Week 32 Overview
If UK next-day gas prices volatility climbed to the highest level since June 2013, there is a reason. The 32nd week of the year has further proved that the standoff over Ukraine is not a regional issue. It is not a simple conflict between countries or blocks.
The frictions between Russia and the West hide an all-encompassing clash, whose consequences have not completely unfolded . Other regions of the world might be soon affected. In this context, it comes as no surprise that these uncertainties are likely to have an impact on gas prices. An imminent increase in price volatility is more than possible.
After being hit by financial sanctions, an arm embargo and restrictions on export of high tech goods in energy sector, Russia came out with its own strategy. The country is betting on operations in the Kara Sea, while disinvesting from Europe and pushing forward with restrictive measures against the West.
Kremlin can capitalise on European economic problems, benefiting from the poor results announced by Italy and Germany. Rome did indeed slip back into recession, while Berlin reported lower-than-expected factory orders. A real trade war between Europe and Russia is indeed possible. Opening the opportunity for Russia to hit back.
On Thursday, Moscow banned most food imports from the EU and the US. Around 10% of EU agricultural exports go to Russia and this might have an impact on European economic recovery. The fact that the sanctions could take an economic toll in the region confirms that gas is just part of the confrontation. Nonetheless, hydrocarbons remain central for Russia, as they make up over 60% of total exports.
On Saturday, Russia unveiled the second part of its strategy. Putin participated in the the launch of the drilling operations at the West Alpha rig (Universitetskaya-1 site) in the Kara Sea. The project is central for Russia, which needs to find new areas to produce oil and gas, offsetting declining production from mature fields to maintain its geopolitical clout. At the same time, cooperation with ExxonMobil has been welcomed as a vote of confidence in Rosneft.
“As I have already said, all this great work was made possible by uniting the efforts of Rosneft and our US partner, ExxonMobil. Practice shows that it is nearly impossible, or at least very difficult, to implement alone such large high-tech projects, projects of global scale and significance. Today commercial success is determined by effective international cooperation,” commented Putin on Saturday.
The Russian strategy is really pragmatic also when it comes down to divestments, which represent the third part of Russian strategy. On Monday, Lukoil moved forward with its plan to divest assets in Eastern Europe. Following a similar deal signed last week, the Russian company agreed on contracts with Hungary’s MOL and Norm Benzinkút Kft.
‘Slovnaft Česká Republica, Spol. S.R.O. (a subsidiary of MOL Plc.) will buy from LUKOIL a network of 44 gas-filling stations located in the Czech Republic’s territory. Norm Benzinkút Kft will purchase LUKOIL’s filling-station networks in Hungary (75 stations) and the Slovak Republic (19 stations),’ reads a note released on Monday.
Finally, the Kremlin is trying to preserve other projects, mainly the South Stream pipeline.
On Monday, Russia’s engineering construction company Stroytransgaz has withdrawn from the planned construction of the Bulgarian section of the South Stream project. Stroytransgaz is controlled by an investment vehicle in the hands of Gennady Timchenko, who has been hit by the US Treasury’s sanctions imposed in May.
Referring to the divestment, Timchenko said that the withdrawal is intended to keep the project going.
Ukraine is not standing there twiddling its thumbs. It is working on a tax change and sanctions on Russia. Doing so, the country is putting short-term security first, penalising long-term business activities to overcome severe threat to its own existence. Before thinking about its future, Kiev has indeed to survive.
In this context, it is logical that Kiev did decide to increase production taxes for oil and gas companies for the period 1 August to 31 December 2014.
‘The most significant tax increase is on gas production where the rate will approximately double to a level of 55 per cent,’ reads a note released by JKX on Monday evening, commenting on the emergency budget legislation passed by the Ukrainian Government.
Meanwhile, Kiev is also trying to promote underground gas storages.
According to a document published by Ukrtransgaz, the country has increased its gas reserves in UGS facilities. The reserves registered on August 1 are 53% more than the ones registered in the same period of 2013.
‘As of August 1 this year, reserves of natural gas in Ukrtransgaz’ underground gas storages (UGS) total 14.947 billion cubic meters, accounting for 48.3% of the total capacity,’ the Ukrainian company wrote on Monday.
But the rate of pumping in July fell in comparison to the second half of June, following reduced gas imports from Hungary (3.2 mcm a day against 5.5 mcm in the June 16-June 30 period).
