Should Europe be fracking?

Daniel Gros is Director of the Center for European Policy Studies.

BRUSSELS – The global energy community is abuzz with excitement about hydraulic fracturing, or “fracking,” a newish technology that has opened formerly inaccessible reserves of gas trapped in underground shale formations. The boom in this so-called shale-gas production has allowed the United States to become almost self-sufficient in natural gas.

Europe, by contrast, is clearly lagging. Exploration is proceeding only hesitantly and shale-gas production has not even started, prompting many observers to lament that Europe is about to miss the next energy revolution. Should Europeans be worried?

Critics of Europe’s apparent lack of enthusiasm for fracking miss two key points. First, Europe’s geology is different from that of America. There is a huge difference between potential deposits hidden somewhere in large shale formations and recoverable reserves that can actually be produced economically.

In fact, estimates by the International Energy Agency suggest that the most significant recoverable reserves of shale gas are in the US and China, not Europe. Moreover, even these estimates are really not much more than educated guesses, because only in the US have shale formations been subject to intense exploration over a period of decades.

This process is starting in Europe only now. Poland appears to have Europe’s most favorable geology, and it might become a significant producer on a local scale in about ten years. This is a fortunate coincidence, because shale-gas production would probably make it politically easier to phase out Poland’s economically and environmentally irrational subsidies to local coal production (and consumption). Fracking would also be a strategic boon, because it would diminish the country’s dependence on Russia for gas.

But pro-fracking critics of the European Union miss a second point: the EU has no authority over the development of shale gas in Europe. Licensing and regulation of exploration and production are decided at the national level.

One must admit, however, that in Europe the “Nimby” phenomenon (not in my backyard) is a much more serious obstacle than it is in the US. While it might be true that Europeans are too sensitive to environmental concerns, incentives also play a role. In particular, whereas ownership rights over natural resources in the US typically belong to the individual owner of the land under which the resources lie, in Europe ownership belongs to the state.

As a result, Europeans, facing uncertain environmental consequences while receiving none of the revenues, tend to oppose fracking nearby. In the US, by contrast, local residents benefit handsomely from being able to sell their ownership rights to gas companies – a strong counter-balance to fears of environmental costs.

But private versus state ownership of natural resources is not the only institutional factor underlying the US gas boom. A seldom-mentioned reason is that shale-gas development in the US has benefited from important tax incentives – a model that Europe has no reason to emulate. Governments certainly have a role to play in supporting the development of new technologies, such as fracking; but, once the technology has been developed, there is no reason why one form of gas production should be subsidized via tax breaks.

But the most crucial – and almost always overlooked – point about fracking is that shale gas, like all hydrocarbons, can be used only once. The real issue is thus not whether shale gas should be developed in Europe, but when it should be used: today or tomorrow.

Europe is already a heavy user of gas, but its consumption is stagnating (along with its economy). Despite the hype about the shale-gas revolution, the extraction cost of (onshore) conventional gas remains below that of shale gas. Moreover, an existing pipeline network implies that this conventional gas can be brought to Europe at a low marginal cost. From an economic (and environmental) standpoint, fracking is thus unlikely to bring large benefits for Europe: shale gas might simply substitute for plentiful conventional gas.

In an environment of ultra-low interest rates, the economic cost of being late is low. The best option for Europe might be to wait and let the market operate. Fracking is not yet a mature technology, and thus it is very likely to improve over time. Maybe Europe will become a leader in “advanced fracking” when the shale-gas deposits in the US have already been exhausted.

The opinions expressed here are those of the author, not necessarily those of the World Economic Forum. Published in collaboration with Project Syndicate.

Image: Two natural gas drillings rigs operating the U.S. REUTERS/George Frey