With an insatiable demand for power to fuel their economies and few reserves of their own, European countries have been in an increasingly symbiotic relationship with the hydrocarbons giants of the Middle East and North Africa (MENA) region, but this may be set to change as shale gas discoveries in the US shake up energy markets around the world.
Italy imported some 1.21trn cu feet of natural gas from North Africa in 2008, while Spain bought 316.8bn cu feet the same year. In return, the hydrocarbons-producing trio of North Africa – that is, Algeria, Egypt and Libya – is heavily dependent on European countries’ demand for gas.
EXPORT EARNINGS: The energy sectors in Libya and Algeria account for 95% of each country’s export earnings, while Egypt’s more diversified economy is still hydrocarbons-intensive, exporting 348.6bn cu feet of natural gas to Italy in 2008. Elsewhere, Qatar alone exported 2.41trn cu feet of natural gas in 2009, and Oman 406.12bn cu feet.
Although consumption has slowed in the wake of the eurozone debt crisis, the EU still remains a significant customer. The increasing demand from Europe has, in turn, fuelled growing investment in the complex and expensive infrastructure needed to export the gas. There are several projects under way that will add new pipelines across the Mediterranean, linking the MENA region with the peninsulas of Southern Europe. Egypt, for example, plugs into the Arab Gas Pipeline, which may eventually be linked to the lattice of pipes crossing Turkey, carrying both Russian and Azeri gas to the EU. Algeria and Libya both pipe directly to consumers in Italy and Spain.
On the face of it, the equation is simple. Russia has gas, as does the MENA region, but, with the partial exception of Norway and the other North Sea states, the energy-hungry industrial core of Europe has few reserves of its own to exploit. Until just a few years ago, the certain outlook looked to be one of rising dependency by Western Europe on its energy-rich neighbours and an ever-denser grid of pipelines channelling in gas from the south and the east to guarantee supplies.
A QUIET REVOLUTION: However, a quiet revolution has taken place over the past half-decade, starting across the Atlantic in the US. Just three years ago, the expectation was that, with demand for energy rising and natural gas reserves limited, the country would need to start importing liquid natural gas (LNG). However, since 2007, imports to the US have begun steadily dropping, while more recently, consumers in the energy-voracious economies of Asia have begun signing contracts for deliveries of US LNG.
Advances in technology have changed the picture, with unconventional gas – from fields that were previously either too deep or too small to be economically exploited – playing an ever greater role.
DEEPER UNDERGROUND: From almost nothing at the beginning of the decade, gas from shale rock some 5 km below the surface of the earth now makes up some 10% of the US’s gas supply.
Menno Koch, a consultant at Lambert Energy Advisory, a London-based consultancy, said, “Shale gas has been a huge game-changer in the US. By 2020 it will make up 20% of the total gas supply. It was thought that there would be a huge rise in demand for LNG in the North American market – but now North America is self-sufficient again.”
In the US it took 20 years to get from the first exploratory attempts at exploiting shale gas to here. But following the dramatic changes that unconventional gas has led to in the US energy market, there may be more impetus to accelerate the process in Europe. Thus far, however, exploration has been slower due to the specific geographical, social and legal issues facing Europe that did not affect the US.
For 200 years, gas extraction has been a matter of drilling down a short distance to a layer of porous rock infused with gas, and letting the gas hiss its way up to the surface. With conventional gas reserves becoming depleted, however, geologists began looking deeper beneath the surface of the earth, to the shale rock layer. The layer of black-coloured shale rock, found some 5 km beneath the surface, is the original source of conventional gas – because oil is less dense than water, the gas that is today extracted by conventional means has gradually been displaced upwards to the conventional gas strata.
Starting in the 1980s, in the Barnett Shale field in the Fort Hood basin in the state of Texas, prospectors started drilling down the full 5 km to the shale level to extract the gas from its original source. This was not without its challenges: unlike the conventional layers of natural gas, shale rock is not porous, and must be processed if it is to yield its gas reserves.
The solution to this problem is to drill down all the way to the shale rock layer, and then change direction, drilling horizontally for many kilometres through a cross-section of the rock. Subsequently, a cocktail of water, sand and chemical additives – the composition of which is a closely guarded secret of the drilling companies – is pumped down the well under very high pressure to release the gas.
At the bottom of a 5-km column of water, the pressure is, in any case, very strong – comparable to the crushing pressures found at the bottom of the ocean – and is sufficient to fracture the shale rock, releasing the gas trapped inside. Hydraulic fracturing, or fracking, is the most expensive part of the extraction process, accounting for around a quarter of the cost of the well.