In this sense, it is clear that European support might be not enough. Logically, Ukraine is trying to get some more help.
On Tuesday, Ukraine’s Prime Minister Arseniy Yatsenyuk met with the Minister of Economy, Trade and Industry of Japan Toshimitsu Motegi.
‘Arseniy Yatsenyuk confirmed striving to develop relations between Ukraine and Japan in economy and trade with attracting high technologies of Japan. Top priorities in this direction are energy efficiency projects,’ reads a note released after the meeting.
The final piece of the jigsaw is the attempt of the government to promote sanctions on a list of 172 citizens of Russia and other countries.
‘Arseniy Yatsenyuk has noted that the decision on introduction of sanctions on the countries and persons that have been supporting and financing terrorism in Ukraine and encroaching on the territorial integrity and independence of the Ukrainian state was adopted at today's Government meeting,’ reads a note released by the Ukrainian government.
Europe’s attempts to hold talks with Russia did not pay out so far. Nonetheless, EU Energy Commissioner Guenther Oettinger and Russia’s Alexander Novak are expected to be holding talks on gas supplies at the end of the month.
Reportedly, the meeting will take place in Moscow on August 29.
In the meantime, European countries focus their attention on their two traditional pillars: integration and transparency.
An example of European integration came on Monday, when PEGAS, the natural gas platform jointly established by Germany’s European Energy Exchange (EEX) and France’s Powernext, announced a year-on-year 209% increase in total volume traded in June.
The platform offers access to all spot and derivatives products offered by the two exchanges for the German, French and Dutch markets. It also launched a platform for the Belgian ZTP spot market and the new ZTP Futures market on 9 July 2014.
An example of transparency came on Wednesday, when the United Kingdom announced a possible crackdown on people rigging the energy market, proposing new laws that would give national regulators new powers to prosecute suspects.
‘Anyone found guilty of rigging wholesale gas and electricity prices could face up to two years in jail under proposals being put forward by Energy and Climate Change Secretary Ed Davey today,’ the government wrote on its website.
These two options - integration and transparency - seem to be the only two cards in European hands. Production and financial patterns are indeed quite discouraging.
For instance, Lundin Petroleum reported poor results on Wednesday. Not that differently, Statoil is experiencing similar problems. The Oslo-based company completed its summer’s drilling campaign in the Hoop area, announcing disappointing results. It did not report any commercial discovery.
“We are naturally disappointed with the results of this summer’s drilling campaign in the Hoop area,” Irene Rummelhoff, Statoil senior vice president for exploration on the Norway continental shelf, commented in a statement.
In this sense, financial problems and economic distress further complicate companies' attempt to adapt to the continuing deterioration of the European market. For instance, Eni’s attempt to sell its stake in Saipem might encounter some difficulties.
IRAN, ARMENIA, AZERBAIJAN
Russian approach to the confrontation with Europe also passes through a consolidation of its ties with neighbours, reasserting its centrality in former Soviet countries.
At the moment, eyes are locked on the conflict between Armenia and Azerbaijan, which could further destabilise hydrocarbon-rich areas. The conflict between the two neighbours came with a frenzy of diplomatic activities.
Socar’s President met a delegation from Teheran to strengthen ties with Iran. The two countries are interested in promoting a stronger cooperation. According to the two delegations, Azerbaijani and Iranian oil and gas companies want to coordinate to meet European gas needs.
Despite this move, Moscow is doing what it takes to remain the main diplomatic power in the area. After meeting with President of Armenia Serzh Sargsyan, Putin did indeed hold talks with President of Azerbaijan Ilham Aliyev in Sochi.
‘Our cooperation extends to a wide range of areas: in addition to political interaction, we have seen good results in the economic sector. Trade is thriving; we have seen growth last year and this year. The structure of trade has improved and mutual investments have reached significant levels. Naturally, this gives a new dynamic to our relationship,’ Aliyev said as reported by the Kremlin on Saturday.
In this sense, Russia is well prone to maintain its clout in the hydrocarbon-rich area to stop eventual alternative to its gas. Azeri and Iranian gas to Europe would be a blow to its attempt to maintain centrality in the European market. This is why, the confrontation in Eastern Ukraine could come to an end in some months, but the conflict will spill over into other countries.
There are hundreds of possible scenarios. The only certainty is that Russia will not easily give up.