What really happened in Groningen [Gas Transitions]

The Dutch government’s historic decision to phase out production from the giant Groningen field has been defended as a rational measure to protect local citizens from the risk of earthquakes as well as aligned with climate policy designed to end the use of fossil fuels.

But according to a new research paper, the decision rather came about because the oil companies and the Dutch government squandered their licence to operate. The authors suggest that the decision will not do the citizens or the climate much good and will leave €75bn ($85bn) worth of natural gas unnecessarily stranded in the ground.  

You have heard of the story: the Dutch government surprised the world with its announcement last March that it would stop production from the giant Groningen field altogether by 2030. Thus, it pulled the plug on the mainstay of the northwest European gas market.

 The ostensible reasons for the decision are well-known. I wrote about them in my first post for Natural Gas World – Why the Dutch lost their faith in natural gas – on February 13.

“Climate policy is one”, I wrote, “but the earthquakes around Groningen are even more important. The government and NAM, the Shell-ExxonMobil joint venture that exploits the field, denied for years that there was a connection between earthquakes and gas production, and when they eventually did admit it, they were still very slow to compensate people for damages. Such was the public anger that in the end the government had no choice but to close the field altogether by 2030.”

That’s the generally accepted narrative in the Netherlands: the state and the oil companies are the bad guys, the citizens of Groningen are the victims who are now finally being heard and compensated. In this context the decision to end gas production in Groningen was inevitable and right. This is also how I personally understood what had happened.

However, it now turns out that there may be a bit more to the story than that. A fascinating paper – Groningen gas: the loss of a social license to operate – written by analysts Jilles van den Beukel and Lucia van Geuns for the respected think tank The Hague Centre for Strategic Studies (HCSS), published February 12, draws attention to parts of the story that have had very little attention so far and put matters in a rather different perspective.

Why is their paper important? First of all, the authors point out that as a result of the Groningen phase-out “about 500bn m³ of gas that could be produced at a relatively small technical cost will be left in the ground.” That’s a loss to Dutch citizens as well as to the northwest European gas market.

What is more, they observe that since “Dutch gas demand is currently stable and will, even if ambitious reduction plans are realised, decline much more slowly than the expected Dutch gas production capacity” – it won’t even do the climate any good. The Dutch gas will simply be replaced by gas from elsewhere.

But there’s another broader issue at stake here. The basic argument of the paper is that Groningen production is killed not because it will do the people of Groningen any good, but because, as the result of a series of poor policy decisions, Groningen lost its “social licence” to operate. Politicians could not continue to support Groningen gas production any longer because there was too much public resistance to it.

This is important because it has implications for other oil and gas projects in the world as well, even if circumstances around them are different. As Van den Beukel and Van Geuns – both well-respected researchers with solid backgrounds in geoscience and petroleum engineering – express it:

“It is not peak fossil demand … that may turn out to the biggest future risk for oil and gas companies but the loss of the social licence to operate, which can result in legal measures that can turn out to be extremely costly … In the developed world assets becoming stranded because of the loss of the social license to operate may turn out to be more common than assets becoming stranded due to a lack of demand.”

The turning-point

The authors leave no doubt that NAM and the Dutch government initially responded wholly inadequately to the situation around Groningen. Earthquakes in the area were first registered in 1986, but until 1993 NAM spokespeople denied there was a relation with gas production, even though the relationship “should have been relatively straightforward”, they write. (Van den Beukel is a geophysicist and seismic specialist who used to work for Shell.)

It was not until 1993 when a first official study appeared – undertaken by NAM, the Dutch royal meteorological institute KNMI and SOdM, the Dutch national mines inspectorate that regulates the oil and gas industry – that confirmed that the earthquakes had something to do with gas production. However, even then “neither NAM nor SodM [representing the Dutch government] was pro-active in starting further research,” Van den Beukel and Van Geuns note. “There was a genuine expectation that earthquakes could only result in limited material damage. This was not backed up by solid research, however, and in hindsight uncertainties were underestimated.”

The first turning point occurred in 2012 when the village of Huizinge was hit by an earthquake with a magnitude of 3.6, leading to 2,000 damage claims, some 1,600 of which were indeed related to the earthquakes. This should have served as a major warning signal that something was rotten in the state of Groningen. But both the authorities and NAM ignored it. Worse, in 2013 the government allowed NAM to boost production from the Groningen field to the highest level since the 1970s: 54bn m³. In the complex way the Dutch gas sector is organised, the government has the final say on the maximum annual production of the Groningen field.

In retrospect, the production increase in 2013 was perhaps the biggest scandal in the Groningen saga and it will be a key issue in the parliamentary investigation that has just been announced and that will most likely take place next year. NAM and the government failed to realise the extent to which support for gas production had been eroding, note Van den Beukel and Van Geuns.

However, the Huizinge earthquake did jolt the SodM, the mines inspectorate, into action. It advised the government on several occasions to lower gas production in Groningen. In addition, on March 30, 2017, the Dutch safety board, another government institution, published a damning review that concluded that NAM and the ministry of economic affairs had “underestimated risks related to gas production and disregarded uncertainties”.

