Pasquale Salzano, Consigliere ECFR e Vice President for International Governmental Affairs di ENI, per Longitude sulla “shale gas revolution”

As Shale leaves Europe in the dust


Pasquale Salzano

These are hard times for policymakers and businessmen, challenged as they are by market transformations, reverse global trade flows, new price dynamics and producer/consumer imbalances. Energy scenarios are sliding with relevant economic and strategic implications. The game-changer is the already well known shale phenomenon in the US, which is reshaping the global economic scene and the US role. Such a shift in energy geopolitics would have probably happened in any case, but without the US revolution it could have taken much more time and, mostly, different directions.

The shale revolution should not be underestimated in Europe, where a deeper understanding of the ongoing global changes should open a new strategic debate. In view of Italy’s Presidency of the European Union, in the second half of 2014, our country may become the key promoter of a wider and comprehensive assessment of the EU energy future.

The extraordinary combination of two pre-existing techniques, fracking and horizontal drilling in the US, was at the origin of a process enabling low cost extraction of oil and gas directly from source rock and low permeability formations. New discoveries and shale resources are extending the world’s hydrocarbon supply base meaningfully. According to the United States Geological Survey (USGS), global gas reserves rose by one third over the last six years, corresponding today to more than 230 years in terms of consumption. Benefits for oil, although more limited, are also very significant, since there is enough oil today to cover 130 years of current consumptions: a “new Saudi Arabia”.

Even if huge hydrocarbon reserves have been discovering from Sub-Saharan Africa and Asia to Latin America, the very nature of shale production makes it specifically tailored for the US economic context. The shale expansion to other parts of the world will probably therefore require more time than generally estimated.

The revolution is already deeply affecting the relationship between the US and the global energy market. The US are quickly increasing energy self sufficiency, decreasing total imports by 30%. From being the world’s biggest gas importer, low costs and high production volumes have the potential to make the US the world’s biggest exporter potentially as significant as Qatar, Australia and the new East Africa’s gas province. Also, and more astonishingly, in a few years the US may become the largest world oil producer overtaking Saudi Arabia and Russia.

The US’s good fortune is affecting the traditional status quo: from Russia to Qatar, from Nigeria to Algeria, established oil&gas suppliers are updating their energy strategies. Beyond winners and losers, the revolution will probably produce unexpected beneficiaries and unintended consequences, which are important to assess.

Canada and Mexico, US traditional energy partners, for example, are reversing gas trade flows with the US. As a consequence, Canada lost its largest export market, while Mexico has started to import cheaper US gas in order to meet its growing internal demand. Both the Canadian and Mexican governments have therefore started to develop new energy strategies.

The Canadian government is helping national producers to access new markets in Asia through Liquefied Natural Gas (LNG) exports. China, at the same time, considers closer energy ties with Canada as a win-win case: it secures more resources to face its growing internal demand and provides equipment and capital to Canada. While Mexico is capitalizing the North American Free Trade Agreement to increase gas imports from the US (doubled over the past three years), balancing declining domestic gas output.

Against this background, however, temptations to fall in love with oversimplified scenarios should be resisted. The argument of a possible US disengagement from the Middle East (due to decreasing energy imports), for example, is more controversial than generally thought. The US involvement in that region, in fact, does not merely rely on energy aspects, but also on other strategic interests like security of key allies, fight against international terrorism and geopolitical stability.

Furthermore, the US will likely continue to import part of its oil needs and Middle East will remain a key supplier (together with Venezuela and Canada). This depends by the quality of middle eastern crudes, which are suited for US refineries, and by the lower production costs. Venezuela and Canada higher marginal production costs, in fact, are due to complex technological application to exploit extra heavy oil and tar sands.

Finally, tensions in Middle Eastern oil provinces affect global energy prices, prompting the US to maintain consistent influence in the area.

Lesson learned from the United States can be useful for Europe. Shale gas discoveries are at the very heart of the so called “American Renaissance”. The ample supply has slashed domestic gas prices, displacing coal in power generation, with benefits on carbon emissions. This dynamic, moreover, is propping up US economic recovery thanks to booming investments and jobs creation in oil&gas and related sectors. Low energy prices are revamping the “Made in the US” because low production costs and cheap feedstock (i.e. gas in petrochemicals, oil in refining) advantage US manufacturing. Moreover, the US business-friendly environment is attracting foreign investors and even strategic European industries are moving key assets to the US.

In fact, energy prices in Europe are higher than other markets and, particularly, three times those in the US. Since 2005, European industries have seen gas prices increased by 35%, while the US peers have experienced a reduction of two thirds.

How was this possible? Unconventional gas exploitation in the US has freed up significant gas volumes for the rest of the world: from being just regional, the gas market is becoming global like the oil’s one. LNG supplies originally planned to be delivered to North America have been re-directed, mostly towards Europe.

As a result of the economic crisis, moreover, Europe has been experiencing the most severe gas demand contraction of the past 30 years, while gas has been facing increased competition with other energy sources, including coal.

Finally, new policy and regulations at the EU level have been leading the European gas market towards greater integration, cross-border gas flows, and booming of short-term trading at main gas hubs in Continental Europe.

Excess on the supply side, coupled with decreased consumption, led to increasing liquidity at European gas hubs and a significant drop of spot prices. Since mid-2008, spot prices have been constantly lower than long term oil-linked contract prices (as oil-prices doubled between 2005 and 2012). A gas market dynamic completely new and opposite to the past decades, when spot prices were well above oil-linked prices was.

The benefits of European shale gas imports or production, would more likely be in terms of EU’s energy mix diversification, increased energy security or, even, stronger political and economic ties with the main gas suppliers. In the best case scenario, European shale gas could just partially compensate declining internal production. A tough prospect for a self-sufficient Europe.

Ensuring affordable, sustainable and secure energy supply for households and companies is, therefore, key for Europe’s competitiveness.

A strategic priority in this light is a stronger EU energy integration, extending interconnections among gas and electricity national networks. New infrastructure projects will of course boost employment and revitalize growth. More effective and transparent rules could also help to mobilize private capitals, making the European Business Environment more attractive: the market itself, in fact, could be the primary source of investments financing.

If deepening European energy integration is a priority, strengthening connections with supplying nations is not less strategic. Most probably, in fact, Europe will continue to import most of its energy in the coming years, and traditional producers like Norway, Russia, Libya and Algeria will continue to play a key role for Europe. Consolidating commercial and political ties with them could be an effective way to increase European energy security.

Diversification of Europe’s energy supply and a more efficient domestic resources exploitation could, simultaneously, stimulate growth and increase competitiveness. In this respect, shale gas in Europe is much more controversial than in the US, for technical, legal, political and social reasons. The debate on its possible exploitation, however, should be less ideological, more inclusive and acknowledged on benefits and drawbacks.

In front of the European Hamletic dilemma between austerity and growth, the EU could point on large transnational projects, in a renewed and more friendly business environment, attractive to private and international investors. Energy infrastructure could be the key for a more economically integrated and farsighted Europe.

The shale gas revolution challenges the Old Continent’s traditional energy posture, prompting policymakers to strengthen the strategic link between energy and the economic recovery.

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