• Natural Gas News

    The Bridge: Natural Gas in a Redivided Europe [NGW Magazine]

Summary

Europe and Russia have had to bury their political differences to make the gas industry work – but this is not a given forever, argues a new book. [NGW Magazine Volume 4, Issue 21]

by: William Powell

Posted in:

Featured Articles, Europe, Premium, NGW Magazine Articles, Volume 4, Issue 21, Security of Supply, Exploration & Production, Supply/Demand

The Bridge: Natural Gas in a Redivided Europe [NGW Magazine]

Europe’s prolonged gas trade with Russia should come as no surprise from the economic point of view: both sides have benefited hugely from it, regardless of the political temperature.

But past performance, as banks have to warn investors, is no guarantee of future returns; and a book by the professor of government at Georgetown University, Thane Gustafson (published next January), is well worth a read for those wanting more insight into the mindsets of the main actors and what might influence the flow of Russian gas to Europe in future.

After all it comes out soon after the 11-year Ukraine-Russia gas transit contract expires on New Year’s Eve. But its appeal is a lot broader than that.

The Bridge: Natural gas in a redivided Europe (Harvard University Press, 500 pp, £31.95) covers the whole spread of politics, society, commerce and -- not least -- the people who made the industry what it still (just about) is.

Ruhrgas CEO Burckhard Bergmann, Wintershall’s Herbert Detharding, Statoil’s Arve Johnsen and the Russian pioneers Alexei Kortunov and Nikolai Babaikov are among the many individuals name-checked for their contributions over the past 60 years, and whose memoirs are quoted from. Directing the investment of billions of dollars in infrastructure and marketing operations, they more or less invented or facilitated an industry where before there had been nothing. 

Gas: the long-term investment

Oil can be transported to the customer in a bucket, if need be. But gas, while being easier to produce, is much more expensive to store and transport than oil. And it takes time and effort to develop the necessary governmental and other relationships to create the conditions for cross-border trade, and then it can take dogged persistence to see a project through to the end.

As Gustafson explains, ”natural gas from the beginning has been the product of enthusiasm and vision… the people who work in it have been true believers in gas.”

While the book is chiefly concerned with the role of gas in east-west relations and placing particular emphasis on the time since Crimea signed up for membership of the Russian Federation in 2014, the book is necessarily also a political and economic history of the region since the Groningen gas – not the hoped-for oil -- field was discovered in the Netherlands and brought into production.

Later came Russian gas, and then Norwegian gas – again, a fortuitous event -- all fitting in to the mix, adding to the supply flexibility and reassuring buyers that there was no risk. As the pipeline network expanded, Russian gas could be replaced by the same-quality Norwegian gas if needed.

Demand swelled far faster than the marketers’ initial expectations, leading to more and larger contracts with the producers, but all with the same fundamental elements embedded.

The whys and wherefores of oil indexation, take or pay and netback pricing are all explained as being the point to start from in the absence of precedent. And as the book shows, none of it might ever have happened; failure lurked around every corner.  Nor was there anything predestined about the road to today’s spot market for capacity and commodity with unbundled networks and the growth of electronic trading -- imports from the UK that in turn had originated in the US. 

The long-term is over

These new methods all gained particular significance with the oversupply of expensive, oil indexed gas for which there was no market in the economic downturn of the mid-2000s, but which had to be bought under take-or-pay terms. Just as happened in the UK in the mid-1990s, continental hub gas displaced oil indexed gas and destroyed the economics of the incumbents. They were forced to buy more gas than they needed at high prices – owing to the oil price -- and sell it all low. They had to hang on grimly until the next price review, and then the next, haemorrhaging cash.

The book also describes the growing authority of the European Commission – thanks mainly to British politicians of the 80s and 90s – and the strength of the competition directorate in particular. If it wanted to realise Jacques Delors’ dream of a single European market, it had to bang some heads together. It had no time for special pleading from the gas industry and abstruse arguments about contracts and the merits of demarcation zones.

With its unique ability to impose colossal fines – which it exercised -- start sectoral enquiries and its refusal to comment on a proposal before it was too late for the company concerned, DG Competition occupies a special place in the EC’s mythology. Yet while Gazprom might have been in its sights, it was a foreign company and most of the directorate’s early actions were aimed at the European companies: the ‘dawn raids’ on Ruhrgas, Gaz de France, Eni and so on. Only later did it pursue Gazprom and its numerous affiliates in eastern Europe, following a complaint by Lithuania in 2011.

