Breaking new ground – advisers hope shale revolution can restart CEE market

While most of central and eastern Europe (CEE) predictably remains in recovery mode from the global financial crisis, the buoyant energy sector has led to a steady stream of foreign investment and some prized mandates for law firms active in the region.

Anything that can galvanize the region’s economy is to be welcomed. While the CEE’s major countries have generally avoided the kind of economic contraction seen in western Europe since the 2008 banking crisis, the rise of more potent rival emerging economies has drained away much of the foreign investment that would have once gone to the region. The mood has been further darkened by persistent concerns over cronyism and the quality of political governance in some states – a factor not helped by an increasingly difficult balancing act between the competing influences of the European Union (EU) and Russia.

As such, it is easy to see why there are high hopes being pinned on the potential for shale gas development of the CEE’s sizeable reserves. The hunt for shale has spurred much interest in Poland, which contains the CEE’s largest reserves. The Polish Geological Institute estimated in March 2012 that Poland had between 346 and 768 billion cubic metres of shale gas – enough to supply the country for the next 35-65 years. This followed higher estimates that indicated Poland’s total reserves could have reached 1.9 trillion cubic metres.

In 2013, European governments were increasingly vocal in talking up measures to stimulate the industry, lifting a moratorium on extracting shale gas and unveiling tax breaks to usher in investment, especially in Ukraine. While fears of red tape have been particularly felt in France, which has western Europe’s largest shale gas reserves and maintains its ban on shale exploration, some energy groups are now focusing their investments into Ukraine, Romania and other parts of the CEE.

It’s not hard to see why interest has been piqued. In a little over a decade, shale gas has transformed the energy dynamics of the world’s largest economy, now constituting over 20% of US energy production, and is expected to exceed 40% of US energy output by 2035. Shale has also become a significant force in the UK, with the British Geological Survey last year doubling estimates for shale reserves in northern England to 1,300 trillion cubic feet of gas.

Partners from a mix of international and domestic firms in key CEE jurisdictions, including Poland, Turkey and Romania, are unsurprisingly eager for governments to adapt laws to accelerate energy and infrastructure work across the region. This may have something to do with the fact that the M&A market has slowed generally compared to last year when league tables showed CEE in relative terms outperforming the rest of Europe.

Freshfields Bruckhaus Deringer corporate partner Sebastian Lawson says: ‘Investors have moved away from the more exotic eastern destinations of Kazakhstan and the Balkans, and are playing safe now. They have reverted back to the four core regions of Poland, Czech Republic, Slovakia and Hungary, where returns are not particularly exciting, but safe.’

Shale hail

With Poland theoretically holding enough shale gas reserves to cover its energy output over the next few decades, it’s easy to see why the country deserves particular attention from ambitious international firms.

The Polish government is generally viewed as becoming more pro-business since the collapse of Lehman in 2008, while hosting the UEFA European Championship in 2012 also drove it to invest in infrastructure. In short, it has weathered the crisis better than some. Now, Poland is keen to permit the controversial shale gas extraction method of hydraulic fracturing, or ‘fracking’ – a drilling process in which a cocktail of chemicals is pumped into the ground.

In December 2013, the Polish state-controlled gas company Polish Petroleum and Gas Mining (PGNiG) and Chevron Polish Energy Resources signed a co-operation agreement to explore shale gas in south-east Poland. The initiative would enable both parties to reduce costs and speed up exploration work, and came as PGNiG announced its policy to welcome global oil and gas giants exploring shale gas reserves in Poland.

Similarly, co-owners of Lane Energy Poland – 3Legs Resources and ConocoPhillips – announced in November plans to invest further into the gas deposits in Pomerania, which lie along the Baltic coastal plain between Germany and Poland.

Additionally, the government looks set to bring out new legislation next year aimed at clearing the regulatory bureaucracy and red tape around shale exploration. Its ministry of finance is also planning to draft a new tax law around shale development in 2015, creating a regulatory framework in Poland that lends clarity to investors.

