An earthquake is winding up under the crust of European soil—not a conventional seismic one, but an energy temblor, with the potential to transform the Continent’s energy market and alter the strategic parameters of Russian-European relations. The prospect of the commercialization of shale gas has already generated a high-stakes debate within the European Union about how fossil fuels, nuclear power, solar and renewables should factor in its energy mix. Adding an American dimension to the problem, Europe’s debate on energy security also affects Transatlantic relations because of shale gas’s potential to link U.S. and European energy sectors and influence the wider Euro-Atlantic debate on climate change, regulatory requirements, emissions and supply sources.
A silent global shale gas revolution has been underway since 2001, thanks to improvements in hydraulic fracturing technology, or “fracking”, which uses large amounts of compressed water, sand and a small amount of chemicals to free natural gas from its geophysical reservoirs. Over the past decade, U.S. energy companies have leveraged “fracking” to increase domestic unconventional gas production from 1 percent of all gas extracted in 2001 to over 20 percent today. By 2035, almost half of all U.S. natural gas output is projected to come from shale.
With shale deposits distributed generously worldwide, Europe is beginning to catch the trailing edge of this game-changing moment in global energy production. Today the European Union is engaged in a crucial debate over whether and how to tap into its own shale deposits, which contain more than 17.5 trillion cubic meters (and with the recent discovery of a new major deposit in the United Kingdom, possibly as much as 22 trillion).
In Europe, Poland has led the way as the country with one of the largest deposits and with the greatest commitment to make unconventional gas commercially viable. Polish shale gas deposits comprise about 5.3 trillion cubic meters in all. To put this number in perspective, consider that in 2010 Poland produced domestically only approximately 4.2 billion cubic meters of conventional gas, the balance covered by long-term conventional gas contracts from Russia (64 percent or 9 billion cubic meters provided by Gazprom) and Germany (1.0 billion cubic meters of gas, or approximately 7 percent of its annual consumption). Poland also bought marginal amounts of gas from Ukraine and the Czech Republic. The current projection for 2011 is 4.3 billion cubic meters of domestically produced gas. Unofficial projections by several energy companies exploring for Polish shale gas have put their annual commercial production targets at 10–15 billion cubic meters of output. If one were to add what just two or three major companies currently drilling in Poland hope to produce, the projected annual output would surge to 40–50 billion cubic meters. This is ten times what the country produces today, and that is not counting other international and local producers that are working to carve out a share in the business.
The total annual demand for natural gas in Poland stands today at just under 15 billion cubic meters, and it is projected to reach 18 billion in 2015 when commercial Polish shale gas production is expected to begin. The possible volumes of unconventional gas thus transcend Polish circumstances. Even if Poland managed to absorb and store an additional 10–15 billion cubic meters of domestically produced gas, the projected volumes from the major companies alone indicate that Poland would need to become a net exporter for the project to be viable at scale. Intense lobbying in Europe these days is driven by the recognition of this potential sea change in European gas supply and pricing. It reflects the growing realization in Moscow, in particular, that shale gas produced in Poland would be significantly cheaper throughout Europe than Russian gas, posing a danger of significant market-share loss for Gazprom. But will any of this happen?
Today there is intense lobbying against shale gas in Europe, all intertwined with national interests of individual EU member-states or Europe’s energy suppliers. The most politically influential is the nuclear power lobby. In the wake of last year’s nuclear disaster in Japan, the nuclear power lobby is already mobilized for combat, especially in light of Germany’s recent decision to completely abandon nuclear power by 2022. The future of nuclear energy in Europe is tied to the question of unconventional gas. France is the largest producer of nuclear power in Europe, but smaller countries like Hungary and the Czech Republic have decided to grow their nuclear power generation capacity. All three, and possibly others, want to sell power to the Continent’s largest and soon-to-be nuclear-free energy market, Germany. But that prospect will diminish if shale gas becomes more economical than nuclear power, the cost of which may be pushed upward by political externalities if the nuclear lobby cannot prevent it. The question of what—and who—will supply Germany with energy is more than a simple euros-and-cents exercise, however. Supplier-consumer relationships with Europe’s key political and economic power have strategic implications both within the European Union and beyond.
