Moscow and Brussels have switched their gas business from the model of "interpenetration and interdependence" to the model of "pure diversification".
Moscow and Brussels have switched their gas business from the model of "interpenetration and interdependence" to the model of "pure diversification".
At the conference entitled "Europe and Eurasia: Towards the New Model of Energy Security" organized by the Valdai Discussion Club in April 2015, Energy Minister Alexander Novak and Gazprom Head Alexey Miller presented a new concept of gas cooperation between Russia and European countries.
The innovations in their relations include the need to consider the Asian factor, which will have a great impact on pricing for European consumers, and the renouncement of the policy of mutual shares in the assets of Russia and Europe.
We agree to follow the European playbook, but it is unclear how beneficial it would be for Europeans.
Turkish Turn
EU economies may pay a dear price for the uncompromising position of the European Commission in the construction of the South Stream. The emergence of the Turkish Stream project forces them to invest in new infrastructure needed for imports of Russian gas, a substitute for the Ukrainian transit corridor.
Russia declared the decision to build the Turkish Stream and annul the gas transit deal with Ukraine in 2020 without preliminary consultations with the European Commission, and it doubtlessly took the European functionaries aback. The organization was accustomed to making new game rules, creating barriers for Russian gas in Europe: the EU's third package of energy market legislation, the purpose market model, and, finally, the concept of the European Energy Union with accent on intervention in commercial gas contracts.
The South Stream project, which received vast investments, allowed the EU to keep Russia in a suspended state.
Our country had to constantly concede to many states, the territories of which would be needed for the South Stream. The prospects of the project to gain a special status and a relief from the effects of the third package in reserving the capacity for third parties were still ambiguous. Now, instead of Russian investments in the construction of the South Stream on the territory of EU member-states, European bureaucrats got Turkey as an additional transit state outside the European Union, problems in the construction and expansion of internal infrastructure to supply the Southern and South-Eastern Europe after 2019.
We can say that Russia launched the "mechanism of early warming" by declaring the end of gas transit through Ukraine.
Russia and the EU signed the memorandum on the mechanism of early warning in the energy sector after the gas crisis of 2009 to cope with the emergency situations in the sector, including transit risks, with minimum repercussions. Appealing to the mechanism of early warning, Gazprom may as well declare a force majeure situation in supplies to Ukraine before the expiration of the transit contract.
The Turkish Stream has become the result of a cardinal change in the gas business of Russia and Europe. The business has switched from the model of "interpenetration and interdependence with elements of diversification" to the model of "pure diversification". While the European Union struggles to reduce dependence on Russian gas, Russia is trying to make a full-fledged turn to the East and diversify market outlets. After realization of the Power of Siberia project, Europe will cease to be the only market for Russian network gas, and will lose the priority status if the Altai project succeeds.
We follow European rules and win
Announcing the Turkish Stream gas pipeline project in December 2014, Gazprom declared that it would sell gas on the trading platform on the Turkey-EU border. The goal of Europeans was to create the needed transport infrastructure in the European Union in order to receive the gas volumes. Purchases of Russian gas at a hub instead of a delivery post, the reverse of existing gas pipelines, investments of the European systemic operator into construction of new gas pipelines via supply contracts are all the principles corresponding to the ideology and rules of the third package.
Russia is sort of telling European partners: we sell gas in Turkey, the rest is up to you.
Gazprom's demonstrative compliance with the third energy package in the case of the Turkish Stream can be regarded as reductio ad absurdum, proving the inconsistency of the European regulatory system by demonstrating absurd controversies arising from their application.
Paradoxically, the rules of the third energy package have never been fully applied in the construction of the new gas infrastructure in the European Union. In order to attract investors, the European Commission was forced to make exceptions in the rules when reserving 50% of gas pipeline capacities for third parties. A good example is the Trans-Adriatic Pipeline (TAP) with a capacity of 10 billion cubic meters a year, which will transport Azerbaijani gas to Europe.
Formation of an interface for connection of the Turkish Stream to the European gas infrastructure will in fact become an experiment to verify the adequacy and firmness of the new game rules on the European gas market.
What does Russia get from realizing the Turkish Stream? First of all, lower transit and commercial risks, compared to transit through Ukraine, the situation around gas shipments that has become absolutely unacceptable and encumbered by constant negotiations under the duress of the European Commission as the guarantor of negotiability of the Ukrainian side.
Secondly, the Turkish Stream is proactive and competes with gas supplies to Europe within the framework of the Southern Gas Corridor through Turkey (for example, via the Trans-Caspian Pipeline), snatching the potential consumer demand from competitors.
Finally, reaching an agreement with Turkey - a non-member of the European Union - Russia no longer needs to make a deal on the construction of the gas pipeline with the European Commission, note the case of Bulgaria within the framework of the South Stream.
In order for many European consumers to receive Russian gas through Turkey by 2020, they need to create transport infrastructure in the European Union. The third energy package frees Russia from incentives for the construction of gas infrastructure in the EU, albeit enabling Gazprom to take a minority part in gas transport consortiums in association with European companies. Furthermore, Russia will take advantage of the European rules on 50% access to transport capacities of third parties, demanding access to European gas infrastructure, for example, the second TAP branch.
The problem of the compulsory 50% reserve of capacity in the new infrastructure on the territory of the EU can be solved by striking a deal with European companies to move the delivery post of gas from Baumgarten to the Turkey-Greece border. However, it would most likely involve a discount for gas in Baumgarten comparable with the cost of its delivery from the Greek border.
Motivation and risks of EU states
Many countries of the Southern and South-Eastern Europe are highly dependent on Russian gas supplies delivered through Ukraine and want to reduce related transit risks. The European Commission has made it clear that it was absolutely opposed to the Turkish Stream. Is there any logic in the position of the European Union and does anyone in the Old World back it?
