Shale gas confronts Brussels with the challenge of recognising its potential and future role in the European energy policy. Any shale gas policy the EU may choose to follow would not need necessarily to be a start-up, as it could be integrated in the current policies. The crucial issue with regard to the regulatory process is recognising the specific geological, technical and environmental aspects of shale gas, understanding how it varies from conventional oil and gas exploration and production, and ultimately addressing these issues via regulation. In addition to the regulatory challenges, public acceptance proves to be an extremely sensitive issue, especially in Europe.
If these environmental impacts can be contained, shale gas's potential is too large for it to be ignored both by Brussels and those member states with considerable reserves. Some progress has been made since the shale gas discussion in Europe started in 2011 and the Commission's 2013 Work Programme proposed delivering a framework to manage risks, address regulatory shortcomings, and provide maximum legal clarity and predictability for both market operators and citizens across the EU.
This briefing looks at those regulatory challenges, the lessons from the US experience, Europe's position on the matter, and the likely regime for shale gas in Europe, with a particular focus on Poland and Romania.
Shale gas is a type of natural gas produced from shale formations that typically function both as a reservoir and source. Shale gas is a dry gas composed primarily of methane (90% or more). Shale formations are sedimentary rock formations consisting predominantly of consolidated clay particles.
The combined processes of horizontal drilling and hydraulic fracturing are the enabling technologies that have made the recovery of shale gas economically viable. Hydraulic fracturing involves the injection of large volumes of water, sand and some chemicals at high pressure down a well. The pressurised fluid mixture causes the formation to crack open, allowing natural gas or oil to flow up the well. Horizontal drilling is used to maximise the surface contact with the shale deposit.
Large scale hydraulic fracturing was first developed in Texas in 1950s and was used to drill the Barnett shale (Texas) in 1986. During the 1980s, production volumes began to expand rapidly, and the first horizontal well was drilled at the same shale play in 1992.
In an interview with The Economist in 2012, famed energy researcher and writer Daniel Yergin1 said: "the technological revolution in unconventional gas has been the single most important energy innovation so far this century. Its tremendous potential has already transformed North America's energy landscape and may now transform the global gas industry".
Indeed, in the US shale gas production has increased from 1% of overall energy production in 2000 to 20% in 2009, with an average annual 50% increase in shale gas and oil production since 2007. A recent McKinsey strategy report identifies shale gas as one of the five game changers that will revive US economy and ensure growth. The report estimates that capturing the shale opportunities could add 2-4 percent to the country's annual GDP and create up to 1.7 million permanent jobs2.
In spite of this success in North America, it is not yet clear whether the "shale gas revolution", as it has been coined, can be replicated in Europe.
The industry and the market have been ahead of the regulators in the shale gas game. To date, there is no legislation specifically addressing shale gas, neither in the US nor elsewhere in the world. In spite of this, there are a number of common regulatory challenges that have been recognised and associated with unconventional gas exploration and production, regardless of the jurisdiction:
- Hydraulic fracturing – in addition to the technical side, there is increasing public, media and governmental concern regarding potential contamination of drinking water aquifers as a result of the fracturing fluid chemicals dispersing beyond the well.
- Water management – the key issues associated with water are the extremely large volumes (ie: 10,000-30,000 tonnes of water per well) needed to fracture the shale rock with the current technologies and the disposal and safe management of the waste fluids used for fracturing.
- Well spacing requirements – the optimal well spacing and densities are extremely relevant for the efficient recovery of the gas, as shale gas resources are characterised by reservoirs that have an extremely low level of permeability and are laterally extensive. The reservoirs also vary substantially depending on their location, thickness and number of layers.
- Environmental issues – three crucial elements have been identified: surface and groundwater pollution risk; increased local greenhouse gas emissions; and local deforestation and natural habitat disturbance.
- Public acceptance – as shale gas reserves are located mainly on shore, sometimes in areas with high population density, public acceptance is a main concern. In addition to fracturing, the heavy truck traffic, the noise, the effects of emissions on the local air quality, and potential property damage also need to be dealt with at the regulatory level.
- Overcoming the influence of lobbyists and environmental pressure groups.
- Information collection and dissemination – the key issue is to appreciate that a different set of information is needed than for conventional oil and gas drilling. It should also be noted that the operators have so far been very active in protecting what they consider to be proprietary information (most importantly, the composition of the fracturing fluid) in their desire to secure their competitive advantage.
