Introduction

Although geologists have known of the existence of unconventional gas for many years, it is only following recent technological advances that it has become commercially profitable to extract. This has had a significant impact on gas production prices in the US in the last five years. In this update we consider the current trends relevant to unconventional gas, highlight areas of new development in Europe and set out some of the key regulatory and other constraints likely to impact this thriving sector.

Background

The three main types of unconventional gas are shale gas, coal bed methane (CBM) and tight gas. Shale gas is natural gas trapped in shale, a common sedimentary rock; CBM occurs in underground coal seams and the surrounding rocks; and tight gas is natural gas which is trapped in unusually impermeable, hard and non-porous rocks. The abundance of shale makes shale gas the most promising of the unconventional gas resources – gas analysts estimate that shale gas could increase the world's known reserves of natural gas by 20% or more.

Among the recent key advances is the ability to drill horizontally and the development of a process known as hydraulic-fracturing ("fracking"). This process injects quantities of water, chemicals and sand via special wells to shatter underground formations and release trapped gas.

European opportunities

While the success of shale gas in the US is well documented, investors are becoming increasingly interested in opportunities to develop unconventional gas projects in Europe. Investors are attracted to the significant estimated quantities of unconventional gas reserves in Europe (up to 549 tcf of shale gas, 431 tcf of tight gas and 275 tcf of CBM:), potential benefits include perceived low entry costs, attractive fiscal regimes, stable regulatory environments and, in some cases, the existing gas pipeline infrastructure. Current development targets include the European shale basins of the Baltic Basin in Poland, Lower Saxony Basin in Germany, Makó Trough in Hungary, East Paris Basin in France, Weald Basin in England, Vienna Basin in Austria, and Cambrian Alum Basin in Sweden.

Poland is of particular interest to investors. It is thought to have extensive unconventional gas reserves and the government appears to be broadly supportive of development as a means to reduce energy dependence on Russia. It is also less densely populated than other European states meaning that more areas could potentially be opened up for drilling. The Polish government has already granted around 60 concessions for shale gas exploration and some drilling activity has already begun.

Hurdles and constraints

Despite the potential for development, critics point to a number of issues constraining the development of unconventional gas resources, including:

• Regulatory issues: regulatory regimes for the exploitation of gas reserves have been developed in response to the demands of conventional gas developments and conflicts between the jurisdictions of different regulatory bodies with different agendas. Accordingly, some countries may need to amend existing legislation to deal with the development of unconventional gas resources and investors in unconventional gas projects will need to be alive to the possibility of change in law risk.

• Environmental issues: although the increased use of natural gas as a fuel (in place of fuels which emit large amounts of CO2 when burnt, such as coal) is seen as one of the quickest, most realistic and cheapest ways in which targets for carbon emission cuts could be achieved, significant and increasing environmental concerns could hinder the development of unconventional gas reserves. This is particularly the case in the US where energy regulators are already on a heightened state of alert following the Deepwater Horizon incident in the Gulf of Mexico. Among the concerns are that chemicals added to water as part of the "fracking" process could contaminate local drinking water. In response, the US Environmental Protection Agency has initiated a study into the potential adverse effects of "fracking" on water quality and public health, although this will take at least two years to complete. Until then, many state regulators have put in place local monitoring programs, for example the New York State Senate has recently approved a nine month moratorium on issuing new shale gas drilling permits. At the national level a bill has been proposed (the Fracturing Responsibility and Awareness of Chemicals Act or "FRAC Act") which would, if enacted, allow the Environmental Protection Agency to regulate hydraulic fracturing and would require the energy industry to reveal what chemicals are being used in the sand-water mixture. Obviously, environmental considerations will also be of concern outside of the US and other jurisdictions will be closely following developments in the US in this regard.

• Ownership of resources: the US oil and gas regime is based on the landowner owning the resources beneath its land. However in many other jurisdictions the ownership of oil and gas in the ground is specifically vested in the state. Accordingly, in the US landowners have a vested economic interest in the development of unconventional gas resources and are consequently more likely to be tolerant of such exploration and development operations. Unconventional gas operations are large and invasive and in jurisdictions in which the state is the owner of the resources but not the surface land and the local population is not a direct beneficiary of the proceeds of production, there is an increased risk of opposition from local communities and/or nongovernmental organizations.

• Operational and commercial issues: as noted above, drilling for unconventional gas projects is a large and invasive operation. Rapid production decline in wells can necessitate continuous drilling operations and such operations are likely to attract local opposition in densely populated areas, creating difficulties in obtaining planning permission.

Conclusion

It remains to be seen whether unconventional gas reserves in Europe can achieve a change in the gas landscape as dramatic as that in the US. Although there is skepticism about the size and profitability of unconventional gas reserves, it appears the rewards could be very substantial for companies that can successfully and economically develop unconventional gas. It is clear however that there are sizeable regulatory and other risks which investors should be conscious of before making any binding commitments.