The Ukrainian crisis has revitalized discussions in Europe about the role shale gas could play in the European energy mix and to enhance security of supply. Opinions on this are very polarized. Whereas optimists declare that Europe could start commercial production in 2020, the pessimists insist that shale gas will never be profitable in Europe. According to Alexander Gusev, the real picture is not black-and-white. Cutting through the confusion surrounding the shale gas debate, Gusev, a researcher who works in a team headed by Nobel Prize winner Carlo Rubbia at the Institute for Advanced Sustainability Studies (IASS) in Potsdam, shows that domestic shale gas can be developed and could make a significant contribution to European gas supply, but its effects on the European gas market depend on many factors.
Speed of development
Many experts argue that production of shale gas in Europe is not possible anytime soon. The reason given for this is that shale gas production requires a large amount of drilling annually, because production decline rates are much higher than for conventional gas. As one study puts it, “as decline rates of conventional gas fields are measured in years, unconventional plays are measured in months”.
The decline rate during the first year ranges between 70 and 90%. Thus, in order to keep up production, it is necessary to quickly replace depleting wells with new ones. According to a recent report from the Paris-based Institute for International Economic Development (IDDRI), in Europe “to produce around 30 bcm of shale gas per year would require drilling about 700 to 1000 wells per year”. The US drilled on average 167 exploratory natural gas wells per month between January 2005 and December 2010 whereas in Europe there have only been around 50 wells drilled so far. Consequently, Europe will need 5-10 years to go through a similar process”.
This is true, but these assumptions don’t take into consideration technical improvements and innovations, which have so far been main drivers for the shale gas revolution. Current technology makes it possible to drill 12-30 wells per pad, to decrease the number of drilling days per well (from 17 in 2007 to 10 presently) and consequently to reduce drilling costs between 20 and 40%. The latest fracking technologies applied in the US also make it possible to reduce the duration of the fracturing process from several days to several hours.
Moreover, modern equipment allows operators not only to drill more wells in less time but also to significantly increase the amount of extracted gas per well. Thus, for example, at the Barnett Shale the ultimately recoverable resources (URR) per well increased from 11.3-14.1 mcm/well in 1985-1990 to 65.2 mcm/well in 2007-2008. Another recent example is the Fayetteville Shale where an average initial production (IP) rate increased from 1,260 mcf/day in the first quarter of 2007 to 3,230 mcf/day in the first quarter of 2011. All this means that Europe can start at a different point than the US.
With regard to the availability of rigs, a 2012 report from the Joint Research Center of the European Commission notes that “full-scale shale gas field development in Europe will require the design and construction of new drilling rigs. In order to build this required rig fleet within a reasonable time, a building capacity of 30 to 40 rigs per year would be required”. Indeed, the number of active rigs in Europe is not comparable to the US: 151 versus 1835 according to Baker Hughes.
To create an adequate rig fleet, Europe has two options. Firstly, there is a number of European companies which are active in rig construction such as Bentec GmbH, Drillmec, Trevi Group. European companies are able to manufacture up to 18 rigs per year which are specifically designed for drilling in Europe. Secondly, it is possible to import rigs from the US. This takes about 4-6 months. United Oil Fields Services in Poland is one of several companies providing such kind of services.
The number of rigs in Europe has actually been growing quite quickly in 2014 and has increased from 126 in January to 151 in April (by 25 in total). Thus, the required annual building capacity, defined by the European Commission as 30-40, has almost been reached within several months. It is also important to mention that technological improvements of rigs (lightweight drilling equipment) and drilling as a process (industrialized drilling) currently allow to drill in densely-populated areas with significantly fewer resources (in terms of mud, cement and casing).
At present, shale gas in Europe is in its exploratory phase and before starting commercial production of shale gas, pilot projects are indispensable. In this exploratory phase, which could take up to 6 months, between 8 and 12 wells per pad could be drilled. In the next stage, when it has become clear that there is gas in place and there is enough geological information, drilling efficiency could be substantially increased using modern equipment. Thus, a simple multiplication of an average number of rigs (20-25) per year by an average number of wells per pad (between 12-20) shows that a fleet of rigs as well as a number of wells could be available to start commercial production of shale gas in Europe within a reasonable timeframe of 5-8 years.
So, Europe might have a slow start, but it could develop quickly with substantial investment over the coming years. Note that some independent forecasts predict steady growth in unconventional hydrocarbons in the UK for the next 15 years with peak production in 2030. According to the Institute of Directors peak production will be 24-40 bcm/year, the Energy Contract Company predicts 19-49 bcm/year, Navigant 20-65 bcm/year and Bloomberg New Energy Finance 21-41 bcm/year. Others such as Consultancy Ricardo-AEA and the IEA forecast lower numbers. To put these figures into perspective: in 2013 UK gas consumption accounted for 79.2 bcm and net indigenous production was 34.2 bcm.
