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SHOULD WE LOVE EXPENSIVE SHALE GAS? Michalis Mathioulakis

M.A. Strategic Studies & International Policy University of Macedonia, Thessaloniki - Greece

mathioum@otenet.gr

“A nation that can't control its energy sources can't control its future”1

Barack Obama

This expression by the American president sums up in a very eloquent way the importance of

energy in today’s world. In the short presentation that follows, we examine this very issue

from the prospective of the European Union and the challenges that it faces on its Energy

Security Policy.

EU is currently covering almost 45% of its energy needs from resources originating from its

Member-States, therefore being forced to acquire more than half of the volume of its energy

needs through imports.

Euro Area & European Union net energy import dependency 2012

Source: European Environment Agency http://www.eea.europa.eu/data-and-maps/indicators/net-energy-import-

dependency/net-energy-import-dependency-assessment-2

1 Barack Obama, The Audacity of Hope: Thoughts on Reclaiming the American Dream (New York: Random House, 2006), 168.

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A growing trend in EU focuses on improving energy efficiency in an attempt to reduce energy

demand and untangle it from economic growth. This process was encouraged by EU’s energy

strategy that aims to cut its energy consumption by 20% by 2020 while simultaneously

addressing the issues of import dependency and energy costs2.

When viewed over a longer period, the production of primary energy in the EU was lower in

2013 than it had been a decade earlier. In 2013, gross inland consumption of natural gas in

EU-28 decreased by 0.4 % in comparison with 2012 to reach 17.957 thousand terajoules.

Gross inland consumption in EU-28, in thousand terajoules (Gross Calorific Value)

Source: Eurostat http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Natural_gas_consumption_statistics

As mentioned earlier, more than half of the EU’s energy comes from countries outside the EU

and this proportion has been generally rising over the last decade.

The Energy Dependence Rate, defined as net imports divided by gross consumption, which

shows the extent to which a country is dependent on energy imports, was 54% in the EU in

2011, nearly stable since 2008. Much of this energy comes from Russia.

2 Eurostat, “Consumption of energy”, (8/2012), http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Consumption_of_energy

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EU Imports of natural gas by country of origin 2011 -‘12

Source: Eurostat, http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Natural_gas_consumption_statistics

EU-28 natural gas production in 2013 fell by 0.7 % in comparison with 2012 to total 6.154

thousand terajoules. Total EU-28 imports of natural gas increased by 29.5 % to a total of

22.986 thousand terajoules in 2013.

EU has implemented an ambitious plan in order to improve all aspects of its energy policy from

reducing its emissions of greenhouse gases to the reduction of its dependency on imported

energy. A general conclusion from all the above mentioned data is that although EU has

managed to not increase its total energy consumption over the past 10 years and managed to

improve its energy mix and efficiency, the shift from oil and coal to natural gas, keeps its

dependency on imports of Russian gas in approximately the same levels.

This means that Europe’s vulnerability against Russian energy exports is still high. To this end

the European Commission has implemented the Energy Security and Solidarity Action Plan that

-among others- targets to reduce energy imports by 26% by 2020.

From the six priority actions that the plan proposes, half pose a direct threat to Russian

interests as they result in decreased dependence from Russian gas3. These Actions are:

Developing the Southern Gas Corridor for the supply of gas from the Caspian region and

from Middle Eastern sources.

3 EUROPA-Summaries of EU legislation, “Energy Security and Solidarity Action Plan”, (3/2009) http://europa.eu/legislation_summaries/energy/european_energy_policy/en0003_en.htm

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Making use of Liquefied Natural Gas to ensure the liquidity and diversity of the European

Union markets.

Linking Europe with the Southern Mediterranean through electricity and gas

interconnections.

The structure of EU’s energy production capability and supply demands has spawned a wide

discussion on the inevitability of the EU turning towards the USA for gas supplies as an

alternative to Russian gas. This will be considered in case that the availability of Russian gas is

put under serious question. However, we have to see the US alternative with caution. Indeed

the US seems to offer an alternative. Yet, is it an optimal alternative?

