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Poland’s shale flop

Why has Poland’s unconventional gas sector failed to live up to the promise?

Five years ago Poland was the symbol of Europe’s shale-gas aspirations. Boosters talked up its vast reserves, which would give it 200 years of domestic supply, freeing the country from Russia’s gaseous grip. Energy companies flooded in to explore this exciting new play.

But difficult geology, inadequate regulations and an uncertain tax regime have all put paid to the vision, setting back Poland’s shale-gas hopes. Investors now shy away. “It it has gone from an original period of understanding and then hype, where everybody thought we would have an abundance of shale gas straight away, to a bit of a reality check,” Kamlesh Parmar, chief executive of 3Legs Resources, one of the earliest entrants to Poland’s shale sector, told Petroleum Economist. “The results so far haven’t been as people would have liked and the rocks have proven to be more challenging than people were expecting.”

3Legs Resources holds six concessions in Poland’s Baltic basin. ConocoPhillips decided last year not to exercise a right to acquire a 70% interest in three of the licences it holds in a joint venture with 3Legs.

Parmar says that a lack of a developed services sector in Poland and differing attitudes across the EU to shale gas have all dampened enthusiasm, though the company is holding fast. “It’s a new shale play and all new plays take time to unlock. We still see potential in our acreage, which is why we’ve been carrying on with the work we’ve been doing,” Parmar says.

In June, the US Energy Information Administration (EIA) reduced its estimates for Poland’s shale-gas reserves from 5.3 trillion cubic metres (cm), an earlier number, to 4.2 trillion cm. The EIA also slashed its estimate for Poland’s Lublin Basin to 260 billion cm, or 80% less than previously thought.

The downgrades reflected a change in methodology to calculate reserves, but it was a blow for Poland and its efforts to keep bringing in investors. So far only around 40 shale-gas test wells have been drilled in the country, with mixed results.

Canada’s Talisman Energy pulled up sticks in May, selling its Polish shale assets to UK independent San Leon Energy. Talisman had drilled just one vertical well in each of three Baltic Basin blocks and has now closed its office in Warsaw. The company said it wants to focus on liquids-rich US shale plays such as the Eagle Ford in Texas.

ExxonMobil has also abandoned its concessions in the Lublin and Podlasie basins. It left in June last year after drilling just two wells. The company said it could not find commercial-scale quantities of shale gas.

The slew of bad news puzzles some observers, who say reasons beyond geology might be to blame. Grey Pytel, an analyst at the Sobieskiego Institute, told Petroleum Economist at least 10 wells would be needed to appraise a new concession and ExxonMobil’s decision to leave Poland was more likely because of unsatisfactory negotiations with the government rather than technical problems. “It’s nonsense. It doesn’t make technical sense,” Pytel said. “It’s true they (ExxonMobil) didn’t make any sort of big breakthrough but then nobody expected them to at that early stage. It would have been a huge surprise if they had come up with the technical resource.”

ExxonMobil declined interview requests from Petroleum Economist.

Stumbling block

Wolf Regener, chief executive of BNK Petroleum, another driller, said it’s not the geology that’s the problem but the government’s sluggish pace in forming shale-gas regulations.

BNK Petroleum has six shale-gas concessions in Poland. It has drilled five wells in the Baltic basin and is hoping to spud another well in the fourth quarter of 2013. But its plans depend on the government, which hasn’t yet approved the drilling.

Obtaining the right permits to begin work can be a long, arduous affair. It can take over a year to win permission even to change a work programme by drilling a deeper well, say jaded drillers.

It has left investors with “a bad taste in their mouth”, says Regener. “I wish they would just finish the hydrocarbon law and put it out there because that’s keeping a number of larger players from stepping in. No one likes uncertainty in fiscal terms.”

Fiscal uncertainty

In September 2012 the Polish government announced a new fiscal regime which, it claimed, would spur unconventional gas development. From 2015, Poland’s upstream taxation framework would be based on a proportion of energy companies’ production volumes and their gross profits.

The new regime sought to clarify what industry operators say is a hazy regulatory framework, which among other things lacked a specific upstream tax regime or separate hydrocarbon tax.

Poland said it planned to impose a royalty tax of 5% on gas extraction and 10% on oil, plus what it calls a special hydrocarbons tax of 25%, which will be levied on the difference between revenues and costs. An extraction fee would take the total tax take, including Poland’s standard 19% corporate tax, to 40% of gross profits.

