A Warning for Poland's Shale Gas Developers

Source:

"Authorities must weigh potential economic benefits and problems, but the U.S. hasn't figured out all the answers to these questions either."

I am leaving for Krakow, Poland, early Wednesday morning.

That means the next Oil & Energy Investor will be coming to you from one of the most enchanting medieval cities in Europe.

During this trip, I will present what we have learned thus far in North American shale gas development before a meeting organized by the Polish government and chaired by President Bronisław Komorowski.

What will take place in that room, however, is more than a simple exchange of data.

The Shale Gas Revolution Has Hit Eastern Europe

It began only a few years ago, in places like Texas, Arkansas, British Columbia, Alberta, and Pennsylvania. . .but the shale gas revolution is now sweeping the world.

To date, 142 basins and more than 680 shale plays have been discovered worldwide. In them are sitting a mind-boggling 6.6 quadrillion cubic feet of natural gas. Even if only 10% of that can be lifted, we are still looking at huge new reserves.

Europe has its fair share of these basins, with five major ones located in Poland alone. And that is the reason for the meetings this week.

The government in Warsaw is about to open up these shale plays to major investment.

Before they do so, however, the authorities must set regulations for drilling, determine what environmental impact will take place, weigh the potential economic benefits and problems, and discuss how this newfound energy wealth is going to change lives.

Turns out that's pretty much my job in Krakow; I will be advising on the policy challenges in each of these areas.

Still, they are not likely to expect my first comment. . .

That we haven't figured out all the answers to these questions, either.

It's an Exercise in Tightrope-Walking

For Poland—and Ukraine next door—there are major political considerations at hand.

Both remain dependent on gas being piped in from Russia. And, because virtually all Russian gas exports must cross over these two countries, so is everybody else in the European Union.

Both Poland and Ukraine desperately need to find alternative sources to offset reliance on Moscow. Shale gas seems to be the ready answer. Yet there are time pressures involved that we do not have in North America.

For one thing, Russia has already cut crude oil exports to the major refinery base in Gdansk—sending a clear signal to Warsaw that they should expect other retaliatory actions if the Poles renege on long-term contracts to import gas from Russian giant Gazprom.

Poland's shale gas basins do hold considerable promise, but they will not allow the country to cut imports of Russian gas.

Warsaw knows that. So does Moscow.

The advice I will give on this matter is an exercise in tightrope-walking.

If, in the next five years, Poland could develop an additional 3% to 5% of its domestic gas needs from new sources, it could force Gazprom to improve the contract particulars.

This should be the objective, because—in addition to the shale gas—Poland will begin importing liquefied natural gas (LNG) by 2014, at the now-under-construction Swinoujscie terminal near Szczecin in the western part of the Polish Baltic coast.

LNG has already created problems for Gazprom elsewhere in Europe, especially after the opening of the Rotterdam Gate complex, one of the largest LNG receiving facilities in the world. Russia bases prices for gas on a basket of crude oil and oil product prices. As the price of oil goes up, so does what Europe must pay for its imported Russian gas.

The introduction of LNG from places like Qatar and Algeria, however, is changing the landscape. It has created a local spot market, where consignments of gas can be traded quickly, at discount to pipeline prices.

Gazprom has been forced to consider renegotiating some of its contracts with major European utilities—Edison and ENI in Italy, EDF Suez in France, REW and E•ON in Germany—as a result.

Poland would like to be on that list, as well.

They just need a few years to increase LNG and shale gas volume.

Of course, one does not upset the Russian bear until the other pieces are first in place.

For Ukraine, the Problem Is Even More Acute

Two weeks ago, Ukraine approved its first shale gas contract development agreement with Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) in the western portion of the country.

However, it is confronted with another Russian gas war.

Once again, Kiev cannot afford to import Russian gas. Moscow, on the other hand, remains dependent on throughput across Ukraine for some 70% of its gas going to Europe. The last time this came to a head was January of 2009. During a very cold snap, the gas was completely cut off to Europe as Moscow and Kiev traded accusations.

That fight was resolved by a new multi-year contract. The one Ukraine now cannot afford to pay.

Russia has also completed the first line of its new Nord Stream pipeline under the Baltic to Germany and is moving on the South Stream to move gas into southeastern Europe. Both lines bypass Ukraine, accentuating the crisis.

Kiev is taking about building an LNG receiving facility near Odessa, but that terminal exists only on paper. It cannot meet the current energy shortfall.

Ukraine is moving into opening shale gas (and coal bed methane development) as quickly as it can. And that is one of the cautions I am compelled to give to a Polish audience in Krakow…

Enormous Potential, Significant Problems

Ukraine will usher in drilling with little regulatory oversight of any consequence… and no environmental protection.

They are looking squarely down the barrel of a gun: They must make a short-term hard choice between a clean environment and staying warm during bitterly cold winters.

I intend to tell the Poles that shale gas has enormous potential—but it also carries with it significant policy problems in how it impacts infrastructure, labor and service usage, economic dislocation, land and water usage, and especially the environment.

This will also require a concerted move into the technological and planning changes needed to offset these negatives.

One of the other suggestions I will make is to set up special economic zones to encourage joint venture development aimed at meeting such problems.

That, of course, will provide some significant opportunities for U.S.-based companies to profit from what is opening up in European shale gas.

But that will need to be the subject of a later column.

Sincerely,

Kent

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