USA has been advancing rapidly over the past decade in the field of mining for oil and natural

gas with the use of “Hydraulic Fracturing” commonly known as “Fracking”. This advancement

leads to an unprecedented change in the global energy map. The International Energy Agency,

(IEA) in its’ 2012 World Energy Outlook expects that: “by around 2020, the United States is

projected to become the largest global oil producer, overtaking Saudi Arabia and eventually

becoming a net oil exporter around 2030”4. On a similar report in 2013 the US Energy

Information Administration (EIA) estimates that the United States becomes a net exporter of

natural gas by 2020.5

US natural gas balance 1990-2040

Source: US Energy Information Administration (EIA) http://www.eia.gov/forecasts/aeo/pdf/0383%282013%29.pdf

4 IEA Publications, “World Energy Outlook 2012”, November 2012, http://www.iea.org/publications/freepublications/publication/English.pdf 5 EIA Analysis & Projections, “Annual Energy Outlook 2013”, April 2013, http://www.eia.gov/forecasts/aeo/pdf/0383%282013%29.pdf

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According to these figures, United States will become energy self-sufficient in net terms within

the next 15 years, a fact that according to the International Energy Agency is a: “dramatic

reversal of the trend seen in most other energy-importing countries”6.

For the European Union, the upcoming US energy self-sufficiency seems to be the beginning of

a process that will end up with the EU - the world’s biggest trade partner - being the only

major actor in the international system that will remain dependent on imports in order to

cover its energy needs. With Russia being already energy self-sufficient and China having an

estimated double shale gas potential compared to the United States7, EU seems to be rapidly

left behind in the energy race.

Top 10 countries with technically recoverable shale gas resources

Rank Country Shale gas (trillion cubic

feet)

1 China 1,115

2 Argentina 802

3 Algeria 707

4 U.S.A* 665

5 Canada 573

6 Mexico 545

7 Australia 437

8 South Africa 390

9 Russia 285

10 Brazil 245

World Total 7,299

*EIA estimates used for ranking order.

Source: U.S. Energy information Administration http://www.eia.gov/analysis/studies/worldshalegas/

However, the question that EU seems to focus on, is not whether it can reach energy self-

efficiency but rather if and how it will increase its Energy Security by diversifying -among

others- the origin of the energy flowing into European ground.

6 IEA Publications, “World Energy Outlook 2012”, November 2012, http://www.iea.org/publications/freepublications/publication/English.pdf 7 U.S. Energy information Administration http://www.eia.gov/analysis/studies/worldshalegas/

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In this spirit, the European Commission adopted on 28 May 2014 the “European Energy

Security Strategy” aiming to provide a comprehensive plan to strengthen European security of

energy supply.

Taking into consideration the situation in Ukraine and the possible related risk of a disruption

in gas supplies to the EU, the Strategy encompassed measures in order to increase the EU's

resilience to a major gas disruption in the upcoming winter.

As part of those immediate measures, the European Council endorsed on June 2014 the

Commission's proposal to launch a “stress test” exercise with the purpose of assessing the

resilience of the European gas system to cope with a severe disruption of gas supply to the EU

in the following winter8. The test included various scenarios with the main test emphasizing on

a six month disruption of Russian gas flows to EU.

The results of these unique stress tests reveal that the EU member states would, after

reshuffling the supply mix, altogether still be missing between five and nine billion cubic

meters (bcm) of gas. It also shows that when such six-month disruptions occur, Russian

volumes are replaced particularly through the import of additional volumes of LNG. In the

most extreme of these scenarios LNG in the supply mix would increase by 130% from 24 bcm

to 56 bcm.

Source: European Commission http://ec.europa.eu/energy/doc/nuclear/2014_stresstests_com_en.pdf

8 European Council Conclusions of 27 June 2014, EUCO 79/14 http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/143478.pdf

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For the EU, the abundance of shale gas shipped from the US in the form of Liquefied Natural

Gas towards various LNG Terminals on European ground could seem like a credible way out of

its asymmetrical interdependence with Russia.

Furthermore, the low prices for natural gas in the American market give the impression that

the shale gas shipped from the US could be cheaper than the current prices that EU member

states pay for conventional natural gas.

Examining the use of Liquefied Natural Gas in EU’s priority action, it has to be noted that LNG

terminals are still rare in Europe but are expected to boom in the following years. Currently

there are less than 15 terminals around European ports.

According to a study conducted for the Council of European Energy Regulators (CEER), more

than 30 new terminals are under planning or construction leading in tripling of the existing

terminals while regasification capacity in Europe has already doubled from 100bcm/y in 2008

to 205bcm/y in 20129.

LNG terminals in Europe

Source: The Global Warming Policy Foundation, http://www.thegwpf.org/eu-buy-shale-gas/

9 Council of European Energy Regulators, ”LNG Terminals in Europe”, (6/9/2011), http://www.energy-regulators.eu/portal/page/portal/EER_HOME/EER_WORKSHOP/CEER-ERGEG%20EVENTS/GAS/1st%20workshop%20on%20access%20to%20European%20LNG%20terminals

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The price of LNG shipments of shale gas from the United States to the European markets is a

crucial factor on the issue of replacing conventional natural gas with LNG. The abundance of

shale gas production in the United States combined with a stall in demand for natural gas led

to a deep fall in the US natural gas prices in the last 5 years.

