Shale Comedy of Errors

Shale gas exploration frenzy in Poland has nearly all been rhetoric and very little action. How it did not work?

Owing to the Chief Geologist of Poland, a Deputy Minister for Environment at the time, Prof Mariusz-Orion Jędrysek, exploration for shale gas in Poland started in 2006. His original strategy was to award around ten exploration licenses spread widely across the prospective basins, then appraise the results and decide on the next step. Following change of the government, and the departure of Prof Jędrysek from his office, since 2007 Poland went into a shale gas frenzy, reaching its heights in 2010–2011. More than 110 exploration licenses were awarded at one point. (One also has to bear in mind that a size of a typical exploration license in Poland is around 10 times larger than its typical counterpart in countries such as Norway.)

More than 7 years later, as of November 2013, only 49 wells were drilled (only 7 of those were horizontal) and 16 wells were fracked. In order to appraise a typical exploration license in Poland, due to its vast size, around 10 wells must be drilled. By comparison, in the last four years in Pennsylvania, in the area more than 5 times smaller than the area licensed in Poland, more than 1,600 have been drilled. Therefore, any claim that there is, or ever has been, a real shale gas exploration in Poland is an insult to intelligence. Shale gas exploration frenzy in Poland has nearly all been rhetoric and very little action.

Is the current disappointment with the state of shale gas exploration in Poland so unexpected? A matter for a benefit of hindsight reflection? Let us examine some of the relevant considerations. How it did not work?

“Free” for “All” Licenses

In 2006–2007 when it all started, the licenses awarded were only for exploration. They did not give automatic legal rights for production (whilst it was claimed that the practice up to then implied such a legal right, it was not on statue books. It could have been easily disputed leading to many years of legal wrangling and delays, which would kill any development project).

Exploration licenses only give the right to spend money. However, they do not give any right to make money, i.e. start getting a return on investment, if exploration proved to have been successful. Therefore, no one would expect any private company to start making any significant investment in such circumstances, facing a realistic risk that its exploration success can be auctioned off to the highest bidder, possibly its competitor.

Monopolistic Market

In 2006, as it is now, Poland’s gas market has been dominated almost totally (nearly 100%) by the state-owned monopolist, PGNiG. For many years, PGNiG has been locked into a very expensive and unfavorable gas supply contract from Russia, which runs out in 2022. Any independent and competitive gas production in Poland would threaten the very existence of PGNiG. Being government-controlled, the company is really the government in Poland with respect to natural gas issues. No one can expect that the government would do anything, which might damage the survival of PGNiG. In fact, the structure of oil and gas, as well as natural resources, business in Poland is such as if the market changes post-1989 collapse of centrally-planned economy never happened. Hence, despite all the rhetoric as shale gas subject has been sexy, in practice, it was a reasonable expectation that the government would do everything to frustrate the development of the shale gas exploration in Poland. In practice “doing everything”meant “preserving the key aspects of the existing status quo.”

Furthermore Poland, as Europe in general, does not have a competitive and top technology oilfield services market. These services, not surprisingly, are dominated in Poland by the subsidiaries of… PGNiG. The business of any independent service provider is so much dependent on the state gas monopolist. This makes the market completely closed.

Mentally Taxed

In practice there is no tax on oil and gas production in Poland. There are some small fees, which can amount to around 1%–2% of the value of produced hydrocarbons. The oil and gas companies in Poland pay a standard corporate tax of 19%. Therefore, those who create economic value thanks to their business initiative and ingenuity pay tax on the same basis as those who extract natural resources. In fact, in 2004, when the oil price was growing rapidly the corporate tax was slashed from 32% down to 19%. Whilst it was the right move with respect to nearly all service sector companies, it was clearly irrational if applied to oil and gas production. In a way this situation could have been sustainable had the hydrocarbons been produced in Poland by companies owned in their entirety by the state (i.e. what the state does not get through taxes, it would get through dividends). Although such situation creates its own pathological outcomes, inefficient companies, which behave like their management empires, with “a state inside a state” mentality.

Such tax situation was clearly unsustainable if shale gas was to be produced in Poland by private companies on any significant scale. It would have clearly amounted to a robbery of state-owned natural resources. Yet, bizarrely, a number of corporate presentations showed this tax situation not as an uncertainty and unresolved high long-term risk, but as a very friendly business environment. In 2012, the reality just showed that. The government inspired discussion on tax on future production of shale gas showed this misunderstanding of the business fundamentals in full glare.

Russian Gas? Yes, Please!

