Reducing European Dependence: Facts and Fiction
As winter sets in, it is becoming increasingly clear (at least for now) how realistic (or not) it is for countries in Europe that are dependent upon Russian gas sources to diversify away from them. Surely, a thorough plotting out of all the possibilities and limits, a review of all the plusses and minuses for regions and specific countries in Europe, was needed.
To fill that bill, the gas thinkers over at the Oxford Institute for Energy Studies (OIES) have put their heads together and come up with a comprehensive review of every fathomable aspect of the European gas market and to what extent countries can reduce their Russian gas dependence. Coming in at over 80 pages, OIES recently released Reducing Dependence on Russian gas: distinguishing natural gas security from geopolitics (available HERE)
To get a taste of what's inside the publication, Natural Gas Europe submitted a number of questions to the publication's authors: Jonathan Stern, Ralf Dickel, Elham Hassanzadeh, James Henderson, Anouk Honoré, Laura El-Katiri, Simon Pirani, Howard Rogers, Katja Yafimava, who say they grappled with whether it is possible to reduce overall, and individual, European dependence on Russian gas.
How are Russian gas dependent countries in Central and South-eastern Europe likely to fare this winter?
This is not something we deal with in the paper (what may happen this winter was specifically excluded) but with the agreement on the “winter package” having recently been successfully concluded (during the Russia-Ukraine talks mediated by the European Commission) – and provided that all parties adhere to this agreement - this should not be an issue. However, if the agreement is not honoured in full (which is not impossible) there would be consequences for central and more so south east Europe – but these issues have been deliberately kept out of the paper as this was not its subject. The answer depends entirely on the duration and timing of any transit gas disruption. Certainly there is the potential for energy deprivation.
How seriously are efforts being taken to reduce European dependence on Russian gas sources?
Individual countries – particularly the Baltics and Poland – are making serious efforts to reduce dependence on Russian gas by importing LNG, and may be successful. Countries in SE Europe could also take measures to do this. However, individual countries appear to be relying on EU funds to build new infrastructure to import LNG or alternative pipeline gas.
Overall in the short to medium term these efforts are: LNG re-gas terminals in the Baltics, although whether such supplies will be lower cost than Russian gas is questionable. The same would apply to new LNG terminals in SE Europe. Renewables investment reduces gas demand which is an existing policy but would be seen by many policy makers as having the potential to reduce gas (and Russian gas) demand. With financial support mechanisms increasingly restricted though, it is doubtful that wind and solar will result in a material reduction in Russian gas imports.
Our paper concludes that with European domestic production in decline (110 bcma lower in 2030 compared with 2013 and only modest potential from other pipeline gas sources (North Africa and Caspian area – after Turkish consumption) – the main source of alternative supply will be LNG. With Asia the favoured target region for new LNG supplies however, Europe will be the ‘residual’ market for LNG and therefore the degree to which LNG displaces Russian gas in Europe will be a consequence of global LNG balances and Russia’s price/volume strategy.
We are not optimistic about the future contribution from domestic shale gas in Europe due to popular resistance and overly complex planning and approval regimes.
Biogas may have more potential but at some level competes with food crops for feedstocks and will require significant subsidy/financial support.
You point out that, in the context of sanctions against Russia resulting from the Ukraine crisis, it has not affected the Russia-Europe gas relationship. Could it and, if so, how would it?
It has not directly affected the gas relationship because no EU sanctions have been placed on the gas industry (although note that the US has imposed financial sanctions on Gazprom). The most direct impact could be if the EU (and US) imposed sanctions on LNG technology. However, note that in Moscow the EU “stress test” which used a scenario of a complete cut-off of Russian gas was treated as a signal that the EU was contemplating a complete embargo of Russian gas.
Ultimately Europe could decide to accelerate a switch to alternative energies in order to catalyse a move away from gas altogether, and in particular from Russia, but in the short term the contractual ties between the two mean that a strong bond is likely to remain. It is possible that Russia and Gazprom may decide that, in order to reduce the desire of Europe to move away from Russian gas, they will start to play more by EU rules. This could mean more hub-related pricing, more trading on hubs, perhaps agreeing to third party access to export pipelines for non-Gazprom companies. This is not going to happen immediately, given the political situation, but over the medium term we could see Russia start to play more by EU rules in order to secure a place for its gas on the continent over the long term.
So far politics has not affected the commercial relations, deliveries and take by EU countries are within the normal range, also reports on under deliveries by Russia have to be taken with great care, not knowing exactly the term of the supply obligation and in view of the announcement that Russia did not deliver the volumes requested (instead of claiming it did not live up to its contractual obligations.) The sanctions do of course result in great insecurity and mistrust. So far the more measurable effects of sanctions are more longer term, e.g. when it comes to financing and participating in new projects, prominently Yamal LNG. Total stopped buying more shares as originally planned in Novatek (its partner in Yamal LNG) beyond the 18% it already owns. Sanctions especially by US in combination with recent record fines for western banks create significant insecurity even for large investors in Russia like Exxon or Total.
