Private equity's trepidation over European shale

Historically, private equity, unless investing from an energy-focused fund, has maintained a measured and somewhat distant relationship with the oil & gas and wider energy market. The asset class is rightfully cautious of the cyclical dangers of the energy industry and has positioned itself just outside the exploration and production (E&P) industry heart, cautiously sticking to companies that provide services, and therefore have a greater level of protection against cycles.

Will the asset class stick to the same rules when it comes to European shale gas opportunities? With a clear need for advancements in technology for safe and low impact extraction, will venture investors be vying for opportunities in the nascent sector?

European enigma
Despite shale success in the US, the size and reality of the opportunity in Europe is still unclear. The US Energy Information Agency's (EIA) latest assessment of shale reserves in Europe estimate there is 470 trillion cubic feet of technically recoverable shale gas in Europe, with Poland taking the lion's share of 148 trillion cubic feet, France coming in at 137 trillion cubic feet, and the UK lagging in the doldrums with a mere 26 trillion cubic feet. By way of comparison, the US has 567 trillion cubic feet alone.

For technically recoverable shale oil, Europe is estimated to have a total of 12,900 million barrels, this time with France leading the pack on 4,700 million, Poland on 3,300 million, and just 700 million barrels in the UK.

These estimates follow EIA's 2011 report in which Norway was believed to have 83 trillion cubic feet of shale gas. However, in its latest report this figure has plummeted to zero. While in Poland's Lubin Basin, where there was an estimated 44 trillion cubic feet of shale gas reserves in 2011, the EIA's newest report now puts the figure at just 9 trillion cubic feet.

Seperately, a report by the British Geological Survey, expected to be released today, will say that the Bowland shale in the north of England contains about 1,300tn cubic feet of gas, much more than previous estimates.

The ever-changing estimates cloud the European shale gas industry with investors' most feared state of affairs: uncertainty.

Constantine Biller, chemicals and industrials specialist at Clearwater Corporate Finance, concedes that the quality of shale assets in Europe, both oil and gas, is different to those in the US. He remains upbeat despite its complex accessabilty. "The presence of shale in the US heartland was known for decades but always thought of as too costly to extract. Eventually the technology was developed to enable cost-effective extraction. Therefore, we can naturally assume that newer technology will be developed to extract the deeper, more embedded shale in Europe." Biller believes that despite Europe's smaller volumes, the opportunity exists and there is a place for investors.

Others are less convinced, such as Adrian Reed, managing director of Altium Capital. He observes that even with its plentiful supplies, the reality of extracting shale gas is a monumental task. He points to the sheer number of wells in North Dakota alone, which for all intents and purposes is an uninhabited and undeveloped landmass, currently housing nearly 9,000 producing wells over almost 70,000 square miles. "Imagine those wells on a smaller landmass of 1000 square miles in the UK, that would be the area from Liverpool to Lancaster," he illustrates. "Then think of the population density in that area, the existing infrastructure – the roads, the railways, the sewage pipes and telephone cables." According to Reed, there would need to be a well at least every three miles, with an interconnecting network of pipes for any commercial scale exploitation.

Clusters of the UK population often struggle with major changes to their surroundings. The sheer uproar caused by the High Speed 2 rail plans and the lengthy planning requirements in place for erecting wind turbines are clear examples of the country's reluctance to change.

In Poland, where the scale of shale reserves makes it the most attractive destination in Europe, the government has already awarded 111 exploration licences. However, as mentioned above, the EIA recently downgraded the level of technically available reserves in the Lubin Basin to 9 trillion cubic feet. To rub salt in the wound, two sizable energy firms have ceased fracking operations and packed up their bags. Canadian business Talisman Energy and US oil company Marathon both failed to uncover commercially viable levels of hydrocarbons.

France, the next most promising hunting ground for shale-seekers, banned fracking in 2011. The French government has recently hinted the moratorium will ease off, making room for dozens of exploration wells. But, uncertainty is plaguing energy officials, who continually point to outdated data on the country's actual level of reserves. Even without the ban, the scepticism is mounting.

With so many unknowns, and a growing sense of resistance to hydraulic fracking in Europe, it is no surprise that we've seen few deals in the space. There are signs this could change, with Centrica's purchase of UK fracking company Caudrilla, at £40m for 25% stake (thereby valuing the company at £160m), a clear signal of the energy company's faith in UK shale. However, Reed views the deal with caution: "The deal gives Centrica an option if shale gas ever becomes a reality. And for a company of Centrica's size, £40m is practically pocket money."

Causing a frackas
The one idea that both Biller and Reed wholeheartedly agree on is that private equity will involve itself, somewhere, somehow. "The industry will watch and wait for businesses providing services to these companies," says Reed.

"The interesting opportunities for private equity are in the value chain," explains Biller. "There's a whole raft of products and services supplying the oil and gas chain that will naturally apply to shale. Furthermore, the bulk of these companies are privately owned so will provide plenty of stock for the asset class."

While uncertainties around actual levels of shale reserves persist, large-scale exploration projects are underway. This is the industry's first in-road. "Geotechnical companies already map out offshore opportunities and have developed technologies that can be used on-shore for shale," says Biller.

For Reed, while the European shale industry is at its very earliest stages, planning operations will need environmental consultants and lawyers. Companies providing these services will be well-suited for private equity backing.

If momentum picks up significantly, then the next area to consider will be around drilling work. First, stringent regulations will likely require lengthy public reports on the chemicals, equipment and people involved in drilling work. Then, the asset class will start investigating opportunities around companies that provide drill casings, water decontamination, pipe work on surface level and linking extracted gas to the grid.

When it comes to more opportunistic plays, venture and early-stage investors will need to approach developing technologies for fracking with a similar attitude to pharmaceutical investing. "Investors will have to back multiple developers in the hopes of landing one big-hitter," believes Reed.

Despite all of the uncertainly over the commercial viability of shale gas, last year Enterprise Investors took a minority stake in Polish oil services company United Oilfield Services, which plans to grow by tapping into Poland's shale gas reserves. But the vital aspect of this deal is that the company already serves the oil and gas market and is not wholly reliant on the European shale industry.

The overriding factor for any private equity investment will be growth, so while private equity's ears have been pricked by the potential returns shale gas could generate, the plethora of ifs and question marks hanging over shale gas in Europe means it will be some time before we see a swathe of such deals. And even then, the industry will keep a level of distance between itself and the core companies involved in actual drilling and extraction work.

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