The most vocal and highly visible lobby consists of environmentalists, moving in parallel with the renewable energy sector. Europe’s renewables industry has already staked a claim to large-scale government money transfers and is now being threatened by the appeal of cheap Polish unconventional gas. In Germany alone, renewables have already reportedly generated about a million jobs and continue to grow. Notwithstanding debates over renewable technologies, this is a compelling argument for funding renewable energy at the height of the Great Recession, when the euro crisis threatens to push the European Union over the cliff: It’s about jobs, not just energy.
The lobby most determined to stop shale gas exploration and eliminate unconventional gas from Europe’s energy is conventional gas producers—specifically Gazprom and the Russian government, which view Polish efforts as a direct threat to Moscow’s political influence and revenue stream. Gazprom’s lobbying in Berlin and Brussels has acquired added urgency following Germany’s announced exit from the nuclear energy field, which has changed expectations and calculations on a grand scale. Moscow has tried to link Germany’s energy sector ever closer with Russia’s. On November 8 the Nord Stream pipeline became operational; it runs under the Baltic Sea from Russia to Germany, bypassing the Baltic States and Poland. On November 14 Gazprom announced the acquisition of Envacom Service GmbH, a German energy and communications company, which gives Russia a foothold in Germany’s energy provider market. Gazprom continues to look for other potential acquisitions in Europe, especially in Germany.
As lobbying heats up, some hope that the shut-down of German nuclear power plants will translate into an opportunity to increase direct electricity imports from other countries. Others hope Germany will substitute conventional gas sales from Russia for what it will no longer produce from nuclear power. Still others hope Germany will make up its energy deficit with new and much cheaper European shale gas from Poland, especially if, as expected, Germany converts its decommissioned nuclear power plants to natural gas as a more cost-efficient and environmentally friendly alternative. Finally, tacked on to this lobby is the coal industry, which sees the prospect of abundant, cheap shale gas as a significant threat to its own position in Europe’s energy market, especially when looked at from an environmental perspective.
The most radical among these groups of opponents are environmentalists and the Russian lobby. The former is very good at appealing to the higher angels of human nature, and the latter is very proficient at enticing the lower angels of said nature with sacks of money. Environmentalists seek to ban fracking, thereby effectively ending all unconventional gas exploration in Europe, but their opposition to shale gas often goes hand-in-hand with the demand-side policies of a number of European governments that have favored for very different reasons the indigenous development of renewables or nuclear energy sources. For instance, last summer the French parliament passed an outright ban on fracking, and subsequently Paris retracted the shale-gas exploration permits held by the French energy company Total and the U.S.-based Schuepbach Energy. In doing so, France, with its strong commitment to nuclear power generation, effectively closed the door to unconventional gas development on its territory, notwithstanding its own large local shale deposits. There is growing concern that a similar ban could be passed by the German Bundestag.
There is also the real possibility that Poland may fail to develop a viable regulatory and tax regime to make massive production of cheap shale gas in Europe both profitable and sustainable. Poland, as the pioneer in European commercialization of shale gas, is trying to learn and implement the most effective practices used in Canada and the United States. It hopes to strengthen North American energy companies’ commitment to investing in Polish gas while they assess how much there actually is. Even if there turns out to be plenty, as is likely, moving from exploration to production involves a delicate balancing act that must factor in not only how to price Polish production permits but also how to design a tax regime that satisfies the government and guarantees a healthy investment environment. That balancing act must also factor in the added costs of the infrastructure improvements needed to move heavy equipment into and gas out of the country. In short, the key challenge for Polish legislators will be to ensure that unconventional gas will be not just a small addition to Poland’s energy mix but a game-changer that redefines how Europe develops and prices energy.
Poland will not achieve that status simply by allowing market incentives to play out. It must fund and develop major infrastructure upgrades to make commercial gas production competitive, especially in light of the recent discovery of large British gas deposits. But Poland will need European Union money to do that. Specifically, it will need money to build a pipeline infrastructure and interconnectors to supplement the liquefied natural gas port currently under construction on the Baltic Sea, scheduled for operation in 2014. The question is, given all the various interests at play, will Poland be able to get that money, and if so under what conditions?