How do you see conservation/alternative fuel sources displacing Russian gas? What are likely to be the most efficacious methods of reducing/replacing gas consumption?
Displacing gas as a heating fuel by better insulation for existing dwellings and by fostering the use of renewable energies in new buildings has already been underway for several decades as part of the energy efficiency programs of EU member countries. Household gas sales are therefore or at best stagnant or declining in several Member States.
The most effective method to substantially reduce gas consumption (and Russian imports to the extent not needed to compensate for reduction of other gas supply) would be to multiply energy saving efforts in household heating. While there are no technical obstacles, this would require tremendous economic, regulatory and social efforts by Government which are not realistic. Even Germany which already has ambitious saving targets since 2010 still has only a refurbishment rate of 1% of building stock per year, and would need at least 2% to meet its ambitious de-carbonization targets for 2020 and beyond. In any case the time horizon would be decades rather than years.
How likely are US LNG imports going to be able to alleviate some of Europe's dependence on Russian gas?
As mentioned above US LNG exports will likely make a very significant contribution to global LNG supply. The extent to which they supply Europe will depend on the future LNG requirements of Asia, and most specifically China. China’s future LNG requirements are the subject of significant uncertainty.
In the long-term, will the Baltic States and CEE/SEE countries be able to afford/choose to purchase LNG over cheaper gas from Russian sources?
This depends on how much money they are prepared to spend, and how much they will receive from the EU. Note that many countries – particularly in the Baltics and Poland – have been talking about this for 20 years and are only now creating LNG import options using EU (and other external) finance. Whether LNG imports prove to be cheaper or more expensive that Russian gas in the future is a matter of speculation, however note that for most of the 2008-14 period it is highly unlikely that these countries could have imported LNG more cheaply than Russian gas (note the very substantial fall in overall European LNG imports post 2010 as a result of extremely high international prices).
Could you give brief comment on gas sources like Shah Deniz, East Med, Iran or KRG as potential alternative sources?
Shah Deniz – at 10 bcma for Europe this is a minor additional source. Other Azeri fields and exploration potential could be more significant but these are unlikely before 2025. Even then, if Turkish demand continues to grow, the amount moving on to Europe may be modest.
East Med is mainly focussed on MENA markets in the first instance with the balance probably exported as LNG. Only modest LNG volumes are envisaged.
On Shah Deniz (see page 25) the main takeaway is that 10 bcm is the maximum amount of SD2 gas that would be available to Europe in late 2019.
Iran has many challenges to overcome before it becomes a significant net exporter of gas, not least the need to improve its political relations with the international community, build a functioning investment framework and satisfy internal domestic demand including oil field re-injection needs. From a commercial point of view, LNG projects from (say) South Pars may have better economic viability and could access world markets (including Europe), however these are unlikely prior to the end of the 2020s. Pipeline exports could proceed before more complex LNG projects, however the cost to supply Europe beyond Turkey may be challenging. Pipeline exports to Europe would require transporting gas all the way through Iran and then all the way across Turkey thus making for very expensive pipeline gas by the time it gets to key European markets. However, from a political/diplomacy point of view, it is not inconceivable that the Iranian government, when/if witnessing interest from Europe, might prefer getting engaged in a long-term gas export contract through pipeline to fulfil its political objective of exporting gas to Europe, even at a higher cost.
The Kurdistan Regional Government (KRG) export potential is difficult to foresee – especially timing due to current instability in relations with Iraq.
What does your report make of Europe's reverse flow capabilities?
The Security Regulation introduced the legally-binding obligation of reverse flows by 3 December 2013 on all cross-border interconnection points between member states however some exemptions have been granted (reverse flow must be enabled at the existing unidirectional interconnections whereas all new interconnections must be built as bidirectional). Many interconnection projects have already been completed but some projects have faced significant delays, for example the reverse-flow project in Romania. Thus there still remain physical bottlenecks (as well as contractual) which explains continuing vulnerability of some countries. The continuing presence of infrastructure bottlenecks also limits the ability to flow LNG eastwards in a network which was designed for predominantly westwards and southwards flows; this is even more so in a situation of crisis as it would place additional limitations under scenarios of high demand and simultaneous maximization of all remaining import sources and of storage use across Europe.
How likely are we to see countries in the region increasing their use of coal?