However, the process has its challenges. The government faces opposition from environmental groups that say fracking of rock formations releases methane into the atmosphere and may pollute water tables.

Freshfields environment, planning and regulatory counsel Daniel Lawrence says: ‘There is a huge disconnect between those who really oppose it and those who really understand it. Shale exploration is like keyhole surgery and is not really risky compared to other mining activities that can reduce a whole mountain, for example.’

Progress has been slow due to delays to fiscal and regulatory reforms and industry claims of excessive bureaucracy. Poland’s hopes of hitting its target for recovered shale were dealt a blow when ExxonMobil ended its exploration in June 2012 after tests failed to find the gas in commercial quantities.

The exits continued when Marathon Oil Corporation announced in May 2013 that it would end its shale operations in Poland following unsuccessful attempts to find commercial levels of hydrocarbons. The US-based company holds a total of 11 licences for exploration covering 1.2 million net acres, including a 51% working interest in nine concessions in partnership with Nexen (40%) and Mitsui (9%). All of its shale-related operations in Poland are expected to cease in the middle of 2014.

This followed global oil and gas company Talisman Energy’s decision to sell its shale gas interest to San Leon Energy, after it signed a farm-in agreement with San Leon in 2010 to earn a 30% working interest in three concessions in the Baltic Basin.

However, Schoenherr’s head of corporate and M&A, Alexander Popp, says: ‘Exxon, Talisman and Marathon have pulled out, but state companies are still active there. PGNiG has taken over these concessions from those entities that left the market and new legislation regarding shale gas and hydrocarbons is expected next year.’

Freshfields’ Lawrence needs further convincing. ‘There are great expectations from Poland, but big companies have withdrawn. The conflicts between regulators, the treasury and the environment ministries show they are not in agreement,’ he says. ‘A lot of bureaucracy and red tape has slowed down exploration in Poland. Energy companies are frustrated because they want to get on with drilling exploratory test wells. They have only drilled around 50 to find around a dozen with recoverable gas. In all, they will need to drill around 300 test wells.’

Corporate lawyer Darren Spalding at US energy specialist Bracewell & Giuliani, which has made a real push through its London office to take advantage of the anticipated shale boom in Europe, says: ‘Shale gas is in its infancy in Europe, but the rewards are potentially huge. There are a number of hurdles, including the infrastructure and accessibility to rigs. In the US there are around 1,000 rigs, whereas the whole of Europe has around 100. There are also land-rights issues as well as geology issues at play.’

Nonetheless, international firms are optimistic that shale deals will become easier to execute once a legal framework is put into place in Poland. ‘The government is in favour of developing shale exploration and is starting to put into place the necessary regulatory frameworks,’ says Spalding. ‘It’s already happened in the UK, it’s happening in Poland and will likely happen in Ukraine next. Romania may also follow. We will see a lot more drilling once the regulatory regime is more certain, which could lead to a rise in M&A work, where investors will want to buy an interest at an asset level.’

Further east

Revised lower estimates as to Poland’s shale reserves are unlikely to turn the country into a major gas exporter, but it would make it much less dependent on gas imports from Russia, which currently supplies about two thirds of the 14 billion cubic metres of gas the country consumes annually.

While some remain optimistic about shale recovery in Poland, other advisers are looking to Ukraine for a more pragmatic solution.

Vitaliy Radchenko, energy and projects partner at CMS Cameron McKenna in Kyiv comments: ‘Ukraine has years of experience in conventional oil and gas production and sits on a vastly under-explored Black Sea, making it very interesting for international oil and gas majors.’

According to the US Energy Information Administration, Poland has the 11th-largest shale reserves in the world, followed by Ukraine, which is ranked 12th. Ukraine also has Europe’s third-largest shale gas reserves after France and Poland, with 1.2 trillion cubic metres.

‘Although Ukraine has high levels of shale gas resources, what is recoverable is yet to be proven,’ notes Lawrence.

