Polish shale gas sparks bonanza hopes

Shale rock poses a threat to Russia’s dominance in gas and oil supply as drilling techniques and expectations of plentiful reserves instigate exploration in Europe - particularly in Poland.

Ever since the Rothschilds financed the completion of the railroad from the oilfields of Baku to the (ex-Turkish) port of Batum in 1883, Russia has enjoyed a significant balance of oil derived geo-political power. Russia enjoys a near monopoly of gas supply to southern and central Europe and provides Europe, as a whole, with more than 25% of its gas supply.

Europe has increasingly suffered from a shortage of supply and higher prices as a result of the various gas disputes between Russia and Ukraine. Consequently, Europe has strived to diversify its base of energy supply, whether by building wind farms in the North Sea, pipelines from Norway (Ormen Lange gas-field) or by building liquid natural gas terminals (thereby allowing the reception of gas from anywhere in the world).

However, something is happening in Poland that may lead to the most significant development in European energy supply since Phillips Petroleum struck oil at Ekofisk, in the North Sea, on August 30, 1969.

The source of all this attention lies within 140m cubic meters of Polish shale rock - a rock that may hold tightly confined gas in economically recoverable quantities. Shale is a layer of rock that formed more than 400m years ago and created an impenetrable ’cap’ or ’seal’, stopping the oil trapped beneath it from migrating to the earth’s surface and dissipating. Traditionally, it has been something to drill ’through’ and not ’for’.

There is nothing new about getting gas from shale rock - the first shale gas was drilled in the 1820s. What is new, however, are the drilling techniques that make the recovery and production of that gas more affordable - less than half the cost of tar sands.

The ability to horizontally drill, combined with the technology that allows us to puncture and crack long seams of rock, are at the centre of this potential energy revolution. Directional (although fairly uncontrolled) drilling has been around since the late 1920s, but it has developed to such an extent that having drilled vertically for up to 6km the drill string can be manipulated with great precision, to travel in a horizontal direction through the rock-strata (containing the oil/gas) for more than 3km.

However, the rock will not relinquish the gas locked within it by simply drilling alone - the gas still needs to be released from the shale rock and the key to this is a technique called ’fracking’. Liquids are sent under extreme pressure down the well and along the horizontal section, which is cased with a perforated pipe. The liquid exits the perforations at such high pressure that it blows fractures through the shale, releasing the gas which travels back along the fracture path, into the perforations and up to the wellhead.

America has been drilling in this manner for several years, but it is only relatively recently that production has become significant. In 1996 this shale gas provided 0.3 trillion cubic feet (or 1.6%) of American gas supply. This is expected to climb to more than 18% by 2030. Europe, however, is yet to drill its first shale gas well.

"Drilling techniques make the recovery and production of that gas more affordable (less than half the cost of ’tar sands’)”

The reason there has been a delay from transferring know-how from America to Europe was first, a result of the extent of the success that the shale gas drilling companies have experienced in America. Over the past 10 years, companies have been focused elsewhere (as when the oil majors missed the oil exploration opportunities of offshore West Africa). It was not until BNK and Lane Energy bought more than 6,000 Polish drilling core samples gathered by Polish research institutes over the past 50 years and examined their contents, that attention shifted to Poland. The findings were promising and other companies began to wake up to the potential of the Polish shale gas story. This interest has sparked a land grab. Since 2008 - the amount of Polish acreage (as a percentage of the entire Polish land area) leased to various oil exploration companies has risen from about 30% to 75%.

As well as its geology, what also makes Poland interesting, with respect to exploration, are the cheap land costs and attractive royalty splits. Producing acreage in America can sell for up to $30,000 (£20,600) an acre. Polish acreage, on the other hand can be leased at rates that stand at between 3 cents and 25 cents per acre. Corporate tax rates are half those in America and royalties that must be paid back to the state are 1% (compared with America, where they stand at between 18-25%). Gas prices are also twice those of America. These enticing fiscal incentives are not, however, just restricted to Poland.

Europe, in general, is keen to diversify away from Russian supply and to encourage exploration. It is embarking on a fairly rapid process for the review of the legislation that governs security of gas supply. Consequently, exploration is occurring in England (in the Weald Basin, about 20km west of Guilford, The Wessex and Chesire Basins), Northern Ireland, France, Switzerland, Spain, Germany, Austria, Sweden and Hungary.

However, there is likely to be a three to five-year demonstration period and unless an exploration company hits a substantial find, production is likely to be insignificant for the next five to eight years and some of the potential issues may fall short of the more ’hyped’ expectations.

However, the combination of an early strike by one of the three wells due to be drilled in 2010 and the prospect of energy power shifting away from their ’home patch’ may lead the Russians to reduce the pricing incentives of European drilling. As Saudi Arabia did in 1986, the Russians may choose to drive prices lower to reduce the likelihood of non-Russian gas development so they can maintain market share and dominance. Gazprom released a report stating that its revenue from traditional gas production could be significantly affected if Poland’s new found deposits live up to expectations.

It is interesting to note that Russia is not supporting an output cut to support gas prices as called for at the recent “Gas Exporting Countries Forum” meeting in Oran, Algeria. It is too early to tell whether volumes could be of an order that will redress any balance, but when Lane Energy drill its first Polish well in the second quarter of 2010 all eyes will be watching - many of them will be Russian.

By Richard Robinson

Source: Fund Strategy