A new state-operated company, the National Energy Minerals Operator, would also be created, and take stakes in future shale production. But the exact terms of these proposals are still being debated and many of the first shale-gas licenses awarded in 2008 are due to expire in 2013-2014, before the changes are enacted.

Shale-gas exploration licences in Poland carry five-year terms. So the financial risks for companies that don’t find commercial shale resources within that time are daunting. Poland’s finance ministry has tried to calm concern by postponing collection of any new taxes until 2020. This has helped to ease some concerns over uncertainty, Parmar said. “Industry needs to feel confident that it can work in a commercial way,” says 3Legs’s Parmar. “Otherwise it will start looking very carefully before it spends more money.”

There are other theories about why Poland’s promise has faded. Pytel told Petroleum Economist that some in government were deliberately sabotaging development of shale gas by delaying its regulatory process – all to protect long-established business links with Russia.

Shale gas would threaten state-run PGNiG’s monopoly of Poland’s gas market. Its domination depends on conventional gas supplied by Russia. Outsiders might assume Poland wants to secure energy independence, but Pytel says the men who run the Polish gas sector are quite happy with the Russian status quo. “There is a myth propagated by a lot of (media) publications, mainly in Poland, that somehow Poland wants to diversify from Russian gas and to become independent. Nobody better understands that than Americans,” Pytel says. “The reality is that there are so many vested interests on the ground in Poland, in terms of gas contracts, that in reality any attempt at the highest level to diversify from Russian gas supply would be torpedoed.”

PGNiG has a 48% stake in EuRoPol Gaz, which owns the Polish section of the Yamal-Europe gas pipeline. Gazprom owns the remaining stake. The 4,000 km pipeline transports 33 billion cm a year of Russian gas from western Siberia to Germany via Belarus and Poland. “If (shale gas) production starts in Poland then the first victim would be PGNiG. It would end up with gas it wouldn’t be able to sell,” Pytel says. “They don’t have any trading experience so they know they will basically be killed on the market, which is not unusual for a state monopoly.”

Poland’s new environment minister, Maciej Grabowski, said at the end of November that draft legislation for shale-gas extraction would be sent to the government for approval by the end of 2013. Speeding shale-gas development was a top priority for the government, he said, adding that a separate bill, outlining shale-gas taxes, would also be prepared by the finance ministry. Donald Tusk, Poland’s prime minister, said he had dismissed former environment minister, Marcin Korolec, to speed up the shale gas regulatory process. 

For Ukraine, shale gas an alternative to Russian supplies

After years of friction with Russia over gas supplies, Ukraine is also emerging as an attractive unconventional-gas frontier, with recoverable reserves of shale gas thought to be as great as 1.2 trillion cubic metres (cm) and another 3 trillion cm in coal-bed methane (CBM) deposits.

The most prospective areas for CBM production are in eastern Ukraine, while shale gas is being explored in the Lublin basin, which extends from western Ukraine into Poland, as well as in the east of the country.

The majors are starting to move in. In January Ukraine awarded a 50-year production sharing agreement (PSA) to Shell for the Yuzovska field, in the eastern Dniepr-Donets Basin. The company is expected to spend around $10 billion in developing the field’s unconventional resources, which could amount to around 4 trillion cm of shale gas (resources).

In November Chevron also signed a PSA for appraisal and development of shale gas from the Olesko field, in the Lviv and Ivano-Frankivsk regions, western Ukraine. Ukraine’s government is getting excited. Prime minister Mykola Azarov said Chevron would initially invest $350 million in exploring the Olesko field, which is thought to hold 3 trillion cm of shale-gas resources. Chevron’s total investment could eventually rise to $10 billion, Azarov said.

Ukraine has a strong incentive to break free from dependency on Russian gas by developing shale resources, given several spats between the countries in recent years. These precipitated cuts in gas flows to and through Ukraine, which has long been a transit hub for Russian supplies to Europe.

In October Gazprom demanded that Ukraine pay an overdue gas bill, re-igniting fears of another so-called gas war between the countries.

Last year Ukraine imported 29.8 billion cm of natural gas, according to Cedigaz, all from Russia. Ukraine now pays some of the highest gas prices in Europe. 

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