New Realities of the Gas Market in Europe: Challenges for Gas Exporters

Energy Delta Institute (EDI) in cooperation with the Institute of World Economy and International Relations (IMEMO) organized a very thought-provoking conference was held in Moscow titled "New Realities of the Gas Market in Europe: Challenges for Traditional Gas Exporters." In particular, the discussion about shale gas developments in Europe brought out objective elements of analysis. This was refreshing with regards to all of the hot speculation on the topic. Renewables and European energy law were also on the menu. All is linked by the issue of securing affordable energy supplies. (This article mainly re-uses speeches and material displayed during the conference).

Aleksander Van de Putte (Managing Director of Kazakhstan Development Bank, Chief Adviser to the Deputy Prime Minister of the Republic of Kazakhstan) gave a really interesting speech on whether the US shale gas revolution could happen in Europe. As a matter of fact, production in Europe decreases, while demand increases. The future of renewable energy sources is also an issue. Hence the big question: from where will incremental demand come from, knowing that the US shale revolution will not happen in Europe? Indeed, there may be some shale developments, but not similar to those in the US. The United States benefits from unique geological characteristics. It may be worth to recall that conventional gas deposits and the way to recover them differ from those of unconventional gas. Conventional gas is extracted via vertical wells and large areas of gas; unconventional gas through horizontal wells with gas trapped in rocks. Further, the wells drilled to recover unconventional gas suffer from rapid depletion. As a consequence, a lot more drilling is required. The drilling ability is then a condition for shale gas. This entails a huge need for water, raising criticism regarding the environmental footprint.

There are reasons why the shale gas revolution happened in the United States. Alexander Van de Putte refers to them as the “seven enablers.” First of all, there are large numbers of shale plays with positive geological conditions. Second, US gas market fundamentals were favourable to such a revolution: conventional gas was declining meanwhile demand for natural gas was increasing. Third, there is a clear regulatory level in the US. Issuing licences is dealt with at the state level, not at the federal level. Further, these are states that ensure the respect of safety and environment. The fourth enabler is fairly unique: mineral rights are private. Fifth, the technically advanced and competitive service sector. The US is home to the most technically advanced service sector at all stages of development and production. Last, but not least, competition among upstream players (exploration and production) and low entry players. Entry barriers are low and full unbundling helps quickly increasing production. And finally, the recent advances in technology are the seventh enabler. With shale gas, it is more difficult to find the sweet spot, so exploration is more intensive in data: big data and seismic imaging make up enabler number seven.

In addition to these enablers, the US energy landscape is changing. Indeed, the cost of production decreases due to strong competition, so it is compatible with low gas prices. Natural gas in the US could be used for the industry and for transportation. The necessary network for that is already in place. It is cheaper than diesel so it is expected that heavy trucking companies in the US will move to natural gas.

So here comes the question - will such a revolution will happen in Europe? Well, unconventional gas may not be a revolution in Europe. Globally, there is plenty of shale gas. Question is whether it can be developed economically. Europe's problem is supply, and it will be difficult to secure domestic supply. The seven enablers are different in the US than those in the EU member states. As explained by Van de Putte, quantity is not an issue. But the quality differs, and EU shale gas is trapped much deeper so its actual cost of recovery could be 60% higher. Moreover, the market size differs. Member states have different gas infrastructure. It is then more difficult to reach end consumers. Gas network is not in place, so markets will vary from country to country. Mineral rights regime differs from that in the US and the competition landscape is different as well. In addition to this, in Europe, public opinions are receptive to the environmental argument, while in the US the economic prevail. And finally, government support is an issue as well.

To conclude, as explained by Mr. Van de Putte, in Europe, shale gas will be more an evolution than a revolution. There may be some shale gas. So far, seven EU countries have granted licences. But time, geology, technology remain issues. If Poland is taken as an example, and if it is assumed that it has the technology now, it still has only 72wells (against 2000 in the US). Plus, there is the issue of bringing gas to the market, and the time to do it (to build infrastructure).

Regarding the surplus of gas in the US, it is doubtful that it will be exported in a massive way. Natural gas is the cleanest burning fuel, but also competitive against Europe. European industry cannot compete against US industry that has cheap gas. Further, the necessary infrastructure for this is actually not here. So, why not keep it at home for trucking and energy intensive industry, and export coal instead? Many countries would be happy to import coal from the US. Coal from West Virginia is the best in the world. But it is a swing state: no parties (between Republicans and Democrats) want to close down factories so as to not to lose elections. So coal remains. The question is what to do with it? There are countries building electricity capacity such as India and China. They have coal but they are also facing issues of mining area and quality of coal. So US coal could go to Asia.

If unconventional gas in Europe will be more part of an evolution than a revolution, then the crucial issue of securing supply remain. And to secure supplies, it is not only a matter of underground resources within Europe or within European reach - the physical infrastructure available and the regulatory landscape is important. Just as it is an enabler in the US to secure their supplies, it can be either an enabler or an impediment in Europe.  The EU Third Energy Package versus the EU-Russia energy relation was discussed by Pieter Trienekens (Managing Director Salern Energy Advisory BV). He underlined that the EU gas market is in a turbulent state; and that availability of supplies and availability of infrastructures are issues. Restructuring of companies, indiscriminate access to pipeline capacity, strengthening of spot prices are part of the new model of EU gas market. Four risks are emerging with the changes of the EU gas market: first, the capability to deliver gas; second, the changing tarification (transportation cost under the new entry-exit system will be higher); third, certain investments may be uneconomic; and fourth is adapted action (new demand in the EU may not be met by Russian gas). As a matter of fact, on this last point, Tatiana Mitrova (Head of oil and gas complex of Russia and the world Energy Research Institute of Russian Academy of Sciences) noted that there may be no possibility for Russia to increase supply to the EU due to its unclear political and regulatory landscape. Such an instability and unpredictability are problematic for all investors.

Moreover, high price of gas does not support the use of gas in the power sector. And cheap American coal is squeezing gas on the EU market.  Mitrova further pointed out that it is rather the Golden Age of Coal in Europe than the golden age of age. In fact, the CO2 price has to increase more than ten times to make gas competitive. The problem is that factors leading to low gas plant utilization are largely irreversible. So, policy-driven decommissioning of coal fired power plant would help recovering a bit gas demand by the end of the decade, but not timely enough to have the necessary investments done on time. So here comes again the crucial question: from where will the new additional gas come to Europe. Mitrova warned that the use of force against each other could end in harming both side. She concluded that the next decade will be sellers’ decade.

To conclude, the European natural gas market is changing, it’s a fact. If indeed the shaky energy law and political environment is challenging for suppliers, offering little incentive for investments; the challenges currently experienced by suppliers may soon turn back to importers. With decreasing indigenous production, ambitious climate targets, and heavily subsidized renewable energy[1], the question is from where will the new supply needed come? One may then wonder if, after all, the EU is not cutting the branch on which it sits.

Yasmina Sahraoui