It also appears that the private companies, which entered Poland believed that the Polish government—being heavily dependent on the Russian gas supplies—would be very keen to develop the indigenous shale gas production and give very favorable business terms to the companies that would do so. It was clearly an irrational approach. As the Polish Geological Institute records show, Poland has had abundant conventional gas reserves and resources to have been independent on the Russian gas supplies all along. The fact that it is, is a direct result of the policies and actions of all successive Poland’s governments since the 1980’s. On a rhetorical level many politicians argue for, and seemingly work towards, making Poland independent on the Russian gas supplies. It appeals to many voters. However on a practical level all is done to keep Poland in this dependency: “nondevelopment” of local abundant conventional gas resources combined with long-term, “take-or-pay” supply contracts from Russia. It begs a question why private companies entering Poland could not understand that the Polish desire of energy independence is in practice nothing more than a political slogan. In reality, everything would be done to bolster the Russian energy position on the Polish market. Incidentally a very similar process to one which happened in Poland a few decades ago and made it dependent on the Russian gas supplies, has been happening in coal business now. Whilst the coal production is deliberately made uneconomic and pushed into decline, Poland pushes hard for further development of coal-based electricity generation, leading to a rapid growth of coal import. One can only guess where the imported coal is going to come from.

Know Your Environment

Both the Polish government as well as private companies believed that environmental concerns were at the top for the local communities’ agenda in the areas of prospective shale gas developments. Inasmuch as we cannot disregard the issues of safety, such approach was not justified by the evidence then. There was a long catalogue of examples showing how local communities damaged their own environment. For example, treating surrounding local forests as a dumping ground for general waste, or releasing farm waste into local rivers is not uncommon. Furthermore the natural resources business was developed successfully in Poland in the past. It is popular, in some instances very prestigious. For example copper mining in Lubin region, coal mining in Silesia and Lubelskie.

The key reason, which made these industries so popular seemed to have been completely overlooked by the government and the companies looking to explore for shale gas in Poland. It was the fact that these successful copper and coal industries grew from within the local communities. They did not offer handouts or ran expensive media campaigns how good they were for the local people. Instead, they present employment and education opportunities to local people. They see their future and future for their children in these industries.

However, in case of shale gas campaign, local communities were subjected to dialogue and awareness exercises instead, presenting how safe it all was in general and how good and prospective were private gas companies. In truth— however still subject to competent management of the industry by the state authorities, which can be a long shot in Poland—they may well be. Ultimately the oil and gas industry which really benefited the countries as well as local communities, as in Australia, Canada, Norway and the US, were developed with a strong participation of the private sector, under a strong state control. Nevertheless running cheesy media campaigns exactly at the time when the private pension system in Poland has had effectively collapsed and it had also promoted itself in the same way some 15 years before—which is well remembered— can only be counterproductive. Such PR stunts seemed to have crossed the border of farce. No wonder Poland is now a country that whilst shale gas exploration is very popular overall— with around 75% support—this support goes dramatically down once a shale gas exploring company starts realizing the country’s “dreams.” The support is reversed into opposition. And picket lines are not uncommon.

“No Free Lunch”

“There ain’t no such thing as a free lunch.” Technically the shale gas licenses in Poland were awarded for free (i.e. at administrative cost only). However recent report of the Poland’s Supreme Chamber of Control pointed out that some companies applying for licenses were treated more favorably than others. In fact, there is a very well known story how a multinational entering Poland applied first through their law firm for licenses. Considering a global presence of the said multinational and their vast experience, it is hard to believe that their application could have possibly been defective in any way. However it was turned down. Subsequently the company decided to hire some Polish officials related to the award process as consultants to help with the preparation of the application. And… it was successful. This story was repeated at the Polish Geological Institute, on a side, to other prospective applicants with rather obvious intentions.

It must have been unsurprising to many when the arrests of state officials, including people from the Polish Geological Institute, were made in January 2012. It is another matter whether the arrests were meant to stop the discovered corruption practices. Or they were nothing more than a re-arrangement of a share of proceeds from such practices.

Poland: Opportunities Lost

In 2010 and 2011 at least two Polish state- controlled companies were approached by the oil and gas world leaders. The aim was partnerships in Poland, standard modus operandi in the industry. This would have been beneficial for all involved: local risk sharing, better contacts with the government and on the ground, better ability to argue for and shape future policies. In return the Polish companies had a chance to gain access to producing oil fields abroad. In a way, it would be a way of trading Poland’s high shale gas long-term prospects for a share in existing but mature fields. The synergy was obvious. As Poland imports nearly all of its crude oil, nearly all from Russia, this would have been a very welcome development for the Polish companies. Whilst such deals are not always easy to make, this was an unprecedented, once in a lifetime, opportunity for the state-controlled Polish oil and gas companies to give a turboboost to their upstream ambitions. However, there was no interest on a Polish side: no serious negotiations took off. In fact, one of these two foreign companies left Poland shortly after this failed partnership attempt. The other one decided not to enter at all. In the latter case the corrupt license management practices mentioned above were also a serious consideration.