Russia will also have a say in how all this turns out. European shale gas development poses the greatest challenge to Russia’s position as a key supplier of energy for the European Union. If produced in sufficient quantities under workable regulatory, tax and environmental regimes, Polish shale gas could end Europe’s dependence on Russia, and in the process revolutionize how energy is produced, priced and delivered across Europe. This would fundamentally change the nature of Europe’s relations with Russia, reordering Europe’s security equation as well as its energy markets. Polish shale gas would shift energy pricing away from long-term contracts in the Central European gas market and toward the spot market pricing prevalent in the North American market.
Clearly, then, the prospects of commercial exploration of Polish shale gas have far-reaching implications for foreign policy. If Russia wishes to avoid having its energy market share in Europe pushed down into single digit percentages, it can be counted on to lobby Germany and other EU countries to obstruct development of Polish shale gas. To put it mildly, this would not aid the recent strides toward an historical Polish-Russian reconciliation.
Warsaw clearly appreciates what is at stake. As of this past fall, Poland has issued more than a hundred permits to explore for shale gas. Commercial production of shale gas in Poland reportedly could begin in just five years and ramp up sufficiently to begin changing the natural gas landscape in Europe by the end of the decade. Europe’s quest for secure natural gas, which is comparable to America’s, is already transforming state-to-state relations on the Continent and has complicated negotiations with Russia over long-term contract pricing. The development of American shale gas technology and the current drive toward unconventional gas in Europe has cut Gazprom out of further expansion into the U.S. market; it is now left with defending its current position in Europe, which will likely yield downward pressures on the pricing of Russian gas. The greatest impact of the unfolding shale gas revolution, however, is that it is moving the world toward a more interconnected gas market that would benefit the European Union at multiple levels, from energy pricing to industrial production.
Today the European Union relies on Russia for some 25 percent of its gas consumption However, the degree of that dependence changes dramatically as one travels west to east. In the post-communist region, Russian gas meets somewhere between 60–100 percent of a country’s annual energy requirements, which translates into a powerful policy tool for Moscow. This phenomenon was amply demonstrated during the January 2009 supply crisis, when Gazprom cut off supplies over dispute with Ukraine. Energy vulnerability in Central and Eastern Europe is compounded by serious pipeline and interconnector deficiencies, making it difficult for other EU countries to supply the region during a time of crisis. The flow of major pipelines across Central Europe reflects the residual effects of the Cold War. Even the controversial Nord Stream project is just another incarnation of the East-West “Druzhba” pipeline, except for its running under the Baltic Sea. Resource dependency coupled with an underdeveloped infrastructure combine to make the region susceptible to Gazprom’s price dominance. The European Energy Program for Recovery is trying to address this issue by building new Central and East European interconnectors, but it will take time.
The Polish shale gas project, if successfully implemented, would undercut the Russian strategy. To put this into perspective, during the April 2011 Russian contract negotiations with Poland, this price disparity was clear: Poland paid $336 dollars per 1,000 cubic meters of Russian gas, Germany paid $271 and the United Kingdom $191. European shale gas would allow those buyers to diversify their sources, reducing the amount of revenue Moscow could expect to draw from its energy exports. In short, Polish shale gas is a make-or-break struggle for Russia’s power position in Europe. If it becomes a reality, one could easily imagine the European Union dictating terms to Russia and demanding concessions on prices in exchange for market access, rather than the other way around.
In theory, the European Union should be committed to breaking Gazprom’s near monopoly in the European gas market; in practice, some influential EU countries may wish to preserve the status quo. Large amounts of cheap gas could, for example, undermine the French strategy of dependence on nuclear power generation. Likewise, a number of German or other energy companies locked in long-term Russian contracts could find themselves saddled with a considerable surplus of expensive conventional gas. Hence the upcoming EU assessment of the environmental impact of shale gas technology will undoubtedly be subject to intense lobbying and political pressure. In theory, vital security interests should trump inbred parochialism in EU member-states’ business-government relationships; in practice, unfortunately, they don’t.
