EU-Russia: Depoliticizing Natural Gas

In his appearance at South Stream: the Evolution of a Pipeline in Budapest, Hungary, Adnan Vatansever, Senior Lecturer, Kings College London spoke of the nuances of EU-Russia gas relations, providing a context to their relations, addressing disruptions in supply, price disputes and how Gazprom would adapt to Europe's new, forthcoming market realities.

He started by putting EU-Russian gas relations into context.

“Hardly any other type of relationships has been so much on the spotlight on the world scale as EU-Russian gas relations,” he said, offering US - Middle East oil relations as a comparable. Europe was the largest importer of hydrocarbons and Russia the largest exporter in terms of gas and the second largest exporter of oil in the world – and most of its exports went to Europe.

Mr. Vatansever added, “So the magnitude of the relationship we are talking about is very substantial and as a result that relationship is quite important and most importantly this relationship is there to stay for quite a few decades a lot of investments have been already sunk and Europe's indigenous supplies are declining and basically you can imagine that 2 decades from now probably energy relations between Europe and Russia will still be quite significant.”

He noted that despite imports of coal and uranium from Russia, there had not been tensions regarding those supplies, in contrast to the natural gas tensions.

“It is partly because of the nature of the gas market; it is a market for which you can’t say that there is a world market as in the case of coal or oil. Still markets are very regional and prices are very different even though there is some progress on integration across regional markets. You can assign part of the blame to both Europe and Russia,” he explained.

Meanwhile, according to Mr. Vatansever, one could observe the variety of discrepancies among the prices paid by Russia's natural gas customers, across both regions and countries, leading some to accuse the Russians of using energy prices as a political tool.

He added, “On the other hand, when you look at it from Moscow’s perspective Gazprom has quite often seen itself as unwelcome in Europe, especially in terms of its acquisitions of different  assets in the downstream market and there has been a very consistent effort on the European side to reduce the dependence on gas, but his has been regarded as something very politicized from Moscow as well. So, on both sides there has been politicization which actually leads to tensions in the gas relations.”

While natural gas was incredibly important for Russia, he said that it was dwarfed by the country's oil exports, which applied to EU-Russian oil relations.

“The trend is that gas is going to become increasingly more significant in terms of export revenues and overall in terms of sales for Russia in the upcoming 2 decades as oil is peaking in Russia or as it is expected to peak soon,” he explained.

Mr. Vatansever touched upon what he termed the “overstated risk” of physical disruption in EU-Russia gas relations – that there was anxiety that gas might suddenly be cut off.

“I think this is not very well justified,” he opined. “There have been a few occasions that this has happened in the past 4 decades. Even in those cases it would be probably hard to put the sole responsibility on the Russian side, as it has been a part of much more complex pricing negotiations and transit negotiations with Ukraine.”

However, he said this could also be considered a credibility issue for Gazprom. This made disruption unlikely, according to him. Projects like Nord Stream would further minimize such risks; with the help of new interconnections, it and similar projects would also bring more liquidity to the market.

Meanwhile, how would Gazprom adapt to the new gas market transformations? For the past 3-4 years he said there had been multiple disputes that were not likely to disappear, like over gas pricing. He said, “One country can pay significantly lower than the other and that is not really justified by geographic distances but probably by market power that belongs to Gazprom.”

He believed pricing disputes would continue and that several trends would be apparent, but explained that Gazprom was facing serious market challenges on all of the five fronts where it was either selling its gas or aiming to sell gas. The first, he said, was LNG, that Gazprom had got into the game late; second, negotiations with China had not reached the desired result.

“Both of these could be things that provide some breathing room for Gazprom in the future when it negotiates with European clients, at least if it will have new significant sources of revenues from elsewhere.”

In Europe, demand was not really growing as fast as it was expected to in the past, said Mr. Vatsanever, while the CIS market was actually shrinking mainly because of Ukraine's demand and also the domestic market which used to go grow by 2-3% before the 2008 crisis, but was now growing much more slowly.

Meanwhile, Soviet-era fields were cheap to produce, but places like Yamal, he explained, were much more costly to extract the gas, while fields in western Siberia were declining, adding up to hard times for Russia's gas industry. He added, “On the other hand, there is transportation which may add more costs, like building North Stream and South Stream which could be quite positive for energy security but at the same time will involve much higher cost for delivering the gas to Europe, especially if the rate of utilization of this part remains below what is projected.”

The tax burden on gas would likely go up in this decade, according to Mr. Vatsanever, who said of the USD 208 billion of taxes from the oil and gas sector in 2012, 89% was from the oil sector but only 11% from the gas sector. “As the production of the oil sector is peaking the government is trying to find ways to incentivize production, so you can expect that the burden on the gas sector will probably go up,” he said, explaining that it had been low in part because of lower domestic prices, a sort of subsidy from Gazprom.

While the discrepancies between Russian domestic gas prices and European gas prices had been traditionally huge, but now this gap had been narrowing for the past three years. “Gazprom is making profit on an average sale in its domestic market and it is quiet a significant development until a few years ago all the profit would come from sales to Europe and domestic sales would be on average were making loss.”

Would Gazprom benefit from that, he asked, given the growing supply of gas coming from independents? It would benefit some because domestic prices were likely to be much higher that they used to be in the '90s or in the 2000s. And how was Gazprom adapting to the market transformations in Europe?

Mr. Vatsanever contended that the company needed to adapt in terms of market liberalization, not just regarding the Third Energy Package but also the new Gas Target Model, which could lead to new rules for allocation of capacity. He offered: “This is a process that people in Moscow have regarded as one that is directed against Gazprom. It is important to remember that it all started in the ‘90s, pretty much as a process that aimed to raise competition within the European gas market. It was not against Gazprom but against the largest energy companies in Europe, such as companies in Germany, Italy and France.”

It would be important, he said, to narrow the gap on the divergent perceptions of the Model of Moscow and Brussels. Secondly, building more liquidity in the European market though big investment into infrastructural projects such as storage and pipelines was going more slowly than expected; he called it important for depoliticizing gas supplies as countries would have access to a greater variety of sources.

“It would mean more competition for Russian gas which, from Gazprom’s point of view, may not be positive news, but overall it would help to put the relationship on a more stable basis so in the longer run it should be quite positive,” he explained.

Finally, ensuring competition, he said, was crucial. European Commission decisions were likely to impact suppliers like Gazprom. Mr. Vatsanever commented: “It is is going to be a difficult process to manage, especially with suppliers but it is also a process that provides some opportunity on both sides. For Europe it would be an opportunity to give an assurance that no major market participant is using an excessive market power and, on the Russian side (or any other supplier side), it could be an assurance that as long as you play according to the same rules you have the same rights.”

He cited the Joint Advisory Gas Council as important for pushing market transformations forward between the EU and Russia, but concluded that this was a process that should not be rushed.