Shale gas, not bound by traditional risk assessments? Part I

Separating the game changing analysis of shale gas from hype and connecting it with reality is an important task. Providing an effective analysis of shale gas requires separating between the different elements of the industry. Just as the study of oil has multiple dimensions with a mature analysis ‘industry,’ shale gas has suffered from the element of news media hype and an over reliance on the geological and technical analysis of extraction and incubation of the industry.  This focus fails to provide both a short-term and long-term perspective that assesses traditional risks existing in the energy industry.

Traditional risk analysis demonstrates shale gas is just like you and me – not a superstar Hollywood actor. The debate around shale gas as a ‘game changer’ needs to give way – including in the media – to a new level of analysis that sees the industry as bound by traditional political-economic risks. The recent report produced for the European Commission on the legal frameworks that surround unconventional ‘shale’ gas demonstrates how the laws of gravity apply to this ‘new’ technology.

The study examines the legal and regulatory framework in four EU Member States: Poland, France, Germany and Sweden. The report provides a good overview of the legal environment, and the licensing procedures, including public involvement and how environmental concerns and impact of the technology are addressed.

What emerges is a barenaked industry, with limited drilled wells and companies operating in constrained regulatory and legal framework. No doubt improvements could be made to the permitting process and procedures streamlined or public involvement increased, but the industry is not breaking down the steal door to become the disruptor of the gas sector. There are too many traditional risks blocking a clear path to a broad use of the technology.

A risk typology can be produced that demonstrates just how down to earth shale gas is. Drawing from two categories of risks that I put together for an article on the transition towards a low carbon economy by 2050, the risks emerge as applicable to the new industry.  If we take the identified risks, and just list a few anecdotal events then we can see the constraints.

Contractual risks

  1. Fuel price risk: price variability and uncertainty over future costs; e.g. comparison between Russian pipeline gas and shale gas.
  2. Demand risk: gas produced will not be needed as projected; e.g. impact of renewables, LNG and pipelines (and energy efficiency?).
  3. Performance risk: wells do not produce as predicted to satisfy contractual obligations.
  4. Environmental compliance riskThe financial risk to which parties to an energy contract are exposed, stemming from both existing environmental regulations and uncertainty over possible future regulations; e.g. this is the most popularized risk at the moment, France and Bulgaria demonstrate that public opinion can lead to blocking the use of shale gas technology.

Regime risks

  1. Financial risk: no or limited amount of money available. This does not seem too applicable at the moment.
  2. Regulatory risk:  The risk that future laws, regulations, regulatory reviews or renegotiation of contracts will alter the benefits or burdens of contracts for either party; e.g. this is real and tightly connected with environmental risks.
  3. Technological lock-inPerpetuation of a dominant design that is inferior to newer technology. Industries that have a significant systemic-technological relationship are most susceptible, due to buffered market forces. This may be more applicable in Russia where shale technology is not being deployed. But the use of ‘traditional’ conventional technologies may be encouraged to be used first before unconventional technologies are deployed; e.g. the ban in France and Bulgaria will continue the use of established technologies.
  4. Institutional lock-inTo reduce uncertainty and to provide continuity to past investors regulatory institutions may change only incrementally, thereby relying on older technologies and inhibiting newer technologies. This may not occur like this, but avoidance of unconventional technology by regulators may lock a country into older technologies, that over time, if traditional gas fields faulter, won’t work as well.
  5. Administrative capacity risk: Constrained staffing levels in government institutions prevent a larger policy and regulatory response. This may occur, as demonstrated in the EC report, if laws and regulations and the agencies that implement these, are not made more flexible or given the tools to properly account for the special characteristics of the shale gas industry.
  6. Investment risk:  Investments are impacted due to uncertainty in the operational environment; e.g. the differenence can be seen between different countries like Bulgaria and Poland, where one country is not moving ahead and the other is. At the moment, it seems like there are willing investors and uncertainty in any country (only legal blockades) are preventing greater investment.

Geopolitical risks: relations with third countries. This is a separate category that needs a full analysis of how Russia is and will react to greater use of unconventional gas technology in Europe.

The categories listed here provide a rough guide to examine the types of risks that have emerged to stop greater investment and what risks may emerge more forcefully in the future. No doubt environmental compliance risks, administrative capacity risk and geopolitical risks emerge as key areas that the industry must focus on. These are divergent risks and take different strategies to overcome or to mitigate. But effectively addressing these becomes important to the growth or decline of the small industry in Europe.