Gazprom, the Nord Stream project and the EU gas liberalization

Apr 06, 2010 02:00 AM

The construction of Nord Stream pipeline in the Baltic Sea has officially started on 9 April 2010. On 16 March Nord Stream consortium secured a EUR 3.9 bn loan which enables to it to finance the first leg of the pipeline.
It furthermore appears that there will be no difficulties in garnering loans for the implementation of the second phase of the project, nor are any delays in construction expected; this comes despite information surfacing about the final cost of the project having risen (reaching as much as EUR 8.8 bn). The first line is to be put into operation in 2011 in spite of ongoing protests from ecologists (WWF, BUND) and from Poland and the Baltic states.

The fact that Nord Stream's construction has actually begun does not however signify an end to all of Gazprom's problems. There are more issues to be cleared up with the second leg of the pipeline; almost no contracts for gas supplies make it impossible to give a definitive deadline for its implementation. What is more important is that Gazprom now has to ensure the profitability of Nord Stream and selling Russian gas in a situation of lowered demand and a gas oversupply (including LNG) on the EU market.
As regards the fact that Nord Stream's construction is now a foregone conclusion, questions are being raised as to what its launch will mean for the European gas market. This new route means a new, direct link for the EU to the largest gas supplier and also greater possibilities of importing Russian gas. Given present market conditions and the ongoing processes of the European market liberalisation and integration, however, Nord Stream opening may contribute to gradual change in the way Gazprom is doing business in the EU.

First to change will be the logistics of the supply of Russian gas to Europe. Gazprom will not only have the possibility to reduce transit through third countries (Ukraine, Belarus and also Poland and Slovakia) but also the option to change supply routes, for example in response to market conditions. These possibilities would increase further as a result of the construction of South Stream.
The likelihood of such re-routings of gas will increase with continued comparatively low demand for gas in the EU, resulting in rather modest needs for Russian gas in addition to what is currently contracted. Voices are already being heard about possible delays of several years before fuel supplies via Nord Stream, contracted by several western companies are initiated; the result of this could be a considerable reduction in the transit through Ukraine.

The price of gas supplied by Gazprom for the better part of 2009 was comparatively high. The rigid pricing formula incorporated into long-term contracts negatively affected its competitiveness on the EU market. The construction of a new pipeline along with Gazprom's other planned investments for new routes (e.g. South Stream) and deposits (the Yamal Peninsula, the Shtokman field) could lead to a further drop in the price competitiveness of Russian gas.
Thus, one of the key factors influencing Gazprom's strategy (along with its west European partners) in the EU will be to take steps to counteract the possible fall in competitiveness and the negative consequences that come with this.

On the one hand the companies may aim to keep down the costs of extraction and transit. On the other hand, likely courses of action are:

-- Efforts being made to secure sales of Russian gas in the EU (over next few years chiefly in Central Europe where demand is set to rise, but also in western and northern Europe). This could be achieved by the creation of joint ventures or taking over shares in firms operating in downstream (e.g. Vemex in the Czech Republic, an increase in shares in Germany's VNG, and plans to create a joint venture in Slovakia);

-- Entering new markets (for example, the power generation sector -Gazprom's cooperation in gas power plant projects in Germany or Latvia and also the petrochemical market);

-- And last but not least... to influence the price of gas. Anexample of this type of action is that already taken to add flexibility to the conditions of some long-term contracts, for example by allowing the sale of a part of the gas at prices linked to the spot market price. A similar aim (increased price competitiveness) could be served by the alleged (reports in the media) attempts at garnering tax relief for Nord Stream gas sold in Germany.
One cannot, however, rule out attempts to influence the mechanism for determining prices, for example by increasing shares in gas infrastructure (transit, storage facilities and also exchanges -- CEGH/Baumgarten -- the importance of which is increasing) and by manipulating the quantities of supplies, especially in regions where Russian gas is dominant. The Austrian energy regulatory authority, E-Control, openly expressed its concern that the situation could develop in this way with Baumgarten.

There is the potential for some of Gazprom's activities and its use of Nord Stream to be rather against the spirit of market liberalisation. Gazprom's strong links -- e.g. due to shared infrastructure investment -- with western energy companies may be conducive to this and may result in action on common interests, for example a resistance to changes in EU legislation unfavourable to large firms.
The continuing liberalisation of the European gas market could also lead to a modification of how Gazprom functions there; including in how it uses Nord Stream. Thought should also be given to the possibility of a longer-lasting adaptation of Gazprom's European strategy to the new market conditions, for example by selective changes in the conditions of long-term contracts (information on changes made to contracts with E.ON and ENI and the current negotiations with other European firms) and/or by Gazprom's increased involvement in the short-term gas market (e.g. after taking over shares in CEGH/Baumgarten).

The effectiveness and principles of Gazprom's functioning in the EU will be dependent to a large degree on the speed and efficiency of the implementation of a tangible liberalisation and integration of the gas market.
This will include individual regulations concerning the functioning of large corporations on this market.

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