Shale Development in Eastern Europe: Interview with Keith Smith

Ambassador Keith Smith is a Distinguished CEPA (Center for European Policy analysis) Fellow in Residence. Ambassador Smith was previously a Senior Associate at the Center for Strategic and International Studies (CSIS). He retired from the U.S. Department of State in 2000, where his career focused primarily on European affairs. From 1997 to 2000, he was U.S. Ambassador to Lithuania, with additional posts in Europe, including Hungary, Norway and Estonia. In addition to several other State Department assignments, he most recently served as Director of Policy for Europe and Senior Advisor to the Deputy Secretary of State regarding U.S. assistance programs in Eastern Europe. Since 2000, Smith has been a consultant to several energy companies and has lectured on Russian-European energy issues in the United States, Poland, Belgium, Norway, United Kingdom, Germany, Czech Republic, Estonia and Lithuania. He is the author of numerous articles on international energy issues that have appeared in over 30 newspapers around the world, including the Financial Times and International Herald Tribune. Smith’s most recent publications include “Unconventional Gas and European Security: Politics and Foreign Policy of Fracking in Europe,” “Managing the Challenge of Russian Energy Policies,” and “Lack of Transparency in Russian Energy Trade.”   Ambassador Smith, thank you for taking the time to speak with us today. Based on your biography, you have spent the past two decades actively engaged in Eastern European energy policy and affairs. How has the situation changed since you became Ambassador to Lithuania in 1997? Several things have changed, most of all, my perspective. Beginning in the early 1990s I became much more aware of the use of energy as a political weapon on the part of Russia. I was first made aware of the issue of energy as a weapon in 1992. I was stationed in Estonia for the State Department and suddenly oil and gas were cut off for political reasons. In order to stay warm, we had to sleep in a hotel with blankets piled over us. These kinds of moves by Russia were intended to force the Baltic States to follow Moscow’s insistence that its military officers be allowed to remain in the Baltic States. After some help from the West, Russia re-opened the pipelines. Over a separate two year period (1998-2000), I watched Russia shut off oil flows from the Druzhba pipeline to the Mazeikiu oil refinery nine times. These latter disruptions made me determined to look more closely at this type of coercion. In many years past, I worked in oil producing countries Venezuela and Norway.  That experience increased my interest in energy. But with what I observed in Central Europe, I became more and more interested in understanding Russia’s use of energy as a coercive economic instrument. Here at the Center for European Policy Analysis, we’re working now on developing a comprehensive paper regarding best practices and best science of hydraulic fracturing so that we can spread information regarding these important technologies around Central Europe.  We will publish those materials in English and hope to translate the paper into Polish, Ukrainian and Romanian. I’ve been to Poland six times in the past year, the latest a month ago and have been following the painful process through which the Polish Government is trying to develop a new hydrocarbon law that will increase incentives for foreign energy companies. Recently passed after a two year delay, the law encourages companies to operate in Poland and to step up their exploration and exploitation of shale oil and gas. Russia has tried to discourage the Central Europeans from engaging in fracking operations. Can you tell us more about Poland’s new hydrocarbon law? The new hydrocarbon law that the Polish Parliament has passed is much better for companies interested in helping Poland tap its shale gas resources. The law provides a five year tax window for companies to exploit discovered hydrocarbons. In the past, in order for them to exploit a resource after discovering it, they would have had to go through a long process to acquire another license allowing them to develop production. This law has been in the making for quite a long time. Hopefully, it will encourage companies to speed up the whole fracking process, and bring in more rigs. The process has been delayed because of internal arguments within the Polish government about how to create a small Polish company that would have a piece of the action in all shale operations. There have been extended internal disputes over which ministry was going to control NOKI—a state-owned gas company that would work on hydraulic fracturing.  This long-running discussion delayed the entire process and damaged the momentum that existed when the companies first applied for permission to operate in Poland. The hydrocarbon law was written by the Ministry of Environment.  