Henry Hub Natural Gas Spot Price

Source: U.S. Energy information Administration http://www.eia.gov/dnav/ng/hist/rngwhhdm.htm The argument for a steady flow of cheap US natural gas towards the EU markets is supported

by the estimations for a growing supply of Natural Gas in the United States as a result of the

continuously growing shale gas production in the country. In its most recent report, released in

April 2014, the US Energy Information Agency estimates more than 50% rise in US Natural Gas

production.

Source: U.S. Energy information Administration http://www.eia.gov/forecasts/aeo/pdf/0383%282014%29.pdf

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However, there are elements indicating that shale gas prices cannot stay low much longer,

especially within the timeframe of USA reaching self-sufficiency. Adding to that, LNG prices

have shown signs of violent fluctuations in the past that are very similar to the price instability

of conventional natural gas.

Despite the sharp fall in the Henry Hub Natural Gas Spot Prices, we note that LNG export prices

for US Natural Gas have risen in the past years thus weakening the argument of lower Natural

Gas prices for EU in case the European Union decides to gradually disengage from Russian

Natural Gas to replace it with US LNG shipments.

Source: U.S. Energy information Administration http://www.eia.gov/dnav/ng/hist/n9133us3m.htm

A solution to the above mentioned problem could lie in the way that the European Natural Gas

market is structured and Natural Gas is traded in the European Union markets; an element

that can have deep repercussions on the security of supply of the Member States.

Two main systems are currently in place: Long Term Contracts (LTC) and spot markets.

Long Term Contracts are formulated by bilateral negotiations between two actors;

they are normally oil indexed and have a take-or-pay clause which imposes to the

buyer, the purchase of a determined quantity of gas regardless of the actual demand.

Spot markets enable demand and supply of gas to meet on a trading floor and they are

generally participated by a wide range of players. They are flexible and can adjust

more easily to variations both on the demand and the supply side.

Northern Western Europe holds the majority of important trading platforms in the EU, while

Southern Europe’s trading platforms for Natural Gas are still in a beginning state. Central and

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Eastern Europe has no active trading platforms and gas prices are completely oil indexed. Less

than 30% of the annual gas supplies in the European markets come from spot market contracts

while the rest comes from LTCs10.

European Gas Hub development

Source: European Commission http://ec.europa.eu/economy_finance/publications/occasional_paper/2013/pdf/ocp145_en.pdf

Consequently it seems imperative that the European Commission acts boldly on the subject of

expanding and strengthening the creation of healthy trading platforms across Europe in order

to increase competition and rise the percentage of Natural Gas volumes priced on a spot

market rather on LTCs.

Still the question remains: Can the future LNG price for US natural gas be cheaper than the

existing prices paid by Member States for conventional natural gas originating from Russia?

An ongoing debate in the United States on the sustainability of the shale gas production model

reveals growing concerns on the issue of the operative cost for the majority of the US shale gas

producers11.

The shale gas industry has yet to achieve the technological innovations required to

lower the production cost to a level that will protect the producers from the negative

effects of the volatility in global natural gas prices.

Wellhead prices have remained consistently below the break-even cost benchmark for

many producers of unconventional gas.

10 European Commission, “Member States’ Energy Dependence”, (April 2013) http://ec.europa.eu/economy_finance/publications/occasional_paper/2013/pdf/ocp145_en.pdf 11 Nasta, S.,2010.North American Shale Gas Output Defies Break even Economics: Analysts. By Sheet al Nasta www.platts.com

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A break-even analysis by the Bank of America of 32 major US unconventional gas operators has

set a median break-even price for the industry at 8$/Mcf using 2008 data. At a current (2014)

spot price of less than 5$/Mcf, none of these operators meet break-even cost12.

Average break-even price for 32 major unconventional gas producers in the US

Source: BOA 2009 - ELSEVIER, Energy Policy www.elsevier.com/locate/enpol

Pending upon new technological breakthroughs in the shale gas sector it is safe to say that

long-term prices of US shale gas need to rise in order to sustain the rapidly growing American

unconventional gas production, since current prices are not viable for the industry.

The above analysis leads to the conclusion that the argument for a turn of the European Union

Energy Security Policy towards the US Shale Gas Market cannot be supported by the notion of

low natural gas prices.

