By Charles Ellinas
Gazprom’s supply of gas to Europe in 2016 broke all previous records, despite sanctions and the EU’s drive for diversification of supplies. So, what is driving this?
Given the importance of Europe to East Med gas export aspirations, it is important to examine the impact Gazprom has on Europe’s gas demand and supplies in more detail.
Compliance with EU regulations
When tensions with Ukraine flared-up in 2009, leading to disruption of Russian gas supplies to Europe, the EU sought to reduce dependence on Gazprom. It also put in place Energy Union with the aim to improve interconnection, including LNG import terminals, and increase security of supplies.
In response, Gazprom adapted its contracts to be more flexible and closer to hub-pricing in Europe, and adopted approaches more compatible with EU regulations. In other words Gazprom is now ‘playing by the rules’ of the EU gas market.
As a result of these developments, the threat of supply disruption from Russian gas is no longer considered serious, to the extent that EU is now siting with Germany and Gazprom against Poland in the European Court of Justice hearings on granting Gazprom full access to the OPAL pipeline. This is now likely to go through.
Moreover, Gazprom has been expanding its gas-transportation network, circumventing Ukraine, to remain competitive and reliable, and maintain and even increase its gas supplies to Europe.
NordStream1 demonstrated clearly last year that it is very successful and of high demand, making the case for NordStream2. Even though Poland and some central European countries object to the 1,200km NordStream2, it has the support of Engie, OMV, Wintershall, Shell and Uniper, Gazprom’s gas partners, and their countries, notably Germany. Gazprom and Uniper are continuing with the project, expected to be in service by 2019, and the European Commission has limited scope to challenge it.
Through adoption of these measures, the EU has achieved its targets which are: compliance with its regulations, price flexibility, supply stability and cheap gas. As a result, diversification of gas supplies no longer appears to be the priority it was in 2009.
Gas in Europe
Overall gas demand in Europe has gone down 20% from its peak 10 years ago, and may have peaked already, even though there was a small increase last year. Gazprom forecasts a further increase this year.
According to BP, gas demand growth in Europe is expected to be slow, averaging about 0.7% per year over the next 20 years. The key reasons are cheap coal, and increasing efficiency and penetration of subsidized renewables. The share of gas imports to Europe is expected to rise from around 50% in 2015 to more than 80% by 2035, due to depletion of indigenous resources.
Gazprom has means to remain competitive. After adjusting price formulae in its export contracts during the last few years, it has diluted the influence of oil prices in favour of linking revenue to Europe’s trading-hub gas markets. That means its prices will adjust competitively if a sudden inflow of gas from elsewhere depresses the market. It is important to remember that, in Europe, gas trading is done by companies, not by governments – for profit. Evidently European utilities are quite happy to trade with Gazprom and benefit from cheap gas.
Gazprom gas supplies to Europe
Russia will keep Europe hooked on its natural gas for years to come, using its huge reserves, about 48tcm, and lower production costs to maintain attractive prices, according to Bloomberg.
Gazprom’s Deputy CEO Alexander Medvedev said, “Europe was, is and will remain, Gazprom’s priority market… We can’t see yet who else could offer European customers natural gas that’s as affordable.”
US and Australian LNG is going mostly to Asia and South America. US LNG to Europe was estimated to be over 30% more expensive than Gazprom’s gas in 2016 and, despite being politically attractive, it is finding it hard to penetrate the European market.
Gazprom supplied close to 180 bcm gas, about 34% of Europe’s gas demand last year, 12.5% up on 2015, at an average price of $4.7/mmBTU. Supplies to Turkey were close to 25bcm, at about $5/mmBTU.
This success is driven by low prices. Even if prices go up as a result of the recovering oil price, Gazprom says its gas price will not exceed $5.4/mmBTU. Still too low for anybody to compete with it.
BP predicts Gazprom gas supplies to Europe will carry-on growing to 40% of EU needs by 2035. Shell agrees.
Gazprom has the world’s highest company gas reserves, over 36tcm. It also has 150-200bcm spare capacity and can produce this on demand at marginal cost of about $0.8/mmBTU. By the time it gets to Europe, Gazprom can sell it as low as $3.5/mmBTU and still make profits. This means that it can stay competitive for years to come and even be more commercially aggressive if it has to. So far, this has not been necessary.
Norway and Algeria, EU’s other main gas suppliers, can neither match this nor have the capacity to export more gas to Europe. And the much-heralded Southern Gas Corridor has limitations. Azerbaijan’s ability to fill the pipeline is questionable. Gazprom said, invoking EU rules, that it may use the 10bcm spare capacity in TAP under the auction system to take TurkStream gas to Europe. ENI and Gazprom have just signed an MOU to promote this southern gas route to Europe through Greece and Italy.
Nobody else can sell gas to Europe at such prices. Gazprom made it clear that, if it needs to, it has the capacity and is prepared to defend its gas markets both in Europe and in Turkey.
A recent article in Bloomberg says “Russia will for sure remain Europe’s largest gas supplier for at least two more decades”, driven by low prices. And it is important to remember that, by then, Europe is targeting to obtain 30% of its energy through renewables.
Implications for East Med gas
BP’s Energy Outlook 2017 concluded that less than half of technically recoverable hydrocarbon resources will be consumed between now and 2050, with the result that there will be a glut of resources and oil and gas prices will stay low for the longer term. This also means that over half of these hydrocarbon assets will not be exploited and will remain stranded.
If East Med assets are to avoid falling into this category, they must be developed at competitive prices and secure export markets within the prevailing low-price environment. The driving factor is low gas prices, not gas quantities, as often stated in our region. US LNG is not penetrating Europe due to prices, despite its vast gas resources.
It is amazing that when East Med gas exports are being discussed, the price factor is invariably ignored! We seem to believe that Europe will buy our gas irrespective of cost, for strategic reasons. But, as I have shown, in European gas markets low risk, price and profit are the driving factors. That’s what buyers look for.
Expectations require urgent reconsideration.
In the longer term, and especially if Total/ENI are successful with drilling in Cyprus’ block 11 this summer, if the price is right FLNG/LNG may become serious options for gas exports to Europe and the Asian markets.
Charles Ellinas is a Nonresident Senior Fellow at the Eurasian Energy Futures Initiative – Atlantic Council