In the past, the Ministries of Economy and Treasury were the prime actors in the energy area. In the meantime, companies in Poland have fracked a little over 40 wells in the country over the last three years. A lot of time has been lost in internal discussions. Now, with what’s happening in Crimea, there’s pressure to move faster. Does public opinion strongly support use of fracking technology to develop domestic resources? When it comes to public opinion, there’s not as much opposition in Poland as in some of the other Baltic States. In Lithuania, Romania, and Bulgaria, there has been a lot of public outcry against the use of hydraulic fracturing technology. A lot of this is stirred up by greens in Western Europe. In some cases, funds have flowed from environmental groups in France to demonstrators in Central Europe who are concerned about the alleged environmental damage. Can you elaborate on some of those external influences? Some Western European greens are promoting unsubstantiated claims about damage to the environment and public health from fracking. There are also environmentalists pushing to stop any kind of hydrocarbon development whatsoever and immediately move to a fully renewable system. This policy is wildly unrealistic. Finally, there are power companies, such as the coal and nuclear industries that oppose natural gas development in central Europe. And of course, there are the Russians themselves, who don’t want to lose their stranglehold over European gas markets. They promote propaganda campaigns designed to frighten the public away from hydraulic fracturing. Of course, Russians have been fracking in west Siberia for some time, so this reflects the usual hypocrisy out of Moscow. Some greens, however, are legitimately motivated by their environmental concerns, but others are front groups for Russian interests. For example, there’s the American documentary, Gasland, produced by Joshua Fox. Gasland has been shown around Europe, but it’s unclear who has been distributing it or paying for it to be shown. The first Gasland movie was shown twice in the EU Parliament.  The films are full of unsubstantiated allegations designed to frighten the public. Can you speak toward the sentiment on the ground about the urgency of moving away from dependence on Russian oil imports? In Poland and Ukraine, what do they see as most viable: developing their own resources, importing LNG from other nations, or demand reduction? It used to be that if you brought a drilling rig into Poland, it had to be dismantled and examined, then reassembled and moved to the site. They’ve cut down on most of those kinds of barriers, but substantial commercial production is still a long ways off. Poland is in a rather messy situation with some of the energy agreements they’ve made. For example, the country signed a long-term contract with Russia in which it agreed to pay too much money for natural gas. It also signed a 20 year deal with Qatar for some of the most expensive natural gas in the world.  The country is stuck with these poorly thought out contracts. In terms of infrastructure, a lot of pipelines are being considered, some of which will probably get off the ground, but the government has moved rather slowly. A pipeline from the LNG receiving plant that will go south to Slovakia and the Czech Republic is in the works, and another is planned to go from the German border to Gdansk. It’s been a very slow operation. The EU has only taken energy security seriously since 2009 when the shutoff impacted Western Europe, but the Commission is now helping quite a bit. In addition to shale gas development, is there political will behind demand reduction solutions in Poland and Ukraine? That’s a tough question… Poland and Ukraine are very different. Poland has taken some steps to reduce demand. The United States government played a role in the 1990s in providing energy efficiency programs through USAID programs, and the energy efficiency projects were particularly good. Demand reduction is very important in Ukraine, which has the second worst energy efficiency per capita in Europe, second only to Bulgaria. Ukraine is improving slowly—there is an energy efficiency program funded by the World Bank that is helping. All of Central Europe could do more to beef up energy efficiency programs.  A major challenge is the large amount of corruption in Ukraine, which means there needs to be a lot of monitoring by Western donors to ensure the funding for these programs is utilized properly. That monitoring and accountability is important because there is a tremendous amount of room for improvement in Ukraine. There are opportunities to improve the production side. It’s not just fracking. There’s a decent amount of conventional oil and gas in Ukraine; I used to consult American companies looking to tap those resources, but it’s extremely challenging for Western companies if they don’t have a politician or some other advocate to protect them from the corruption. We need to wait and see if the new Ukrainian government, the EU, and the IMF are vigilant enough in protecting foreign investors. In Poland, I don’t think they need as much work on that end. It’s not as corrupt. The Poles can tap their shale resources if they just get their act together. One of the major enablers of shale development in the United States has been mineral and property rights. How are they different in central and eastern European countries? Has the recent law brought the European regulatory structure closer to the one here in the United States? In Europe, it’s still