A reality check
Central Europe is addicted to natural gas. In the Visegrad countries, this addiction is primarily fed with gas imported from Russia. In 2010, Poland imported 63 percent of the natural gas consumed in that country; Hungary, 80 percent; the Czech Republic, 92 percent; and Slovakia, 95 percent. In Poland, the Czech Republic, and Slovakia, 90 to 100 percent of those imports came from Russia. In Hungary, about 70 percent of imported gas came from Russia. An alternative pipeline supplier could help alleviate the single-country dependency, but it is unlikely such relief will come any time soon. The proposed Nabucco pipeline, which would transport gas from Turkey to the Hungary-Austria border, faces an uncertain future. Meanwhile, the Russian state-owned company Gazprom is increasing its share of Europe’s gas imports. Last year, it launched Nord Stream, a Baltic Sea pipeline connecting Russia and Germany. Later this year, it will start building the South Stream pipeline, linking Russia to the Balkans.
The share of gas in the energy mix of the V4 ranges from 37 percent in Hungary to 12 percent in Poland. Among the fossil fuels, coal plays an equal or more important role as gas. But the share of coal in the Visegrad countries is set to fall. It does not fit into the EU’s plan to reduce greenhouse emissions by 20 percent by 2020. Coal produces twice the CO2 emissions of gas. Gas is cleaner than coal; the number of gas-fired power plants is expected to grow.
Central Europe does realize the dangers of its addiction, thanks to the 2009 gas crisis. The Russia-Ukraine dispute led to gas supply interruptions in all four countries, with Slovakia suffering the most. Accepting that in the medium-term they can neither replace gas, nor rely on Nabucco, they turn to the American example: shale gas and LNG. What are the opportunities – and risks?
Shall shale prevail?
When small gas producers began horizontal drilling in the vast states of Texas and Louisiana in the 1970s, few predicted that they would bring about a silent revolution by the end of the century. The United States is enjoying today the fruits of that revolution, including, in the words of the International Energy Agency, an “abundant supply of gas, low prices, and considerable economic benefits” (Golden Rules for the Golden Ages of Gas, 2012). According to the IEA, shale gas’s share of U.S. gas production will increase from 23 percent in 2010 to 50 percent in 2035.
This energy revolution has not crossed the Atlantic yet, but Poland has already been nicknamed the “Qatar of Central Europe”. The Polish government, inspired by the U.S. example, has given out exploration concessions to North American companies with the production know-how and the means to invest. It plans for commercial exploitation by 2014 and for gas self-sufficiency by 2035. Current estimates indicate that the country has 346–768 billion cubic meters of gas in reserve, enough for up to 50 years.
Bratislava and Budapest have followed Warsaw’s lead, albeit cautiously. Slovakia is exploring if the shale gas formations detected in Poland cross the border. Hungary, part of the same geological zone as Romania and Bulgaria that holds an estimated 500 billion cubic metres of gas, is conducting drilling exploration. Only Prague is likely to hold back. Despite the initial estimations that it could use shale gas to cover up to 10 percent of its annual gas consumption, the government is considering the imposition of a two-year moratorium on exploration because of environmental concerns.
The Czech dilemma points to the risks of shale gas development. First, the drilling techniques may damage the environment. Horizontal drilling and hydraulic fracturing involve shooting chemical solutions mixed with sand into the shale to fracture it and make the gas leak. The technique demands large amounts of water, and may lead to groundwater and soil contamination. If methane is released, air is polluted, too. By raising awareness of the environmental risks, activists have already made a difference in the Czech Republic.
Second, exploiting shale gas is costly. As KPMG’s Central and Eastern European Gas Outlook (2012) points out, shale gas development in Poland can cost, on average, three times more than in the United States. The drilling of a 2000-meter horizontal well averages €3.2 million in the United States, compared to €8.9 million in Poland. And, as Michal Hudec of energia.sk argues, the incumbent gas suppliers bound by long-term contracts with take-or-pay clauses may not be keen to share the costs of such an enterprise. Another problem is the cost of acquiring land for drilling, a process more complicated in Poland than in the United States. ExxonMobil has quit exploration in Hungary and Poland. It may have been discouraged by the pessimistic perception of the risks coupled with decreasing reserve estimates.
The liquid hopes
But pessimism is not realism, either. Those saying that shale gas cannot have a major impact on the European gas market ignore LNG. The story is based on the simple demand-supply curve. The shale gas inflow on the American market reduced prices and imports. Middle Eastern LNG originally earmarked for the United States was redirected to the EU. Thanks to shale gas, the United States is expected to become a natural gas exporter by 2021. In addition, gas replaces coal redirected to Europe, which in turn reduces the American carbon footprint.
LNG is a gas which has been cooled to -161 degrees centigrade where it condenses into a liquid phase. Compared to its gaseous form, LNG’s energy density is 600 times greater, which enables marine transportation. One LNG tanker can transport a volume equivalent to the annual consumption of an average French city. And it can change destination fairly rapidly based on the demand.
In 2010, almost one quarter of EU gas imports were in a liquefied form. The LNG flowing to the North European gas trading hubs has pushed down prices and created a gap between the hub and the oil-linked prices embedded in long-term contracts with such suppliers as Gazprom.