Price of shale gas
It is usually believed that shale gas in Europe will be too expensive.Indeed, comparison ofshale gas production costs in Europe to those in the US shows that in Europe it will be 2-3 times more expensive to drill for shale gas. The reasons for this are multiple and include more complex geology of shale formations, a less competitive service industry, scarcer water resources, higher infrastructure costs and others. Thus, the production costs per well range from $2 to $9 million in the US versus $5 to $20 million in Europe. Consequently, the pessimists argue, the final price of shale gas in Europe will never be as low as in the US.
However, all technical consultants agree that that these costs could be decreased considerably, more than 50%, once sufficient activity and investment take place (within 5-10 years). In fact, according to Navigant, “even at the current high cost levels, shale gas in Europe should be at least break-even at current prices”.
Estimated prices for shale gas in Europe vary between $6 and $15.5/mmbtu. The first analysis by the Oxford Institute for Energy Studies estimates a breakeven at $7.5-15.5/mmbtu, whereas Rice University assumes $6-7/mmbtu, Eon about $6-10, Centrica $7-10. Finally, the European Commission estimates as a most likely cost for the beginning $9.9 /mmbtu and $7.2/mmbtu as a long run cost. Thus, “about 60% of this production is possible at breakeven between $8 and 11 per mmbtu, whilst the weighted average breakeven for EU28 in 2020 stands at $9.1/mmbtu”.
It is also important to mention that the price of shale gas could vary significantly depending on the type of well. The abovementioned prices are valid for wells with dry gas only. Shale gas from a well with liquids would cost less because natural gas liquids (NGLs) such as condensate, butane and propane are linked to crude oil prices and only ethane to gas prices. Thus, the price of shale gas from a well with liquids in Europe will be lower, estimated at $5.90 /mmbtu.
To put these figures in perspective (USD/mmbtu):
Note: Henry Hub is the main US gas spot trading market, NBP ((National Balancing Hub) is the UK spot market, TTF is the Netherlands-based Continental European spot market.
Comparison of prices shows that shale gas production may be competitive to LNG imports and Russian pipeline gas. Thus, in case of any considerable shale gas production in Europe, first LNG will be forced out of the market and only then pipeline gas, because LNG imported by Europe is the most expensive among all the sources. Russian pipeline gas could be potentially reduced in the mid and long term.
However, this will be true only if current high transportation costs for LNG remain the same. A new generation of LNG tankers referred to as Q-Flex and Q-Max has approximately 50% and 80% more cargo capacity than conventional LNG carriers, which leads to a reduction in transportation costs by 40% and consequently to a decrease in LNG prices. In this case pipeline gas would be crowded out of the market or its price would have to come down.
Impact on European gas market
Estimates of the potential impact of domestic shale gas production on European market prices vary considerably. The potential impact depends both on the volumes of shale gas produced and the price of shale gas.
Thus, the Institute of Energy Economics in Cologne estimates that production of 20 bcm in Germany could potentially reduce gas prices by 4% in Germany and 2-3% in nearby countries. If, however, the UK, Germany and Poland produce 20 bcm each (60 bcm in total), gas prices could go down by 9-11%.
Joint analysis by Cambridge Econometrics and Pyory Consulting shows that 20 bcm production of shale gas decreases gas prices very slightly in the EU by 2-3% and production of 60 bcm by 6.2%. Finally a report by AT Kearney expects a decrease in gas prices between 2 and 6%. The highest impact on European gas prices is anticipated by energy consultancy IHS which predicts that production of 50 bcm of shale gas in the EU could decrease gas prices for example in Germany by 20%. This seems optimistic in comparison to all other reports.
All the experts interviewed by the author among the business and scientific community agreed that estimates by Cambridge Econometrics and the Institute of Energy Economics sound realistic. In this case shale gas production in Europe would not affect gas prices substantially and will only substitute declining indigenous production. It was also underlined by all the experts that a positive effect from the shale gas production could be counteracted by pipeline exporters such as Russia, Algeria and Norway who could potentially limit their supplies to Europe and thus increase the prices to sell lower volumes with higher price instead of higher volumes with a lower price.
However, many questions remain, because the economic impact on the European energy market from shale gas production should not be considered in isolation. Its possible effects can be enhanced or mitigated by numerous external factors. An excellent example is the gas glut in the EU in 2008-2010 when spot prices went down due to additional volumes of LNG coming from the Middle East and Africa. Europe imported 52 bcm of LNG in 2008 and 82.9 in 2010. This additional 30.9 bcm more than halved the NBP spot price from $10.79/mmBtu in 2008 to $4.85 and $6.56 in 2009 and 2010 respectively. The same situation was observed in Germany: the average German import price decreased by roughly 25% from $11.56/mmBtu in 2008 to $8.52 and $8.01 in 2009 and 2010 respectively. Import from Russia into Europe decreased from 167.6 bcm in 2008 to 138.6 bcm in 2010. This price reduction was due to a combination of different factors: additional volumes of LNG increased liquidity and along with a slowdown of gas demand in Europe triggered the fall in gas prices. But in any case nobody had expected such a dramatic fall.
