Shale gas doesn't make Poland the new Norway yet

Poland is being hailed as Europe's new Qatar. Located deep beneath its rolling landscape are 5300 billion cubic metres (bcm) of recoverable shale gas, more than enough to meet the country’s needs (currently 14 billion bcm per year) for centuries to come. This has captured the imagination of a country that sees its dependency on Russian gas as a threat to national sovereignty. But Poland already seems to have sold its resources to American oil companies – and they might find it more lucrative to sell into the Russian-controlled pipeline network. As one analyst puts it, ‘Poland is not on course to become a second Norway, more a second kind of Turkmenistan.’ Ekke Overbeek reports from Warsaw.

The Nesvizh compressor plant of the Yamal-Europe gas pipeline (photo: Belarus.by)
‘Our country is always prepared for war, but not for success. I want to prepare you for success, for a situation in which Poland will become the second Norway of Europe and rakes in twenty to thirty billion zlotys annually in taxes.’ The words of Andrzej Sikora, a specialist with the Institute of Energy Studies in Warsaw, haven’t fallen on deaf ears in the parliamentary commission for energy affairs. Ever since Poland shook off the communist yoke, some twenty years ago, there hasn’t been a single government able to present a balanced budget. There isn’t a politician who wouldn’t welcome several billions in extra cash to woo the electorate.

But the billions of zlotys that Sikora promises his public are still as virtual as the billions of cubic metres of gas that the US Energy Information Administration (EIA) is forecasting lay buried underground. The man at the centre of the Polish shale gas story advises caution. ‘As a civil servant I have to be careful with these kinds of estimates’, says Hendryk Jezierski, Poland’s chief geologist and junior minister for the environment. Of the 127 test drillings that companies have pledged, only seven have so far been carried out. ‘It will still take several years before we can say whether there is gas that can be drilled.’

The Poles are eagerly counting their chickens, but even so they’ve left it too late: foreign oil majors have already staked their claims. Unlike the Polish state. Leader of the opposition Jaroslaw Kaczynski last month demanded a guarantee that companies cede 40% of the revenues from shale gas to the Polish state. It’s a percentage that sounds attractive to the electorate, but it won’t solve the problems of the Polish state.

Mosaic of concessions

The caution of top geologist Jezierski stands in stark contrast to the eagerness with which foreign companies have snapped up Polish concessions in recent years. Drilling rights have already been granted for almost the entire region where the shale layers are located. The mosaic of concessions stretches in a broad swathe from the port city of Gdansk on the Baltic Sea right to the Ukrainian border in the south east. ‘If there isn’t anything in it, the big boys really wouldn’t be here’, opines a delegate at the umpteenth shale gas conference in Warsaw. ‘There’s no such thing as a free lunch’, he says, tucking into the buffet paid for with US money.

The oil companies themselves venture little information on the financial side of things. ‘The Polish government is very cooperative’, is the only comment that Patrick Blough, vice president gas commercialization for Chevron, is prepared to give. His presentation at the same conference amounts to a wish list addressed to the Polish state: Maintain a stable fiscal environment. Facilitate gas volume chain development. Support the development of an in-country service industry. Develop a strong but fair regulatory framework. Educate and maintain public support for responsible development.

The latter is crucial. It’s hard to imagine there won’t be any protests if Kashubia, Zulawy, Kujawy and Lublin are turned into ‘Gas land’, the title of a much talked-about American anti-shale gas documentary. The number of drilling sites can be limited through multilateral drilling, but shale gas development will

'New technologies are always feared, but if you allow yourself to be ruled by fear, you shouldn't be investing in nuclear plants'
nevertheless result in an invasion of thousands of drilling rigs and their concomitant infrastructure: between a half to three hectares of industrial site per borehole. Add to that the concerns about drinking water pollution and gas explosions and all the ingredients of a strong anti-lobby are there. ‘Up until now the ecological movement in Poland has been behaving very responsibly’, says Pawel Poprawa of the State Institute for Geology, which dismisses environmental concerns as ‘exaggerated’.

Public secret

Environmentalists don’t stand a chance of winning support from the powers that be. Poland’s foreign minister Radoslaw Sikorski can count on a roar of approval when he comments on the shale gas moratorium in nuclear nation France. ‘New technologies are always feared, but if you allow yourself to be ruled by fear, you shouldn’t be investing in nuclear plants.’

