Alan Riley, Professor of Law at City University London, examines the regulatory framework governing Europe’s energy resources. Emphasizing that the EU’s liberalization policies necessitate a diversification of upstream suppliers, Riley argues that the push for a single energy market will likely underscore the importance of Central European shale gas at the EU-level.
Market liberalization on its own cannot deliver a functioning single European gas market — breaking up dominant vertically-integrated gas monopolies will do no good if the gas is largely imported from one source. This is why indigenous unconventional gas resources are so important to Central European (CE) states heavily dependent on a single external supplier. When combined with the European Union’s (EU) liberalization policies, any significant shale gas deposits will fundamentally transform the energy security profile of the region. The United States is seeking to promote shale gas exploration and development, but perhaps the greatest task would be to help defuse the legitimate regulatory concerns across the region — notably highlighted by the recent ban on shale gas exploration in Bulgaria.
Europe’s Energy Market
It is difficult to decry the work undertaken by the European Commission and a small group of pro-market EU member states led by the United Kingdom (UK) to liberalize Europe’s energy market. The starting point for almost the entire continent (except the UK) some 15 years ago was a strong command-and-control energy supply system. Each EU member state usually had only one utility company, which controlled the supply network and either produced the gas and/or imported it on the basis of an exclusive supply contract. In theory, the external supplier would rely on the security of demand stemming from the long-term contract and a price linked to oil to invest in upstream infrastructure and new gas fields.
As the dominant supplier in the CE region, Russia’s Gazprom benefitted tremendously from this monopoly model. It enjoyed security of demand and no market competition while effectively rendering the CE states dependent on their former occupying power. According to a study undertaken by the Swedish Defense Research Agency in 2006, between 1991 and 2004 there were over 40 politically-motivated energy cut-offs across the former Warsaw Pact and Baltic States, and the overwhelming majority of them were of gas supplies.
The only defense mechanism for the CE states — with the exception of the “gas island” of the Baltic States — was that they were transit countries for the gas flowing to Gazprom’s richest markets in Western Europe, particularly Germany. Any significant cut-offs in the CE region would disrupt supply to these markets as well. It is worth noting that the 140 billion cubic meters (bcm) Gazprom sells to the EU each year represent only one-third of its production but account for two-thirds of its revenue. Unfortunately, the construction of the Nord Stream pipeline substantially limited this advantage by circumventing the CE states as gas transit countries. News of not only Nord Stream Two, but also Nord Stream Three being contemplated suggest that over 80 bcm of gas could reach Gazprom’s key markets in the next few years without transiting CE states, thus expanding the energy giant’s market dominance in the region.
For states such as Poland, which currently use significant amounts of coal rather than gas to meet their energy needs, the prospect of supply dependence is likely to be reinforced by another factor. EU de-carbonization policies are forcing member states to look for alternatives to coal. Given the high cost of renewable energy resources, the only cheap CO2-light option is gas, which emits 50 percent less CO2 than coal. Thus, unless alternative gas sources are secured, there is a real danger that supply dependence in the CE region could increase.
Looking for Alternatives
Under these circumstances, the effort of the EU Commission to open the European gas market — whether by antitrust actions or by regulations — will likely face significant hurdles. Liberalization regulations will have limited impact if there is only one dominant upstream supplier and no other options.
Liquefied natural gas (LNG) is one potentially significant alternative. In 2010, Gazprom suffered a noteworthy financial setback when large amounts of LNG was dumped onto the EU market following the shale gas boom in the United States and the need to redirect supplies originally destined for the U.S. market. While there is hope that in the longer run considerable supplies of LNG will be available to European markets, the short- to medium-term outlook is not that positive. The lack of new LNG ships is limiting the ability of producers to transport LNG, while liquidity is being drained by Chinese and Japanese demand. It is also questionable whether the United States will grant enough fossil fuel licenses to permit the export of LNG. In any case, it is far from certain that any LNG will reach Europe, given the scheduled 2014 opening of the widened Panama Canal, which will permit Marcellus shale gas-as-LNG to slip into the high-priced Pacific market instead.
Thus, shale gas remains the only dependable alternate source for the CE states. But it is also more than just an alternative — if shale gas is produced on a commercially viable scale it would be cheaper than conventional gas, especially such produced in Western Siberia and shipped across the continent. Shale gas production on any significant scale would set the benchmark price for gas, forcing pipeline suppliers such as Gazprom to match it or lose market share. EU liberalization rules would then come into play, giving customers and shale gas producers access to the pipeline infrastructure and the less expensive gas.
Cheaper gas will also have a major impact on CE industries. One notable and often overlooked feature of the U.S. shale gas revolution has been its effect on the economy. Gas prices have now fallen below $3 per million British thermal units (MMBTU) in the United States, while they remain between $10-14 MMBTU in Europe. These low prices are boosting the competitiveness of the U.S. manufacturing sector, particularly the chemicals industry where gas is both a feedstock and a fuel. If CE states such as Poland, Hungary, Romania, Slovakia, the Czech Republic and Bulgaria can begin developing their shale gas production at a viable scale, the economic and energy security benefits could be profound.
The major obstacles to shale gas development in the CE region are a combination of regulatory and environmental concerns. Shale gas production involves hydraulic fracturing and horizontal drilling, which are well-known and well-understood methods for oil and gas production. There are over one million wells in the United States where hydraulic fracturing has been used, and the key issue of concern with regard to shale gas, as with any fossil fuel extraction, is ensuring that the well is properly cemented from the well-head to a point somewhere below the water table; that any flow-back water is properly safeguarded; and that all waste is disposed of according to existing standards. Addressing these issues is not beyond the capacity of EU member states.
Nevertheless, significant public disquiet regarding the exploration and extraction of shale gas has emerged in some member states, most notably in France and Bulgaria. And the anti-shale gas position may well enjoy the backing of some energy companies, which are likely to lose out if production takes off. Yet, the main obstacle remains the fact that most EU states do not have experience in either on-shore or off-shore oil and gas development. Outside of the UK, Norway, Denmark and the Netherlands, there is limited regulatory capacity to deal with large scale oil and gas production. In the UK, as a result of the significant oil and gas know-how within the state administration, a lot of fears surrounding shale gas were rapidly dispelled. An effective regulatory regime also makes it easier to develop shale gas on a commercially viable scale. One of the reasons why the UK may end up beating Poland to large scale production is that it has in place the capacity to effectively regulate the industry.
A Role for the United States?
In this context, a particularly effective way in which the United States could support CE states seeking to develop their shale gas reserves would be to promote the establishment of a Shale Gas Trust, which would seek to provide advice on shale gas exploration and production best practices. It would offer assistance in drafting national regulations and certifying universities to educate the officials who supply the administrative capacity necessary to run production. The Trust would also undertake and commission independent research. It would be jointly run by European oil and gas states, such as the UK and Norway, which have the relevant experience, and would include representatives from all CE states as well as industry and NGO participants.
Ultimately, shale gas presents a tremendous opportunity for Central Europe in terms of both energy security and greater industrial competitiveness. With support from both the United States and some of the EU member states with oil and gas production experience, this opportunity will be realized.
Center for European Policy Analysis, 1 March 2012