Three decisions crucial to Russian gas
The volume of exports hangs on crucial events at home and abroad
It is no exaggeration to say that the future of Russian gas exports to Europe may well hinge on the outcome of events in 2019, in particular the progress of three pipeline-related negotiations. Meantime Gazprom's record exports to the continent in 2017 are likely to be surpassed in 2018, with total volumes probably exceeding 20bn cm, with the consequence that capacity in the existing pipeline system is reaching its limit. This is particularly true in the winter months when daily demand is at its peak. If a cold weather event such as March 2018's "Beast from the East" is repeated in 2019, then the system may struggle to cope.
As a result, the negotiations around the future of Nord Stream 2, the use of the Ukraine transit system, and the ruling on capacity utilisation of the OPAL pipeline which brings Nord Stream 1 gas into Germany will be crucial. The least controversial of these is likely to be the ruling on OPAL where the European Court of Justice is set to confirm the 2016 ruling of the European Commission that Gazprom can use up to 100pc of the capacity, therefore allowing full utilisation of the Nord Stream 1 pipeline. Although there are some caveats—for instance, Gazprom cannot outbid third parties for up to 20pc of the pipeline capacity, confirmation by the court should underline that the existing Nord Stream pipeline through the Baltic Sea is fully available for Gazprom's use. Indeed it has been running at full capacity for most of 2018.
Much more controversy surrounds the future of Nord Stream 2, which would add an additional 55bn cm of capacity, taking the total for the Baltic system to 110bn cm. Construction has already begun from the German and Russian sides and is currently scheduled to be completed by the end of 2019. However the final route of the pipeline will depend on a ruling by Denmark over whether it can cross its territorial waters. If Denmark refuses permission on the grounds of national security, which its laws now allow it to do, then the pipeline will have to be diverted to the north-west, most likely delaying completion beyond the end of the year.
Further debate surrounds the potential intervention of the European Commission, which is seeking to extend the legislative power of its Third Energy Package to include offshore pipelines bringing gas to Europe from third countries. This could allow it to impose third-party access regulations on Nord Stream 2 (at least in EU waters) and limit Gazprom's use to 50pc of the capacity. It is unclear whether the commission will ultimately be able to achieve its goal because new rules would need to be approved by a qualified majority in the European Parliament and a number of countries (primarily led by Germany) are opposed to the change.
Gazprom is seeking new markets in the East to diversify its sources of demand
However the ultimate outcome may well be tied to the third major pipeline issue for Europe—the future of the Ukraine transit agreement. Russia's ten-year agreement to pump as much as 110bn cm of gas across Ukraine expires in December 2019 and it is very unclear what will replace it. The political animosity between the two countries is creating a fevered backdrop to the negotiations, and the Kremlin initially indicated that its goal was to avoid any transit through Ukraine at all. The reality of Gazprom's growing exports to Europe as well as pressure from the EU has forced it to re-assess its position, and it now seems likely that it will agree to continue transiting some volumes beyond 2019. But at present the two sides appear to be far apart on the issue of what is an acceptable level to keep the Ukraine system operational.
The EU is attempting to act as an intermediary, but the imminence of Ukrainian presidential elections in March and EU Parliamentary elections in September is complicating proceedings, not to mention the Russian navy's aggression against Ukrainian ships in late November. Furthermore the constant threat of US sanctions being imposed on Nord Stream 2 participants is an additional threat which could disturb the negotiations. Thus the potential for the talks to go to the wire and even fail is real, with significant consequences for the European gas market.
The Kremlin is fully aware that Russian gas has become a major concern in Europe over security of supply. As a result Gazprom is seeking new markets in the East in order to diversify its sources of demand. A major milestone is likely to be achieved in December 2019 when the Power of Siberia pipeline from east Siberia to north-east China is due to be completed. After a five-year ramp-up period the pipe will carry 38bn cm a year under the current contract between Gazprom and CNPC. But perhaps of even more interest is the potential for further negotiations in 2019 to expand Russia's eastern exports beyond this initial level.
At the economic forum in Vladivostok in September 2018, presidents Putin and Xi both committed their state gas companies to reopen negotiations on two new pipeline options from Russia to China. The first of these is the Altai pipeline, now known as Power of Siberia 2, that would run from west Siberia to the western Chinese province of Xinjiang, and from there across the west-east pipeline to the eastern seaboard. Although it would be in direct competition with central Asian gas, both the economic and political catalysts appear to be in place to make the Russian pipeline a realistic option, in particular because Chinese gas demand is continuing to grow at a rapid pace. This new line could ultimately allow Gazprom to export a further 30bn cm a year of gas to China, and potentially to divert gas away from a source that has historically been entirely focussed on Europe.
55bn cm—Nord Stream 2's capacity
The second line would run from Sakhalin Island into north-east China and is known as the Far East pipeline. In fact, the infrastructure is already largely in place because the Sakhalin-Khabarovsk-Vladivostok line was completed in 2011 and has a current capacity of 5.5bn cm, but the addition of extra compressors and a spur line to China could see exports reach 10bn cm a year in future. However, negotiations on price for both this pipeline and for Power of Siberia 2 remain a major sticking point. Although a decision has been promised on both in 2019, the history of negotiations between Russia and China suggests that a delay is possible.
Two other potential investment decisions in 2019 concern Russian LNG. The sector took a major step forward in 2018 with the completion of all three trains at the Yamal LNG project ahead of schedule and for 2019, operator Novatek has indicated that a second project, Arctic LNG-2, may be approved for development. French company Total has already become a 10pc shareholder and a number of other potential partners from China, Saudi Arabia, Korea and Japan are keen to join. If agreement on a partnership group and the development options is reached in 2019, then the project could be producing 19.8mn tonnes of LNG per annum by 2023-24 and would mark a major step towards Russia's goal of turning its Arctic region into a major source of LNG output.
Finally, we may see in 2019 a development decision taken for a third train at the Sakhalin 2 project. This has been delayed by disagreements over its source of gas, but we could now be close to an agreement between Gazprom and Rosneft over the use of gas from the Sakhalin 1 project. Political intervention may be required to ensure that a decision is reached by the two state-owned companies. However the logic of a deal is becoming clear as the project could provide another important contribution to Russia's expanding presence in the Asia-Pacific gas market and ensure that Russia has two major players in the global LNG market.
James Henderson is Director of the natural gas programme at the Oxford Institute for Energy Studies