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Shale gas could alter European market dynamics, as demand rebounds

E.On expects gas-demand growth in Europe this year, but shale-gas development could fundamentally alter the continent's market, leaving Gazprom out in the cold

UNCONVENTIONAL gas is shaking up the energy world. That much is true at the corporate level, at least. ExxonMobil's December take-over of XTO, a big shale-gas player, was the most obvious sign of that. Other independent producers will probably also be gobbled up soon.

But at what point will the world's conventional gas producers, such as Russia's Gazprom, begin to worry that their business models are under threat? The shale-gas optimists, such as BP boss Tony Hayward, talk of a "revolution" under way in the energy sector because of the new unconventional resources that are now considered exploitable (including coal-bed methane, which is already causing excitement in Australia, and so-called tight gas).

But there are sceptics. If it ever began developing its own potentially huge unconventional resource, Russia would remain the world's leading gas producer. Yet Gazprom is cautious. Alexander Medvedev, the head of the company's export division, told Petroleum Economist in October that many "myths" surrounded shale gas. It would remain expensive to develop, he said, because of the number of wells needed to produce the gas. Stop drilling, he added, and a field's productivity drops almost instantly.

But as one executive from a shale-gas operator recently told Petroleum Economist, "Gazprom would say that, wouldn't it?" After all, should the nascent shale-gas drilling in Europe prove half as fruitful as it has in North America, the energy-security anxieties among the continent's consuming nations will quickly dissipate.

It was only a few years ago that US natural gas production was considered to have peaked and its reserves were thought to be in decline. Developers planned dozens of liquefied natural gas (LNG) receiving terminals to meet the forecast import requirement. The handful that came on line are now scarcely needed – and stand as testaments to the power of technology (in this case the advent of horizontal drilling and hydraulic fracturing) to change markets and the inability of the corporate world to predict "black swan" events.

Gazprom's export-oriented strategy has relied on its partners in Europe making a cold calculation about their need to co-operate – or risk antagonising the supplier of their most important fuel. It works, so long as Europeans continue to perceive that Russia will remain their dominant supplier of natural gas. Even Gazprom's difficulties in financing expensive upstream developments support this: give us long-term contracts, the company can argue, because they are vital to future supplies.

For the time being, there is little evidence to question this model, notwithstanding a drop in EU demand last year, because although unconventional gas has changed the dynamics of the North American energy market, drillers in Europe have yet to unearth the same riches in the continent. The earliest results of exploration in countries such as Poland and Austria, where the resource could be large, are only likely later this year.

So the continent's importers can't yet start looking beyond the existing paradigm, even if analysts are predicting a global gas glut. Furthermore, the dip in European natural gas demand brought by the recession could be ending. A spokesman for Germany's E.On says the company does not foresee the "substantial pressure" on supply markets persisting.

"At present the European gas industry is undoubtedly in an oversupply situation," he said. "This constellation is likely to shape markets for some time to come. However, we do not assume that this high liquidity will last permanently." Indeed, E.On says improved prospects for economic growth in Europe and Germany mean gas consumption could grow this year. "It seems we have come out of the trough and it will probably not take too long until the present low level of demand is completely overcome."

In theory, that would put Gazprom and other suppliers back in the driving seat. It would also re-establish the logic for Europe's drive to build new infrastructure to meet its rising demand. This week, the US special envoy for Eurasian energy, Richard Morningstar, reiterated his government's support for the Nabucco pipeline, while also pointedly mentioning that "questions have been raised" about Russia's two rival proposals, South Stream and Nord Stream. Yet Europe needs more gas import infrastructure, he said, to guarantee its security of supply.

Yet all of this sounds dangerously similar to the debate in the US a few years ago about how to ensure more liquidity and greater gas supplies to its market. Yet that was all before the shale "revolution".

Will things change in Europe? Greg Pytel, an analyst from the Sobieski Institute, a Polish think tank, and the UK's Royal Institute of International Affairs, predicts that shale-gas development in Europe could render Nord Stream a white elephant. South Stream, he says, "has no prospects", while Nabucco would make sense "in the other direction" as a "reversible pipeline balancing European gas distribution".

"A lot of supply from Russia will be replaced by local shale gas production driven by multinationals," claims Pytel. In the longer term, output from Gazprom projects such as the Shtokman gasfield in the Barents Sea could be destined for the Chinese market, not the European one.

All of this is speculative, because no one has cracked shale gas in Europe yet. But also speculative were the independent firms in the US that blasted open the market with their hydraulic fracturing. Unconventional gas is now drawing the majors to the European upstream. As the battleground for the gas wars of recent years, Europe offers a great prize for shale-gas developers. And if demand in the continent is recovering, as E.On predicts, there are sound financial reasons for the developers to exploit the shale, too.

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