Hungary: Keeping the Home Fires Burning
Can Hungary’s hydrocarbon assets contribute to a more endurable utility price cut?
The Hungarian government’s utility price reduction program, a process which began with a lowering of household gas and electricity prices by 10% from January, is by no means finished. An unprecedented parliamentary consensus forming behind it portends that any further price reductions will be less and less dependent on a government or a party, but rather become an integral part of future policy making.
Whichever party wins Hungary's 2014 parliamentary elections will have to find a solution to finance further utility price reductions, or at least figure out a way to keep them at the same level after the elections. If strategists consider the public utility price reductions viable then they must create a long-term, coherent program, otherwise they will cause great damage to Hungary's energy infrastructure and security of supply—a loss much bigger than the savings from the lower utility prices. In the future, Hungary’s hydrocarbon wealth could potentially play a major role in utility price reductions and in the reduction of energy import dependence, ultimately reducing suffocating government debt.
Currently, natural gas is the most significant of the hydrocarbon assets beneath our feet here in Hungary. However, at present Hungarian gas fields can supply only 10-18% of the country’s daily gas demand. Even though gas consumption has fallen drastically over the past five years (from 2006 to 2012 falling from 14 to 10 BCM/annum), it is a fundamental interest of the government to use all means to increase investments which reduce energy import dependency and encourage domestic gas production.
Yet for almost three years hydrocarbon exploration companies have not been able to enter engage in exploration activities due to the fact that in October 2010 the Hungarian Mining Bureau (MBFH) declared the entire country off limits for hydrocarbon exploration. The reason behind this decision was to take more into account the interests of the state (ultimately the public) in future concession procedures instead of the previous – said to be liberal – practice of “giving away exploration rights.” The National Energy Strategy 2030 adopted in 2011, moreover, stating “we cannot yet lose fossil fuels,” also takes into account of the various available hydrocarbon resources in Hungary and identifies that the most significant exploitable stocks are of natural gas. Based on MBFH estimates, Hungary has 3563 BCM of gas lying under the surface, of which 2393 BCM are exploitable reserves. Considering that in the 75 history of Hungarian hydrocarbon production only 210 BCM of natural gas has been extracted, the numbers in the strategy appear quite high; it also notes “the technology is not ready to exploit this type of gas yet.” This is due to the fact that, based on an estimate which is still debated amongst professionals in the industry, most of the assets (97.6%) are of unconventional gas in the Mako basin. Hungary has 56.6 BCM of natural gas available and, according to the current production and consumption ratio, it will enable production to go on for 21 years with a strong downward trend, which basically means that - in the absence of further exploration – domestic natural gas production could become irrelevant within 5-7 years; at present it supplies one-fifth of the country's total natural gas consumption.
Conventional and unconventional energy sources are fundamentally different from each other based on their origin and production methods while in the end, the extracted gas is the same. The most widely accepted theory on the creation of hydrocarbons is the biogenic theory, whereby organic matter (plant and animal) is derived from sedimentary rocks over millions of years, due to high pressure and temperature, are converted into a variety of hydrocarbons. Due to the laws of physics these hydrocarbons start their millions of years' long migration among various rocks until they reach a place where there is damage in the rock’s permeability and therefore it is here the migration is interrupted, and the hydrocarbons trapped in various structural positions. The hydrocarbon miners (geologists, geophysicists, engineers, mineral oil producers) find these traps and open them to bring the hydrocarbons up to the surface. In the case of unconventional hydrocarbons, this migration process is interrupted in the very beginning due to the rocks' permeability, which is so low that it does not allow any movement, so mineral oil or natural gas gets trapped in the pores of the rocks. This makes the extraction of these "stuck" hydrocarbons more difficult because it is not enough just to open up the flow to the surface with one or two drillings, but also necessary to make artificial channels to bring up the trapped hydrocarbon molecules. For this purpose hydraulic fracturing is used, a technology developed in the last few years, which has triggered strong opposition from green organizations and politicians heavily influenced by environmental groups.