Mirroring the rise of short-termism was the collapse of the German gas industry, despite the intellectual leadership of Bergmann. After several decades of amicable trading agreements with each other, the merchants found themselves suddenly fighting a rearguard action against the regulator’s directives and competition law. He reddened when he was told at a meeting that his erudite arguments on the contract structure were not valid. “We are the customers, you should be listening to us,” one said. Ruhrgas, known as the law firm with pipelines, had two contracts: one where it was the seller and one where it was the buyer.

Thawing the Cold War

The book’s narrative keeps the reader’s attention with regular shifts from one side of Europe to the other and back again: from industry association meetings in the Ruhr and the hostile take-over of Ruhrgas; to the alternately midge-infested or icy wastes of Yamal; from Leonid Brezhnev and his gas experts; to Gerhard Schroder and his political successes and the rise of Angela Merkel. She delighted in the destruction of the Berlin Wall as much as Putin deplored it and the two do not get on.

The narrative also shows just how little each side knew of the other’s activities in real time, each too preoccupied with its own concerns and too secretive to let the cat out of the bag. After all, for much of the early days there was a Cold War on.

Russia for instance had agreed a major new gas supply contract with the West that it had no hope of meeting without the right kind of imported pipelines, and the pipelines needed to be bought with gas yet to be produced. Gazprom has since caught up with the west in that technology, as the author reminds us.

But that was not the case then and the head of Gazprom, Rem Viakhirev, had to fly to Ashgabat and grovel at the feet of the president of Turkmenistan in order to extract more gas for delivery westwards. He had earlier said in an interview that central Asia could “swallow its gas bubble.” The interview was televised but for reasons of technology this is unlikely to be on Youtube.

The struggle between the gasmen and the Kremlin for military-quality equipment, such as much-needed turbines for the compressors, set work back years. Improvisation had to do the job, machinery being bolted together to add power. And the impossible challenge of developing the western Siberian gas fields in time for the major new contract also had consequences, including the rapid depletion of Ukrainian gas fields.

Indeed the Russian upstream chapters of the book, from the discovery of the supergiants in the Nadym-Pur-Taz region and latterly Yamal, and the heroism of the visionaries who built and insulated the giant diameter pipelines safely on permafrost but shortened their lives through overwork, is a fascinating story in its own right.

Viakhirev himself departed the stage for political reasons: failing to read the signs, he voted against United Russia and Vladimir Putin. Putin was another man whose indirect but rapid rise to power was just as adventitious as Viakhirev’s and the rest of the Orenburg group’s had been. But even had Viakhirev thrown his weight behind Putin, it is still likely that one of Putin’s St Petersburg associates would have taken over sooner rather than later, as Alexei Miller did – and still going strong after almost two decades at the top.

There are startling reminders of old hostilities. Some of us in the European Union might worry now for example about Washington’s attempts to impose sanctions on Nord Stream 2 -- just as others welcome it -- but there were the same worries about interference from the US in the latter part of the last century, to block Russian imports. Then too Washington did what it could to boost rival suppliers to compete with Russia.

And Russia’s use of gas as a weapon to assert authority over its satellites too has proved a double-edged sword. Moscow felt that the goods and services it received in return were substandard. And always there was the squabbling between them: a favourable deal with East Germany rankled among the other countries who demanded better terms from the Kremlin -- even as the waves lapped at the foot of the economic sandcastle of the USSR.   

So it was that personalities, the political and economic ideologies on either side of the Soviet Union/Russia and the customary mix of fear and greed all played a part in shaping the region’s gas markets over the past decades.

Now though the rise of LNG deliveries – another industry that is undergoing huge change -- has helped neutralise any threat Russian gas might pose. The pipeline network is vast and growing and it matters little what physical route the gas originally followed.

One downside for Russia – and any other producer – Gustafson says, is that the balance of risks, so elaborately devised in the original contracts, has gone. The producer bears both price and volume risk.

The scope for natural gas to grow might in the end be more limited by the extent to which environmental concerns enabled by technology gain the upper hand. For the book even finds room for hydrogen and synthetic gas, enabled by ever-cheaper renewable energy, in the energy mix. But this is not expected at scale before the mid century. While there is demand for gas, Russia will be able to provide it, he says. Politics permitting of course.