EU Reliance on Russian Gas Increasing

The European Union's dependency on Russian energy continues to increase.  Demand for natural gas has grown from 325 bcm (billion cubic meters) per year in 1990 to an estimated 550 bcm in 2015, according to the International Energy Agency.  Consumption is projected to increase to 669 bcm by 2035.    Some European countries, such as Belarus, Latvia, Lithuania and Slovakia depend on Russia for 100% of their natural gas, according to the US Senate's Committee on Foreign Relations.  Several others, such as Austria, Bulgaria, the Czech Republic, Estonia, Finland, Moldova and Turkey rely on Russia for over 60% of their gas needs.

European consumption of Russian gas had been expected to decrease in face of competition from coal, LNG, and shale fuels.  Alternative fuel sources, combined with the slowdown in European economies, was supposed to reduce the demand for Russian gas, which is priced at a premium to the market.

Faced with these forces, Gazprom has initiated a series of price cuts for its European customers.  In 2012 they reduced prices 7-10% on average, even returning money via "retroactive payments" to customers with long-term supply contracts.  These rebates totaled $3.22 billion.  In June 2013, Gazprom export chief Alexander Medvedev announced that prices would be further reduced, but "The price correction will be even less than in the previous round of talks."  Medvedev estimated the new reductions would total less than $800-$900 million.  Medvedev also said that the company would cut prices in new contracts in which the price of gas is tied to the price of oil.  As a result, the average gas price for Europe would decline to approximately $375 per 1,000 cubic meters, from the 2012 price of $402.  (Of course, not all European countries benefit from this action:  Ukraine is stuck with a long term contract with a price of $440 per tcm.)

As a result of these actions, in the first eight months of 2013 Gazprom shipments to Europe and Turkey increased 14%, to the highest level since 2010, according to Gazprom Export.  The reasons are price (the premium over the spot price dropped 66% over the previous 12 months) and the failure of LNG supplies to materialize.  "The European gas market is shifting again, to a certain extent, from a buyer's market to a seller's market because of a sharp decline in LNG supply," said Sberbank analyst Valery Nesterov.

The increase in demand is providing Gazprom a rationale to limit further price concessions.  Gazprom, and its owners (the Russian government) rely heavily on the European market for its revenues--and the Russian budget relies on the income.  50% of the Russian government's budget comes from energy export revenues; with the decline in price for Gazprom's product, the funds are coming more from Rosneft's sale of oil.  80% of energy export revenues today are due to oil, not natural gas. according to the Atlantic Council's senior fellow Dr. Frank Umbach.  This has led to a shakeup in the Kremlin's hierarchy, with Rosneft's Igor Sechin increasing in influence at the cost of Gazprom's Alexey Miller.

  

China--The New Balancer

In 1991, Zbigniew Brzezinski described Central Asia and the Caucasus as "The Grand Chessboard."  He concentrated on the competition between Russia and the West for control of Mackinder's World Island.  Brzezinski wrote in the belief the United States was the world's sole superpower.

Since then, America has been bloodied in the wars of Iraq and Afghanistan.  A country that Brzezinski considered to be on the periphery, China, is assuming a larger role on the world stage.  The chess match continues, but the Russian Federation has a new opponent:  the People's Republic of China.  "China is likely to overtake the United States (as an oil importer), and Russia has to stake its claim in China," said Raiffeisenbank analyst Andrey Polishchuck.  The head of Russian studies at the China Institute of Contemporary International Relations, Feng Yujun, concurred:  "It has become very important for Russia to expedite entering the Asia-Pacific, especially the Chinese market.  It risks losing more opportunities if it keeps dragging its feet."

The record is pretty clear that it is China, and not Russia, that is in the driver's seat on energy deals.  Rosneft is scrambling to fulfill crude oil contracts with China, while reducing forecasts for production from the Vankor field in East Siberia.  As a result, Russia might have to reduce it's delivery of crude to Europe. The company emailed Reuters that "Rosneft's production plans will without doubt ensure that oil supply commitments are met...In the event of possible deviations, existing agreements and the most profitable supply routes will be prioritized."

Rosneft is also granting the China National Petroleum Corporation (CNPC) an equity stake over one of its oil fields.  Rosneft would maintain control of the project (51% ownership) but China will receive 49% in return for its willingness to help develop the field.  The deposit, the Srednebotuobinsk field, is close to the Eastern Siberia-Pacific Ocean (ESPO) pipeline which delivers crude oil to Daqing, China.  Rosneft has a similar deal with the Chinese company Sinopec, to produce oil in the Republic of Udmurtia.

At the same time, Russia has been trying to negotiate for two years a contract to sell natural gas to China, and deliver it via pipeline.  These efforts have been in vain, despite numerous statements from the highest authorities that a deal was imminent.  Despite the Chinese need for energy to fuel its economic machine, it refuses to accept the Russian price for the gas.  According to the Brookings Institute's Erica Downs, "The Russians probably need this more desperately than the Chinese." Fyodor Lukyanov, head of the Moscow think tank, the Council on Foreign and Defense Policy, believes that a gas deal would be a "major breakthrough" for Russia, but the economics of the proposal would scuttle it.  "China...won't agree to major concessions just to improve its strategic partnership with Russia."

This follows on the heals of Chinese president's Xi Jinping's recent visit to Central Asia. Xi signed an agreement in Turkmenistan to double gas exports to China, cut the ribbon on the Galkynysh gas field (the world's second largest), and pledged $8 billion to build a pipeline from the field to China.  In Kazakhstan, Xi signed $30 billion in deals that included the CNPC purchase of 8% of the Kashagan oil fields, agreed to double the size of the pipeline from Kazakhstan to China, and agreed to build a new refinery.  In Uzbekistan he signed $15 billion in purchases of oil, gas and gold; and in Kyrgyzstan he agreed to a $3 billion deal to construct another pipeline.  In Tajikistan, he signed another $3 billion pipeline deal, which resulted in Gazprom cancelling its own pipeline project to that country.

Alexander Rahr, the research director of the German-Russian Forum, believes that Russian President Vladimir Putin is allowing China to increase its Central Asian presence, so that Russia can concentrate on its Western flank.  ""I think this was a firm choice, a difficult choice, but it was made.  He cannot afford to have geopolitical battles with NATO and the West on the one hand and, parallel to that, battles with China for influence in Central Asia."  Rahr believes Russia is using energy to keep Belarus, Ukraine and Modova aligned with Moscow instead of Brussels.

As China moves deeper into Central Asia, it is forcing Russia out--as the Tajikistan pipeline incident demonstrates.  It is locking up energy supplies that Russia was previously selling to Europe, is obtaining equity interest in Russian energy fields, and forcing Russia to divert supplies from European buyers.  China is telling Russia what to do, and not the other way around.