By that time the government had been gradually lowering production caps for the field: 42.5bn m³ in 2014, 39.4bn m³ in 2015, then 27bn m³, 24bn m³, 21.6bn m³ and, this year, 19.4bn m³. But it was too little too late. Public indignation could not be contained any more. Groningen-gate became a big issue on television news shows. Local citizens came to be seen as victims of grave injustice, which they no doubt were to some extent.

Adding fuel to the flames, Van den Beukel and Van Geuns note, was the state’s distribution of the gas sales revenues. When investments from the FES (the Dutch infrastructure fund which received 40% of Groningen gas income for 1995-2009) were analysed it was found that less than 1% went to the province of Groningen. Gas production also offered few jobs, so local people had little interest in preserving it.

Burden of proof

As a result of the commotion, now the political pendulum swung to the other side, the authors observe. For example, a building reinforcement programme was introduced which, according to independent reports, was much too generous compared with the real earthquake-related damage people suffered. In addition, there was an explosion of damage claims, many of which were awarded. However, research from the well-respected research institute TNO showed that for large parts of the affected area tremors from traffic and building activities exceeded those from earthquakes.

A detailed study from the Technical University of Delft showed that earthquakes were less than 10%, if at all, responsible for damages in some areas. Van den Beukel tells me that the researchers wrote this down in their reports, but they were afraid to draw public attention to this as they wanted to avoid involvement in the heated public debate.

In 2016, a new law reversed the burden of proof for damage claims in the Groningen area. This meant that rather than citizens having to prove they suffered damage from earthquakes, it was NAM’s responsibility to prove that the damage was not caused by earthquakes. Since that time, write the authors, “NAM has lost virtually all the cases that ended up in final arbitration procedure.”

By the end of 2017, the total cost of claims stood at €1.2bn. According to Van den Beukel and Van Geuns, if production were to continue at 20bn m³/yr, that cost could be expected to increase to around €10bn. A major project to reinforce buildings was expected to cost a similar amount.

What this meant, according to the authors, was that production in Groningen had ceased to be worthwhile for Shell and ExxonMobil: “Assuming remaining total Groningen production of 500bn m³ and total revenues of €75bn (assuming an average sales price of €0.15/m³ of gas), total NAM revenues would be about €7.5bn [NAM gets 10%]. With NAM paying a relatively high share (36%) of the costs, this implies that Groningen becomes an asset with a negative value once total costs exceed €20bn.… With the rapid development in legal, regulatory and political measures a much higher future cost could not be excluded.”

Thus for Shell and ExxonMobil, “Groningen had ceased to be a valuable asset. Instead, it had become a major potential liability.”

Historic decision

The straw that broke Groningen’s back was an earthquake January 8 last year in the village of Zeerijp with a magnitude of 3.4 – after two relatively quiet seismic years.

According to most accounts the Zeerijp event directly led to the historic decision by the government on March 29 to announce the phase-out of Groningen. However, according to Van den Beukel, again the story may have been a bit more complex. He says there had been secret meetings between the oil companies and the government before the decision at which Shell and ExxonMobil made it clear they did not want to continue production any longer under the current conditions.

There is indirect evidence for this. In June 2018, the minister for economic affairs Eric Wiebes announced he had reached an agreement with Shell and ExxonMobil whereby the state would take full control of the production level of the Groningen gas field and to cease production as quickly as Dutch demand and existing export contracts allow.

In return the government agreed that, with effect from the start of that year, NAM would be entitled to 27% of the revenue from Groningen instead of the 10% it used to get and would have to pay only 27% of all costs related to Groningen production, including from damage claims, instead of 36% as before. Clearly the oil companies demanded and received better terms as a condition for continuing production.

Learning points

What can we learn from the “fact that the Groningen gas field has become a 500bn m³ stranded asset”, ask Van den Beukel and Van Geuns?

The authors conclude that “the decision in March 2018 to stop Groningen production as soon as possible was the logical outcome of the loss of a social licence to operate and the resulting political and legal measures … Once a social licence to operate is lost, a rational cost-benefit analysis … no longer plays an important role in decision-making.”

As a further piece of evidence for this conclusion, Van den Beukel notes that Shell researchers had for two years considered injecting nitrogen into the gas field to maintain pressure. They found that this measure would likely ensure that the risk of earthquakes would decrease. But by now such solutions, Van den Beukel says, were a non-starter: continuing production despite the concerns of Groningen citizens would never win approval.

Thus, a decision was made, write Van den Beukel and Van Geuns, with “severe repercussions from a financial, security of supply and environmental point of view (in practice Groningen gas is going to be replaced by Russian, imported gas with a significantly larger footprint due to methane leakage).”

The Netherlands, from being a natural gas paradise has turned into a country with an energy policy that “may impose more restrictions on the use of natural gas than any other country in the world.”