governments will need to be competitive in order to attract investment.

The Outlook for Europe

Misinformation, domestic politics and a lack of private ownership have slowed the development of shale in Europe so far. Those countries most dependent on imported gas from Russia have been the most motivated, led by Poland and Ukraine. Romania and Bulgaria have important resources, but internal political rivalries and some external desire to preserve market share have temporarily complicated development. In Western Europe, the United Kingdom has made major strides towards allowing the development of its shale resources in a safe and sustainable manner, evaluating the risks, working with industry to consider safe operating requirements, and being pragmatic about the timeline for development. In Germany, which currently has a de facto moratorium on fracking, a formal moratorium is expected to result from recent coalition-forming talks among the leading political parties. Similarly, France currently has a moratorium on the practice of hydraulic fracturing.  Russia, on the other hand, already a major player in the oil and gas world has substantial reserves of shale oil, providing them with a potential win in oil even as shale gas development elsewhere in the world is forcing them to adapt. So far, Russia has proven to be better able to adapt than expected, negotiating on fiscal terms and attempting to become more competitive. This will serve to make the Russian economy more competitive and, in the long run, less dependent on natural resources.

At present, no single European country has taken a leadership role with regards to developing a strong regulatory framework for shale development, and the EU Commission is not in a place to do so with such fragmented views among member states and given the intensely local nature of allocation of water resources, land access and drilling safety. The US has taken a leadership role in promoting the safe development of shale gas through initiatives like the Department of State’s Unconventional Gas Technical Engagement Program, but global leadership on shale will have to extend beyond the US. The shale revolution should not just be an American tale; it should be a global opportunity.

In the end, the shale revolution strengthens global energy security and lowers the cost of carbon reduction.  New supplies of oil and gas, be they from shale or from ultra-deepwater reservoirs or the Arctic, represent a slow democratization of energy that provides new countries with the chance to generate economic growth, improve their carbon intensity and reduce the power of hegemonic suppliers.  Even as incremental energy demand shifts from West to East, the world is becoming less dependent on energy production centered in an elite few countries. US LNG exports and perhaps new supply from Canada, Australia and East Africa will give countries more choice. In an era where ‘energy security’ remains critical to national security in Europe and elsewhere, this is an important shift, and one to be encouraged.  But it will take good leadership to get the mix right.