Meanwhile Poland was filled with the government rhetoric of making Poland a “second Canada” or a “second Norway,” I. e. natural resources managed effectively for the benefit of the country. In contrast to the declarations the government officials were not interested in a material cooperation with Norway. For example Norway is a significant provider of development aid to Poland (e.g. “Norway Grants”). Norwegian sovereign fund is vast, worth many hundreds of billions of dollars, at the level that is hard to manage safely in the current economic climate. However Norwegian hydrocarbon reserves are on a declining path. Norwegian oil and gas industry needs new frontiers to develop. In these circumstances it would have been quite natural for Norway to consider a tax deal whereby investments in shale gas business in Poland of companies operating in Norway could be to some degree treated as if they were in Norway. This would have provided a risk sharing element, but also—and more importantly—brought the credibility to the nascent Polish shale gas industry. Of course, the Norwegian government would have negotiated hard. However, considering that Poland and Norway are members of NATO, Schengen Treaty, European Economic Area, this approach had a clear hallmarks of being a win-win deal for both sides. Yet, despite a “second Norway” rhetoric, Polish government was not interested in such thinking.

All these indicate that, after all, Poland was, in reality, not much interested in developing its local shale gas production or building crude oil production abroad. The government was caught in the midst of unexpected developments. It is not surprising: as Poland failed to become self-sufficient in natural gas supplies (Poland’s consumption is around 15 Bcm a year) using its abundant indigenous conventional reserves (at least 170 Bcm) and resources (around 1.73 Tcm), it would have been rather paradoxical if it achieved that based on more risky and expensive shale gas potential.

Leaving rhetoric aside, only looking at the hard facts, Poland’s dependency on Russian gas supplies clearly appears to have been self made altogether, an inherent part of the Poland’s foreign policy paradigm. It is the only constant goal achieved since the early 1980’s. It went unchanged through the 1989’s collapse of the soviet system. Whether it has been an intended effect or an unwanted outcome is quite another matter. The answer to this dilemma looks to be different with respect to different, successive governments in Poland in the last three decades.

Need of Brain Fracking

None of the above is surprising in any way. Yet most think-tanks and mainstream media publications had been optimistic, very enthusiastic at times until just over a year ago. Articles claiming that “Poland was steaming ahead”and other selfserving rhetoric were common. Shale gas, as well as vast quantities of conventional gas, still is in Poland. It has not gone away. The problem is not in the ground—although shales in Poland are technically very challenging indeed—but in the heads of those governing the industry. Both on the business and government (including regulatory) sides.

Poland needs a rethink in its approach to natural resources management altogether. It has to be prepared to think with its best long-term interest in mind, beyond the ongoing agenda of different interests groups. In the same way as the general economy in Poland was reformed post-1989, when it failed and was unmanageable, natural resource industry needs a fundamental turnaround to stay under state control but be a part of a proper, free market competitive system. It is not a matter of one bill of law, “hydrocarbon law,” that may go through the Polish parliament, Sejm. It is a process of reforming the industry structure and turning around the management practices.

The apparent lack of understanding of the need of such changes by the industry leaders is not helpful. As the quest for shale gas propagates across Europe, currently reaching such diverse countries as the United Kingdom and Ukraine, the failures in Poland and clear lack of reflection over it, affect the industry’s reputation on competence. The negative public perception is compounded by the high and growing energy prices vis-a-vis impressive companies’ profits and, very often, their offshore tax avoiding arrangements (i.e. a perception that companies do not pay their fair share to the society). Quite often rather than being seen as a huge opportunity at the current depth of the economic crisis in Europe, the industry which has been hugely successful thus far is seen as exploitative and a threat to a long-term future. This led to a quite unusual situation that even some prominent environmental activists joke that there is no need for “action” to stop fracking in Europe—“watching brief” and some local protests are enough for now—as the industry is damaging its own interest sufficiently anyway.

Poland, as well as Europe, needs oil and gas for many years to come. This is a hard truth. The economic growth is critical at this stage of a cycle. Shale gas and now oil developments are major drivers of the economic recovery, industrial revival and new security foundations in the US. Clearly, in Europe, before shales can be fracked effectively to extract gas and oil, the brains of many politicians, policy advisors, journalists and indeed industry captains need be fracked to free the flow of some common and business sense. Only then, shale gas—and oil—has a chance.

Grzegorz Pytel

Senior Policy Adviser, Sobieski Institute, Member of Expert Advisory Panel, Shale Gas Europe.

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