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.

  

Bulgaria Playing Both Sides

Against all expectations, Bulgaria has emerged as a key player in the battle for control of the Southern Energy Corridor.  This Black Sea country is astride the most logical route between the gas fields and European markets for both South Stream and TANAP.  Bulgaria has agreed to cooperate with both consortiums, while playing for maximum advantage.

 

In August 2012, Bulgaria and Gazprom announced they would conclude an investment contract in November for the construction of South Stream.  Simultaneously, Bulgarian Minister of Energy and Economy Delyan Dobrev announced a new gas-supply contract that featured an 11% price in gas for the remainder of 2012.

 

Once having achieved its goal of obtaining Bulgarian cooperation, however, the Russians appear to have upped the ante.  For construction of South Stream to begin, the Russians declared they wanted $1.3 billion in compensation for the Belene nuclear plant.  This was a project that the former Bulgarian government had contracted with Russia, but that current Prime Minister Boiko Borisov cancelled when he took office last year.  Borisov was outraged.  "We are observing all our commitments on South Stream.  For Belene we continue to negotiate...That is why I think we have been absolutely treacherously surprised by that claim."  Bulgarian observers pushed back, threatening that the government would be forced to cancel South Stream.  Ilian Vassilev of Innovative Energy Solutions said, "There is no way Bulgaria can pay both the claim and let South Stream happen."

 

The dispute has led to a delay in a visit by Russian President Vladimir Putin, who was supposed to be present in Sofia on November 9 for the signing of the South Stream papers.  Instead, Putin has postponed his trip until December, possibly signalling his unhappiness with Bulgaria's recalcitrance.

 

Meanwhile, in September 2012 the European Union criticized Bulgaria for  supporting South Stream while lacking sufficient commitment to the EU's version of a Southern Energy Corridor.  The EU's concern was that South Stream only diversifies supply routes from Russia, but does not diversify the ultimate, Russian source of supply.  "Bulgaria needs to complete the ongoing investment projects on gas interconnectors with Romania, Serbia and Greece, and make reverse flows possible on its interconnector with Turkey...Bulgaria also needs to play a more proactive part in opening up the Southern Gas Corridor, which has the potential to diversify supply sources," said a leaked document.

 

The Bulgarian Prime Minister was non-plussed.  In an interview with Euronews, Borisov said he was commited to the European vision.  "It is very important that the Turkish Tanap-pipeline reaches Bulgaria and that Nabucco-West and the South East Europe Pipeline move closer to Europe...Regarding the Nabucco project, Bulgaria has done all it can:  the parliament approved its construction.  We have signed all the documents that are required and we can start construction work tomorrow if necessary.  I am looking forward to the launch of the Nabucco project."

 

Despite any agreement with Nabucco, however, as of 30 September 2012 there was no agreement between Bulgartransgaz and Turkey's Botas to connect with the Turkish pipeline network.  Without such a connection, any discussion of Tanap or Nabucco is moot.  To give the country some negotiating room, Bularia delayed its plans one year to connect its gas network with neighboring Balkan countries.  Bulgartransgaz announced the connection would take place in 2014, instead of the originally-planned 2013.

 

 

Russia Offers Possible Compromise on Third Energy Package

The European Union's Third Energy Package, demanding the "unbundling" of energy production from energy distribution, had been headed for an impasse between Russia and the EU. As of December, however, it appeared that a Russian compromise may be finding traction.

The low point came in early October, when the European offices of Gazprom were subjected to anti-trust raids. The EU seized files to determine if Gazprom was engaged in anti-competitive practices. While the Russians may have been angered, they recognized they were in a confrontation from which there could be no winners. Russian President Dmitry Medvedev told Gazprom and the Russian Ministry of Energy to submit proposals on how to operate under European laws.

The results were a disaster: the Russian Energy Ministry proposed an intergovernmental agreement establishing a special legal regime for major international infrastructure projects. The EU rejected the proposal. Energy Minister Sergei Shmatko told the press, "Talks with the European Comission on the third energy package...have hit a dead end," according to Reuters. The Russians threatened to legally challenge the Third Energy Package in court, and to shift their energy business to the Far East.

In the end, however, despite the diplomatic setback, Russia continued to look for a compromise. "What does this mean? Nothing terrible," Shmatko continued. "All the obligations that the Russian Federation and Russian companies have taken on with regard to supplies of energy under long-term contracts will without doubt be fulfilled." He also said Russia is committed to being a stable and reliable supplier of energy to the EU, and maintenance and increase of supply natural gas transport capacity is a top Kremlin priority, according to Deutsche Presse-Agentur. In early December, Shmatko offered hope. "I would not rule out resolving a fair number of regulatory conflicts at the level of national regulators," he said according to Reuters. At the same time, top EU energy officials said the dispute between Russia and the EU could be worked out under existing law.

