Hungary: Oil and Gas Peak or a Renaissance?

Oil and gas import dependency is the major issue for CEE countries and is the key former of energy policy, not just in the region, but on the EU level as well. With the shale gas revolution in the United States, the existing conventional policies have been challenged by an unconventional method, technology, business model and thinking which created huge expectations and controversy as well. During the shift from the oil age towards renewables, can Europe or its member states switch from an uncompetitive and constrained subsidiary-based energy policy towards a competitive and market based model as seen recently in the US combining GHG-emission reduction with reindustrialization? Or is it our inescapable fate to do it in the old fashioned way, straining obsolete policies and remaining uncompetitive?

On one hand, there is Germany, which chose to be a trailblazer with its renewables policy where the results are interpreted as a poster child by the greens with low GHG-emission and cheap electricity prices possibly serving as a greening model for other countries. But the majority of the experts are worried that this poster child can also be a basket case where export based German economy simply loses its competitiveness in the midterm. And the truth lies somewhere between the two sides: CO2 emissions are rising in Germany since last year despite the efforts of greening the energy production and low electricity prices are present only on the wholesale market which does not affect end user prices yet, but instead the seasonally cheap German green-electricity simply crushed the CEE electricity wholesale market. This left many countries in the region to simply give up the more effective power generation strategies and choose the electricity import instead or even worse to get back to using black and brown coal which is definitely not the way to reduce GHG-emissions. This mess is just a side-effect of the forced renewables policy of Germany where the grid infrastructure simply could not keep up with the ultra-fast expansion of wind and photovoltaic power generation dumping the production—regardless of whether it is needed or not—on the surrounding countries. This reflects on the paradox how a single member state policy and its effects can be outsourced to other member states through free trade and liberalized markets—forcing many other member states towards higher energy imports instead of self-dependence.

On the other hand, there are member states who choose the path of US trying to ease the problem of growing energy import by extracting the conventional hydrocarbon reserves and exploring the newly discovered unconventional resources. Poland is truly a pioneer in European shale gas development with the promise of independence from natural gas imports by the 2020’s. Also the United Kingdom, where the underlying unconventional hydrocarbon resources can be compared to the wealth of the North Sea which discovery placed the UK and it’s economy on a much more thriving—and repriseable—path a couple decades ago. Hungary’s hydrocarbon assets can also contribute to a much lower rate of energy import dependence where the size of the problem can be easily demonstrated through comparing last year’s energy import bill to the personal income tax return where the import check was 30 % higher than the tax return. Hungary—as any other country in the region—is in a need of rebalancing its budget not just through budget cuts and tax raising but by simply lowering the cash paid for expensive energy imports.

Currently, natural gas is the most significant of the hydrocarbon assets beneath our feet in Hungary. However, at present Hungarian gas fields can supply only 10–18 % of the country’s daily gas demand. Even though gas consumption has fallen drastically over the past five years (from 2006 to 2012 falling from 14 to 10 BCM/ annum), it is a fundamental interest of the government to use all means to increase investments which reduce energy import dependency and encourage domestic gas production.

Yet for almost three years, hydrocarbon exploration companies have not been able to engage in exploration activities due to the fact that in October 2010 the Hungarian Mining Bureau (MBFH) declared the entire country off limits for hydrocarbon exploration. The reason behind this decision was to take more into account the interests of the state (ultimately the public) in future concession procedures instead of the previous—said to be liberal—practice of “giving away exploration rights.” The National Energy Strategy 2030 adopted in 2011, moreover, stating “we cannot yet lose fossil fuels,” also takes into account the various available hydrocarbon resources in Hungary and identifies that the most significant exploitable stocks are of natural gas.

Based on MBFH estimates, Hungary has 3563 BCM of gas lying under the surface, of which 2393 BCM are exploitable reserves. Considering that in the 75 year history of Hungarian hydrocarbon production only 210 BCM of natural gas has been extracted, the numbers in the strategy appear quite high; it also notes “the technology is not ready to exploit this type of gas yet.” This is due to the fact that, based on an estimate which is still debated amongst professionals in the industry, most of the assets (97.6 %) are of unconventional gas in the Makó basin. Hungary has 56.6 BCM of natural gas available and, according to the current production and consumption ratio, it will enable production to go on for 21 years with a strong downward trend, which basically means that—in the absence of further exploration— domestic natural gas production could become irrelevant within 5–7 years; at present it supplies one-fifth of the country’s total natural gas consumption.