The US experience
Although specific legislation to cater for shale gas exploration and production has not been enacted in the United States, the US government has played its part in supporting unconventional gas through fiscal policies, R&D funding, and non-stringent exploration and production and environmental regulations – although the latter set of policies are now subject to substantial criticism. It will be interesting to follow if this recent criticism will eventually crystallise into a regulatory framework.
Aside from its economic and security of supply benefits, the exploration and production of shale gas in the US has fuelled debates amongst its stakeholders, mostly from an environmental perspective. In the words of the gas industry, hydraulic fracturing is a proven technology that has been used safely for more than 60 years in drilling over one million wells. For those opposing shale gas exploration and production, the matter represents a substantial threat to the environment and the health of local communities. A good example of how unsettled the matter is at the regulatory level: ExxonMobil Corp. (Exxon) inserted an "opt out" provision in its December 2009 merger agreement with XTO Energy in an attempt to insulate itself from any regulatory consequences, allowing the deal to be called off by Exxon in case of a "Company Material Adverse Effect" which included changes to the existing legislation that would make hydraulic fracturing illegal or "commercially impracticable."
According to the US Department of Energy, the exploration and production of shale gas in the US by and large falls under the same complex set of federal, state and local laws as for the conventional oil and gas industry at large.
The key legal issues with shale gas are not related to upstream legislation, but rather arise mainly from environmental legislation.
The Environmental Protection Agency (EPA) is in charge of the administration of the federal environmental legislation in the United States. In addition to this, there are one or several regulatory authorities for each state in which oil and gas is produced that are, collectively or separately, in charge of licensing, including setting the site for the wells, operation, abandonment, waste and disposal, air emissions, undergoing injections, wildlife impact, surface disturbance, and health and safety issues. By statute, the states may adopt their own environmental legislation, provided they cater for at least the minimum level of protection imposed by the federal legislation. The complexity of the federal, state and sometimes municipal legislation has been criticised as being a source of inefficiency and confusion in the development of this new source of energy for which the stakes are high, and industry has often taken action at a faster pace than either legislation or the regulatory authorities.
Despite the fact that industry and, in previous years, even the US Department of Energy stated that fracturing is a well-tested and safe technology and that the current legal framework is well-equipped to tackle the regulatory challenges, there have been voices from the public, as well as from professional and academic environments, who have carefully flagged and explained some concerns related to this new-found bonanza.
Historically, due to an exemption in the Safe Drinking Water Act (SDWA), the EPA until recently had not regulated gas production wells and had not considered hydraulic fracturing to fall within the definition of underground injection. Following Leaf v EPA in 1997 and reflecting an increasing number of public complaints, the EPA issued a report in 2004 and concluded that the injection of hydraulic fracturing fluids posed little threat to the underground sources of drinking water and required no further study. That report was heavily criticised by public opinion and some members of Congress.
In 2005, following the Energy Policy Act, Congress decided to amend the SDWA to specifically exclude from the definition of "underground injection" the injection of fluids or propping agents (other than diesel) used in hydraulic fracturing operations related to oil and gas. This meant that the EPA's authority to regulate underground injection was expressly removed. The New York Times dubbed this legislative action "the Halliburton Loophole", as it was inserted at the call of then-Vice President Dick Cheney, a former chief executive of Halliburton.
Following this exemption, public concern grew stronger and a new bill was introduced in 2009 (Fracturing Responsibility and Awareness of Chemicals Act – FRAC Act) that amended the definition in the SDWA of "underground injection" to expressly include the "underground injection of fluids or propping agents used for hydraulic fracturing in oil and gas operation and production activities." The FRAC Bill requires disclosure of the chemicals used in the fracturing fluids. This Bill was introduced on 15 March 2011 in the US House of Representatives, but it has not been enacted yet; in May 2013, the Bill was referred to a congressional committee that will consider it before possibly sending it on to the House or to the Senate.
In March 2011, President Obama announced a plan for US energy security in which he also instructed the Secretary of Energy Advisory Board to improve the safety for shale gas development by working with the gas industry, states, and environmental experts in this respect.
The Secretary has set up a Subcommittee specifically tasked to work with the EPA and industry experts on issuing recommendations by examining fracturing issues. A number of high profile energy experts were appointed as members of the Subcommittee.
In November 2011, the Subcommittee issued its revised report putting together a list of twenty recommendations. The bullet point list below flags only those recommendations that are also relevant for a European discussion on shale gas:
- Disclosing the composition of fracturing fluids– the Subcommittee takes the view that the risk of fracturing fluid leakage into drinking water is remote; nevertheless, there is no economic or technical reason to prevent disclosure of all chemicals, except for genuinely proprietary information.
