Saturday, November 01, 2014

2030 Energy Security | Brussels | Dec 10th
Drew EGC Report

The Risks for Shale Gas in Europe: Technology and Avoiding the Frackenstein Label

Comparing the game changing analysis of US shale gas and the reality in Europe exposes how traditional risks affect the much hyped industry. Understanding the risks for the European shale gas industry exposes a range of constraints that impact the growth of the industry. The debate around shale gas as a ‘game changer’ needs to give way - particularly in the media - to a new level of analysis that sees the industry as bound by traditional political-economic risks.

Providing an effective political-economic analysis of shale gas requires separating different elements of the industry. Just as the study of oil has multiple dimensions with a mature analysis 'industry,' shale gas has suffered from the element of news media hype and an over reliance on the geological and technical risk analysis of extraction. Academia and scientific forums are catching up, but while everyone waits regulators, politicians and the industry itself are being called on to make immediate decisions. This produces its own set of risks, which correspond more closely with political-economic risk that have long term impacts on the industry's long term growth.

The recent report produced for the European Commission on the legal frameworks  surrounding unconventional shale gas demonstrates how the laws of gravity apply to this 'new' technology. The study examines the legal and regulatory framework in four EU Member States: Poland, France, Germany and Sweden. The report provides a good overview of the legal environment, and the licensing procedures, including public involvement and how environmental concerns and impact of the technology are addressed.

What emerges from the study is an immature industry displaying its limited progress. Limited drilled wells and companies operating in a constrained regulatory and legal framework, often guided by mining standards and lacking all the tools of the trade easily accessed in America's gas sector. No doubt improvements will be made to the permitting process and procedures streamlined or public involvement increased, but the European industry is tiny and remains years away from becoming the disruptor – or game changer, for Europe's gas dependency.

Gazprom should sleep easier at night. There are too many traditional risks, such as environmental and regulatory blocking a clear path to a broad roll-out of the unconventional gas technology. Closer reading of interviews with energy company officials demonstrates (Exxon, Orlen Upstream, and Enel) the medium and long term time horizon foreseen. In short, the race for Europe's own gas riches, fuelled by high prices, may arrive at the same time as Russia's gas pipeline, South Stream (if it does) and a more robust European LNG capacity.  

Assessing risks

A risk typology can be produced that demonstrates just how down to earth shale gas is. Drawing from two categories of risks previously developed, focused on the transition towards a low carbon economy by 2050, the risks emerge as applicable to the new European industry. Shale gas technology is integral to this transitional energy mix while also competing against older gas extraction technologies. The laws of gravity (hype vs. reality) and the laws of transitional regime risks, impact the speed and locations where new technologies will be applied.

A quick note on this risk typology: The identified risks are partly based on previous research into contractual risks that exist in electricity contracts for gas power plants and wind farms in the United States. The regime risks, are focused on broader political, economic and social elements that are expressed through state institutions, such as ministries or regulators. The term, 'regime' mainly refers to how society, companies and state institutions interact in a form of general agreement, in a given period of time, on the types of economic and social policies (e.g. monopolistic vs. competition). This general agreement affects how companies operate and even their investment strategies.  

If we take the identified risks, and list a few anecdotal events, then we can see the constraints of the European shale gas industry.

Contractual risks

  1. Fuel price risk: price variability and uncertainty over future costs; e.g. comparison between Russian pipeline gas, LNG and shale gas.
  2. Demand risk: gas produced will not be needed as projected; e.g. impact of renewables, LNG and pipelines and energy efficiency.
  3. Performance risk: wells do not produce as predicted to satisfy contractual obligations; e.g. unexpected poor well performance may impact return on investments or supply contracts.
  4. Environmental compliance riskThe financial risk to which parties to an energy contract are exposed, stemming from both existing environmental regulations and uncertainty over possible future regulations; e.g. this is the most popularized risk at the moment, France and Bulgaria demonstrate that public opinion can lead to blocking the use of shale gas technology. Examples from the U.S. abound around water issues.