Conventional and unconventional energy sources are fundamentally different from each other based on their origin and production methods while in the end, the extracted gas is the same. The most widely accepted theory on the creation of hydrocarbons is the biogenic theory, whereby organic matter (plant and animal) is derived from sedimentary rocks over millions of years, and due to high pressure and temperature, converted into a variety of hydrocarbons. Due to the laws of physics, these hydrocarbons start their millions of years’ long migration among various rocks until they reach a place where there is damage in the rock’s permeability and therefore it is here the migration is interrupted, and the hydrocarbons trapped in various structural positions. The hydrocarbon miners (geologists, geophysicists, engineers, mineral oil producers) find these traps and open them to bring the hydrocarbons up to the surface.

In the case of unconventional hydrocarbons, this migration process is interrupted in the very beginning due to the rocks’ permeability, which is so low that it does not allow any movement, so mineral oil or natural gas gets trapped in the pores of the rocks. This makes the extraction of these“stuck” hydrocarbons more difficult because it is not enough just to open up the flow to the surface with one or two drillings, but also necessary to make artificial channels to bring up the trapped hydrocarbon molecules. For this purpose hydraulic fracturing is used, a technology developed in the last few years, which has triggered strong opposition from green organizations and politicians heavily influenced by environmental groups.

However, exploration and production of hydrocarbons compared to traditional mining sectors still leave a significantly smaller environmental footprint, since they do not open mine shafts, nor mountains are broken down to access the minerals; instead a point-open method of boreholes (wells) is used to bring hydrocarbons to surface.

Hydraulic fracturing technology has been used since the 1950’s to improve flow into the well. Until now, there have been thousands of hydraulic fractures carried out in Hungary without any soil or water contamination. The mass proliferation of the technology has been induced by shale gas production, as in the case of unconventional hydrocarbon production, it is the only production technology that can be applied successfully, so not only has the number of wells increased drastically, but hydraulic fracturing has become a daily routine.

Mineral oil and natural gas exploration is very capital intensive and high risk. The biggest risk for investors is drilling success. As the cost of one domestic drilling is higher than HUF 1–1.5 billion, while the probability of a discovery on average is between 20–30 %, meaning 70–80 % of the time the incurred costs will not bring any returns. Due to the high financial risk, governments typically invest in hydrocarbon exploration and production only in countries where there is a high chance of drilling success.

National oil companies have mainly been developed in major oil provinces (Arabian Peninsula, South America, Africa, etc.), where the vast majority of revenues are from petroleum and natural gas production. Although it was typical of socialist governments in Central & Eastern Europe to have large state-owned oil producer trusts representing the people’s property, after the fall of communism the privatization process began almost everywhere and a growing number of countries opened their borders to foreign companies with appropriate technical and financial capabilities, since the low level of domestic financial resources did not allow governments to put taxpayers’ money in jeopardy.

Hungarian domestic hydrocarbon exploration got a boost in the second half of the 1990’s when more investors with international experience appeared on the market and brought new methods and financial resources to the declining mineral oil and natural gas production industry. The previous state-owned monopoly transformed into MOL, its dominance on the exploration market has persisted, and due to its country-wide exploration infrastructure it was almost the only gas production company on the market. But nowadays there are more and more foreign—mostly with English-speaking management— companies that carry out successful drillings in the country.

The greatest successes have been achieved by Hungarian Horizon Energy Ltd., who not only drew attention to themselves by successful drillings in “abandoned” areas, but also established fruitful cooperation with MOL, both in the fields of exploration and production.

However, the most publicity has been received by TXM Ltd., the Hungarian subsidiary of the Canadian enterprise, Falcon Ltd., for its several hundred million dollar reinvestment in the exploration of unconventional gas in the Makó basin.

The worst situation for an exploration company is when it does not have the opportunity to explore. This uncertainty was caused by the state closure of the exploration areas, which not only has a negative effect on foreign companies but also on MOL. Exploration rights, which were given out in the 1990’s, after being extended by the maximum time that the law allows, are expiring and there are no new areas for hydrocarbon exploration. This carries major financial and technical risks for hydrocarbon exploration companies who are able to invest and take high risks, if their exploration licenses expire and they cannot acquire new areas for exploration. Their exploration portfolios narrow below the level of economies of scale, which means new discoveries and service companies (drilling, geophysical, geological modeling companies and their supporting industry) cannot work—the industry withers.