- Protecting water quality and supply – the regulatory system should be based on continuous and consistent measurement and public disclosure of the flow and composition of water at every stage of the production process.
- Managing the impact on communities, land use and landscape, and wildlife.
- Improving public involvement and information on shale gas operations.
On a general note, the Secretary of the Energy Advisory Board concluded that if action is not taken to reduce the environmental impact associated with the already considerably large-scale drilling and production of shale gas, there is a serious risk of real environmental consequences causing a loss of public confidence that could in turn delay or stop those operations.
The European experience
One of the ingredients for the success of shale gas production in the United States, the title to the hydrocarbons, cannot be replicated in Europe, where gas is the property of the state. As a consequence, there are no upfront benefits to the local land owners in Europe and this situation directly impacts the level of public acceptance.
In addition to this, European voters are perceived as environmentally-aware electorates with strong and vocal environmental organisations and lobbyists, and a successful track record of preventing or unwinding large infrastructure projects.
Europe's energy policy is based on three core principles: the internal energy market, security of supply, and climate change. Many observers argue that even if no shale gas is as yet being produced in Europe, US production has nevertheless radically changed the security of supply and pricing game of gas for Europe.
Under the Lisbon Treaty, EU member states are free to determine the conditions for the exploitation of their energy resources and their energy mix. They are also free to adopt environmental legislation that is stricter than the one in place at the EU level.
The Hydrocarbon Licensing Directive 1994 (HLD 1994) recognises the rights of the member states over their hydrocarbon resources. As an effect of this Directive, the upstream oil and gas market in Europe has been opened up for competition (transparent, objective, non-discriminatory criteria), ensuring that member states could not restrict exploration and exploitation rights to their own national companies. Nevertheless, it is up to each member state to decide whether to open its geographical areas for exploration and production and, if so, which particular areas to develop.
The implementation of the HLD 1994 by the member states had not been problematic.
There are no conceptual barriers that would prevent the HLD 1994 from covering the licensing process for shale gas exploration and production. As is the case with the US legal framework, the issues with shale gas in Europe will likely revolve around the environmental impact, land use and planning, and public acceptance, rather than exploration and production.
It was only in 2011 that shale gas really appeared on Brussels' radar, and no overarching, comprehensive EU policy has been articulated so far. Prior to 2011, there are almost no relevant materials, reports or press statements from Brussels on this topic.
The crucial issue with the regulatory process is to appreciate the specific geological, technical, and environmental aspects of shale gas and their variations from conventional oil and gas activities, and ultimately to address these issues and via regulation to bridge the gap presently associated with this new commercially viable sector.
Following a European Council meeting in February 2011 and the European Parliament's November 2012 call for the introduction of an EU-wide risk management framework for unconventional fossil fuels exploration and extraction, with a view to ensuring that harmonised provisions for the protection of human health and the environment apply across all member states, the Commission has released several studies on shale gas3.
A study commissioned in 2011 concluded that the existing EU legislation is applicable also to shale gas exploration, development, production, and decommissioning; however, more information was required to determine if the existing legislation was fit to cover the topic adequately.
An on-line public consultation came to an end in March 2013 and the results are now freely available4. The context of this public consultation is the preparation of the impact assessment on the 'Environmental, Climate and Energy Assessment Framework to Enable Safe and Secure Unconventional Hydrocarbon Extraction.' The questionnaire's scope is to provide an understanding of the views on the opportunities and possible solutions to address the challenges associated with the exploration and production of unconventional fossil fuels. 22,875 respondents (22,122 individuals, the rest being various public and private organisation and companies) provided their input. The majority of the respondents agreed on the absence of adequate legislation, the need for public information, and the lack of public acceptance. Out of the policy options proposed in the questionnaire, 'doing nothing at EU level' is the least appealing approach, according to the respondents. The results of this public consultation clearly show that stakeholders and the public at large expect the EU to develop an official position on shale gas followed by some type of legislative initiative.
The Commission's 2013 Work Programme proposed to deliver a framework to manage risks, address regulatory shortcomings, and provide maximum legal clarity and predictability for both market operators and citizens across the EU. The Impact Assessment will look at options to prevent, reduce, and manage surface and subsurface risks, to adapt monitoring, reporting, and transparency requirements, and to clarify the EU regulatory framework with regard to both exploration and extraction activities. Complementary studies were launched by the Commission, which will provide further socio-economic and legal support in the frame of this exercise.
Focus on Poland and Romania
Poland is estimated to hold substantial reserves of shale gas, although an inconsistency between the figures reported by the Polish Geological Institute and the reality on the ground has become apparent. The US Energy Information Administration estimates that Poland holds some 4 billion cubic metres, making this the largest reserve of shale gas in Europe.
