This last winter, temperatures were extremely low (hitting records in several countries) throughout the European continent. As a consequence, demand for natural gas soared in countries that found difficulties to satisfy its consumers.
It is a fact the European Union relies on non-member countries for its supply of this commodity. According to the latest available data and historical trajectoire, Europe imports more than half its energy consumption and in terms of gas, close to a 70% (source: BP Statistical Review 2016).On top of all this, there are 18 members of the Union with an energy dependence ratio above 90%.
In the chart it is plenty to see how the 28 members’ energy dependence ratio follows a clear upward trend.:gasinfocus.com
In a recent report, the International Energy Agency warned that such imports may ascend to 80% levels by 2030. Besides, primary gas production in Europe is declining (there are estimates of a decline close to a 25% between 2015 and 2025 according to ENTSOG), being the main producers The Netherlands and The United Kingdom (which is already a market with is limitations due to its isolation from Europe).
Monthly EU gas production :Reuters.
Exposed data are clear evidence of the alarmingly growing dependence of Europe for gas supply. Before this situation, common sense makes us think on diversifying the supply sources to diminish risks facing geopolitical conflicts or events of force majeure. ¿ But does that needed diversification really exist?
Imports
In 2014, 69.1% of European gas imports came from Russia and Norway. In 2016, the figure increases up to 76% (45% Russia and 31% Norway).
The state-owned company Gazprom had a total output of 419 bm3 with capacity to generate another 150. Out of this amount, it supplied some 158.6 bm3 (Δ12%) to the 28 countries in the Union (which has seen its Russian gas demand increased by a 23%, in part due to the efforts to transition to cleaner sources than coal) and close to 220 bm3 domestically. Let us see some of the imports by country (Source: Reuters):
- United Kingdom: 17.8 bm3 (Δ60%)
- France: 11.5 bm3 (Δ18%)
- Poland: 11.1 bm3 (Δ24%)
- Austria: 6.1 bm3 (Δ38%)
- Netherlands: 4.2 bm3 (Δ77%)
- Denmark: 1.7 bm3 (Δ156%)
- Germany: 49.8 bm3 (Δ10%)
It is worth noticing that russian gas supply provisions mainly the East of Europe, and in a lesser degree to the North-West (except Germany, that relies in such to meet 43% of its consumption), as those are market with prompt access logistically.
Concerning Spain, 55% of its gas demand is covered from Algeria via pipeline and part of LNG, and a 10% from Qatar. For another example, France has got the most diversified gas supply in Europe, dividing it in Norway, Netherlands, Russia and other via LNG (Algeria, Qatar, Libia…).
Russian supply routes
Geographical distribution of russian gas pipelines to Europe : Gazprom.com
It is worth reviewing briefly the routes that Gazprom uses to penetrate in the European markets and spread its reach to new ones. Let us see in detail the most important pipelines supplying the Union, and the main projects in which the gas giant is currently investing in.
Nord-Stream: This pipeline is one of the main means of transport for gas to Europe of Gazprom, crossin the Baltic Sea directly to Germany. Last January the 4th it reached a record supply of 165 m. m3 . Its initial designed capacity increased in a 10% last year. Gas traffic was intensified after the European Comission allowed Gazprom to use 90% of Opal pipeline (which connects the German grid with Nord-Stream).
Now, part of the gas crossing Ukraine (Urengoy pipeline) is re-directed to Nord-Stream, as it involves cheaper fees of transit. Nonetheless, at the beginning of February Gazprom announced its intentions to decrease exports in this pipeline by a 5%, which is likely to add bullish pressure on prices.
Nord-Stream 2: Still in development (with several companies as partners, its cost amounts a 9.9 billion €), it will be a parallel pipeline to Nord-Stream in order to duplicate its capacity of supply. Counting with two streams of 27.5 bm3 yearly. In addition, from Gazprom they claim it could also offer supply to the United Kingdom through the BBL connection in the Netherlands.
