Shale Gas Trailblazers Will Benefit From Russo-Ukrainian Rift

We believe that one of the consequences of the Russo-Ukrainian crisis will be a renewed focus on European energy security, which in turn may provide momentum for more intensive exploration of indigenous resources, specifically unconventional. We expect this to be especially so on the Eastern European frontier, where markets are particularly dependent on, or feel vulnerable to, Russian energy supplies. While accelerating US LNG supplies to Europe is one prospect mooted to enhance diversification of supplies, we believe the game-changer could take place a lot closer to home; in the shale gas space. At the forefront to benefit will be independent oil and gas explorers that have been spearheading exploration in Europe such as San Leon Energy, BNK Petroleum, and TransAtlantic Petroleum.

It should be noted that Russia has made no comments suggesting it may be looking to disrupt supplies to Ukraine -which would translate into supply disruptions further downstream in Europe- and it would be counter-productive for Russia to also use this lever and exacerbate mistrust with its European customers. Nonetheless, Ukraine's debts to Russia for gas purchased are mounting, the price Gazprom charges will go up by US$100 to US$368/thousand m3 from April, and it would be within Russia's rights to restrict supplies until its debts are settled or negotiated.

European diversification of energy supplies has advanced in recent years and the latest available data show that Russian gas made up 34% of total European gas supplies in 2012 compared to 38% in 2006 (at the time of the first Russo-Ukrainian gas dispute).

Increasing Diversification Of Supplies
Russian - European Gas Trade Data

We believe that one of the consequences of the Russo-Ukrainian crisis will be a renewed focus on European energy security, which in turn may provide momentum for more intensive exploration of indigenous resources, specifically unconventional. We expect this to be especially so on the Eastern European frontier, where markets are particularly dependent on, or feel vulnerable to, Russian energy supplies. While accelerating US LNG supplies to Europe is one prospect mooted to enhance diversification of supplies, we believe the game-changer could take place a lot closer to home; in the shale gas space. At the forefront to benefit will be independent oil and gas explorers that have been spearheading exploration in Europe such as San Leon Energy, BNK Petroleum, and TransAtlantic Petroleum.

It should be noted that Russia has made no comments suggesting it may be looking to disrupt supplies to Ukraine -which would translate into supply disruptions further downstream in Europe- and it would be counter-productive for Russia to also use this lever and exacerbate mistrust with its European customers. Nonetheless, Ukraine's debts to Russia for gas purchased are mounting, the price Gazprom charges will go up by US$100 to US$368/thousand m3 from April, and it would be within Russia's rights to restrict supplies until its debts are settled or negotiated.

Increasing Diversification Of Supplies
Russian - European Gas Trade Data

European diversification of energy supplies has advanced in recent years and the latest available data show that Russian gas made up 34% of total European gas supplies in 2012 compared to 38% in 2006 (at the time of the first Russo-Ukrainian gas dispute).

The data in the chart below show the level of varying dependency of European (including Turkish) markets to Russian natural gas supplies. The higher the level of dependency, the higher the propensity in our view of the country to explore alternative, preferably indigenous, sources of natural gas. Germany, Italy and Poland are the largest importers in terms of volumes, but the Baltics, Central Europe and Balkans are the least diversified and consequently much more dependent on Russia for their supplies.

Policy Shift A Function Of Dependency On Russia
European - Russian 2012 Gas Trade Data

Ukraine, Poland, Romania, Bulgaria, Lithuania and Turkey are the markets that have been identified with the largest shale gas resources and are at varying stages of exploration.

List Of European Unproven Technically Recoverable Shale Gas Resources, tcf
Poland 148
France 137
Ukraine 128
Romania 51
UK 26
Bulgaria 17
Germany 17
Source: EIA

Poland and Ukraine, the two countries most exposed to and dependent on Russian natural gas have been the trailblazers in European shale gas exploration. We believe this crisis has only reinforced Poland's commitment to take advantage of as much of its indigenous resources as possible. Similarly, one of the two major prospective basins in Ukraine is located in the west of the country (Lviv basin) near the border with Poland, which is within the government's effective area of control ( see 'O&G Investment Outlook: IOCs On The Sidelines', 4 March). Turkey is another interesting case. With one of the highest dependencies and volume imports from Russia, it too has strong reasons to explore what could prove to be one of the most prospective shale acreages in Europe in the southeastern Dadas shale basin. While Turkey has been much more detached from the rhetoric in the Russo-Ukrainian conflict and it maintains its own supply lines with Russia, not via Ukraine, the fact that it is the most dependent large market on Russia in Europe could push new momentum behind Turkey's strategic goal of higher energy independence. Lithuania, which is 100% dependent on Russian supplies, ended negotiations with Chevron in October 2013 over the only shale gas exploration licence issued in the country. We anticipate that recent events in Ukraine will prompt the government to revise the deal-breaking fiscal and tax proposals in an effort to revive negotiations for shale gas exploration.

If new momentum does indeed build for intensification of unconventional exploration then the independents that have been focusing on tapping this segment in Europe will be at the forefront to benefit. Even though it is the IOCs like Chevron, Exxon and Shell that hold significant amounts of shale acreage across these markets, we believe that the equity price of independents with an exclusive or overweight focus in European shale gas plays will more accurately reflect changes in policy dynamics.

These companies, and in particular TransAtlantic Petroleum, BNK Petroleum and San Leon have achieved a first mover advantage, so changes in policy to promote more intensive exploration of indigenous resources will mean they reap dividends from their pole position in the industry.

Policy Momentum Changes Will Reflect Upside
Share Prices and AIM and TSX Indices - 100 = 1 January 2014

Irish San Leon Energy is the trailblazer in European unconventional exploration and its most prominent independent, with 42 licences across 6.8mn acres in Poland. It has the most advanced stages of hydraulic fracturing appraisal in place and is expecting first production from three wells within 2014 which will mark the first commercial shale gas production in Europe. The company marked a milestone for Poland's shale gas ambitions with the discovery and commercial viability of the Lewino-1G2 well in the Baltic Basin in January 2014. The company also holds licences in Romania's Carpathian Basin, as well a pending application for a licence in the Paris Basin in France and further licences in Spain, where policy restrictions (including a full ban in place in France) have kept exploration at bay.

California-based BNK Petroleum also holds acreage in Polish shale plays and is currently exploring in the Baltic Basin, where it holds a total of 1.6mn acres and six concessions.

American TransAtlantic Petroleum is also a trailblazer in European unconventionals exploration focusing however on bringing its expertise with hydraulic fracturing in Turkey's southeast. It has made a discovery in the Molla area of the Dadas shale play, which geological indications suggest it is more of an oil play, than a gas play, but which could be one of the most prolific source rocks in the region.

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Related sectors of this article: Oil & Gas, Upstream, Exploration, Discovery
Geography: Europe, Lithuania, Poland, Turkey, Ukraine
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