Apart from an expected decrease in gas prices, many analysts also expect that shale gas production in Europe will lead to lower electricity prices. However, in the US in spite of very low gas prices, electricity prices for all sectors (residential, commercial, industrial and transportation) have not gone down. For example, average retail prices in the residential sector continued to rise annually (from 10.65 cents/KWh in 2008 to 11.88 cents/KWh in 2012) and prices for industry remained at the same level (6.83 cents/KWh in 2008 and 6.67 cents/KWh in 2012).
The same situation was observed in the EU in 2008-2010. Although gas prices went down substantially due to additional volumes of LNG, electricity prices for industry continued to rise and for households decreased only insignificantly in 2009. This is explained by the fact that gas in electricity generation in the US accounted for only 30% in 2012 and in the EU it was 21% in 2011. Thus, potential shale gas production in Europe is unlikely to decrease electricity prices.
It has already been mentioned above that shale gas production will develop along with other energy trends which could enhance or mitigate the effect of shale gas in Europe. Among them can be named the following.
Firstly, European gas demand is typically expected to rise. However, European gas demand has been stagnant for the past decade and the IEA lowered the forecasted amount of European gas consumption for 2030 by 40% (from 901 bcm/year in 2002 to 537 bcm/year in 2013). The main reasons for this are high gas prices in comparison to coal, expansion of renewable-based capacities plus energy saving measures.
So, at present there are no evident signs that gas consumption in the EU is going to increase. Substitution of oil by gas in the transport sector does not seem likely to become very significant in Europe in the near or mid term future.
Secondly, European indigenous gas production is in decline and the IEA predicts that it will go down from 185 bcm in 2011 to 114 bcm in 2030. Consequently, these volumes will have to be compensated by other sources of supply.
Thirdly, the volumes of gas available on the European market in the future will depend a lot on Asian demand for LNG, in particular from China and Japan. It still remains to be seen if China could cover its growing energy needs from its internal resources, in particular, unconventional resources. If China were to buy large volumes of LNG, this would support high LNG prices. Just recently Japan has announced its intention to restart nuclear power plants. This could decrease its LNG consumption which would make it possible to redirect some volumes to Europe. However, the public opposition to nuclear power in Japan remains strong.
Finally, additional volumes of gas could come to Europe from the US or Iran, increasing liquidity on the European market and forcing out Russian gas or LNG. Iran could become a game-changer if economic sanctions were abolished, although it might take some time to construct the necessary infrastructure.
As for LNG from the US, Gas Natural Fenosa and BG Group concluded a long-term agreement with Cheniere Energy. The price is set as 115% of the final price of the US Henry Hub natural gas futures contract plus a fixed tolling price of $3.50/mmbtu. This means that the price for the US LNG could be potentially lower than the price charged by Gazprom, considering the low gas prices at the Henry Hub for the past several years (2009-2014).
So the picture that emerges is quite complex. Shale gas is a potential source of diversification for EU energy supply and it would enhance security of supply, because it is an indigenous resource. The economic impact of domestic shale gas in Europe will depend on the cost and the volumes that can be recovered as well as on gas demand in the EU and Asia.
In the short term, modest volumes of shale gas in Europe could compensate for declining domestic production and support the gas industry as a whole. In the mid and long term (10-15 years), if production costs go down and/or bigger volumes are produced, shale gas could contribute to lower gas prices. It is also safe to assume that once any European country proves that shale gas production can be done safely and profitably, other countries will follow its example.
Dr. Alexander Gusev is a Project Scientist at the Institute for Advanced Sustainability Studies in Potsdam (Germany). As a member of the research group on shale gas, headed by the Nobel Prize winner Prof. Carlo Rubbia, Dr. Gusev is responsible for economic and geopolitical implications of shale gas development in Europe. Previously, Dr. Gusev worked as a research fellow at the German Institute for International and Security Affairs (SWP).
 Alexandre de Robaulx de Beaurieux Estimates of shale gas resources, size and location of deposits compared to conventional deposits in the EU, in: Shale gas in Europe: A multidisciplinary Analysis with a Focus on European Specificities, Claeys & Casteels, 2013 p.177-178.
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Fayetteville is taken as a case study. Vello A. Kuuskraa Economic and Market Impacts of Abundant International Shale Gas Resources, May 5, 2011, p.9 https://csis.org/files/attachments/110505_EnergyVello.pdf
 Unconventional Gas: Potential Energy Market Impacts… p.77.
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Author’s interview with several companies.
 Unconventional Gas: Potential Energy Market Impacts… p.78.
 Ibid., p.89, most likely scenario.
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 Unkonventionelles erdgas in Europa – Effekte auf Versorgung, Nachfrage und Preise bis 2035…
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 World Energy Outlook, IEA, 2013, p. 103.
 Ibid., p.109.
 Japan effort to restart nuclear plants delayed until after summer, Financial Times, May 2014, http://www.ft.com/intl/cms/s/0/fa45a170-d1dd-11e3-8ff4-00144feabdc0.html#axzz32GJRymjV
 Iran wants to export gas to Europe, April 2014 http://rusenergy.com/ru/news/news.php?id=73370&phrase_id=1573035