Any revival of coal use outside of power or steam generation will be marginal at best. Use of coal instead of gas in power generation did already happen to a large extent based on commercial considerations (coal is clearly ahead of gas in the merit order at prices of about 70 $/t delivered in Rotterdam). The potential to switch to coal has already mostly been exhausted. However this trend to replace gas by coal could be reversed on environmental grounds (like in UK due to the Large Combustion Plant Directive which restricts the lifetime of coal fired power plants) or for de-carbonization reasons if the Emission Trading System can successfully be reformed. Further development of renewables could however lead to the displacement of more fossil fuel power generation affecting both coal and gas fired power generation.
We've heard about Hungary stopping reverse-flows to Ukraine, possibly via Russian prompting. How likely is it that Ukraine will receive significant volumes of gas through reverse flow in the future?
There are several factors: availability of gas, availability of pipeline capacity to flow this gas to Ukraine, and Ukraine’s ability to pay. For numbers on pipeline capacity which could be used for reverse flow deliveries to Ukraine see page 52. Pipeline capacity is a significant constraint and even if all of it is utilised for reverse flows to Ukraine, the latter would still need to import around one third of its requirements from Gazprom (at current demand levels). In respect of availability of gas – availability of reverse flow gas for Ukraine is very much a function of Russian gas continuing to transit across Ukraine. Importantly, whereas contractually reverse flow gas is not from Gazprom, physically it is Russian gas. Another important issues is the Naftogaz’s ability to pay for reverse flows – all reverse flow gas is delivered only on the basis of prepayment.
How much does Russia need to continue to sell its gas to Europe and for what reasons?
Russia has invested hugely in existing and new (Yamal, Blue Stream, Nord Stream and now South Stream) pipeline infrastructure. There would be no point in doing this if it did not intend to continue and increase exports to Europe. It needs to continue its earnings from European gas exports although these are not critical for the Russian economy accounting for around 5% of budget revenues, although this is set to rise over the next five years, and most of this comes from pipeline exports to Europe. So European exports are important, but not as important as oil exports (45% of budget revenues), and certainly for Gazprom they are a key to continuing profitability (as they account for around 35% of company revenues overall). Furthermore, although Europe dominates export sales at present, and diversification East is the main strategic goal for Russia, over time Russia will not want to become overly reliant on sales to China, so Europe will continue to provide a balance. The ideal would be to have existing sales to Europe and, say, 50-100bcm of sales to Asia via pipe and LNG. So Europe will remain an important market for Russian gas for the foreseeable future, even if its relative importance declines.
What happens to Russian gas if Europe is no longer buying as much?
The gas sold to Europe comes largely from West Siberia and Yamal, and there is no connection to another export route at present. So in the short term it would just stay in the ground, as indeed is happening at Bovanenko now. In the longer term a connection with the east could be made, either via Altai or via Power of Siberia, but this would realistically only soak up gas that is already waiting for a home. If Europe reduced demand for Russian gas below current levels the gas would effectively be stranded, unless Gazprom built huge new LNG export capacity, which seems unlikely at present. So if Europe wanted less Russian gas then it would stay in the ground as there are no alternative markets and will not be for many years if ever. However we don’t believe this will happen given Europe’s likely import requirements, but it is possible.
Given the gas relations between Russia and the numerous gas dependent countries in places like Central & Eastern Europe and South-eastern Europe, how much of a “done deal” is South Stream? Is it just a matter of time before it is built, given that there seems to be no great impetus to reduce this dependence?
The Saipem barge is in place and ready to start laying the pipe; so it seems it is a done deal offshore; but we believe that probably only 2 strings will be completed initially. There seems to be a strong desire for it in SE Europe, and with the main question being what happens onshore. After some wrangling with the EU a negotiated solution on regulatory issues is likely to be reached. Such solution would need to include a TPA requirement but it would also have to ensure that Gazprom will be guaranteed to have access to capacity in South Stream in the amount sufficient for Gazprom to fulfil its existing contractual supply obligations in the event that transit across Ukraine becomes partly or fully halted.
All things considered, are there any takeaways you would like to give us concerning the Russian-European gas relationship going forward?
There are two basic takeaways from this study: 1) It is highly unlikely that Europe can significantly reduce overall dependence on Russian gas over the next decade, and perhaps even up to 2030, for both contractual (i.e. companies have contracts which mean they must take or pay for minimum quantities of Russian gas) reasons, and supply/demand reasons (i.e. there are no significant alternative sources of gas which will be available to Europe over this period except for LNG); 2) Individual countries which are heavily or wholly dependent on Russian gas in the Baltic region (Lithuania, Latvia, Estonia and Finland), Poland and South East Europe, could significantly reduce or completely phase out (dependence on) Russian gas over the next decade as long as they can obtain the finance to build new LNG terminals and pipeline connections as well as to pay for alternative supplies.
-Drew Leifheit
Reducing European Dependence on Russian Gas – distinguishing natural gas security was published by the Oxford Institure for Energy Studies and is available for download HERE