Regime risks

  1. Financial riskNo or limited amount of money available to finance investment. Self-financing from the industry can occur, but Poland is indicated as a country that needs to consider its "fiscal structure" (taxes) to encourage production.  
  2. Regulatory risk:  The risk that future laws, regulations, regulatory reviews or renegotiation of contracts will alter the benefits or burdens of contracts for either party; e.g. this emerges in shale technology and is tightly connected with environmental risks.
  3. Technological lock-inPerpetuation of a dominant design that is inferior to newer technology. Industries that have a significant systemic-technological relationship are most susceptible, due to buffered market forces. This may be more applicable in Russia where fracking technology is not being deployed. But the use of 'traditional' conventional technologies may be encouraged to be used first before unconventional technologies are deployed; e.g. the ban in France and Bulgaria will continue the use of established technologies (in their small industry). The use of distant supply sources delivered by pipeline or LNG also apply.
  4. Institutional lock-inTo reduce uncertainty and to provide continuity to past investors regulatory institutions may change only incrementally, thereby relying on approved older technologies and inhibiting newer technologies. Avoidance of unconventional technology, by regulators may lock a country into older technologies, faltering traditional gas fields may impact on energy security.
  5. Administrative capacity risk: Constrained staffing levels in government institutions prevent a larger policy and regulatory response. This may occur, as demonstrated in the EC report, if laws and regulations and the agencies that implement these, are not made more flexible or given the tools to properly account for the special characteristics of the shale gas industry.
  6. Investment risk:  Investments are impacted due to uncertainty in the operational environment; e.g. the difference can be seen between countries like Bulgaria (anti) and Poland (pro), where one country is moving forward with fracking technology. The cancellation of Chevron's exploration license in Bulgaria demonstrates the shifting sands.

Geopolitical risks: relations with third countries. This is a separate category that needs a full analysis of how Russia is and will react to greater use of unconventional gas technology in Europe. Energy security is a driving force in the debate in Eastern Europe.

The categories listed here provide a rough guide to examine the types of risks that have emerged to stop greater investment and what risks may emerge more forcefully in the future. No doubt environmental compliance risks, administrative capacity risk and geopolitical risks emerge as key areas. These are divergent risks and take different strategies to overcome or to mitigate. But effectively addressing these becomes important to the growth or decline of the small industry in Europe.

Deeper risks

If there is ever a question of whether fossil fuels will survive the rise of renewable energy, we can be assured higher oil prices open up the space for more innovative and expensive extraction technologies. Like an arms race (or actors in a competitive market place) R&D dollars are poured into fossil fuels as well as renewable and energy efficient technologies.

Projections of the world's energy mix, demonstrate fossil fuels remain with us - getting to them and using them however, will be based on new technologies. Peak oil does not stop the drive for oil and gas. The conservative American slogan of 'drill baby drill,' shifts to 'drill deeper and longer.' It is now time to see that renewable energy, energy efficiency and even the concept of peak oil will not stop the resource drive for oil and gas: the green energy movement is riding on technological advances, so is oil and gas. Fossil fuels have momentum to ensure their continued use.

The risk typology applied to shale gas lays the foundation for a deeper risk assessment of what may inhibit the use of fracking technologies. Do the laws of gravity actually apply to the high-flying shale gas industry and all the media hype? Yes, laws, regulations and even social support constrain and direct shale gas investment. The most pressing risks of the industry are not the most visible.

Frackenstein technology?

The risks on environmental compliance and regulatory risk are the most obvious ones. But it is better to go deeper into less publically addressed risks to inform why the more visible risks exist. This approach will also provide a means to mitigate the risks in the shale gas industry. If environmental and regulatory risk stem from technology and the actions of state institutions, then the means to mitigate risks also lies in identifying and addressing the risks of technological lock-in and institutional lock-in.

Technological advances created the fracking method of long horizontal pipes, water, sand and chemicals used to extract 'unconventional,' gas. This development built on the technology of extracting 'conventional gas'(obviously). Technology keeps advancing.

Gas is emerging as the alternative fossil fuel; but supply and demand must be leveled out at reasonable market prices. This can be done by using more advanced technologies to extract gas. ‘Super fracking’ and other advanced shale gas extraction technologies, go beyond current methods, creating greater efficiency for slurping up gas and oil deposits. While downstream, gas to liquid technology can fuel cars as demonstrated in this review of emerging oil and gas technologies.  Both demand and supply sides of fossil fuels are now adjusting to new market conditions of high prices, security of supply issues and technological conditions and potential. Opponents of the technology may only view these advances as an unstoppable technological trend that continues the use of 'Frackenstein' technology that just continues to destroy the Earth.

Locking out risk

If there are advances in technology, then why would technological risk even be an important factor to consider? If advances in fracking technology only occur to withdraw more gas and not address the environmental impact, both perceived and real, then moratoriums on current technologies will be extended by politicians and regulators. Each large scale energy source experiences its own cataclysmic defining moment, most recently the Fukushima nuclear accident, BP Deep Water Horizon oil spill, and even solar power in the form of bankruptcy for Solyndra prompt regulatory and legislative changes.  Shale gas can already to be seen experiencing its own in America with the iconic images of fiery tap water.