OVERSEAS ADOPTION: Despite its expense, the technique has revolutionised gas extraction. There are now more than 35,000 shale gas wells in the US. Together they produce approximately 600bn cu feet of gas per year, with the Barnett field in Texas alone accounting for some 1bn cu feet a day.
European and US prospectors are now eager to repeat this success in Europe, with Germany and Poland having previously been the preferred targets, although a spate of recent legislation looking to curtail the activity, and sparked by concerns over fracking, has dampened enthusiasm by exploration and production firms. Still, Florence Geny, a researcher at the Oxford Energy Institute, reports that there are currently more than 40 companies prospecting for shale gas in Europe. Poland alone has issued exploration licences to over 20 firms.
One of these is 3Legs Resources, an Isle of Man-based unconventional energy company with prospecting rights in both Poland and Germany. Fivos Spathopoulos, a consulting geologist for the company, said, “If any one of these wells finds shale gas then the European energy scene will change forever. Even in the UK, areas like the Pennines, where nobody in their right mind would ever have looked for gas, are now looking promising.”
Further afield but still with the potential to help satiate European demand, South Africa has stumbled across commercially viable shale gas deposits. Shell, which carried out the studies, estimates that the country could have up to 485trn cu feet of gas – an amount that would virtually double the entire continent’s current proven gas reserves.
Not that shale deposits are limited to new producers. Traditional gas-producing countries are also looking to benefit from the new technology. Algeria’s Sonatrach, for example, has conducted studies over potential shale gas deposits alongside ENI, and has recently started talks with ExxonMobile about potential exploration in the country.
Energy security concerns are a major driver behind the growing interest in unconventional gas reserves. “The initial impetus came from the US, because of their concern that their energy supply might be dwindling. There was ever less gas to be found, and much of what remained was to be found in difficult countries with unstable regimes. Then there were fears about China’s growing energy consumption, and a reluctance to be fighting over the same resources with China,” Spathopoulos said.
DIVERSIFYING SOURCES: The same political factors apply in Europe. For policymakers across the continent, the memory of winter power-cuts in recent years as Russia’s Gazprom and Ukraine fought over gas pricing is still very fresh.
Domestic gas discoveries offer the prospect of a more diversified energy mix for Central European countries such as Hungary that obtain almost all their energy from Russia, as well as for France and Germany, which import gas from all directions.
“I have the feeling that European governments want to get out of the grip of Russia,” said Spathopoulos, adding that with gas coming in from all directions – North Africa, Russia and Central Asia – Europe is oversupplied. Despite this, Europe pays significantly more than the US, with European oil-indexed pipeline gas costing around $12 per million British thermal units compared to just $2.50 in the US in July 2012. This may act as an incentive to kick-start the production of unconventional gas in Europe.
QUESTION MARKS: However, Hakim Darbouche, another researcher at the Oxford Energy Institute, sounds a note of caution. “The consensus is that shale gas in Europe is at least a decade away,” he said.
Koch is also cautious, emphasising that there are many unknowns still to be worked out. “The geology of Europe is different – much depends, for example, on the consistency of the shale rock in question. Is it hard, and therefore easy to fracture, or is it like peanut butter?” With drilling still at the exploratory stage everywhere in Europe, it will take a while for the picture to become clear. “Even in the US, there are lots of shales that do not work,” he added.
There are further question marks over the existing infrastructure. Europe already has an extensive infrastructure for LNG terminals, allowing natural gas to be brought from far away by tanker, as well as much more developed domestic pipeline network than the US, giving conventional gas a cost advantage over shale gas. Certainly producers like Egypt and Angola are not shying away from investing in new upstream gas exploration or new LNG terminals. As most gas is currently imported, Europe also has a much less developed drilling infrastructure than the US, with only 100 rigs operational in 2011, according to a report in the Economist. By comparison, there were 1600 rigs at work in the US at the height of its gas boom in 2008. This will also work to make shale exploitation less cost effective.
Shale gas may not offer the cost advantages that it does in the US, where a switch to importing gas was a major shift in the country’s energy supply. “The difference is that LNG was already part of the energy mix for European countries, and the LNG importers want to keep it like that, whereas North America was more or less self-sufficient,” said Koch.
As a result, the rise in shale gas has also brought some short-term complications to the fore for producers as well. LNG had become the primary bet of many operators over the past decade for long-term gas demand, but the glut in supply in the US has forced a revision of that forecast. In July 2012, for example, UK-based BG Group was forced to take a writedown of $1.3bn of its US assets as a result of the increased supply in the market.