However, EU’s Energy Security Policy isn’t focusing solely on the cost of natural gas imported

in the Union but rather in its ability to secure undisrupted flow of energy as well as the

diversification of energy sources and energy origins needed to lift the conditions of

asymmetrical interdependence with Russia.

12 Ruud Weijermars, ELSEVIER, Weighted Average Cost of Retail Gas, (08/2011) www.elsevier.com/locate/enpol

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The question deriving on this level is whether EU is willing to replace its dependency on

Russian gas with a new dependency on American gas.

An answer to the above mentioned dilemma could derive by a closer analysis of the data that

built the existing trade and financial ties between EU and Russia, as well as EU and USA.

The total trade volume between EU and Russia has doubled since 2009 and exceeded the

barrier of 300 billion in 2012 reaching up to 330 billion euro.

Source: http://trade.ec.europa.eu/doclib/docs/2006/september/tradoc_113440.pdf

Trading volumes reveal that Russia and EU play a significant role in each other’s economy since

they both hold a place in their prospective top-five trade partners list.

A closer look in the ranking and the percentages, offers a first clue into the nature of the

relationship between Russia and its European partners. The trade balance between the two

parties favors Russia but also reveals that the EU is a far more important partner to Russia than

Russia itself is to the European Union.

EU’s top 5 trade partners vs. Russia’s top 5 trade partners

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Source: European Commission: http://ec.europa.eu/trade/policy/countries-and-regions/countries/russia/

Russia lists as the 3rd most significant trade partner for EU, holding the 2nd place as an exporter

to the EU and the 4th place as a receiver of EU’s exports. For Russia on the other hand, the EU

holds by far the 1st place as its most important trade partner with “exports-to” & “imports-

from" the EU being in the 1st place of Russian trade while holding a significant difference with

the ones that follow.

While trade with Russia represents less than 10% of the total volume of trade for the EU, for

Russia the trade with EU holds more than 40% of the total volume of Russian trade value thus

making Russia extremely sensitive to its trading relations with EU and to the political relations

that might affect them.

The asymmetric impact that EU-Russia trade has on each party’s economy is revealed if

compared with the total volume of each economy. The total trade of 336 billion euro between

the two partners for 2012 represents less than 3% of the European Union’s GDP while it rises

up to 17% of the Russian GDP. This fact reveals the high dependency of the Russian economy

growth from its trade relations with EU.

Country Comparison by GDP (2012) Rank Economy GDP (million euro) 1 European Union 12.191 € 2 United States 12.168 € 3 China 9.626 € 4 India 3.634 € 5 Japan 3.591 € 6 Germany 2.481 € 7 Russia 1.950 € 8 Brazil 1.827 € 9 United Kingdom 1.813 € 10 France 1.749 €

Source: CIA World Factbook: https://www.cia.gov/library/publications/the-world-factbook/rankorder/2001rank.html

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EU’s trade relationship with USA on the other hand is a far more valuable and complicated

one. EU trade volumes with the United States are 50% higher than the ones with Russia thus

making the relationship between the two biggest global trade partners much more valuable

for the European Union as well as more sensitive to shifts in the balance of power that derive

from the dependence that EU could have in the future in energy flows from the United States.

Source: Eurostat, November 2013 http://eeas.europa.eu/us/economic_en.htm

EU and USA are the two bigger trade partners in the world, holding approximately 3 trillion

euro of total trade volume each and competing for the same trade markets on a global level.

Main players for international trade, 2012 (billion EUR)

Source: Eurostat

http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/File:Main_players_for_international_trade,_2012_%28billion_E

UR%29_YB15.png

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Seen strictly on economic terms, EU’s relationship with USA is far more valuable and critical for

the European economy and growth than the Union’s relationship with Russia.

Analysis of the trade-data between EU and Russia revealed that both EU and Russia have a

critical part of their economy linked directly to the influence and decision making of the other

party.

Russia’s economy and its growth potential is linked directly to the decisions that EU

officials make on the form and volume of trade that they will direct towards the

Russian economy, and EU’s growth is respectively linked to the Kremlin’s decisions on

the flow of gas and oil that it will direct towards the European businesses and

households.

In the case of USA, the European Union lacks the trade advantages that enjoys in its

relationship with Russia thus making its trading negotiations a challenging task,

sensitive to shifts in the balance of power that derive from the dependence that EU

could have in the future in energy flows from the United States.

Under this spectrum the issue of EU decoupling from its dependence on Russian energy in

order to engage in a dependency on US shale gas seems like a high risk endeavor that could

harm EU’s biggest asset; its trading influence and share in global economy.

CONCLUSION

EU’s Energy Security Policy seems to be entering a period of critical decision making that will

shape the future of Europe for the decades to come.

