The European gas market will see “strong competition in the future”. This means that despite declining domestic production, Europe’s dependence on Russian gas will not increase over the long term. In the short term, however, over the next five years or so, Europe’s gas market could become very tight and Russia’s position will be stronger than ever. These are the expectations of energy expert Tatiana Mitrova of the Energy Research Institute of the Russian Academy of Sciences.
Mitrova gave her analysis at a conference in Moscow on 13 December organised by the Energy Delta Institute in cooperation with the Institute of World Economy and International Relations (IMEMO) in Moscow.
Dr Mitrova, who is the Head of the Oil and Gas Department at the Moscow-based Energy Research Institute and one of the leading Russian energy market analysts, says that “the situation on the European gas market does not favour suppliers”, at least not in the longer term. She notes there are four broad trends that are not favourable to current exporters like Russia and Norway.
current and future supplies to the European gas market (Energy Research Institute, Moscow)
When it comes to supply, Mitrova expects “growing diversification” in the European market in the form of LNG and new pipeline sources. Although domestic production in Europe is declining, this will be compensated by LNG from various sources, including North America, Africa, the Middle East and other regions and new pipeline gas from Africa and the Caspian basin. As a result, the share of Russian pipeline gas in European consumption will remain roughly stable in the long term, predicts Mitrova.
At the same time demand will remain weak, particularly in the power sector, where gas is facing stiff competition from coal. Mitrova does not expect the EU Emission Trading Scheme (ETS) to be of much help. CO2 prices are very low, she notes, and therefore cannot support gas demand. They would need to be ten times higher to make gas competitive with coal in power generation. “The factors leading to low gas plant utilization are largely irreversible”, says Mitrova. Only the “policy-driven decommissioning of old coal plants will enable gas to recover slightly by the end of this decade”.
As regards pricing, in 2009-2011 spot-indexed volumes increased very fast (30-40% per annum) and they have now reached approximately half of all gas supplies. Mitrova notes that “the majority of European stakeholders support the transition to spot pricing”. She does not expect gas prices to increase significantly over the next decades, regardless of whether shale gas will achieve a breakthrough in Europe or not. The gas-oil price linkage is increasingly under pressure, she notes, as demonstrated by the “renegotiation of oil-linked contract prices”, which has resulted in 25% lower Russian gas prices. Mitrova even went as far as saying that thanks to all the renegotiations in effect “the good-old gas-oil linkage, as we knew it, does not exist anymore”.
Finally, when it comes to regulation, suppliers are under strong pressure from EU lawmakers. The EU insists on unbundling and European regulators have developed a European “Gas Target Model” which requires that all gas is to be supplied at virtual hubs rather than supplied through dedicated pipelines.
A form of insurance
However, with regard to the short term – over the next five years – Mitrova sketches a very picture. In many ways the short-term trend she pictures looks like the polar opposite of the long-run one. She says that “the European gas market is going to be tight at least until 2015-2016 as LNG is diverted to Asia.”After 2016, “very limited new supplies” will become available and “there will be an additional call on the take-or-pay volumes.” This, says Mitrova, will be a “good opportunity for Russia to enhance its position”.
The position of Russia is strong because Europe has few alternative options for the time being. LNG from North America, East Africa and Australia will not become available before 2016 at the earliest and will first be targeted at Asian markets where margins are much higher. New pipeline supplies, e.g. from Azerbaijan, will remain limited in volume. Indeed, there are scenarios under which the European market could become extremely tight, for example if economic recovery in Europe is faster than expected, or if energy efficiency targets are not achieved, offshore wind and nuclear plans fail and domestic gas production declines faster than expected.
In this context, Russian long-term contracts are a “form of insurance”, says Mitrova. Gazprom has a “huge portfolio of oil-linked long-term contacts for supplies to Europe” in place for the next 25 years and longer. The question now is, will Gazprom go for short-term gains or will it let long-term considerations prevail? Mitrova notes that if Gazprom would decide to switch to spot indexation, this is not necessarily the best outcome for Europe, as Gazprom could become “a dominant player dictating prices at the sport market by changing its supply volumes”. In the end, however, she believes that in the present market circumstances “there are strong commercial reasons for Gazprom to protect oil indexation at least during the next 3 to 5 years”.
Dr.. Tatiana Mitrova is the Head of the Oil and Gas Department at the Energy Research Institute of the Russian Academy of Sciences. She is also a member of the Governmental Commission of the Russian Federation on fuel and energy complex and of the Russian Council on Foreign and Defense Policy. In addition, she is a member of the International Advisory Board of the Energy Academy Europe in Groningen, The Netherlands. She has written more than 90 publications in scientific and business journals and four books. She is co-author of the Global and Russian Energy Outlook up to 2040 published by the Energy Research Institute. She can be reached at firstname.lastname@example.org
Challenges for Gazprom in the European gas market
At a conference in Moscow on 13 December, organised by the Dutch Energy Delta Institute (EDI) and theInstitute of World Economy and International Relations (IMEMO) in Moscow, international gas experts discussed three major “challenges” facing Gazprom in Europe.