In the hydrocarbon mining industry investments, the value of assets and the risks involved are all exceptionally high; meanwhile, welltrained, foreign language speaking professionals’ emigration is very high, therefore to reverse the possible decline of the industry would be difficult as we have already experienced in the last two decades in the coal mining industry.

In addition to the moratorium on licensing, domestic environmental regulation also poses difficulty. Currently there are several oil and gas exploration companies, which are struggling with the environmental authorities to obtain a permit. While the governments declared aim is to contract the remaining exploration areas within concession procedures and to bring in approximately EUR 1 billion of foreign working capital into the economy in the next 5–7 years, there are several domestic companies whose exploration operations are stalled because of the environmental authorities—not due to technical reasons in most cases. It is as if one hand of the government does not know what the other one is doing and they are working against each other.

The authority, in addition to disabling operating companies, is also lowering the chance of successful concession processes, because if it is problematic to receive an exploration and production license on time, then potential investors will stay away. In the last three years the Environmental Authority’s budget suffered major cut backs so the numbers of those in charge of authorization has shrunk drastically; they presumably use a “pre-emptive strike” tactic, prohibiting licenses rather than judging applications, as for the latter they probably do not have the resources. Still, the essence of environmental regulation is not necessarily about strictness, but more about enforcing the rules well. The cost of a ban that is not based on professional requirements to the nation’s economy is much higher than it would cost to provide additional funds for the Environmental Authority to execute appropriate control. Geothermal concession is also worth to mention here: if there is a ban on any kind of hydrofracking, then not only does it affect the hydrocarbon projects but eliminates the chances to create a proper business environment for deep basin geothermal projects— practically all attempts on power generation from geothermal sources. This has a double impact: while the Environmental Authority is wanting to protect the environment at any cost— outsourcing the risks on the nation’s economy by freezing all hydrocarbon upstream investment, they are also making it impossible to extract one of Hungary’s most promising renewable energy source with the second largest potential after Iceland.

The stakes are high: In the last decade, approximately EUR 1 billion in capital arrived in Hungary for hydrocarbon exploration projects, and if we add MOL’s portfolio as well then this amount would be double. From the concession procedures—beyond their immediate revenue— the same amount of direct investment could come by 2020, and if MOL can re-activate its domestic exploration and production portfolio then this amount could reach HUF 500 billion by the end of the decade. From this amount, HUF 250 billion would enrich the country’s budget through mining royalties, taxes, and dozens of other indirect payments (it’s an unwritten law of trade that HUF 1 of foreign investment in the oil industry provides HUF 0.53 to the government’s budget).

Furthermore, current gas production could be doubled which, accompanied by energy efficiency projects, might supply half of Hungary’s domestic gas demand by the end of the decade. Conversely, if domestic hydrocarbon mining is disabled, besides the loss of the amount mentioned, by 2020 we can say farewell to the Hungarian oil production industry and gas production would drastically shrink as well to provide only an insignificant supply to the demand. Finally, it is important that these investments not be made from public funds, not putting public revenues at risk. Exploration enterprises fund these very high-risk projects (over 70 % with no chance of returns) from their own assets, therefore from the owner’s point of view, as geological property is owned by the state, but is the property of Hungarian citizens, this is definitely a worthwhile opportunity.

To elaborate on the overwhelming opportunities described previously, this is a more complex issue and we have reviewed it from the geological, business and in part, the regulatory side. But as every issue this size—especially in our region—has to be put into context not only from the aspect of policy but also that of politics. From this perspective every strategy, policy and market common sense can be overwritten in a matter of weeks by the interests of short- term politics. In Hungary for example energy is now one of the most important campaign elements—for the first time in the country’s history—of the upcoming elections in early 2014 resulting in utility price cuts. And governments are fast learners: Bulgaria just announced a 5 % utility price reduction and many other CEE and SEE governments are thinking about the same. No doubt this is just the beginning and will not stop at any borders, creating a whole new world for the global energy industry making the combat seen between the Seven Sisters and the NOC’s (National Oil Companies) just a sham battle compared to the upcoming war between governments and the energy industry—a clear effect of constantly rising energy prices mixed with skyrocketing demand and the public need for conserving the low utility prices. Oil and gas upstream has proven to be a good investment for both companies and governments in the past decades and even today, as can be seen through the example of the US, providing a middle and long-term solution for energy eagerness. It is everyone’s interest no to sacrifice for the sake of short term politics or as a result of distrust any opportunity—even if it is “dirty” fossil fuels—to provide a sustainable transition towards the age of renewables.