CEE Natural Gas: It's a Family Affair

It's a family that goes way back when it comes to natural gas in Central & Eastern Europe (CEE), but there's a little spat in the gas family as of late, drawing attention to how the countries in the region ensure their security of supply.

Assessing the natural gas landscape in CEE, David Viduna, head of long-term origination at Prague-based utility CEZ AS, recalled the unified system for natural gas in the region at Flame in Amsterdam, the Netherlands. He said, “At that time CEE was considered by the Russian suppliers to be a corridor for the gas to flow to Western Europe. At that time the system for supply was designed as a unified one, under one control. It brought a certain security of supply.”

Mr. Viduna made mention of the distribution clauses at the time which limited gas from flowing between the countries.

“In the 90s and at the very beginning of this century, there was a change, which caused primarily by the expiry of those contracts and there was a renegotiation of those contracts.”

According to him, many of the contracts lost their specific discounts that had been awarded by Russian suppliers during Soviet times, “because those countries were no longer 'brother' CEE countries, so there was no reason to give them discounts.”

Secondly, he said, the unified system was fragmented at that time into individual countries and the supply chain of gas from Russia into CEE became more vulnerable to breakages (word choice.). “We see what's going on right now,” he commented, referring to the Ukraine crisis' potential effects upon gas deliveries to the region. “At that time the European Commission came with liberalization packages whose intention was to make the price, not only of gas, but also of power, more competitive all over Europe.”

The German BAFA price of gas, he said, had decreased due to this liberalization and the economic crisis. He observed that in the last few years its oil-linkage had begun to diverge, edging closer to the NCG spot price. “It really reflects what's going on the market,” he said, “demonstrating that the markets are oversupplied with gas.”

This was not only true for Germany, but for southeastern Europe as well, as demonstrated by happenings in 2009, he explained. Now, said Mr. Viduna, many gas interconnections had been made between Germany and Eastern Europe.

“Many of these, like the one between Czech Republic and Poland, or reverse flow between Czech Republic and Germany, Czech Republic and Slovakia, and others in the region that are still forthcoming – all of these allow the connecting of these markets together and help so that, in the end, the gas price in Eastern Europe – Czech Republic, Slovakia, Hungary – decrease to those levels seen before,” he explained.

According to him, Czech Republic had the most advanced gas market in CEE, with strong interconnection to Germany, the market was fully liberalized, and a virtual trading point had been established, among others.

Trading platforms in the Czech Republic, he said, were typically linked to NCG/TTF market area pricing. This enabled the bringing of gas, for example, from Germany to the Czech Republic, so that the region was not only dependent on the old supply from the East. He also showed Slovakia, the second most liberalized market in the region, which still had Gazprom contracts, but also reverse flow from the Czech Republic. “There's a lot of gas coming from the West, which can influence the pricing which can be seen on various platforms.”

Slovakia, explained Mr. Viduna, also had a virtual trading point, but needed more liquidity.

In Hungary, he said, the situation was not as optimal as in the Czech Republic and Slovakia. While it historically had a Gazprom contract, Hungary was open to supply through interconnections and was awaiting an interconnection with Slovakia to supply reverse-flow to Ukraine. “This is something, again, which will open the markets to more gas from the West.”

While it had a virtual trading point, the market was not as liberalized as the others, either.

Poland, said Mr. Viduna, was the biggest gas consumer in the region, at 16.5 BCM/year. He commented, “It has its own indigenous production, and quite a strong Gazprom contract.

However in recent years, he added, its connections to a gas pool hub were connecting the market to a lot of gas. He mentioned specifically the connections to Germany and the Czech Republic. Liberalization of the market had only been partially realized in Poland, he said, “Nevertheless there is a gas relief program from PGNiG which every year increases the amount of gas to be released by 10%.”

His slide showed that that amount should reach 50% by 2015.

Mr. Viduna explained, “All of these countries are connected through Ukraine, countries which could be hit, in principal, by disruptions of the supply to Ukraine. But those countries are more and more interconnected to the West, so the problem with disruption of the gas from the East really will not make them as vulnerable as they were a few years ago.”

