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On February 28th 2015, I attended a very interesting event – the Polish Economic Forum. Held at the London School of Economics, the conference had been organised by Polish students of the LSE SU Polish Business Society, whose organising skills – in addition to the accompanying attractions – made the Forum a truly spectacular event. As one of the speakers in the panel debate on ‘Stimulating innovation in Poland and in Europe’, I took notice of certain characteristics of the IT sector which support innovation, and which the energy and industrial sectors have yet to acquire.

The dynamic growth of the IT sector is an effect of the digital revolution, which underlies today’s expansion of computers and the Internet (it is said to have started in 1946, when the transistor was invented). There are plenty of building blocks inside and outside of the Internet, which creative individuals can quickly combine into innovative services, creating new needs and unlocking new possibilities. The technology and post-revolutionary phase of the IT sector contribute to a relatively short innovation cycle, in which an idea is transformed into a product. As is often the case with innovative ideas, many such products are ultimately not accepted by the market and end up as building blocks which may or may not fit someone else’s project. However, there are also many stories of success. Thus, if the IT sector’s full innovation cycle is not longer than the typical investment cycle in a small or medium enterprise (less than 2 years), and the cost of an innovative start-up is similar to that of running a small production or service business, the endeavour can be conceptualised with relative ease. The problem which needs to be addressed has to do with risk, which in the case of start-up businesses effectively prevents their financing with credit. Banks are unwilling to finance ideas which cannot be compared with anything else. A low cost of financing individual projects, though, is enough to encourage financial investors, who are fluent in portfolio strategies, risk monitoring and selection of projects, as they do not have to invest a lot of money for long periods to achieve success.

The situation is completely different in the energy sector. We are still waiting for a ‘transistor’, a breakthrough invention, which I believe will have to do with efficient energy storage. When such an invention takes root, it – together with the achievements of the digital revolution – will transform the energy industry. There is no shortage of innovative ideas, many of them mature, but few are building blocks (prototypes) which can be used, so that the results, also negative ones, can be applied in future projects. The problem is that such building blocks are expensive. Prototypes in the energy industry can cost hundreds of millions, which makes it extremely difficult to secure financing. Furthermore, the investment cycle – counting from the well-documented inception of an idea to the start-up of a prototype unit – is usually longer than the typical investment cycle, because the unit’s unique elements have to be individually designed and tailor made. Since everything takes a lot of time and money, it is only natural to avoid risky ventures, such as innovative technologies, in the energy sector. This is why energy generation around the world is based on age-old technologies, and despite considerable spending of public funds in the last 20–25 years, technological revolution is nowhere in sight. Even the best wind turbine is only a wind turbine, and the energy it generates must be used immediately, because we do not how to store it efficiently.

The only breakthrough we have been able to achieve in the energy sector happened where it was least expected – in hydrocarbon (gas and crude oil) production technologies, which have allowed us to extract hydrocarbons trapped deep under the ocean floor or directly from source rock (shale). It is no accident that the potential of unconventional gas deposits was discovered and developed in North America, where suitable conditions for commercial development of unconventional oil and gas extraction technologies from depleted conventional deposits had existed long before first attempts were made to extract gas from shale. They were the function of:

a. thoroughly analysed geology of the country – the locations of hydrocarbon deposits, including gas-bearing shale and clay formations, had been known for a long time;

b. a working, mature and effective oil and gas market, forming a strongly competitive environment;

c. essential elements of a competitive oil and gas market in the form of well-developed transmission and distribution infrastructure and a supportive regulatory regime, which required only minor changes when shale gas came into play.

These conditions were right for independent firms to emerge and thrive, making good money out of wells written off as unprofitable by oil and gas majors. Shale gas pioneers descend from that group of independent producers of conventional oil and gas, devoted to developing innovative technologies to increase well productivity. Their owners were usually seasoned professionals who earned their fortunes and gained experience working for big oil and gas companies. All they needed was the right stimulus to begin experimenting with technologies to extract gas straight from source rock.

That stimulus came when energy security came to the top of the US political agenda (in response to rising demand for gas and ever-growing imports), and the US Congress earmarked grant money for unconventional gas extraction technologies and provided tax incentives to unconventional gas producers. The culture of entrepreneurship, which seems to be running deep in the DNA of the American people, their innovativeness and propensity to take risks in particular, also played a role. How likely is a sixty-year-old person in Europe to give up a financially secure,  pleasent retirement and embark on a very risky business venture?

One of the first unconventional oil and gas companies was founded by George Mitchell, the pioneer of shale gas. Mr Mitchell and his team of engineers developed techniques to exploit shale of the Barnett formation in North Texas. They drilled their first exploration well in 1981, when Mitchell was 62 years old. First gas started to flow only a decade later, following years of testing various methods to fracture shale rock. As Mr Mitchell himself said, they tried all sorts of things, from heavy water to propane. His geologists told him to quit and stop pouring money down the drain. Eventually, he found that slick water, a combination of water and sand to reduce friction, could open shale rock. George Mitchell had spent over six million dollars on shale gas extraction projects before, in 2002, at the age of 83, he sold his company Mitchell Energy & Development to an Oklahoma City-based company Devon for 3.5 billion dollars in cash and stock. Ten years later, The Economist called Mitchell’s investment the best-spent development money in the history of the gas industry.

According to the Potential Gas Committee (PGC), a US natural gas resource appraiser, the dual application of hydraulic fracturing and horizontal drilling contributed to a 35% increase in the US gas reserves in 2006−2008, the largest growth in the PGC’s 44-year history. For his invention Mr Mitchell was awarded a Lifetime Achievement Award from the Gas Technology Institute in the summer of 2010.

I have shared the story of George Mitchell and his groundbreaking innovation because, while not being as widely popular as the story of Mark Zuckerberg, the founder of Facebook, it is equally inspiring. A juxtaposition of the origins of the greatest energy invention since the steam engine with the Facebook story demonstrates how strikingly different the realities of inventors can be depending on the technology and on how fast it can develop. Despite the differences, there is one common denominator − namely, the building blocks. They can only be developed with substantial help from the state, which finances targeted research capable of delivering viable prototypes. In this sense, the IT industry’s success can be replicated in the energy sector. But we have to start from scratch and invent the transistor first.

 

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