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Reasonable regulations on shale gas benefit not just investors

An interview with Weronika Pelc, the partner in charge of the Energy Law Practice, and Michał Barłowski, the partner in charge of the Bankruptcy and Restructuring practices, about shale gas projects in Poland.

Litigation Portal: You recently visited Houston at the invitation of the law firm of Haynes and Boone for a seminar on shale gas mining in Poland. You also gave a presentation for American investors on the conditions for investing in Poland and doing business here. What was the response?

Weronika Pelc: There was obvious interest. Houston is the capital of the US oil and gas industry, but that does not mean that people who work there are involved only in mining in the United States. Companies operating all over the world—South America, Africa, Australia—have their headquarters there. Of course they also know the European market very well.

In the US, shale gas deposits are several times larger than in Poland and the extraction costs are estimated to be only a third as high. So what would bring American investors to Poland?

Michał Barłowski: The lower costs of shale gas extraction in the US result partly from the fact that shale gas has been mined there for five years already. The related development of the technology has translated into a decline in extraction costs. It may be assumed that there will be a similar process in Poland. The technology developed in the US cannot be transferred directly to Poland, however, because the geological conditions are different. I should add that there is a discussion in Poland on whether we should use foreign technology or perhaps develop our own.

But to answer the question: American companies are at the stage of seeking out sales markets. The price of extraction is falling, so the price of the commodity is also falling, which means that selling it in the US is ceasing to be profitable. Therefore American companies are investing in installations enabling condensation and export of gas outside the US. But there is even more interest in the Polish market on the part of companies involved in extraction of shale gas who would like to begin such operations in Poland. Both sides would benefit, because, as we know, Poland is striving to achieve energy independence.

How does Polish law differ from American law on issues surrounding shale gas extraction?

Michał Barłowski: The fundamental difference has to do with ownership. Polish law provides that all minerals are the property of the State Treasury up until the time they are mined. In the US, the deposits belong to whoever discovered them. This affects the nature of the contracts concluded between investors. In Poland they cannot be based on ownership of minerals that have not been mined yet. Also, the security instruments that are typical on the US market do not function in the same way in Poland. I have in mind tangible security interests or those connected with ownership of the hydrocarbons that are still in the ground. In Poland, they may be disposed of only when they have been extracted. Therefore investors have to frame their legal relationships differently.

How favourable is Polish law to investors from the US?

Weronika Pelc: We could begin with the fact that in Poland we are still at the stage of exploring deposits. In this industry, there is a clear distinction between two stages: The first is the stage of prospecting and exploring deposits, and only later, if the deposits are rich enough and have the right geological structure, may a decision be made to extract them. At this time, everyone in Poland is at the stage of prospecting and exploring deposits. So far, Polish law treats investors very well at this stage. Even in Houston, the opinion was stated—by an investor who holds several concessions here—that issuance of concessions for prospecting and exploring has gone very quickly and smoothly. More than a hundred concessions have been issued in this manner. However, the moment is approaching when some of these concessions will be supplemented by concessions for production and extraction, and therefore the government is considering how to set up the legal framework for exploitation of these hydrocarbons, so that we do not become like a third-world country with deposits that can only benefit those with the technology and resources to extract them—so that the deposits are a national asset and annuity. This is why new solutions are being planned which may be less liberal than the current ones but will establish fair rules of the game on this market.

Michał Barłowski: And with respect to investors from the US specifically, there are two sources of law that should be mentioned. The first is the 1990 Treaty between the Republic of Poland and the United States of America concerning Business and Economic Relations (together with a protocol from 2004), which defines the conditions for treatment of mutual investments. Such investments must be treated in a non-discriminatory manner, with certain exceptions related to Poland’s accession to the European Union. Under the most-favoured-nation principle, if Poland treated another state better than the US, it would violate this principle. Art. 7 of the treaty also includes the rule that mutual investments shall not be nationalised, but if they are the party making the investment must be promptly paid full compensation together with interest at the LIBOR rate. The rules are that specific.

The other source of law is the 1974 tax treaty between the US and Poland, which is to be replaced by a new convention.