I. The European Union is currently facing high insecurity when it comes to the supply of

the energy needed to cover the demand in its Member States mainly due to its

disproportional dependency on Russian energy flows.

II. On the other hand the proposed swift in the origin of its external energy sources

towards the ample resources of the US shale gas market seems to bring uncertain

financial gain accompanied with high-risk implications for EU’s trading policies and

market shares.

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PROPOSED ACTION

I. Further diversification of EU’s external energy sources is crucial and therefore

undoubtedly needed to strengthen EU’s energy security. This leads us to the

conclusion that the European Commission needs to implement measures that will

significantly raise the share of US Shale Gas in the European energy mix.

II. Equally crucial is the need to implement policies that will allow the expansion of Spot

Price Trading Platforms across Europe to help keep the price of gas under the

beneficiary influence of a healthy –and well regulated- competition market, away from

the murky field of LTCs.

III. Finally EU needs to take into account that Russia’s national interest lies heavily onto its

financial relationship with the European Union thus revealing it as a vital pillar for the

sustainability of the Russian economy and therefore the Russian state.

This consideration needs to function as a guide for EU’s policies against Russia since an

overly aggressive and demanding EU agenda on Russia’s relations with its neighboring

countries could push Moscow into retaliation tactics that could end up harming

Russian interests but would undoubtedly create significant problems in EU’s plan for

secured, undisrupted energy flow towards the Union.

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Sources: European Environment Agency http://www.eea.europa.eu/data-and-maps/indicators/net-

energy-import-dependency/net-energy-import-dependency-assessment-2 Barack Obama, The Audacity of Hope: Thoughts on Reclaiming the American Dream (New York:

Random House, 2006), 168. Eurostat

http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Natural_gas_consumption_statistics

Eurostat, “Consumption of energy”, (8/2012), http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Consumption_of_energy

http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Natural_gas_consumption_statistics

EUROPA-Summaries of EU legislation, “Energy Security and Solidarity Action Plan”, (3/2009) http://europa.eu/legislation_summaries/energy/european_energy_policy/en0003_en.htm

US Energy Information Administration (EIA) http://www.eia.gov/forecasts/aeo/pdf/0383%282013%29.pdf

IEA Publications, “World Energy Outlook 2012”, November 2012, http://www.iea.org/publications/freepublications/publication/English.pdf

EIA Analysis & Projections, “Annual Energy Outlook 2013”, April 2013, http://www.eia.gov/forecasts/aeo/pdf/0383%282013%29.pdf U.S. Energy information Administration http://www.eia.gov/analysis/studies/worldshalegas/ EA Publications, “World Energy Outlook 2012”, November 2012,

http://www.iea.org/publications/freepublications/publication/English.pdf U.S. Energy information Administration http://www.eia.gov/analysis/studies/worldshalegas/ European Commission http://ec.europa.eu/energy/doc/nuclear/2014_stresstests_com_en.pdf European Council Conclusions of 27 June 2014, EUCO 79/14

http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/143478.pdf The Global Warming Policy Foundation, http://www.thegwpf.org/eu-buy-shale-gas/ Council of European Energy Regulators, ”LNG Terminals in Europe”, (6/9/2011),

http://www.energy-regulators.eu/portal/page/portal/EER_HOME/EER_WORKSHOP/CEER-ERGEG%20EVENTS/GAS/1st%20workshop%20on%20access%20to%20European%20LNG%20terminals

U.S. Energy information Administration http://www.eia.gov/dnav/ng/hist/rngwhhdm.htm http://www.eia.gov/forecasts/aeo/pdf/0383%282014%29.pdf European Commission

http://ec.europa.eu/economy_finance/publications/occasional_paper/2013/pdf/ocp145_en.pdf

European Commission, “Member States’ Energy Dependence”, (April 2013) http://ec.europa.eu/economy_finance/publications/occasional_paper/2013/pdf/ocp145_en.pdf

Nasta, S.,2010.North American Shale Gas Output Defies Break even Economics: Analysts. By Sheet al Nasta www.platts.com

BOA 2009 - ELSEVIER, Energy Policy www.elsevier.com/locate/enpol Ruud Weijermars, ELSEVIER, Weighted Average Cost of Retail Gas, (08/2011)

www.elsevier.com/locate/enpol European Commission: http://ec.europa.eu/trade/policy/countries-and-

regions/countries/russia/ CIA World Factbook: https://www.cia.gov/library/publications/the-world-factbook/rankorder/2001rank.html Eurostat, November 2013 http://eeas.europa.eu/us/economic_en.htm