Poland quickly grasped the opportunity. The state-owned gas companies contracted imports of 1.5 billion cubic metres of LNG from Qatar. A gasification terminal in Świnoujście is expected to become operational by 2014. Terminal will have the capacity to supply 2.5 billion cubic metres of natural gas, 15 percent of Poland’s gas consumption in 2010. The capacity can be extended to 5 and even 7.5 billion cubic metres. Ironically, the Polish LNG station will be constructed barely 70 kilometers from the German exit point of Nord Stream.
The landlocked Visegrad countries could tap into the global LNG market at another point: the Croatian island of Krk. If an international consortium working on the project decides next year to move forward on the construction of the Adria LNG plant, the terminal will be operational by 2016. The proposed capacity is 10 billion cubic metres of gas per year. Zagreb is now trying to woo Budapest to join the project. “It would be a win-win project, as interconnectors in Hungary could supply Slovakia and Poland on one side and Romania on the other,” said Croatian Deputy Prime Minister Radimir Čačić.
There are two major problems with these LNG proposals. First is the cost. Świnoujście is expected to cost €720 million, Adria LNG €600 million. In the case of the Croatian project, it is not certain who will pay the bill. In the case of Poland, the short-term financial impact on state companies squeezed by the Russian long-term prices from one side and by the home market prices from the other side is considerable.
The other problem is the future of LNG prices. While they are lower than oil-indexed prices today, they may be higher tomorrow. The global demand-supply curve will drive the price of LNG. Europe’s demand alone will not be the primary price-setter on the world market. If unconventional gas is developed profitably and with environment safeguards, global gas demand will increase by more than half between 2010 and 2035, predicts the IEA. But it will do so differently in different world regions. Although both China and India have their own unconventional reserves, they may drive up demand in the short- to medium-term.
The medium and long term rise of unconventional gas in Central Europe is challenged by the immediate environmental and commercial risks. Imports of LNG, feasible in the short to medium term, are threatened by commercial and price risks. The Visegrad governments can rely on LNG as well as on shale gas, if they face the challenges together. Joint action is needed at home and in Brussels. The Visegrad governments should tackle these risks through concerted energy, environmental, and fiscal policies.
On the energy front, they should all ascertain they want and need gas. This is not obvious, given their common plans to launch or expand nuclear power plants. If they make the choice for gas, they should promote it together on the EU level, along with energy security. To that end, they should engage together in the diversification of supplies and in the increase of supply security. The former can be helped by Nabucco, the latter by a Ukraine-EU-Russia consortium that would control the Ukrainian gas transport infrastructure. The crucial element for both promotion of gas and energy security is the single EU market. Only a liberalized European gas market can drive down retail prices.
On the environmental front, Bratislava, Budapest, Prague, and Warsaw should promote a debate on the environmental risks of shale gas that would result in a stable regulatory framework. The risks are numerous and real. If exploitation takes place despite the opposition of the population, it will not attract the necessary private investment. The discussion should be promoted at home and in Brussels. Whereas the EU institutions seem to have given a tacit “go” to shale gas, France and Bulgaria have banned exploration activities. Complementary common efforts should be focused on cleaner and more efficient gas burning, along the lines of EU’s 20-20-20 targets.
On the fiscal front, it would be desirable to pool resources. In the climate of austerity, it pays twice. Both shale gas and LNG terminals demand high capital expenditure. Public funding is necessary. Why not fund the unconventional gas exploration, the development of environmentally acceptable drilling techniques, and gasification terminal construction together? And why not lobby for a common EU funding, via the “Connecting Europe Facility” in EU’s 2014-2020 Multiannual Financial Framework?
Connecting Central Europe
The road to such cooperation is bumpy, especially when placed under time constraints. But it is not impossible. They already have the experience from the bilateral cooperation in building new interconnections and implementing reverse flow on the existing ones.
Interconnections and reverse flows strengthen energy security. Without them, gas consumers are dependent only on their suppliers. With them, they have access to alternative supplies from each other. If unconventional gas and LNG projects emerge, they will be able to diversify supplies for Central Europe through the interconnections and reverse flows.
The 2009 gas crisis stimulated in particular Slovakia to promote reverse flow on its existing interconnections. The reverse flow on the Slovakia-Czech Republic interconnector has been operational since the end of the crisis, the Slovakia-Austria one since 2011. Both with EU funding.
The major challenge today is the North-South corridor. In order for the liquefied gas from the Baltic and the Adriatic seas to flow into Central Europe, the countries need to be connected on the North-South axis. The Croatia-Hungary interconnector has been operational since 2011. Two other interconnectors considered crucial for the North-South Corridor should be between Slovakia and Hungary, and between Slovakia and Poland. The former should be operational by 2015, the latter is a subject to a feasibility study. Both are expected to apply for to Brussels for financial support.
Political cooperation bore fruit on the regional level and in Brussels. In early 2011, the Visegrad countries agreed to cooperate on energy security, and the Hungarian Presidency of the EU pushed through a call for the elimination of “energy islands” in the EU by 2015.
But focusing on interconnections and diplomatic successes is not enough. If Central Europe makes the choice for gas, it should inspire a joint action to promote shale gas and LNG and to mitigate their risks. The Visegrad countries gained their political independence from Russia in 1989. Yet, twenty years later, they remain dependent on their former master for their energy needs. The recipe for breaking that dependency is still the same: cooperation.