In November 2013, Kyiv signed a $10bn production-sharing agreement with Chevron – its second shale deal of the year – to explore for shale gas in the 6,300sq km Olesska field in western Ukraine. Clifford Chance is advising energy giant Chevron.

US firm Morgan Lewis and Ukrainian firm Asters advised the Ukrainian government, with Moscow-based business and finance partner and former Dewey & LeBoeuf lawyer Jonathan Hines leading the Morgan Lewis team, alongside energy partner David Asmus to advise the state-owned Nadra Oleska in connection with the Chevron joint venture.

In January 2013, Royal Dutch Shell signed a similar deal covering almost 8,000sq km in the Yuzivska field in eastern Ukraine. CMS, Morgan Lewis and Asters advised with CMS’s lead partner Radchenko advising Shell. Morgan Lewis and Asters advised local companies Nadra Yuvoska and Nadra Oleska – also involved in the deal – with Morgan Lewis’ team led by Hines alongside Houston-based partners Asmus and Jennifer Mosley, while Kyiv-based senior partner Armen Khachaturyan and partner Tamara Lukanina led from Asters. Both deals will be crucial in reducing the nation’s dependency on foreign gas imports.

And energy development has significance beyond economic considerations. Ukraine was thrown into turmoil in November 2013 when president Viktor Yanukovych backed away from a long-awaited political and economic agreement with the EU and decided to focus on restoring trade ties with Russia. In December 2013, Moscow agreed to pay Ukraine a $15bn bailout and cut its gas prices to prevent Ukraine turning to the West. The abrupt shift back towards Moscow angered many in Ukraine, particularly in Kyiv and the western regions of the country. The recent rivalry dates back to 1996 when Russia closed off its gas supply to Ukraine.

‘Recent mass protests have kicked off in Ukraine about failed attempts to join the EU and the violence police have used against peaceful protestors. Natives are fed up of the Soviet approach and want to join the EU, but the government has its own concerns. The Ukrainian economy has a history of exporting goods to Russia, so the government claims it would be tough to break this tie,’ says Radchenko. ‘If Ukraine had joined the EU, it would have probably been sanctioned by Russia in one way or another and this would affect export-oriented producers like steel or chemical producers for example.’

Jason Mogg, managing partner at CEE leader Kinstellar, adds: ‘There have been demonstrations in the streets. The government was trying to sign up a treaty to move towards an association with the EU and Russia has worked hard to stop that. After the president announced he was not going to sign, protests kicked off on 30 November, when up to 350,000 protested on the main square of Kyiv, and this impacts business.’

Ukraine’s resistance affects Moldova – once part of Romania until it gained independence following the collapse of the Soviet rule in 1991 – which is experiencing increased pressure from Russia to drop its intention to join up with the EU after it signed agreements on political co-operation, reform and free trade with the EU on 28 November 2013.

Romanian adviser Nestor Nestor Diculescu Kingston Petersen (NNDKP) has seen some work in southern Moldova on the back of shale exploration, although this has been restricted due to the controversy surrounding the exploration of the gas. Chevron decided to suspend exploration in the eastern region of Moldova after villagers protested for several days, finally triggering it to remove its drilling equipment from the site.

Ştefan Damian, the deputy managing partner of independent Romanian leader T¸uca Zbârcea & Asociat¸ii, says the firm may expand into Moldova. ‘There is big debate on shale at the moment,’ says Damian. ‘Current work in the region is coming from energy, infrastructure – which picked up slightly as more money is coming in from the EU – and projects, while highway construction work is set to come in at the beginning of 2014. Banking and finance will also pick up as M&A work comes back next year.’

And, while Ukraine continues to attract investors, Romania is also spurring considerable interest. Kinstellar’s Mogg points out that major oil and gas companies are considering Romania as a potential shale site and are eager to get the ball rolling. ‘It’s still early stages,’ he says. ‘The geological possibility looks promising, but the shale exploration legal framework is not yet ready. However, the government looks like it will adapt its plans.’

Parliamentary elections are expected around May and June of 2014, and partner and co-head of the corporate energy and natural resources practice at Nestor, Ruxandra Bologa, says a strong parliament majority should translate into a smooth process.