The nature of the possible compromise was finally revealed by Russian Ambassador to the EU Vladimir Chizhov. As reported by ITAR-Tass, the Ambassador suggested that the ownership of Gazprom-controlled projects such as Nord Stream and South Stream be reinterpreted, so that ownership and transportation of the gas had already been "unbundled." "South Stream does not fall under the Third Energy Package, because its owner will be not Gazprom, but an international consortium. That is, it will be under an independent operator," he said. "The same applies to Nord Stream, because its operator--Nord Stream AG--is a consortum registered in the Canton of Zug of the Swiss Confederation."

While the Third Energy Package problem may be solved, EU energy commissioner Gunther Oettinger is creating more problems with the Russians. Gazprom has been highly successful in negotiating bilateral agreements that have hurt other countries in their ability to negotiate with the Russians. Thus, the bilateral Russian-German agreement to build Nord Stream has left Poland vulnerable to energy cutoffs; the bilateral Russian-Turkish agreement to allow South Stream to use Turkish waters in the Black Sea could leave Ukraine vulnerable to the same pressure. To solve this problem, the European Commission approved in September an Oettinger proposal requiring national governments to notify the European commission of international energy negotiations. "The ...mechanism is set to strengthen the negotiating position of member states vis-a-vis third countries, while ensuring security of supply, proper functioning of the internal market and creating legal certainty for investment," said the commission.

Europe Preaches Competition to the Russians

Russian Prime Minister Vladimir Putin came to Brussels on 24 February 2011, and accused the European Union of trying to confiscate Gazprom's private property. He was accompanied by 13 members of the Russian cabinet of ministers, underlining the importance of his presentation. Putin's ire was reserved for the EU's Third Energy Package, which went into effect on March 4. The plan is designed to break-up energy monopolies and encourage competition in the European markets. Putin's response was emphatic: "We consider that the full and mechanical implementation of this package could lead to a rise in energy prices on the European energy market...The third energy package, it is quite clear, will harm the activities of our energy companies. We are talking in practice about the confiscation of property," reported Reuters. Putin separately described the rules as robbery. "Our companies, together with German partners, legally acquired distribution assets. Now they are being thrown out. What is this then? What is this robbery?" he said according to Iranian PressTV.

Under the new rules, Russia might have to sell off some of its pipeline network, to meet EU demands for the "unbundling" of energy asset ownership, including the divestment of Gazprom stock ownership in the Lithuanian gas company Lietuvos Dujos. There are a number of ways of interpreting "unbundling," but under the most severe interpretation suppliers would have to sell their gas transport businesses. Other possibilities include the suppliers maintaining ownership, but an independent operator taking over the transportation arm, or an independent board be appointed to make decisions (such as pricing) on gas transport questions.

In response to the Putin barrage, European Commission President Jose Manuel Barroso did not retreat. "We believe our third internal market energy package is non-discriminatory...What we are asking of foreign companies is to accept the same rules that we are implementing for our own companies," reported Reuters. He said that the rules would not be changed: "Thanks to Russian gas, many of our institutes work and our houses are warm. But we pay for it. We pay for it well...Let me say very frankly, we believe our Third Energy Package is fully compatible with WTO rules, is non-discriminatory and is fully compatible with our bilateral agreements...I'm sure we will find an acceptable solution, but...we have adopted the Third Energy Package. For us and for the member states, it is now binding legislation," Hurriyet quoted him as saying. Interestingly, the Russian press reported Barroso was conciliatory. According to RIA Novosti, Barroso was unusually sympathetic to Putin's presentation.

Putin's visit had been heralded in advance as confrontational. Russian Ambassador to the EU, Vladimir Chzhov, warned that the talks would be detailed but "possibly unpleasant." In addition, the president of the Russian Gas Society paved the way for Putin's visit with an in-depth analysis of the Third Energy Package. Valery Yazev, who is also deputy chairman of the Russian State Duma, told the Russian media that the new law would cause the Russian state-controlled pipeline monopoly Gazprom "direct economic prejudice...the Russian company would be deprived of the right to use a gas transport network it had been establishing in Europe for a long period of time for the purpose of achieving the same energy security the "package" talks about," acccording to the website euractiv.com. Yazev continued his verbal assault on the energy package in a video conference with the Brussels press corps in which he said the new rules would disrupt Russian investments in prospecting and building pipelines. He claimed that plans to build a second, parallel pipeline to Nordstream were being suspended, and implied the suspension was the direct result of the Third Energy package. He also implied that Russia would not be able to meet future European energy needs under the new regulations. Gazprom would have to reasses its long-term supply contracts with European customers, meaning Europe would only be able to purchase gas on the spot market. Deprived of a guaranteed income, Gazprom would pull back on investing in new oil fields so--when European energy demand returns--Gazprom would not have the gas to meet the demand. Yazev concluded his analysis with the threat of an OPEC-like consortium of gas producers that would peg the price at levels higher than Europeans would otherwise have paid. The Asia Times reports that Yazev reiterated these points in a letter to Eurogas, in which he warned that Gazprom would reorient exports toward more attractive markets if it had to relinquish control of pipelines in EU member countries.

