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U.S. shale gas and oil revolution gives Europe a unique chance

This article first appeared in the Energy and Carbon Blog

The success of the U.S. economy in the 20th century was largely built on huge domestic reserves of oil, coal and gas, and for the majority of that century the U.S. was the world’s largest producer of each of those fossil fuels. That changed in 1972 when production of oil peaked at 11.1m barrels a day with gas production peaking the year after at 59.5 billion cubic feet per day. In the ensuing years both Saudi Arabia and Russia bypassed the U.S. in terms of oil production with the latter becoming the largest gas producer as well. The talk in the U.S. was of the catastrophic impact that peak oil would have on the US economy. Yet here we are at the end of 2014 and the talk now is of the U.S. being able to achieve energy independence by the end of the decade. Something no one could have predicted even ten years ago.

In 2014, the U.S. produced on average 70.1 billion cubic feet per day of gas, the highest levels ever, and over 23% ahead of 2009 production levels, making the U.S. the largest producer of gas in the world. However, the real revolution has been in crude oil production which is up 60%, according to the US agency, the Energy Information Administration (EIA), over the last five years to 8.6m barrels per day. However if you include natural gas to liquids (3.2m barrels) and biofuels (1.1m barrels) U.S. oil production reached 11.5m barrels a day in 2014 which is the highest annual production level on record. It also means that the U.S. could end this year as the largest producer of oil in the world thereby bypassing Saudi Arabia. How did this happen?

The answer is the controversial technology hydraulic fracturing, which involves injecting a mixture of water, sand and chemicals at high pressure into rocks to create tiny fractures, along which gas and petroleum can flow to the well. Fracking, as it more commonly known, is controversial for many reasons but mainly because of its negative impact on the environment, and in particular the water table. However, fracking is a technology that cannot be ignored. Because of it U.S. gas production has exploded and gas prices have tumbled to levels one third of European prices, and US oil production is a large part of the reason why oil prices are below $60 down 60% from its 2008 $147 all time high.

Europe has potential for shale gas and oil but there are significant barriers to its economic viability. First and foremost, the geology in Europe is deeper and more fragmented than in the U.S. Secondly, the greater population density in Europe makes planning permission difficult as well as local community resistance more likely. Thirdly, the mineral rights laws in the U.S. are much more favourable towards shale gas as the land owner also owns the below ground mineral rights. This is not the case in most of Europe, where the mineral rights belong to the State which makes the whole exploration process more cumbersome and expensive. Fourthly, Europe does not have the drilling equipment or the necessary knowhow. Finally, the capital investment that is needed is not going to take place with oil prices below $60. The result is that Europe will not see any meaningful shale or oil production for the next decade, if ever. So what should Europe do?

Europe needs to decrease its addiction to oil and gas from in particular two countries Norway and Russia. An oil supply disruption from Russia from which Europe gets a quarter of its oil, would not be that dramatic as there are alternative suppliers and routes. However, roughly two-thirds of Russian gas passes through the Ukraine and there are no real alternatives. And the gas contracts that most European companies and/or countries have in place with the state owned oil companies of Norway (Statoil) and Russia (Gazprom) are at levels twice that of the gas price in the US, and Russia in particular uses its market power to great success. This is particularly the case with Russia’s neighbours such as Latvia and Lithuania; knowing that they have no alternative to Russian gas, Gazprom charges them prices which are significantly higher than what say Germany pays. But that said what I am saying is hearsay as Gazprom contracts have secrecy clauses in place and as a result there is no real price transparency across the European gas market.

The other issue with the high gas price is that across most of Europe it makes no financial sense to produce power with gas. It is simply too expensive. Coal on the other hand is cheap thanks to the 50% price falls we have seen since 2008 and it is the reason why CO2 levels across much of Europe are actually increasing. The big question is how Europe can push its gas price (currently $8.90 per MMBtu) towards U.S. levels ($3.00 per MMBtu)?

The key word is competition which can be achieved in a number of ways. First and foremost, Europe should seize the opportunity of low oil prices to re-negotiate old gas contracts. Secondly, Europe needs to use less oil and gas and this can be achieved by energy efficiency incentives and regulations. Thirdly, Europe needs smart legislation to incentivise the consumer, automobile manufacturers and the utility to consume less. Moving to alternatives is also important and this means pushing renewable energy technologies that can replace gas usage for heating purposes and electricity production. Fourthly, Europe needs to invest in pipelines and LNG terminals. Finally, and the most radical solution is to create a single European entity charged with buying Europe’s gas. The logic is simple. One single buying entity would balance the scales against the state monopolies of Russia and Norway and would put Europe in a much stronger position to negotiate better terms, and if Europe were to do this it would enable Europe to move away from coal, reduce carbon emissions and increase the competitiveness of European industry. The concern of course would be that such a move would be anti-competitive and there would be lots of opposition to overcome especially from those companies and countries which have good gas contracts. What though is interesting is that in Europe there is a precedent in the European Atomic Energy Community (Euratom) which acts on behalf of member states in buying uranium…

The post “U.S. shale gas and oil revolution gives Europe a unique chance” appeared first on Energy and Carbon Blog