Bologa tells Legal Business: ‘Romanian law does not prohibit companies from exploring and producing shale gas, but fracking regulation is still under discussion. The European Parliament wants to make the environmental impact assessment studies for shale exploration and production across Europe mandatory. But for those countries where there is a ban, national law would be more directive than European law.’

In May 2012, the Romanian government temporarily suspended permits for shale exploration, but a year later prime minister Victor Ponta lifted the moratorium to boost the nation’s domestic energy resources and reduce Romania’s dependency on Russian gas.

Following this, energy companies like OMV, Petrom, Romgaz, MOL Group, East-West Energy Service and Zeta Petroleum have also expressed interest in shale opportunities in Romania.

The Legal 500 Turkey: Recommended firms

Firm	Total recommendations 2013
Çaga & Çaga	10
Pekin & Pekin	10
Akol Avukatlik Bürosu	9
Güner Law Office	9
Hergüner Bilgen Özeke	9
YükselKarkinKüçük	9
Birsel Law Offices	8
Cerrahoglu Law Firm	8
Ersoy Bilgehan Lawyers & Consultants	8
Baker & McKenzie	7
Çakmak Avukatlik Bürosu	7
ELIG, Attorneys-at-Law	7
Özel & Özel	7

Firm	Top-tier recommendations 2013
Pekin & Pekin	4
YükselKarkinKüçük	4
Çaga & Çaga	3
Çakmak Avukatlik Bürosu	3
Hergüner Bilgen Özeke	3
Paksoy	3
Akol Avukatlik Bürosu	2
Birsel Law Offices	2
Cosar Avukatlik Bürosu	2
Güner Law Office	2
Mehmet Gün & Partners	2
NSN Law Office	2
Pekin & Bayar Law Firm	2

Alternative energy

While shale is the hyped sector right now throughout Europe, firms are seeing a stream of deals flow from the wider energy, infrastructure and projects market.

Zoltán Faludi, managing partner of Wolf Thiess’ Budapest office, says its energy and infrastructure group is particularly busy with network and gas storage deals; its infrastructure practice is seeing work primarily in roads, railways and hospitals; while its projects group is seeing a stream of work from non-energy infrastructure.

Thomas Starlinger, head of energy at Fiebinger Polak Leon, says infrastructure work is coming into Austria on the back of tighter regulation, particularly within the electricity market. ‘Big energy companies are under pressure because of the low electricity price triggered by subsidies for renewable energy, so they are considering selling infrastructure like pipelines or transmission lines,’ he says. ‘Competition and arbitration work is also rising as gas prices under long-term contracts stay higher than market prices at trading hubs.’

Many deals are coming out of trans-European priority projects, backed by the European Investment Bank (EIB) and the European Bank for Reconstruction and Development (EBRD). For example, in December 2013, the EIB lent €200m to improve the quality of Magyar Telekom’s mobile and fixed broadband telecoms infrastructure, and funded €250m to Poland’s Bank Gospodarstwa Krajowego (BGK) to help construct a motorway in November.

In October, the EBRD provided a long-term loan of up to €70m to three special-purpose companies owned by Polish Energy Partners for the construction of three wind farms in Poland.

‘Local companies or funds are now buying out international investors who entered the region in the 1990s. Back then, international investment was coming in, but now local companies are making the purchases from international companies, because local companies have grown and international investors are selling their core assets,’ says Lawson.

While this is good news for domestic players who can buy assets at cheap prices, it probably won’t benefit the overall economy, as Lawson points out: ‘While local companies can make the acquisition, they don’t always have the resources to develop that investment. We typically see them taking a relatively mature asset and selling it on in a couple of years without radically transforming the business in the meantime.’

However, he believes the corporate market will pick up in CEE. Around 10% of Freshfields’ total revenues for the financial year 2012/13 came from its CEE offices, up from 8% the year before, with the lion’s share of growth coming from disputes, especially in Hungary where international investors have come under repeated attack from its nationalist government.