The European Union has a set of countries indifferent to Russia's ceasing gas transit through Ukraine, so they can painlessly take a neutral or a hostile position towards the Turkish Stream. For example, Slovakia and the Czech Republic - located on the outlet of gas transit through Ukraine - prefer to pump it further to the West, buying gas from the Nord Stream. France, making a clean sweep of Ukrainian transit via the Nord Stream, and Baltic states, that have never been dependent on it, can naysay construction of any gas pipelines bypassing Ukraine indefinitely.
Reduction of Russian gas transit through Ukraine means less income for Naftogaz, hence deficit of funds to keep the gas transport system running. After that, contracts on gas shipments may be revised to the extent of total cease of supplies from Russia by 2020. As a result, Ukraine will have to buy reverse gas, possibly of Russian origin, from the Turkish Stream or the Nord Stream. It would mean higher prices for Ukraine and, in the end, additional financial aid from the European Union within the framework of the realization of the EU Association Agreement. Russia, on the contrary, will take hold of new arguments to encourage full use of the Nord Stream.
At the best of times (for example, in 2011, when transit through Ukraine amounted to 103 billion cubic meters and imports of Russian gas numbered 45 billion cubic meters), "the tribute for Ukraine's loyalty" from Russian gas transit and discounts was worth about $7.8 billion a year, $3.6 billion of which were the payment for transit, $4.2 billion were the gas discount. However, Russia has managed to halve dependence on transit through Ukraine.
The European Union continues relying on reduction of dependence on Russian gas using alternative sources, notably the LNG. It bids on structural excess of gas which will be accrued after 2016, with the launch of shipments of American and Australian LNG to the world market.
Yet, even at the current prices of $2.8/MBTU at the Henry Hub, American LNG in Europe will cost about $300 per thousand cubic meters of gas, which would not make it competitive in comparison to the pipeline gas from Russia sold according to contracts with oil price indexing and other sources. In any case, the premium Asian market will remain the priority for American LNG. The same concerns the more costly Australian gas, 80% of which has been reserved for APAC.
Scenarios
The transit of Russian gas to Europe through Ukraine in 2014 amounted to 59 billion cubic meters. Completion of the Turkish Stream with a capacity of 63 million cubic meters (about the same volume as the South Stream design) will render the Ukrainian transit pipeline obsolete as scrap metal.
The first two branches of the Turkish Stream with a total capacity of 32 billion cubic meters will enable redirection of the contracted volumes to Turkey, Bulgaria, Greece, Macedonia, Romania and Moldova. They are currently delivered to the said states through Ukraine with minimum modification in the existing transport infrastructure (in particular, it would require reversing the Trans-Balkan Pipeline. The gas volumes at the level in 2013 (which meets the contracted gas volumes) may fill about 85% of the capacity of both lines of the Turkish Stream. With account of the growing demand in Turkey and the perspective supplies to Ukraine using the route, the load may go even further up.
The third and the fourth lines of the Turkish Stream will supply gas to Italy, Hungary, Austria, Serbia and Slovenia. Baumgarten in Austria is the main delivery post for gas to the said countries according to the contracts. Theoretically, the Turkish Stream may deliver gas to Baumgarten from the Greece-Turkey border. Moreover, the third energy package stipulates construction of the additional pipeline capacity for the cause by European system operators on condition that gas contracts will be signed. However, judging by the positions of the European Commission, the 30-35 billion cubic meters of the Turkish Stream will be the main subject of disputes.
The transit contract of Russia and Ukraine will expire in 2019, many Gazprom's contracts to deliver the gas currently transited through Ukraine to European consumers have much longer terms (in particular, the contract with Italy's ENI to deliver 25 billion cubic meters expires only in 2035).
There are obviously three prospects
The first one implies embroidery of European gas infrastructure with European sources of finances within the framework of the European playbook. Countries friendly towards Russia (Italy, Austria, Hungary, Serbia, Slovenia and Croatia) and supporting the Turkish Stream are building infrastructure within the framework of the third energy package. Ukraine will completely lose its transiting role for Russian gas.
The second prospect is the extension of the transit contract in 2019 with a switch of delivery posts with unspecified volumes of contracted Russian gas to the Russia-Ukraine border. In this case, Gazprom's contracting parties in Europe will have to take the transit risks in transporting gas through the territory of Ukraine. Russia will sell gas on the border of Ukraine before the expiration of related contracts. The contracts will not be extended because European consumers will have to either seek alternative sources, most likely costlier suppliers, or change the gas delivery post in the outstanding deals with Gazprom with account of the new routes.
The third prospect stipulates signing of a new Russia-Ukraine transit deal on different conditions, the transit volume in this case would make a steep drop, Russia would hardly go for the "pump or pay" condition.
In fact, some combination of the three approaches would most likely appear by 2020, for example, the realization of two-three lines of the Turkish Stream and partial embroidery of receiving transport capacities for the gas in the EU. Part of Gazprom's contracts may be modified within the framework of changing gas delivery posts on the Russia-Ukraine border and/or signing of a new transit deal with much lower transit volumes and new obligations.
As the existing contracts expire, detailed contours of mutually beneficial cooperation will be outlined with more precision. The commercial conditions of the new Russian-Hungarian gas contract (the current contract expires this year) will serve as the determining indicator for the course of future configuration of Russian gas exports to Europe.
Grigory Vygon is Managing director, VYGON Consulting.
Vitaly Yermakov is Research Director, VYGON Consulting.
Maria Belova is senior analyst, VYGON Consulting.
