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Gazprom sees amicable end to gas contract row

Arbitration filed against Russian exporter by European utilities are expected to end “amicably”

Gas contract arbitration claims filed against Gazprom by European utilities are expected to end “amicably”, the Russian gas export monopoly said.

Poland’s PGNiG and Germany’s E.On and RWE are taking on Gazprom over loss-making oil-indexed gas contracts. The European utilities have shed billions of dollars after locking into Russian gas bought on long-term contracts linked with crude prices – which have risen sharply since 2009 – and selling at hub levels, which have remained relatively flat.

“We will find a solution out of court... and basically we’re moving in that direction," Sergei Komlev, head of contract structuring and price formation at Gazprom Export, said in an interview with Petroleum Economist

“We’re meeting with our partners and discussing things so it’s not like a Chinese wall or the Iron Curtain between us. We have had years and years of good cooperation with our energy importers,” he added.

Over the past few years, other gas suppliers have allowed buyers to shift to hub-based deals, with the oil element for European gas contracts falling from near 80% in 2005 to under 60% in 2010, according to the International Gas Union (IGU).

While the hub pricing element in contracts more than doubled, to over 36% compared with 15% in 2005, Gazprom remains stubbornly committed to the oil link.

“Oil indexation offers a win-win option to both buyer and seller,” said Komlev. “To the seller it’s a guarantee that investments will be incorporated so there is no risk that the prices will not support the investment cycle because hub prices are unpredictable,” he argued.

Komlev also expected European gas consumption to remain strong, despite concerns that the Eurozone debt crisis would weigh on economic growth. Consumption dropped in 2011 not for structural reasons but thanks to a mild winter, he claimed.

“In 2011, demand fell 60 billion cubic metres (cm), only driven by weather. And what I’m saying is that at the moment, it’s not GDP that governs consumption in Europe but weather conditions,” he said.

“GDP growth definitely affects demand for gas, but, generally speaking, regardless of economic conditions, people will still pay for natural gas because it provides comfort for houses and heating for public buildings.”

Komlev’s views contrasted with those of the International Energy Agency (IEA), which forecast European gas demand to stay below 2010 levels of 570bn cm a year until at least 2017. For Europe’s four largest gas consumers – France, Germany, Italy, and the UK – the IEA predicted gas demand would remain subdued at 2000 levels of 300bn cm/y for the next five years, as renewable energy, cheap coal supplies and economic worries stymie gas consumption.

“Unfortunately, Europeans have done their best to squeeze gas out of power generation. This is a mistake they’ll have to pay for over many years ahead,” Komlev said.

Cheap gas in the US has freed up more coal supplies globally, cheapening prices for the black stuff. At the same time, EU prices for carbon emission permits have also crashed, making it more profitable to burn coal for power generation.

In pursuit of aggressive emissions-reductions targets, Europe has also put in place subsidies for renewable energy, triggering huge growth in wind and solar energy in countries such as Spain, Germany, and Italy.

But the outcome has been to boost coal’s market share at the expense of gas, a cleaner-burning fuel, said Komlev. “Without subsidies, the price of electricity should be higher. With the subsidies, they’ve basically killed gas-fired power generation and no plants are being built at the moment. The new plants are coal plants,” Komlev said.

He added that the adoption of more natural gas in the transport sector, including heavy-duty trucks, city buses, and ship bunkering fuel, may offset some demand loss in the power sector.  

“What we see now is a kind of a silent revolution that’s taking place, the displacement of oil products in transportation,” he said. In May, Gazprom Germania – a subsidiary of the Russian firm – said it was working with Polish bus company Solbus to develop liquefied natural gas (LNG) powered buses.

But it would need a lot of LNG-powered vehicles and filling stations to offset all the lost demand from Europe’s power sector and the numbers aren’t encouraging.

A typical 1,000 megawatt gas-fired power plant consumes 730m cm/y of gas. Using Shell’s planned 300,000 tonnes a year (t/y) LNG plant, designed for fuelling trucks in Canada, as a template, it would take two such LNG trucking facilities to offset one gas plant.

At peak, Germany was using gas to generate around 33,200 megawatts of power on 14 June 2012, according to EEX energy exchange data, nearly 2,000 megawatts less than a year ago. UK government data also showed gas consumption for power dropped 22.3% year-on-year in the last quarter of 2011 – equivalent to around 1.63bn cm.

So it would need at least eight mini-LNG plants to be built to offset the fall in gas demand in the UK and Germany alone, with no plans for such a rapid ramp up.

LNG-powered vehicles could add 28bn cm/y gas demand by 2030, according to industry trade organization Eurogas, still only offsetting around half of the consumption drop experienced between 2010 and 2011. 

LNG for shipping fuel could add 5m t/y LNG demand (6.8bn cm/y gas), according to Norwegian LNG bunkering company Gasnor, but this would not be until 2020.

A loss in European gas sales would hit Gazprom’s bottom line. Although the company sells 12% of gas to other countries, excluding those in the former Soviet Union, it represents 58.6% of its earnings, according to Gazprom’s own data.

Europe also increasingly relies on Russia gas due to dwindling domestic supply, with Gazprom supplying around 26% of Europe’s gas needs in 2011, according to Cedigaz

Separately, Komlev said Greece’s state gas company Depa remains able to borrow money to cover its gas bills, dispelling fears that its economic crisis would hamper its ability to pay for energy.  

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