For firms in many non-EU states, however, the natural resources and renewable markets have been buoyant throughout 2013. And for firms like Nestor, the key markets in Romania have been oil and gas rather than shale. The firm has informal relationships for referral work with a range of firms including Freshfields, Baker & McKenzie, Berwin Leighton Paisner, Vinson & Elkins and Dorda Brugger Jordis, while countries such as Romania, Ukraine, Bulgaria, Hungary and Slovakia still offer plenty of natural resources and renewables work.

Ukraine opened up its market for importing gas in 2011, from which firms such as CMS Cameron McKenna are now seeing the benefits.

In September 2013, CMS advised Deutsche Bank, Raiffeisen Bank International, Gazprombank, Erste Group Bank and UniCredit on a $375m coal export pre-payment facility for DTEK, the largest privately owned company in Ukraine and the largest coal producer in the country, led by banking partner Mark Segall. The firm also advised Italian oil and gas major Eni to explore oil and gas in the Black Sea.

The region also saw energy giants Shell and ExxonMobil enter the market when both companies announced they would drill in the Black Sea for an estimated 42-84 billion cubic metres of natural gas deposits. CMS advised Shell on its sharing agreements for ‘tight’ gas in Ukraine, which was signed in January 2013 between Shell, Nadra Yuzivska and the government of Ukraine, while Romanian company OMV Petrom was also involved in the deal.

‘We are seeing increased cross-border trades with Ukrainian companies and EU-based specialised energy traders,’ says Radchenko. ‘EU traders are interested in importing Ukrainian electricity, while large Ukrainian industrial consumers are seeking to import gas from the EU. Now that the price of Russian gas will decrease – due to the $15bn sovereign debt deal with Russia – we anticipate that more Ukrainian gas producers will be interested in exporting a cheaper Ukrainian gas produced domestically to Europe.’

For English law firm Harrisons Solicitors – which has offices in Belgrade, London and Podgorica – the firm is active in the renewables and oil and gas market. The firm’s founder and principle, Mark Harrison, says: ‘While Serbia has been generally quiet, with the economy expected to get worse in 2014, Montenegro believes it contains oil and gas reserves under the Adriatic Sea; a tender will go out for this as companies will want to get drilling.’

The firm acted for the Italian distribution company Turner, transmission company CGES and Toshiba in building a 100MW underwater cable to distribute power from Montenegro to southern Italy.

For Kinstellar, 2013 was a modestly better year than 2012 for transactional work, though general corporate work obviously remains subdued. ‘US levels picked up and this had a domino effect on western Europe and then eastern Europe. But we are still behind,’ says Mogg.

He says that historically the CEE region depended on western Europe for investments, which is now changing. ‘It used to be all about western Europe but now investments are coming in from China, Middle East and North America, and these areas have more of an influence now.’

The firm does not have a dominant CEE office. Its practices in Prague, Budapest, Istanbul and Bucharest are all similarly sized, contributing around 18-19% of total revenues, while 12-14% come from Slovakia and Bratislava, with the remainder from Serbia.

Mogg adds that Kinstellar would consider further launches in countries such as Bulgaria, Ukraine, Croatia, or in Central Asia, such as Uzbekistan, depending on the right team. ‘We want to be the key firm for minor markets and markets that are not interesting for big international firms,’ he adds.

But for Freshfields, Poland will be a key focus, as well as Hungary, Czech Republic and Slovakia, as investors revert to those safer havens. Lawson says: ‘There has been a change in balance. We advised foreign investors from the US and western Europe when they moved into the CEE in the 1990s, and we are now advising them on selling their assets. Investors from Korea, China, Russia, Turkey and the Middle East are now acquiring these assets.’

If the CEE has yet to entirely define its place in the global economy after the investment, modernisation and political reform of the 1990s, by consensus, the region retains huge potential. The hope is that shale will be one important element in not only powering up the CEE economy, but also drawing its major states more tightly into a globalising world economy. LB

jaishree.kalia@legalease.co.uk