Lobbying is only part of the unfolding struggle over the future of unconventional gas in Europe. On the positive side, several efforts are underway to address infrastructure deficiencies in Europe, including efforts to build interconnectors between Hungary and Romania, Poland and Lithuania, and the Czech Republic and Poland, and others. Most significant is the mandate that pipelines allow for bidirectional flow so that gas can be redirected out of Western Europe if needed. The European Union has enacted the so-called Third Energy Package, which requires the unbundling of supplies and, most important, third-party access to pipeline infrastructure—a decision which Gazprom views as a direct challenge to its current monopoly. At the institutional level, the Third Package may be the most important lever for achieving broader changes within the European Union when it comes to shale gas, especially as source diversification continues to lag behind. Unbundling (opening up pipeline access to generate competition, namely, separating the generation and sale from the transportation network) is central to the future of the European gas market, but it puts Gazprom on a direct collision course with the European Commission. Increasingly, too, shale gas producers can deploy EU liberalization and antitrust rules to access the market over the heads of the dominant local gas companies, thus forcing them to provide access to the pipelines and effectively pricing their expensive gas out of the market.
The Poles are making a good-faith effort to move forward with their own infrastructure projects. The Polish Gaz-System, which runs the pipeline infrastructure, has already invested in expanding its western interconnector by building a new connector to the Czech Republic, and it is developing a massive infrastructure building project to facilitate Polish shale gas exports, with 1,000 kilometers of pipeline planned for 2014, and an additional 800 kilometers of pipe planned for 2017. If these efforts yield fruit, not only will shale gas technology reduce energy costs, liberalize markets and reduce Russian leverage over Europe; it will also give a major competitive advantage to producer countries in manufacturing, agriculture and virtually every aspect of the economy. Finally, the coming shale storm has great potential to redefine the climate change debate, becoming, in effect, a pathway to renewables down the line while also dramatically improving energy security in the meantime.
There will be international political implications as well. Beyond the refashioning of the EU-Russian balance, as already noted, a Polish shale gas revolution holds the promise of creating a genuine energy price market in Central and Eastern Europe that will link the United States and Poland through new commercial networks. These links are sure to drive close U.S.-Polish cooperation for decades to come, and this, in turn, is likely to upgrade Poland’s position within the European Union.
Success does not depend only on what Poland does, however. The ultimate struggle over Polish shale gas will take place in Brussels, Berlin and London. While EU law cannot ban a country from pursuing efforts to produce gas, the regulatory regime out of Brussels can literally make or break the economic viability of the enterprise. There are growing demands in Brussels that the European Union regulate and control not only the exploration phase but also the production phase of shale gas. As we have seen, some critics want to ban shale gas exploration altogether. Decisions in Berlin as to the future of German energy consumption will have a major impact on shale gas development. And the fact that the British have discovered a vast shale gas deposit comparable to that in Poland, raises the stakes and complicates the overall picture. On the one hand, the United Kingdom is now potentially a key European ally of Poland when it comes to the production of shale gas as a major energy source for Europe. On the other hand, if London effectively leverages its infrastructure advantage, it will be the first to produce large quantities of shale gas, putting Poland at a competitive disadvantage and possibly even rendering continued investment into Polish shale so relatively unattractive as to make the Polish project unviable. The United Kingdom also has a world-class energy law regime, making the process of shale gas development much more transparent and acceptable to the public. Poland is only now developing such a regime. However, Europe—and especially Germany—will need all the cheap energy it can get, so Polish shale gas will be still highly competitive even if produced slightly more expensively than Britain’s. As global competition for cheap energy ramps up, Berlin may be faced with the imperative of facilitating German industry’s access to cheap Polish shale gas, on pain of it relocating to Poland if it does not. And you thought the pipeline competition of the 1990s was complicated.
Shale gas exploration in Poland has entered a decisive stage. The next 18 months will determine whether energy companies will prove able to demonstrate the presence of sufficient gas in their exploratory wells, clearing the way for the production phase. The first-yield assessments of the wells are projected to come in mid-2012, a few short months away.
Ten years ago the United States energy industry began to redefine the country’s energy equation by investing heavily in shale gas production back home. Though skeptics initially dismissed U.S. efforts as either quixotic or unimportant, the ripple effect of those decisions is now being felt across the globe, shaking up conventional assumptions about energy sources and growth prospects and ultimately holding the potential to redefine power relationships among major states. Today, with unconventional gas deposits widely available not only in North America and Europe but worldwide, and with the demand for cheap energy to feed the emerging markets’ explosive growth unabated, the global energy game is changing faster than many thought possible only a decade ago. A shale storm is brewing; best be prepared when it hits.