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Calls for Europe to reduce reliance on Russian gas

With EU aims of cutting greenhouse has, questions have been raised about whether the countries can survive without one another

Escalating tensions between Russia and Ukraine have once again prompted calls for Europe to reduce its reliance on Russian gas. However, with the EU aiming to cut greenhouse gas emissions by 40% below 1990 levels by 2030, the continent will need more Russian gas – not less – in the coming decades, and any rupture in this mutually dependent relationship would be costly for both sides. 

The diplomatic row between Moscow and the West following the disputed Crimean referendum, fears over growing unrest in eastern Ukraine and Gazprom’s threat to stop supplying gas to Ukraine after 1 June have raised concerns that gas supplies to Europe could be interrupted, as they were in 2006-7 and 2009.

In mid-May, in an open letter to world leaders, Russian president Vladimir Putin said that state-controlled gas exporter Gazprom could halt supplies to Ukraine unless the country pays off a fuel bill put at $3.51 billion and makes pre-payment for gas supplied after 2 June. Gazprom says Ukraine owes it for gas supplied in 2013 running through to May this year.  

Putin also claimed Russia had supplied Ukraine with an estimated $35bn in subsidies, including discounted gas, which had saved the country around $17bn since 2009. He added that if the EU does not step in to help reach a solution to the dispute, supplies to Ukraine could be completely cut. 

On 12 May, Gazprom’s chief executive Alexei Miller met Russian prime minister Dmitry Medvedev to discuss the row. Miller told Medvedev Gazprom would invoice Ukraine for June deliveries. If payment were not made by 2 June, then Gazprom would halt Ukraine’s gas supply at 10am on 3 June. In remarks published after the meeting, Medvedev said: “It’s time to stop coddling [Ukraine]… move them to pre-payments.” He added: “I think that all possible ways to settle this situation – one way or another – were undertaken by Gazprom.”

But any such move by Gazprom will leave Europe vulnerable. And despite Russian calls for EU intervention, the continent’s leaders are instead focusing on supply diversification. Indeed, at the G7 meeting in Rome on 5 May, politicians devoted much effort to the issue of alternative energy supplies. 

Ed Davey, the UK’s energy minister, called for a pan-EU effort, claiming shale gas, building new storage sites and increasing the number of electricity interconnectors between EU member states would help wean Europe off Russian gas. Europe must stand together to maintain its security, said Davey, adding that the bloc must “ensure no single power can use control of energy supplies as a weapon in the future”.

Weak demand, good storage

While the threatened cut-off would pose an immediate problem for Ukraine, the rest of Europe is not likely to run out of gas anytime soon. A combination of historically low European gas demand; seasonally reduced consumption as the northern hemisphere moves towards summer; and high gas storage levels after a milder-than-expected winter have left the continent less exposed to a supply disruption than it was during the earlier gas wars.  

EU gas demand plunged following the 2007 global economic downturn and has yet to recover. Total consumption across the block was just shy of 500bn cm in 2008. It fell steeply the following year, rose in 2010, and fell sharply again thereafter. Last year, demand was 462bn cm.

The International Energy Agency (IEA) says economic weakness will continue to depress European consumption. While global gas demand will rise by 510bn cm between 2010 and 2016, Europe’s will stagnate. Europe won’t reach pre-2008 levels again before 2020, the agency says.

Russian gas still has a crucial role in meeting this demand. OECD Europe (including Norway, itself a key source of EU gas) imported 167.2bn cm of Russian gas in 2013, a 13% increase on the year before, according to IEA data. This equated to about 60% of OECD Europe’s total imports of 274.5bn cm; and about 36% of total EU consumption. 

It follows that if Russia were to cut supplies to Ukraine, through which slightly less than half of its exports to the EU passed last year, European customers would face sharp price increases. Graham Freedman, an analyst at Wood Mackenzie, noted that while European gas prices already carry a 10% premium because of the Ukraine crisis, a cut-off could see prices climb to $18/million Btu. Other analysts put the figure even higher. Last year, Gazprom sold its gas for an average price of $387 per 1,000 cm ($10.50/m Btu).

But Europe’s situation is complicated by limitations on its supply options elsewhere, not least thanks to political instability in North Africa, says Jonathan Stern, a fellow at the Oxford Institute for Energy Studies. Supplies from Algeria and Libya have both slumped in the past few years.

A number of outages have also crimped Norwegian volumes, while liquefied natural gas (LNG) producers are diverting spot cargoes to Asia, where they can command prices as high as $19.60/m Btu, almost twice the prevailing price for Russian gas. “If we were in normal economic and gas demand times in Europe we would already be in a very difficult situation,” Stern says. “It’s only because demand is such a catastrophe at the moment that we’re not very worried. Can we reduce dependence on Russian gas? No. If anything we’ll need more of it in the future unless other sources start to come online.” Europe would also have to stomach some economic pain if it tried to hit Gazprom’s supplies, by imposing sanctions on the company, for example, or by banning its gas altogether. 

Fitch ratings agency said a long-term embargo on Russian gas would cause supply shortages, and, as gas prices soared, they would drag up electricity, coal and even oil prices too. Increased gas production from Norway and piped gas from North Africa could offset only a small proportion of the gas Russia supplied to Europe last year, it said.

Trying to tap global LNG supplies wouldn’t help much, either. Although European LNG imports fell by 27% last year, to 47.1bn cm, leaving much spare import capacity, global supplies remain tight. LNG trade was almost stagnant in 2013, up by just 0.1%, to 313.4bn cm. Most existing global LNG supply is already tied up in long-term contracts with other non-European buyers. 