Poland imports more than 60% of its domestic gas consumption from Russia, which in terms of energy security is considered as high exposure.
Poland has given so far 109 concessions for shale gas, covering 88,000 km², with 43 exploration wells.
So far, the Polish government has exhibited the most 'pro' shale gas stance of any other government in Europe. Public acceptance is also very high.
The US Energy Information Administration estimates that Romania holds some 1.4 billion cubic metres of recoverable wet shale gas, making it the third-largest deposit in Europe after Poland and France. This could potentially turn Romania into the biggest gas producer in South-East Europe, and provide the country's domestic consumption of gas for another 100 years.
Chevron holds a number of concessions in Romania and has announced its intention to start exploratory drilling in late 2013. Petrom, Romgaz MOL, Sterling, East-West, and Zeta Petroleum have also all expressed an interest in further shale gas opportunities in Romania.
The Romanian government's position with regard to shale gas appears to be shifting. After a period of a so-called de facto moratorium, the country's prime minister and, more recently, its president have issued public statements in support of shale gas exploration and production. Some protests against shale gas have been reported, especially in Romania's North-Eastern counties.
Title to hydrocarbons
As opposed to the US, in most European jurisdictions (with some exceptions in Germany) it is the state that holds the title to natural resources. This also holds true for both Poland and Romania: in Poland, the proprietor is the State Treasury and the Minister of Environment grants concessions as proxy of the State Treasury, while in Romania, the state itself is the proprietor and the National Agency for Mineral Resources is the authority in charge of the licensing process.
In Poland, the title to exploration and/or production consists of two (separate) legal instruments: a concession (an administrative document issued by the Ministry of Environment) and a mining usufruct (a commercial contract entered into with the Ministry of Environment).
In Romania, a petroleum agreement grants a concession right for exploration and/or production and the right to perform petroleum operations.
Authorities in charge
In Poland, the main public bodies involved in the upstream oil and gas sector are typically the State Treasury, the Ministry of Environment, the State Mining Authority and the Polish Geological Institute, whereas in Romania, the central role rests with the National Agency for Mineral Resources, while it is worth noting that the petroleum agreement needs to be approved by the Government.
The Polish Geological and Mining Act 2011 and the Romanian Petroleum Act 2004 by and large follow the provisions of the HLD 1994.
Also relevant are those provisions of the Polish Energy Act 1997 and the Romanian Energy Law 2012 that cover downstream issues. The Polish Energy Act 1997 is currently in the process of being amended to transpose the provisions of the Third Energy Package, whereas the Romanian Energy Act 2012 arguably transposes most of the provisions of the Third Gas Directive.
Who can hold a license?
In Poland, only entities duly registered in Poland can apply for an exploration licence, whereas in Romania any legal entity (foreign or Romanian) can apply for a licence, with successful bidders (if these are foreign legal entities) needing to register in Romania within 90 days as of the signing of the petroleum agreement.
Joint Operating Agreement (JOA), Unitisation and Farm-Out
The Polish Geological and Mining Act 2011 is silent on whether an investor has the option of entering into a JOA or unitisation agreement, or if the investor can farm out its interest in a block. Arguably, this would be possible, and a bill currently under public debate clarifies these options (please also see section What's next below).
All of these options are already available to a potential licence holder under the Romanian Petroleum Act 2004.
By and large, the awarding procedure is similar in both jurisdictions, based on the framework set in place under the HLD 1994.
By way of a brief overview in Poland:
- the bidding round is initiated by the Ministry of Environment and the announcement is published on its website and in the Official Journal of the European Union
- bidders are given at least 3 months to submit their bids
- the selection criteria are based on the technical and financial capability, as well as on the proposed technology for the works programme
- the winning bidder is awarded a concession and enters into a mining usufructus for up to 50 years with the Ministry of Environment.
As well by way of a brief overview for Romania:
- the bidding round is initiated by the regulator or at the request of an interested party and the announcement is published in Official Journals of Romania and the European Union
- the bidders are given 3 to 6 months to submit a bid
- a bid must include the works programme, and demonstrate the technical and financial capability of the bidder
- evaluation of the bids is set for 15 to 30 days
- the winning bidders enter into negotiations of the petroleum agreement with the National Agency for Mineral Resources
- the petroleum agreement is signed by National Agency for Mineral Resources and approved by the Government
Liabilities and Indemnities
Under the Polish Geological and Mining Act 2011:
- the licensee is liable for any damages incurred by third parties, damages caused to land and water, unless it can prove that the damages have been caused by some other entity
- the State Treasury can be ultimately liable
- there is a statutory joint liability of the licensee and other entities engaged in the operations
- there is no statutory cap on liability
Under the Romanian Petroleum Act 2004, there is no special regime for liabilities and indemnities resulting out of the petroleum operations; inherently, the provisions of the Romanian Civil Code on tort and contractual liability become applicable. Similarly as in Poland, there is no statutory cap on liability.