Needless to say, the biggest question marks appear directed at the technology itself. The benefits it brings are obvious, but there has been rising public concern over the environmental impacts. In the UK, exploratory drilling around Blackpool has resulted in two minor seismic tremors, for example. France, which is estimated to have some of the largest shale gas reserves on the continent, has banned fracking outright as a result of such concerns.
Nowhere more is the debate more clear than in South Africa. While the finds by Shell are impressive, particularly for a country that is grappling with rising domestic energy consumption and aiming to limit its coal generation, opposition to exploiting these potential reserves is heated – in part because the deposit falls under the Karoo, a protected nature reserve, but also because the impacts of fracking on the broader environment are uncertain at best.
COST CONSIDERATIONS: There are also questions of cost and for how long the expensive fracking process will be viable for producers. So long as energy prices keep rising, the prospects for unconventional gas look good. “I think that, as long as shale gas comes in the range of $6-8 per thousand cu feet, it will make for an interesting story,” said Koch.
While Russia may be the focus of European politicians’ fears, North Africa, the key supplier for much of Southern Europe, could be caught in the fall-out.
“MENA producers will not lose their market until 2020 at the very earliest. There will not be a large amount of production from European shale gas until then. However, there is the potential for a major change after that,” said Koch.
INFRASTRUCTURE: The proximity of North African producers to the European market, along with the quality of the existing infrastructure to transport gas, will help them compete if and when the market gets more crowded in the future.
“The European countries are looking for maximum diversification. Norway has the infrastructure to provide gas most cheaply, but Russian gas is looking more expensive,” said Koch. Russia’s pipeline infrastructure is in a poor state of repair, he notes, and new interlinks are needed. Darbouche agrees. “Proximity to the European market and easy transit routes have been the most significant competitive advantages for North African pipeline gas over the years. This will remain the case in the medium term, especially for Southern European consumers,” he said.
Nonetheless, the North African trio are facing changed circumstances. Egypt had to ban any new export contracts for two years between 2008 and 2010 over concerns about meeting export commitments, and more recently it has been more aggressive about negotiating for pipeline exports. Algeria and Libya too are seeing demand at home rise, and must balance domestic needs with the export potential of both existing European customers and interested parties further afield.
“Algeria and Libya are diversifying their customer bases,” said Koch. “You’re seeing them signing contracts with Asian countries. With the Suez Canal, you are not far from China and India.”
SPOT CONTRACTS: Already, there are signs of a push for diversification. Sonatrach, the Algerian state hydrocarbons firm, has been signing spot contracts to supply small volumes to India, though there have not yet been any long-term fixed-price supply contracts of the type that dominate sales to Europe.
Darbouche believes spot contracts represent a strength of North African producers, but has also argued that distance and competition will remain a challenge for North Africa when it comes to conquering the Asian markets. “Sonatrach has only been selling spot cargoes, and so has Egypt,” he said. “It will certainly be quite a challenge for North African exports to compete with Australian, Qatari and eventually Russian supplies to the Asia-Pacific basin.”
PRICE SUBSIDIES: For MENA exporters, Europe remains the most lucrative market. “Domestic demand is seen as a burden rather than a market opportunity because of the subsidised prices for gas in domestic markets,” said Darbouche. “From a commercial perspective, gas producers across the region would rather use their reserves for exports rather than for domestic sales.”
While this has long been true in Egypt, where energy subsidies made up some 70% of the total subsidy bill (which in turn comprised 33% of government expenditure), change is now afoot. The proposed 2012/13 budget seeks to cut fuel subsidies by 27%, and the Freedom and Justice Party has suggested connecting more households to the natural gas grid as a way to reduce the need for subsidised butane imports (see Economy chapter).
RISE IN LONG-TERM DEMAND: For the moment, then, Europe seems likely to remain North Africa’s major customer, regardless of any unconventional gas discoveries in the medium term.
While Europe has no shortage of hydrocarbons suppliers, and is currently facing what may look like a gas glut, this may be a passing phenomenon. The economies of Southern Europe are in crisis, and industrial production is down, with knock-on effects for energy use. This has had a tangible impact. Algeria was forced to cut production that same year. Elsewhere, the rise in US production has made prices more elastic, as Asian markets that previously bought African LNG start to turn towards cheaper US imports. Despite this drop, and the current economic crisis, the International Energy Agency expects European demand to continue rising in the longer term.
Even if the current prospectors deliver on their promise of European shale, a return to economic growth, when it finally happens, will likely generate sufficient demand to see it be just one more component in Europe’s increasingly complex energy mix.
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