Technologoical lock-in occurs from the "perpetuation of a dominant design that is inferior to newer technology. Industries that have a significant systemic-technological relationship are most susceptible, due to buffered market forces."  In the regulatory and legal spaces of gas extraction, conventional extraction techniques may win the day if the concerns put forward by society, politicians and regulators cannot be addressed. Key to extraction from shale formations is water and the resulting contamination of it.

Technological lock-in can also emerge through 'institutional lock-in' which understands that regulatory (or other state) institutions only change slowly to protect past investments in the energy sector. This area may be gray where special interests are involved and act to block, through state institutions (or social organizations), the acceptance of shale gas technologies. Older approved technologies will need to be used, even if output declines due to well depletion - and a country's overall gas balance shifts to higher imports, or sustains currently high import levels, such as Bulgaria. In this consideration, owners of other types of technologies may want to prevent the deployment of newer technology. Social, environmental and political considerations may prevent government institutions from accepting fracking technologies. The underground explosions caused by fracking may not compare to the above ground political and social minefield. 

Risk mitigation

There is strong social and political resistance to shale gas extraction technologies, as seen in France and Bulgaria that have bans on the technology. The recent report on the legal framework  in Member States highlights the nascent industry of shale gas in Europe; with Poland moving strongly ahead but with very small production levels over the short term. The report demonstrates that there is scope for improving environmental and public review of shale gas projects (despite media reports that currently not much needs to be done).

Shale gas supporters or even geopolitical energy realist may have been caught off-guard with the quick introduction of shale gas bans. But there is now public and private push back against these bans, and no doubt there will be a reconsideration of the role that shale gas and oil play in national energy strategies. In France it is possible there will be a re-examination. In Bulgaria a group of energy experts see the current energy policy short sighted, with shale gas as a potential booster to the country's energy security issues - which has an almost total dependency on Russian gas. Just as Poland sees the drive for greater energy security lying in shale gas, so may Bulgaria.

Improvement through the technological process of fracking and shifts in state institutions, through greater environmental reviews and a broader understanding of the benefits and drawbacks of shale gas technologies all influence deployment. As the technology of fracking improves, the industry becomes more knowledgeable about the local geology and political/public landscape, and as state institutions introduce regulatory safeguards - responding to public concerns, shale technology will become more widely deployed. Mitigation of the more obvious regulatory and environmental risks emerge by addressing the technological and institutional risks.

Conclusion

The shale gas debate and discussion is set on the background of the geopolitical landscape of energy independence and climate change. Technological advances are not only for solar and wind power. The dominant position of the fossil fuel industry and its ability to innovate and evolve, reflect market and political-social realities, this should not be underestimated. The future energy mix - realistically, continues to rely on fossil fuels, resource depletion is the end-game, but improved innovation and technology will ensure it continues to compete and (hopefully) contributes to a cleaner and low-carbon energy future.

The engineering risks, are implicit in the discussion on fracking technology. Developing a broader risk assessment that accounts for the political-economic risks of shale gas and oil allows consideration of the actors involved in shaping the debate. Technology does not advance alone. Society, politicians and regulators are all stakeholders. Much can be done in the regulatory arena, but the industry must demonstrate, through thoughtful actions and advances in technology, gas extraction from shale formations is safe and occurs under effective regulatory oversight. Shale gas does not become a game changer if the industry's game does not change.

Michael LaBelle works for the Central European University Business School as a program developer and researcher on issues of innovation, sustainability and entrepreneurship. His research is focused on the European energy market and efforts to move to a post-carbon economy along with energy governance issues. He is a member of the Atlantic Council’s Emerging Leaders in Environmental and Energy Policy. His blog, energyscee.com, is focused on the geopolitics of gas, energy investment and sustainability in Central Eastern Europe.

The author thanks the Atlantic Council's Emerging Leaders in Environmental and Energy Policy (ELEEP) online group for some of the articles cited here - and also a source of inspiration for exploring this topic more.

References:

LaBelle, Michael, 2012 “Constructing Post-Carbon Institutions: Assessing EU carbon reduction efforts through an institutional risk governance approach” Energy Policy, no. 40 (2012): 390-403.

Unruh, Gregory C., 2000. Understanding carbon lock-in. Energy Policy 28 (12),
817–830.
Unruh, Gregory C., 2002. Escaping carbon lock-in. Energy Policy 30 (4), 317–325

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