However, exploration and production of hydrocarbons compared to traditional mining sectors still leave a significantly smaller environmental footprint, since they do not open mine shafts, nor are mountains are broken down to access the minerals; instead a point-open method of boreholes (wells) is used to bring hydrocarbons to surface. Hydraulic fracturing technology has been used since the 1950’s to improve flow into the well. Until now, there have been thousands of hydraulic fractures carried out in Hungary without any soil or water contamination. The mass proliferation of the technology has been induced by shale gas production, as in the case of unconventional hydrocarbon production it is the only production technology that can be applied successfully, so not only has the number of wells increased drastically, but hydraulic fracturing has become a daily routine.
Mineral oil and natural gas exploration is very capital intensive and high risk. The biggest risk for investors is drilling success. as the cost of one domestic drilling is higher than HUF 1-1.5 billion, while the probability of a discovery on average is between 20-30%, meaning 70-80% of the time the incurred costs will not bring any returns. Due to the high financial risk, governments typically invest in hydrocarbon exploration and production only in countries where there is a high chance of drilling success. National oil companies have mainly been developed in major oil provinces (Arabian Peninsula, South America, Africa, etc.), where the vast majority of revenues are from petroleum and natural gas production. Although it was typical of socialist governments in Central & Eastern Europe to have large state-owned oil producer trusts representing the people's property, after the fall of communism the privatization process began almost everywhere and a growing number of countries opened their borders to foreign companies with appropriate technical and financial capabilities, since the low level of domestic financial resources did not allow governments to put taxpayers’ money in jeopardy. Hungarian domestic hydrocarbon exploration got a boost in the second half of the 1990’s when more investors with international experience appeared on the market and brought new methods and financial resources to the declining mineral oil and natural gas production industry. The previous state-owned monopoly transformed into MOL and its dominance on the exploration market has persisted, and due to its country-wide exploration infrastructure it was almost the only gas production company on the market. But nowadays there are more and more foreign – mostly with English-speaking management – companies that carry out successful drillings in the country.
The greatest successes have been achieved by Hungarian Horizon Energy Ltd., who not only drew attention to themselves by successful drillings in “abandoned” areas, but also established fruitful cooperation with MOL, both in the fields of exploration and production. However, the most publicity has been received by TXM Ltd., the Hungarian subsidiary of the Canadian enterprise, Falcon Ltd., for its several hundred million dollar reinvestment in the exploration of unconventional gas in the Makó basin.
The worst situation for an exploration company is when it does not have the opportunity to explore. This uncertainty was caused by the state closure of the exploration areas and it not only has a negative effect on foreign companies but also on MOL. Exploration rights which were given out in the 1990’s, after being extended by the maximum time that the law allows, are expiring and there are no new areas for hydrocarbon exploration. This carries major financial and technical risks for hydrocarbon exploration companies who are able to invest and take high risks, if their exploration licenses expire and they cannot acquire new areas for exploration. Their exploration portfolios narrow below the level of economies of scale which means new discoveries and service companies (drilling, geophysical, geological modeling companies and their supporting industry) cannot work—the industry withers.
In the hydrocarbon mining industry investments, the value of assets and the risks involved are all exceptionally high; meanwhile, well-trained, foreign language speaking professionals’ emigration is very high, therefore to reverse the possible decline of the industry would be difficult as we have already experienced in the last two decades in the coal mining industry.
In addition to the moratorium on licensing, domestic environmental regulation also poses difficulty. Currently there are several oil and gas exploration companies which are struggling with the environmental authorities to obtain a permit. While the government's declared aim is to contract the remaining exploration areas within concession procedures and to bring in approximately EUR 1 billion of foreign working capital into the economy in the next 5-7 years, there are several domestic companies whose exploration operations are stalled because of the environmental authorities – in most cases not due to technical reasons. It's like one hand of the government does not know what the other one is doing and they are working against each other.