First, EU regulation – in particular “unbundling” – is putting a strain on Gazprom’s traditional business model. Secondly, the advent of renewable energy in the EU leads to uncertainty about the future demand for gas.Thirdly, the development of shale gas may present a long-term threat to Gazprom’s market position.
The EU’s Third Energy Package (2009), which requires “unbundling” (i.e. separation of infrastructure and trading activities) and “third party access” (i.e. access on equal terms) to gas pipelines, has long been a source of irritation for Russia. Just recently, on 4 December, at a meeting in Brussels, Klaus-Dieter Borchardt, Director of the Internal Energy Market at the energy department of the European Commission,warned Gazprom that its newly to be built pipeline South Stream does not conform to EU competition legislation (at least not as it’s currently structured).
The next day, Marlene Holzner, spokeswoman for EU Energy Commissioner Günther Oettinger, confirmed that the so-called “intergovernmental agreements” signed by EU member states with Gazprom about South Stream fail to live up to the EU’s unbundling and third-party access requirements.
In a reaction Russian Prime Minister Dmitry Medvedev said that “legal acts of the EU are considered to be national laws for the countries of the EU, [while] intergovernmental agreements, signed by Russia and the above-named countries of the EU are acts of international law.” Since international law takes precedence over national law, Medvedev said he was confident South Stream could continue to go ahead.
Whether this reasoning makes sense or not, it is clear that Russia has a problem with the EU’s market regulations. In Moscow, Pieter Trienekens, Vice-President of the Energy Delta Institute and a former board member of Dutch TSO Gasunie, explained that the Third Energy Package was not directed at Russia in particular, but was designed to create more competition in the European energy market.
He said his old company Gasunie, which was unbundled (split off from its trading part) already in 2005, had by and large fared well as an independent infrastructure company. It had added storage, LNG and additional pipelines to its asset base, operated the trading hub TTF, which Trienekens said “has become the foremost enabler of a liquid market on the European continent”, and had in general benefited from what he called “increased market dynamics”. At the same time, he acknowledged that investment procedures had become more complicated and there was a strong regulatory pressure on tariffs.
Trienekens also showed that hub-based pricing had greatly increased in Europe and that most market players did not believe this trend could be reversed. He concluded that unbundling is an “effective tool to increase competition”, but conceded that “transition problems are not to be neglected”.
The growth of renewable energy in the European market represents another headache for Gazprom. Whether or not renewable energy will in the end be more of a threat than a blessing to gas suppliers is one of the big question marks hanging over the energy market today.
Hans-Jørgen Koch, Deputy State Secretary with the Danish Energy Agency, argued that there was a worldwide trend taking place towards more renewables which could not be reversed. He used his own coutnry as an example. Denmark, he said, is moving “from 99% imports of fossil fuel in 1973 to 100% renewable energy in 2050”. Meaning of course that the Danes will not use any natural gas anymore by that time.
Danish electric power infrastructure in 1985 (above or left) and in 2009 (Danish Energy Agency) (click to enlarge)
How will they do it? Koch explained that the Danes have the lowest energy consumption per GDP-unit in the EU (thanks in part to its 660 combined heat-and-power plants) and the highest share of “new” (non-hydro) renewables. They have also moved to an extremely decentralised power production system and invest a lot in smart grids and demand management. According to Koch, the added cost for the consumer will be very small (one hamburger per household a week). (For more information on the Danish energy transition, see here.)
Although Denmark is of course not Europe, according to Koch many countries are following the Danish example, certainly in Europe. For Russian gas exports to Europe, this may not be good news, although Koch stressed that Russia also has large renewable resources, including huge biomass resources, which it could profitably exploit.
Shale gas evolution
And what about shale gas? Alexander van de Putte, Managing Director with the Kazakhstan Development Bank and a Principal Advisor to the Deputy Prime Minister of Kazakhstan, explained in Moscow that the conditions which had made the shale gas development in the US such a success, for the most part do not apply to Europe.
Some European countries do have significant shale gas resources in place, Van de Putte said, but their geological conditions tend to be more difficult than in the US. Europe also does not have the kind of competitive, large “exploration and production” sector that the US has. For example, in the US there are 2,000 oil and gas rigs active, in Europe only 72. And shale gas requires a lot of drilling.
For these and other reasons, any shale gas development in Europe will be more limited than in the US, and will take quite some time, said Van de Putte. On this front at least Gazprom will not face much competition for the foreseeable future.