On the other side, it represents a real alternative to by-pass Ukraine, country that does not purchase russian gas since 2015. There is an on-going geopolitical conflict since the annexation of Crimea in 2014 by Moscow, as well as an issue of non-payment for a “take or pay” clause between Naftogas and Gazprom.
Urengoy-Pomary-Uzhgorod: With 100bm3 yearly, it is the largest route of supply to Europe. It passes through Ukraine reaching Slovakia, where then it has a branch towards the Czech Republic, which in turn uses its grid to provide supply to further European destinations.
Yamal-Europe : This controversial pipeline goes through Belarus and Poland, countries with which Russia has had their differences recently. It provides 33 gas bm3 yearly.
Poland is studying the possibility to not extend the current gas transit deal with Gazprom, expiring in 2022. If they do not reach an agreement, European supply could be compromised and impact negatively to Germany , according to Gazprom statements.
Turkstream-Southstream (complementing Bluestream 16 bm): In development as well (with an initial investment of 7 billion €), it will cross the Black Sea, and divide into two streams: One aiming to Turkish consumers, and the other oriented to the southern Europe (on the border with Greece). Both will count 15.75 gas bm3 yearly)
The strategy
Russia is making chess moves,and with great logistic manouevres it is managing to make its supply available for the whole Europe. This year, Russia covered 2/3 of the European increase in gas imports, expanding hence its market share.
The country disposes of the greatest natural gas reserves in the planet, even though the commercial license for Gazprom is limited to 5.000 billion cubic meters. That being said, it seems undeniable to me that this limit could be flexible, as the market share gains in Europe add up.
However, if we review the yearly evolution of Gazprom’s net profits, we see declining variations, which means they care further for market share rather than pricing levels. Taking a look at their shares’ yearly evolution, it is clear the falling gas prices situation is translating into a loss in value:
Gazprom yearly shares evolution. Bloomberg
In spite of that, Russian gas remains the most competitive ($165-$170/1,000 cu m), making the rest of alternatives turn into higher costs. We can take as an example the NYMEX gas prices, (around 114-121$/1.000 m3). But then we add regasification costs, transport and others so the final price drives up.
Nevertheless, when Russian gas forward contracts begin to collect the post-OPEC meeting spikes in crude-oil prices, it is likely some European hubs might offer more competitive prices. In this scenario, demand for Russian gas would fall slightly. But the streams would remain ready to supply any increase in demand that may move prices upwards again.
It is worth remembering there currently exists a mutual dependence. In the same way Europe needs Russian gas, Russia is in need of the monetary cashflows coming from Europe to cover part of its State budget (highly reliant on commodities exports). Europe is the most lucrative market for Gazprom, seeing how its domestical sales declined by 7% (in terms of volume) and 19% in CIS countries. It is hence an evidence the importance of Europe as a customer for Gazprom (which in part transfers some leverage power to the Union), as for now, Russia has not many alternatives to drive its exports.
Therefore, Russia cannot employ this scenario as an economic or energy weapon taking it to the edge (cutting supplies), as it would mean the loss of its greatest customer, which would in turn impact heavily on their economy. What they could do at most, is trying to use the situation as a pressure element. The key of the matter depends on how long this dependence of Russian exports with Europe will last.
The Union may try to look for alternatives. Whether it is through an increase in liquefaction capacity, and adding more LNG share (coming from the US, Watar, Norway, Algeria…). However, the greatest part of cargos are parting ways to Asia and other premium markets, so LNG flows to Europe will not be significant enough to cast a shadow over Russian supplies. Besides, in the view to find alternatives in markets like MIBGAS (Iberian Peninsula), which counts on 7 regasification plants, there are other obstacles in the way : Germany prefers Gazprom’s gas, and France does not seem convinced to build the necessary interconnection capacity with Spain for this to happen (see MidCat Project).
Javier Palazón Nadal | Energy Consultant
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