Europe’s Russian gas imports amount to nearly half of the total LNG production capacity. And this capacity hasn’t been rising quickly. Last year, it increased from 380bn cm/y to about 390bn cm/y, following the start up of new capacity at Algeria’s Skikda facility and the commissioning of Angola LNG. 

Only three new LNG projects reached final approval from their developers last year: Yamal LNG’s three-train project in Russia, expansions of train three and four at Cheniere Energy’s Sabine Pass project, in the US, and Petronas’s train nine at Bintulu, Malaysia. 

The new LNG projects due on line in Australia and North America will boost supply in the next three years. However, the amount destined for Europe is uncertain. Australia’s plants have been built with Asian buyers in mind. US LNG supplies – much mentioned by Western policy-makers – are no panacea for Europe’s ills, either. For one thing, it is not yet certain how much LNG the US will actually export, and exports themselves won’t start for at least another two years, possibly more. Seven LNG plants have been granted export licences. 

But start-up schedules are still uncertain; and it is unlikely that US exporters would shun Asia’s cash-rich customers for the less lucrative European market. Exports from frontier projects in Canada, East Africa and the Mediterranean, meanwhile, are unlikely to be flowing by 2020.

Mutually assured dependence

Still, for all Europe depends on Gazprom, the Russian firm needs its market in the EU, too. Revenue from energy exports accounts for 70% of Russia’s export revenue and around 30% of total government revenue. Last year oil revenues made up 9.7% of Russia’s GDP, according to the World Bank, down from 10.3% in 2012. Revenue from gas exports made up another 4.5% of its GDP. “Russia does not want a fight over gas in Europe,” says Stern. “The economy is in a disastrous enough state without adding to that. If there’s going to be a fight, it will be one Europeans will pick over sanctions.”

The US and EU have steadily tightened sanctions on Russian individuals during the Ukraine crisis, triggering waves of capital flight from the country. Anton Siluanov, Russia’s finance minister, said in early April that investors had pulled out $63bn in investments from the country during the first quarter. This is expected to rise to around $70bn. This is bad news for Russia, which faced flat economic growth and rising inflation before the first tranche of sanctions were imposed. 

The sanctions regime could get much tighter, too. Victoria Nuland, assistant secretary of state for European and Eurasian affairs, told US congress on 8 May that a new round of sanctions against Russia would “use the scalpel rather than a hammer” to focus on sectors “where Russia needs us far more than we need Russia”. A few days later, following disputed votes for autonomy in eastern Ukraine, UK foreign minister William Hague said a third round of EU sanctions were in the works.

So far, the sanctions have not targeted energy companies crucial to Europe’s supplies, such as Gazprom. Rosneft’s boss Igor Sechin, a close ally of Putin, has been sanctioned – reflecting the West’s view that a hit to oil executives will be less damaging to consumers of Russian energy. But Alexei Miller, Gazprom’s chief executive, has not been subject to sanctions. (He was rumoured to have been on one US sanctions list, only to have his name removed by the time it was published.) 

Even if Gazprom is left off further sanction lists, changes in Russia could still wound the company. Greater liberalisation of Russia’s domestic market means Gazprom’s dominant position at home is being challenged as independent energy producers muscle in. Last year, Gazprom’s share of the Russian domestic market was 53%. But this could fall to just 25% in the next five to seven years, Vladimir Drebentsov, head of Russia and CIS economics at BP, says.

That’s one reason Gazprom has been pressing to secure new markets in Asia. Years of talks with China National Petroleum Corporation over a contract to export gas from fields in East Siberia to China are nearly complete. A deal was ready to be signed during a visit to Beijing by Russian leader Vladimir Putin in May. Exports are initially expected to be 38bn cm/y, rising eventually to 60bn cm/y. But even if it secures an export deal as large as this, Gazprom cannot afford to ignore Europe. “I don’t see any possible volumes to China offsetting what Gazprom currently supplies to Europe,” Drebentsov told Petroleum Economist, adding this is especially true if the company keeps losing domestic market share to local rivals. “Unless Russian gas exports are liberalised, independent producers will still have to sell gas domestically. They will continue pushing Gazprom out of the domestic market.”

If Gazprom does cut supplies to Ukraine, it will have to ensure any suspension doesn’t affect flows to Europe. The company shipped 82.3bn cm of its gas – almost half of its export volume – to Europe via Ukraine last year. 

If that transit route shuts down, Gazprom has 40bn cm of spare capacity in its Yamal and Nord Stream pipelines. It also has about 30bn cm in storage in Europe. With this in mind, the loss of the Ukrainian transit option may not be as damaging as it once might have been.  

Until Gazprom’s other major Ukraine bypass project – South Stream – is online, this spare capacity, and Europe’s relatively weak demand, should keep both the Russian supplier and the European buyers insulated from another gas war between Moscow and Kiev. 

In the meantime, Gazprom has also agreed with Turkey to look into increasing capacity – from 16bn cm/y to 19bn cm/y - of the Blue Stream pipeline, which transports gas across the Black Sea to northern Turkey. Gazprom hasn’t given a precise timeframe for the expansion, but has said no new pipeline strings would need to be built. It would add marginally more security to Russian supplies to Europe, but also strengthen Turkey’s position as an energy corridor to Europe. 

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