structured such that the subsoil resource belongs to the state, whereas here in the United States, those resources belong to the property owner. So that difference remains, but it doesn’t have to be a problem when people have confidence that money from resource extraction will be returned to their community in one form or another. Aside from that, the regulatory environment in Europe is not that much different—the environmental laws they have established are pretty reasonable. Everyone has to be careful and make sure that fracking is done right. One of the bigger setbacks for European shale, though, is that they don’t have the kind of oil and gas production and distribution infrastructure that we have here. It’s very challenging over there. They have to bring in rigs from a very long way, and don’t yet have the right kind of pipelines and networks to move product around quickly. In 2012, ExxonMobil announced that it was abandoning plans to pursue shale gas development in Poland, despite Poland’s strong desire to tap its shale resources. After drilling two exploratory wells, Exxon said that Poland’s shale deposits were not “commercially viable.” Given that it often takes hundreds of wells to even begin commercial shale production, this raised some eyebrows. The move coincided with a deal with Rosneft to develop tight oil reserves in Siberia. Can you give us some background information on this deal? Was it a simple matter that Rosneft has more appealing reserves, or was there some possible collusion involved? I think that the conspiracy theory is wrong. The general manager for ExxonMobil in Eastern Europe is right across the border in Ukraine, and he’s running operations over there. At the time ExxonMobil moved out of Poland, it was taking six months to drill a single well, due to the various hurdles we’ve discussed. They decided to take their money out of Poland and invest it where they would get a better return, such as the United States, Ukraine and Russia. Keep in mind, Poland isn’t just competing with other European countries for shale development.  It’s also competing with North Dakota, Texas, and Pennsylvania. From ExxonMobil’s perspective, it just didn’t look like Poland was going to finish its hydrocarbon law very quickly.  That’s the reason they pulled out. Exxon is too big to be pushed around by Russia. I’m of the view that the challenges in Poland came from national policies, not geology, or even intervention by the Russians. We know that in the short term, American LNG supplies are not a solution to the immediate threat of disruption of Russian gas supplies. There’s also the issue that LNG import prices are higher in Asia than in Europe, creating incentive for companies to move product to Asia, rather than Europe. Given these factors, what other options are on the table? What advice would you give energy policymakers, not only here in the United States, but also in Poland and Ukraine? First, we need to change the approval process for LNG export facilities, and also allow crude oil exports from the United States. Right now, ever since 1973 (OPEC oil embargo), Congress only allows refined oil products to be exported. But refineries in Europe need crude supplies. We could also release 500,000 barrels per month from our strategic reserves, and send some of that to Europe right away, in a form of swap. There’s no question—LNG exports to Europe are no quick fix, and American companies are incentivized to ship gas to Asia because LNG import prices are higher there. American gas production has already impacted the European market in a positive way, because we’re already not importing gas, which loosens up the market. Regarding the second part of your question, of course the U.S. government can’t tell companies to send gas to Europe, but the fact that we’re not buying LNG from abroad frees up supplies for Europe. Additionally, I think it would help if the Department of Energy and the President more publicly announced oil and natural gas production statistics in the United States—they need to aggressively publicize those numbers on a quarterly or monthly basis. Improving public education will sway the opinions of some in Europe who are skeptical of the long-term impacts of the shale boom. There’s also the matter of technical assistance—FERC could help with regulators in Ukraine with best practices and other measures to make their energy market more transparent and competitive. And maybe the U.S. and EU can make a strong case for price reduction by Poland, which can transport gas through existing pipelines to Ukraine. Finally—the U.S. should really encourage the EU to stand firm on non-completion of the South Stream pipeline. That pipeline is being constructed in order to provide Russian gas to Europe by bypassing Ukraine. If Russia can bypass Ukraine, then Ukraine is in an even worse position than it is in now. If Russian gas needs to move through Ukraine to reach the rest of Europe, it gives Ukraine more economic clout, which is very important for them at this point.    This piece is part of a series of interviews conducted by Securing America's Future Energy with experts in the energy policy space. Views presented in interviews do not necessarily reflect the policy positions of SAFE or SAFE staff.