Weronika Pelc: We have not yet mentioned the long-awaited Hydrocarbons Act. A draft of the proposal by the Ministry of the Environment was released on 18 February 2013. It sets forth new rules for extraction of fossil fuels in Poland. It introduces a National Operator of Energy Mines (NOKE), in order to assure that there is a “government take” in the concessions. In the future, the division of concessions between prospecting, exploration and extraction is to be eliminated. The draft presented in February specifies the new level of fees for extraction of hydrocarbons. It also covers other administrative, procedural and environmental issues, but without tax regulations, which are to be included in a separate act. This aspect is of great interest to investors, because the government has announced that it plans to introduce new taxes so that the total taxation will be 40% of gross profit.

The controversies surrounding extraction of shale gas mainly concern the technology used, such as fracking. Does Polish law adequately protect the environment?

Weronika Pelc: In my view, Polish law protects the environment well. There is an extensive system of protection of every element of the environment: the surface of the earth, the atmosphere, groundwater. What is lacking is regulations concerning what goes on several thousand metres below the earth’s surface. It should be considered whether this should be regulated especially for this technology, and whether the technology used at such a depth could have some effect on the surface of the earth or the groundwater. Such concerns are being raised, but in my view the existing regulations are sufficient because they protect against the negative environmental effects of human activity on a very broad scale. Maybe it would be worthwhile to consolidate these regulations and include them in a separate act governing the rules for extraction of unconventional hydrocarbons, so that investors know what is permitted and what is not permitted, in order to avoid differing interpretations.

In the European Parliament resolution of 21 November 2012 on the environmental impacts of shale gas and shale oil extraction activities, a huge number of concerns were raised with respect to the environmental impact of exploiting such deposits. I believe that the likelihood of the occurrence of the types of damage mentioned in the resolution is minimal. The existing regulations should counter such negative effects.

It is argued, for example, that extraction of shale gas requires vast consumption of water, because water is necessary for fracking. But the quantities of water involved are minuscule compared to the everyday consumption of water for industrial or even household purposes. Perhaps it could be a problem in regions where water is scarce, but probably not in Europe. Of course this water must then be purified and stored in appropriate containers, but there are wastewater regulations already in place. In my view, the case is similar with the other issues.

Michał Barłowski: It should be mentioned in this context that in Poland there is much greater density of the human population as well as various installations than in the regions of the United States where shale gas is extracted. This is why the Polish and EU regulations are much more restrictive than the American ones.

And are the administrative barriers in Poland higher than in the US?

Michał Barłowski: The Americans also have plenty of administrative barriers. It is not necessarily as free as Poles might think. The American procedures are also extensive.

Weronika Pelc: Every civilised country has its own procedures, and obviously they must be complied with.

The media reported recently that several investors have withdrawn from the Polish market and are trying to transfer their concessions to other entities.

Weronika Pelc: If there are no clear signals from the investor on the reasons for its decision, no one knows if it is really withdrawing from the market or simply realising a profit on its investment and selling its projects on to someone else. That is fairly common in this industry.

Michał Barłowski: There can be various reasons for withdrawing from the market. The well-bores may not augur well for commercial exploitation in the future. There could also be non-substantive reasons, for example related to resistance from the local authorities or the community, or the overall investment climate at the local level, not the central level. The government is clearly in favour of exploiting shale gas and in favour of investments in this sector. This is why investors are involved in informational campaigns, in order to show the local community the benefits from conducting such activity in their district. Sometimes investors renovate a road or a church, or sponsor community events.

It has already happened that local authorities have hired advisers to aggressively oppose development projects. But there are also cases where the local authorities support such projects, because they help reduce unemployment, develop infrastructure, improve services, and generate income for the local commune. The current proposal calls for extraction fees of PLN 24 per 1,000 m3 of gas, most of which would go to the local commune. This could generate significant amounts. And some of the areas where shale gas deposits have been confirmed are clearly suffering from unemployment. Thus it appears that reasonable regulations on extraction of shale gas may translate into benefits not only for investors, but also for local communities and the country as a whole.

Interview conducted by Justyna Zandberg-Malec