In Poland, there is no special regime for royalties on shale gas production under the current legislation. For exploration, there is a one-time concession fee of PLN 218 for each square kilometre of the licensed blocks. For production, the fees are structured as follows:
- high-methane gas: (PLN 6.06 for each1,000 cubic metres) X quantity of fossil exploited during a six month period
- other gas: (PLN 5.04 for each 1,000 cubic metres X quantity of fossil exploited during a six month period
Romania too has no specific royalties' regime applicable only to shale gas. The general royalties' regime in Romania is linked to the gross value of the production:
- 3.5% - below 10 million cubic metres
- 7.5% - between 10 million cubic metres – 50 million cubic metres3
- 9% - between 50 million cubic metres – 200cubic metres
- 13% - more than 200 million cubic metres
In both Poland and in Romania, the decommissioning plan must be approved by the regulatory authority.
In Poland, the decommissioning fee is set to 3% of the depreciation allowance for the fixed assets and is deposited into a ring-fenced bank account.
In Romania, there is no statutory level set for the decommissioning fee, but simply a duty to book a provision throughout the entire term of the concession.
Both Poland and Romania have by and large transposed the set of directives that have been identified by the Commission's report as applicable for shale gas exploration and production.
In 2013, Poland published a Bill to Amend the Geological and Mining Act (draft of 12 June 2013) and a Bill on Hydrocarbon Taxation (draft of 12 June 2013) that are meant to address the main issues identified so far as a gap in the existing legislation to appropriately cater for shale gas exploration and production. Some of the relevant provisions of these bills, which may be still be subject to further amendments prior to their adoption by the Polish Parliament, are summarized below.
Bill to Amend the Geological and Mining Act
- no need to obtain a concession for prospecting
- proposed new term for the duration of the concession: 10 to 30 years (currently concessions are granted for a period of 3 to 50 years)
- new and more transparent tender procedure consisting of three phases: (i) qualification, (ii) tender, and (iii) conclusion of a joint operating agreement
- bidding round tender to be initiated also by the interested party
- the joint operating agreement will be concluded with newly established state-owned joint stock company – Narodowy Operator Kopalin Enrgetycznych Spółka Akcyjna (National Operator of the Energy Fossils - NOKE S.A.)
- investment decision for moving on from the exploration to the production phase
- Farm-out is permitted and the bill expressly provides for this option.
The Bill to Amend the Geological and Mining Act has been under public consultation over the past few months. On 18 June 2013, the bill was submitted for debate and approval to the Polish Parliament, where it is currently subject to legislative works. It is difficult to estimate when the final version will be adopted.
Bill on Hydrocarbon Taxation
- high-methane gas: (PLN 24 per 1,000 cubic metres) X quantity of fossil exploited during half-year period
- other gas: (PLN 20 per 1,000 cubic metres m3) X quantity of fossil exploited during half-year period
- Additional tax of:
- 0% if ratio of income to qualified expenditures is lower than 1.5 , or
- if ratio of income to qualified expenditures is at least 1.5 but lower than 2, the tax is calculated according to the following formula: (25 X ratio of income to qualified expenditures - 25) / 100, or
- 25% if the ratio of income to qualified expenditures is at least 2.
1 Daniel Howard Yergin is a Pulitzer Prize winning American author, speaker, and economic researcher. Yergin is the co-founder and chairman of Cambridge Energy Research Associates, an energy research consultancy that is now part of IHS Inc. He is best known as author of The Prize: The Epic Quest for Oil, Money, and Power and The Quest: Energy, Security, and the Remaking of the Modern World.
2 McKinsey Global Institute, Game Changers: Five opportunities for US growth and renewal
3 The full content of the studies can be accessed at this link: http://ec.europa.eu/environment/integration/energy/uff_studies_en.htm
4 The full content of the results of the public consultation and a recording of the stakeholders conference of June 2013 can be accessed by following this link: http://ec.europa.eu/environment/integration/energy/uff_event_7june2013_en.htm
5 According to a United States Energy Information Administration study, carried out without exploratory drilling, it is estimated that France has technically recoverable reserves of 3.8 trillion cubic metres
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