British attorney Alan Riley analyzed the situation in the Wall Street Journal. He opined that no one in the European Union should be considering legal exemptions for Russian companies operating on EU territory, because the equal application of the rule of law is a fundamental European value. Further, Mr. Riley implies that the Russians may cave on their position, stating that Gazprom needs the EU more than viceaversa. Sale of gas to the EU represents one-third of Gazprom's production and two-third's of its revenues.

Russian Energy Minister Sergei Shmatko has proposed a compromise. "We proposed to the EU to differentiate between gas pipeline systems for the EU local market and transboundary trunks from outside...We sent our proposals and are waiting for the reply," he said according to Reuters. His call may not be falling on deaf ears, despite Barroso's strong defense. Russia already has exemptions to the law for two offshore stretches of the Nordstream pipeline, according to Radio Free Europe. Further, RFE says that due to the complexity of the new legislation, EU Energy Commission Gunther Oettinger has postponed legal action against member states who do not implement the new rules. His spokeswoman, Marlene Holzner said , "There is some discretion of maneuver within a law. It is possible under certain conditions to make exemptions, and this can be explored."

Last week, at the 27th Annual EU-Russia summit, European Council President Herman van Rumpoy confirmed that bilateral negotiations were continuing. The president struck a middle road between hard-line and conciliatory. According to CNC World, he said the EU would follow the rules, but was willing to hold "pragmatic talks" with Russia over its concerns.

Russia clearly wants exceptions made to the European law, which would allow them to maintain Gazprom's partial ownership of a number of European pipelines. This is the sort of arrangement that the Third Energy Package was specifically created to prevent. It would appear that Europe will make an accommodation, because of its growing need for Russian energy supplies.

Oettinger Wants United Energy Policy

Representatives of the European Union have issued a call for better coordination among its members on energy. Following a one day meeting in Brussels on February 4, the representatives issued a joint statement calling for coherence in "relations with key producer, transit and consumer countries." The New York Times reports that European energy commissioner Gunther Oettinger (left) is expected to present a formal proposal in June that would give the European Commission the power to negotiate with energy producers on behalf of EU members. http://www.nytimes.com/2011/02/05/business/global/05energy.html

Centralization of European energy policy is something that the United Kingdom has been trying to achieve for at least two years. In a Wikileak/State Department cable dated 26 January 2009, the Foreign and Commonwealth Office's Deputy Head of Energy and Climate Change, Thom Reilly, said that Russia was trying to divide the European Union by lobbying individual members--especially those countries that are reliant on Gazprom for energy needs. Reilly said that the EU had become very concerned about Russia as a dependable energy provider after the 2009 Ukraine-Russia energy crisis. Despite the fact that Gazprom has a monopoly control over the gas pipelines in Russia, Reilly said the EU did not have the appetite to use European anti competitive measures to force Gazprom to become more market friendly. "Conditions are not right" to take the fight directly to Russia, said Reilly. http://www.telegraph.co.uk/news/wikileaks-files/london-wikileaks/8305130/BRITISH-LONG-VIEW-ON-CASPIAN-GAS-BALL-IS-IN-EUROPES-COURT.html

While a unified European position would help the consumer countries negotiate with energy providers, member states' suspicions of giving Brussels more authority may doom this proposal before it is even launched.

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.

Putin Lambasts EU for Robbery

Russian Premier Vladimir Putin is flexing his muscles during his current visit to Germany for talks with Chancellor Angela Merkel. Speaking to a group of investors in Berlin, Putin reacted sharply to EU laws that are aimed to liberalize the European energy market. In March 2009, the EU agreed that companies from outside of the European bloc would not be able to purchase strategic distribution networks without approval of the host governments.

Putin said such laws deprived Russian investors of getting a return on their investment, and said the laws deprived Gazprom the right to use its own property. He asked rhetorically, "What is this? What is this robbery?" He continued that the laws were already creating difficulties for Nordstream, and he confidently asserted that Russia was the source of Europe's energy: whether it be oil, gas...or firewood. "I don't understand: how will you heat your houses? You do not want gas, you do not want to develop nuclear energy. Where will you get your heat from, then?" ("Putin says EU energy laws are uncivilized "Robbery"; Today's Zaman, 28 November 2010)

The Premier is noted for such rhetorical flourishes; but, given Russia's track record of cutting oil supplies to Europe in the dark of winter during its disputes with Ukraine, questions about where Europe will obtain its heat need to be taken seriously. Putin's rhetoric is a direct threat to the energy security of the continent.

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.