The idea that the European Union might block shale gas exploration and production is also a non-starter: ‘The EU can’t ban production of shale gas’, says Mikolaj Dowgielewicz, Secretary of European Affairs in the Ministry of Foreign Affairs. ‘That would require a unanimous decision and I can’t imagine a Polish government that would agree to that.’

It’s clear the Polish government has thrown its full weight behind shale gas exploration and development -- and indeed seems to be in even more of a hurry than the oil companies themselves. The reason behind this haste is never uttered officially, but it’s a public secret: shale gas could free Poland from its dependency on Russia - at least as far as gas is concerned (the Polish energy mix is dominated by coal and oil). Polish gas consumption currently amounts to some 14 billion cubic metres annually, of which just five billion is produced within its borders. The rest is imported from Russia on the basis of a contract that runs to 2022. Most Poles are convinced that Russia wields its oil and gas reserves as a political weapon – something Poland’s eastern neighbours of Lithuania, Belarus and Ukraine know all about.

So shale gas offers a guarantee of national sovereignty. But Grzegorz Pytel of the think tank Sobieski Institute in Warsaw says the public are being fed a lie. ‘Poland has enough conventional gas to be independent from Russia’, he says. ‘We have proven gas reserves of 140 billion cubic metres and an

'In Poland there's no bidding round: it's simply first come, first served'
annual consumption of 14 billion. Poland could produce ten percent of this 140 billion cubic metres annually for years. This would be less in percentage terms than Germany, Italy or Denmark produce compared to their reserves. Then they could use part of the revenues to explore and put new conventional gas wells into production. According to the Polish geological institute, the country still has around 1780 billion cubic metres of prospective conventional gas reserves.’

So why don’t they do that? Pytel: ‘The Polish gas company POGC (PGNiG) has a good relationship with the Russians. Why should they risk that, given that they have a workable business scheme: buy your product in Russia and sell it in Poland?’ Governments that have pressed POGC to boost production in the past have all been fobbed off, says Pytel.

Drilling rights

That doesn’t mean to say that the Americans and their shale gas technology should be barred from the country, according to Pytel. On the contrary, business is business. What’s more, shale gas offers Poland another kind of safety guarantee. For years the country has been angling for a permanent US military presence, up until now to no avail because of Washington’s concerns not to jeopardize the relationship with Russia. But should the Americans have major economic interests to protect, that would boost Poland’s security.

The rapid development of shale gas would yield another possible benefit as well: it would put the Poles in a position to profit from knowledge transfer. If Polish companies can train up shale gas specialists over the coming years it would open up new foreign opportunities in the near term. That would more than justify the rapid allocation of drilling rights.

For the time being, the latter scenario looks unlikely, however. So far just three Polish companies have won concessions: gas operator POGC (PGNiG) and the two oil companies Orlen and Lotos. All three are state-owned operations and all three are struggling with a chronic shortage of funds. ‘We need to train a whole new generation of engineers over the coming years’, warns Wieslaw Prugar, president of Orlen upstream, immediately adding the second major problem that Polish companies face. ‘Huge amounts of money are needed to boost production. Financing will not come easily. The Polish financial system cannot handle this.’

Shale gas rig in Poland, where Lane Energy Poland does test drilling to assess economic viability of shale gas deposits. (AP Photo/Andrzej.J. Gojek)

The Polish concerns contrast starkly with the robust self-confidence of the international oil companies. ‘International oil companies are very large. We have a lot of experience along the entire chain and we can finance large projects, like ones of 10 billion dollars’, says Chevron’s Blough. And the US companies are self-confident, too. They are not begging the Polish state for favours. ‘We’ve many opportunities to invest our money’, says Blough. ‘We’re looking for long-life resources. Everything depends on the price; whether shale gas generates more returns than other energy sources.’

Poor starting position

Sometime over the next three years, once the results of the test drillings have become available, parties will have to reach agreement about the distribution of profits. The Polish state looks to have manoeuvred itself into a poor starting position: legislation and concessions are still geared to a situation in which the state forges agreements with state-owned companies, as happened under communism. Funds simply got shifted around. But the arrival on the scene of major foreign companies requires a radically different approach.

To start with, Poland has been giving away concessions for 100,000 dollars apiece. In Poland there’s no bidding round: it’s simply first come, first served. The argument for doing things this way was that Warsaw wanted to know as soon as possible what natural riches were to be found underground. But the point is that a first concession also gives the holder an advantage in acquiring the production rights. For a period of five years after any gas is found, the concession holder is the only party allowed to apply for a production licence. Which means that concession holders can string the government along for five years if the conditions attached to a production licence don’t appeal to him.