In January 2009, he recalled, Czech Republic was fine, but Slovakia had been affected by the situation.

Regarding the Ukraine-Russia gas relationship, Mr. Viduna named what he considered a couple of the most important issues: “The first is the limited diversification options for both, and on the other hand, the limited amount of cash Ukraine has to pay for gas, which has raised the temperature more than we would have liked.”
One thing not to forget, he reminded, was that Ukraine was an important customer for Russian gas. “It takes something like 30 BCM, which makes it like the second or third most important uptaker of Gazprom.”

The second aspect to remember was the issue of pricing. “It has always been connected to political discussions as well, for example an $100/TCM discount was awarded to Ukraine by Gazprom because Ukraine agreed with the extension of the stay of the Black Sea fleet on the Crimea.” Following Russia's annexation of Crimea by Russia, the discount was discontinued.

Aware of its dependence on Russian gas, Mr. Viduna said that Ukraine had been pursuing diversification options, like reverse-flow from Poland and from Hungary at volumes of approx. 2 BCM/annum.

“We're at a point where Ukraine is looking for cheaper gas,” he said, adding that this might come from either the East or the West.

One alternative supply source named by Mr. Viduna was Slovakia, and much of the 100 BCM of capacity that it received could be diverted back to Ukraine. Unfortunately, he noted, based on what Eustream had announced, the reverse-flow that could be performed was limited because of the conditions of Slovakia's contract with Gazprom.

“After a lot of effort from the European Commission, an alternative has been found, for so-called 'small reverse',” he reported, adding that a 10 BCM pipeline from Poland could be used for bringing additional gas to Ukraine.

“This pipeline should be operational by the end of this year with a capacity of 3 BCM/annum, and from spring of next year the capacity could be increased to something like 9-10 BCM/year.

According to him, not only Ukraine was looking into alternative routes.

“Russia is also thinking about how to deliver gas to Europe,” he said, mentioning Nord Stream and the pending South Stream. Of the latter, he said, “It's a pipeline which would bring gas to the areas which would be hit most in case Ukraine is not able to supply gas, or not able to transit gas.”

South Stream, he explained, would bring gas to Bulgaria and the Balkans, but would also be connected to Austria and the rest of the European network, but it was questionable, according to Mr. Viduna, whether the pipeline would be implemented or not. He explained, “There are so-called intergovernmental agreements between Russia and the Balkan countries, but those agreements were questioned by the European authorities from the point of third party access. But from the perspective of Russia and general security of supply, not diversification of suppliers, this pipeline can bring gas to Europe.”

Mr. Viduna said it was necessary to ask what the other sources of European gas were; Norway had limits; Algeria could increase supplies.

He added, “We still have a big opportunity coming from LNG – there is about 200 BCM of capacity which could be used. The question is, is Europe willing to pay the price for LNG, which is more expensive.”

Even if South Stream were built, he said, the Ukrainian pipeline would offer significant “optional value” for Gazprom, which would be supplying about half of total European natural gas demand by 2018. “This puts Gazprom in a different position, allowing it to bring more gas than we see today.”

According to his presentation, a long-term solution of the Ukrainian-Russian gas dispute meant that Gazprom gas would still likely end up in Ukraine.

“One of the principles is that there should be fair pricing of gas towards customers in Ukraine. Naftogaz needs enough money so that it can pay for imported gas,” said Mr. Viduna, who said this was one of the things crucial for a long-term solution.

Transparency on transit and storage operations in Ukraine, he said, was also key, as was diversification of routes.

“At the moment that both players will have some other alternatives to supply gas or uptake gas, the situation will be much more clear, much more stable.”

In the end, this mean security of supply for everyone in Europe, and good for Gazprom as a reliable supplier; Ukraine could offer its gas storage facilities to Western markets.

Finally, it would enable Gazprom the capacity to offer a giant supply to Europe, concluded CEZ's David Viduna.

Drew Leifheit is Natural Gas Europe's New Media Specialist.