The authority, in addition to disabling operating companies, is also lowering the chance of successful concession processes, because if it is problematic to receive an exploration and production license on time, then potential investors will stay away. In the last three years the Environmental Authority’s budget suffered major cut backs so the numbers of those in charge of authorization has shrunk drastically; they presumably they use a “pre-emptive strike” tactic, prohibiting licenses rather than judging applications, as for the latter they probably do not have the resources. Still, the essence of environmental regulation is not necessarily about strictness, but more about enforcing the rules well. The cost of a ban that is not based on professional requirements to the nation’s economy is much more than it would cost to provide additional funds for the Environmental Authority to execute appropriate control.
The stakes are high: In the last decade, approximately EUR 1 billion in capital arrived in Hungary for hydrocarbon exploration projects, and if we add MOL’s portfolio as well then this amount would be double. From the concession procedures - beyond their immediate revenue – the same amount of direct investment could come by 2020, and if MOL can re-activate its domestic exploration and production portfolio then this amount could reach HUF 500 billion by the end of the decade. From this amount HUF 250 billion would enrich the country’s budget by mining royalties, taxes, and dozens of other indirect payments (it’s an unwritten law of trade that HUF 1 of foreign investment in the oil industry provides HUF 0.53 to the government’s budget).
Furthermore, current gas production could be doubled which, accompanied by energy efficiency projects, might supply half of Hungary's domestic gas demand by the end of the decade. Conversely, if domestic hydrocarbon mining is disabled, besides the loss of the amount mentioned, by 2020 we can say farewell to the Hungarian oil production industry and gas production would drastically shrink as well to provide only an insignificant supply to the demand. Finally, it is important that these investments not be made from public funds, not putting public revenues at risk. Explortion enterprises fund these very high risk projects (over 70% with no chance of returns) from their own assets, therefore from the owner’s point of view, as geological property is owned by the state, but is the property of Hungarian citizens, this is definitely a worthwhile opportunity.
In Hungary nowadays, marginal projects regarding the energy supply receive much more attention than the problem areas outlined above. It is recognized that promoting renewable energy and energy efficiency must have priority as well if we really want to build a sustainable society. However, it is also important to note that between the oil age and the renewables age, natural gas will be the bridge. In the past four years this energy source has significantly reduced carbon dioxide emissions in the United States through the shale gas revolution, so much so that if the U.S. had signed the Kyoto Protocol it would now be fulfilling its commitments on emissions reduction.
Furthermore, Hungary's energy production is highly dependent on natural gas, therefore in the diversification process not only should natural gas pipelines play a role, but maintaining domestic natural gas production at least at the current level should also receive a similar recognition.
Currently in Hungary, oil and gas production has shrunk at a a double digit rate each year and if nothing is done to counter this then the question mark over the utility price cut will be even greater: How will any government sustain Hungary's utility price reduction without domestic production? How are we going to account for natural gas imports if they reach 100% by the end of the decade? From where do we replace the loss of revenue resulting from the cessation of production? If we do not want to finance it from loans by increasing the national debt then we have to make sure of two things: that the market is allowed to do its work and that regulation exists to support the industry, not just to oppose it.
This piece has been authored by Attila Holoda, PhD, Ex Deputy Secretary of State, Ministry of National Development of Hungary (now Managing Director of Aurora Energy Ltd.), and András Jenei, Director, CFPA Energy Workshop.
The Hungarian Ministry of National Development is hosting an Investors Forum on Concession Investment in Hungary on 14 June 2013 in Budapest.
The Ministry intends to issue a public call for tenders in the near future for the exploration, development and production of hydrocarbons and geothermal energy. In preparation for this, the Concession Investment Forum, an all-day event, will provide an overview of the current status of the Hungarian hydrocarbons sector, the legal framework of mining concessions and relevant environmental and taxation issues will be discussed.
Along with Hungarian regulators, the representatives of operators such as Hungarian Horizon Energy and Falcon-TXM Oil, Hutton Energy and Wisent Energy will also address Forum participants.
The event also includes a cocktail reception and gala dinner with special guest Ms. Anita Orban, Ambassador-at-Large for Energy Security, Hungarian Ministry of Foreign Affairs.
To receive more information and a registration form, contact the Ministry: email@example.com