What’s more, the Poles are no match for the incomers. On one side of the negotiating table are international operators such as ExxonMobil, Chevron, Marathon Oil and Talisman, on the other, civil servants with no oil or gas experience on a salary of maybe 2000 euros a month. ‘Who in this government has any experience in the oil and gas business?’ asks Pytel rhetorically. He points to Norway, which forces companies to bid against one another. ‘Norway has a very clever tender system’,

But should the Americans have major economic interests to protect, that would boost Poland's security
he says. ‘The winner gains the lion’s share of a licence, but the losers of a particular tender are awarded minority shares. In that way oil companies are forced to cooperate but in the meantime they’re all keeping an eye on one another so that no-one tries to get too clever with the Norwegian government. On top of that, in most cases the state also participates directly through [Norway’s state oil companies] Petoro or Statoil.’ That’s not the case in Poland. ‘The Polish state has already given away control’, says Pytel.

Pytel notes that, ‘while a licence can’t be sold just like that, shares in a company with a licence can.’ In addition to major oil companies like ExxonMobil, Chevron, ENI and Marathon, many licenses have been granted to small operators with modest amounts of capital, such as 3 Legs Resources, San Leon Energy, Strzelecki Energia SA, Emfesz, BNK Petroleum, Composite Energy, Cuadrilla and Realm Energy. ‘These companies can be sold, licence and all, without the Polish state having any say in it.’

Effectively these small companies are a guaranteed cash cow for their owners, Pytel argues. ‘They have very little investment capital of their own – if any – but they are in a position to approach a big company and put forward a deal that unloads the costs and risk while preserving equity. For example they might offer an oil major a 50 percent share of production in return for them shouldering 60 percent of the development costs. And subsequently they could go and see another player and offer them 30 percent of production in return for 40 percent of costs. That way they end up with a considerable share of the production revenues – in this example 20 percent – without investing any money themselves. Of course in the real world it’s not that simple, but it’s a classic scheme for making money on licences where state control allows for that.’

Dismal scenario

Pytel’s final analysis is scathing: ‘Right now Poland isn’t on course to become a second Norway but more a kind of second Turkmenistan’, he says. The comparison Pytel makes with Turkmenistan has to do with yet another Polish headache when it comes to shale gas: the distribution and export

'American companies aren't swayed by politics or nationality but by profits, and it might prove far more attractive to simply sell gas to the Russians than to invest in a new pipeline'
infrastructure that will be needed to develop and sell the gas. This is currently largely controlled by Russia – just as in the case of Turkmenistan, which has to accept that a significant portion of its gas revenues are pocketed by Russia’s Gazprom, which controls Turkmenistan transports. The same thing could happen to Poland, argues Pytel. He predicts that Russia won’t try to block the production of shale gas in Poland, but will try instead to gain control over its transportation and make money out of that.

‘Some 2000 kilometres of gas pipeline needs to be built. If we can’t realise this investment, we won’t be able to use the potential offered by shale gas’, confirms Mikolaj Budzanowski, secretary of the Polish treasury, which owns the state companies.

Budzanowski hopes that the LNG terminal the state is currently building in the port of Swinoujscie could be of help. ‘In the future the LNG terminal can also be used for gas exports’, he says. But Pytel says this vision is out of touch with commercial reality. ‘We’re talking about completely different volumes.’ Pipelines are what is required and why build new ones when one already exists, he asks: Yamal. The Polish part of the Russia-EU gas pipeline is owned by a joint venture of Polish PGNiG (48%), Russian Gazprom (48%) and Polish Gas-Trading SA, which is itself a joint venture.

‘Right now Gazprom has de facto control of Yamal. In one or two years the Nord Stream offshore pipeline between Russia and the EU will become operational, transporting up to 60 billion cubic metres, and that will free up capacity in Yamal.’ If the existing Yamal capacity of 32 billion cubic metres turns out to be too limited, the easiest thing to do would be to double Yamal’s capacity by adding a second leg, as foreseen in the original building plans, Pytel says.

American companies aren’t swayed by politics or nationality but by profits, and it might prove far more attractive to simply sell gas to the Russians than to invest in a new pipeline, Pytel warns. ‘It’s like bread and the bank. What bank is going to lend you money to start up a bakery next to a good one that already exists?’

It’s a dismal scenario: Americans cashing in on production and Russians creaming off the transport revenues while Poland looks on from the sidelines. But luckily the Poles still have some time to count their chickens, because they’re still a long way from being hatched.