Europe's Biggest Gas Supplier: No Bluffing

When it comes to natural gas pipelines, Europe looks to be "all talk," while the continent's biggest supplier - Russia - puts its money where its mouth is, according to one geopolitical expert at the European Autumn Gas Conference in Vienna, Austria.

Natural Gas Europe spoke to Professor Jonathan Stern, Chairman and Senior Research Fellow, Oxford Institute for Energy Studies, Natural Gas Programme, at the event. He offered his insights on the reign of Russia as Europe's biggest supplier of natural gas, despite other sources of gas making their way onto the European market.

How will Russia continue to provide a great deal of natural gas to Europe?

Under any scenario Russia will be the largest single supplier of gas to Europe. But the real question is going to be, will that be at levels in excess of what we saw back in 2007-08, or is that going to be reduced levels such as those we see today, in particular in 2012 when we think we could be close to the 2009 lows, which was the lowest point for many years.

How great a concern is this to Moscow given how much they appear to be counting on the profits from hydrocarbons sales?

The Russian public position is 'What matters to us is revenues and not sales, so as long as we're making the same amount of money that we were making before, we don't care that we're selling gas - we'd rather sell less gas at a higher price than more gas at a lower price.'

The problem that they have to figure out is, 'Well, okay, but are you going to be able to recover your lost market in the future?'

What's been the message, if any, sent through the completion of two strings of Nord Stream to other potentially competing pipelines in Europe?

One of the interesting things about Europe is that Nord Stream is one of the few very large recently completed projects. We talk a lot about projects, but there hasn't been a lot of pipeline building in Europe apart from minor interconnectors. To my recollection the last major pipeline system built in Europe was the Langeled system from Norway to the UK, but that was quite a few years ago. So the Russians are the only ones with big pipeline ongoing projects in Europe; other people have just got plans.

How rational is the building of South Stream? And how much of that is politically driven?

Across much of Europe, including the European Commission, South Stream was always regarded as a bluff in order to keep Nabucco from being built. I've never regarded it as a bluff, because the Russians do not play poker, they play chess. Now with three onshore sections plus the offshore section FID-ed, the Russians could FID the whole project in the next few weeks, I think it's very clear they're tremendously serious about South Stream. But I think it's a hugely risky project for them, because EU regulation as it's evolving may mean that they have to build an enormous amount of additional capacity, which they themselves will not be able to use.

Have the geopolitical considerations helped that project to easily overcome Nabucco?

No. The problem that all the Caspian Southern Corridor pipelines have had is, there is not enough gas for those pipelines. There are huge gas reserves in a range of Caspian and Central Asian countries and we know all about them, but reserves don't make deliverable gas. The only deliverable gas we have from the Southern Corridor before 2020 is 10 bcm (and maybe less) of Shah Deniz gas from Azerbaijan - that's not enough to build a brand new, large scale pipeline. It's enough for the scaled down Nabucco or the TAP lines, but it's not enough gas on which to base a major new pipeline system.

The Russians, on the other hand, are doing something different: they don't have new markets, they're simply reorienting gas from the Ukrainian corridor to the Black Sea corridor. That's, therefore, relatively easy for them in terms of commitments. But of course the world has changed and they cannot rely on being able to utilize 100% of that system. The bizarre thing that we could see - which I'm not predicting, but it's at least possible - is that South Stream pipelines could end up carrying Caspian gas instead of new pipelines that we thought were going to be built, because if the Russians do build South Stream it's highly likely that national and EU regulators will say 'You can build these pipelines, but you can't insist on having 100% capacity - you have to give others capacity.'

So we're looking at a very interesting and rapidly evolving situation, assuming that South Stream is FID-ed and goes ahead.

Is it surprising to you, given the history, that states in Central & Eastern Europe are willing to come on board with the Russian's plans?

Not really in this sense: the Russians are not speculating. What they're saying is 'We're going to build; this is the deal: we pay you this, we build the line, you get this amount of gas.' These states have been approached by numerous Caspian sellers and the European Commission since 2000 talking about Southern Corridor pipelines and their question is 'Where are these pipelines?' They believe the Southern Corridor pipelines have had plenty of time to get their act together and so far it hasn't happened.

There are many reasons why these pipelines have taken a long time to happen and haven't happened yet, but if you're in Central & Eastern Europe, your question is 'Look, I'm tired of talking about this - I want something to happen’. By contrast the Russians are going to build their pipeline and it looks like they're going to build it now.'

Could you let us in on what was discussed in a closed session at the EAGC dedicated to discussion of future Russian gas supplies to Europe?

We spent a lot of time talking about the Russian domestic gas market. People don't realize how important this is becoming. The domestic market is now paying prices which make all gas production in Russia profitable. A lot of the domestic Russian gas companies, including Gazprom, but especially the other producers, are making huge amounts of money just selling to the Russian market. Most people don't realize this; they don't realize what a big market it is and don't realize how potentially profitable it could be.

Up until three or four years ago everyone producing in Russia was thinking about exporting because they couldn't make money domestically. That has changed, and with it the calculations of gas producers in Russia. It is by no means out of the question that as we look forward we could see producers saying 'Forget exports. I'm not interested in the European market, I want to sell my gas in Russia.' It's a big change.

Are European gas supplies from Russia at risk if Asia is a competitor?

I've never thought that was an argument worth talking about. Russia has vast amounts of gas in Asia, very far away from Europe that wouldn't be economic to transport to Europe. At the same time, they've got a huge amount of gas in eastern Siberia and far east provinces which is stranded and not going anywhere, so for me there's no real competition between Europe and Asia for Russian gas.

There is potential competition for investment, but assuming they go ahead with South Stream they will have built all the capacity they will need for a very long time to supply Europe, so even investment competition will be over.

Your new book is entitled "The Pricing of Internationally Traded Gas." Could you tell us a bit about it?

It's the first book in any language on the price of internationally traded gas and what's exciting about it is the fact that it identifies the fact that gas pricing outside North America is in a mess almost everywhere. If I'd known the conclusions before I titled it, I might've subtitled it 'Natural Gas Meets Economics 101' - in other words, for many decades nobody in the gas industry has felt the need that gas prices reflect supply and demand, but this has become increasingly important.

This is leading to different outcomes: prices are too high in Europe and Asia; they're too low in the rest of the world, but more to the point they don't reflect market conditions and price formation mechanisms need to be introduced which ensure that situation changes.