Europe remains priority market for Russian gas

by Valery Yazev

For the first time in 30 years, supplies of Russian gas to Europe have been interrupted. Russia was let down by the transit country -- Belarus.
Moscow hopes that this incident will not sour its relations with its European partners, and co-operation in the gas sphere will continue, despite all the existing contentious issues.

What, then, happened on February 18, 2004? Gazprom halted gas supplies to Belarus, to the domestic Belarussian market, because contracts with independent suppliers (ITERA and Trans Nafta) had all been fulfilled. Moreover, an agreement on preferential prices for gas supplied by Gazprom expired on January 1, but Belarus declined to purchase it at commercial prices.
This saga has its antecedents. In 2001-2002, when preparations were launched to establish a Russia-Belarus union state, a decision was taken to set up a joint venture based on Beltransgaz. However, Belarus violated an agreement signed in 2002 on expanding co-operation in the gas sector by blocking an independent audit of Beltransgaz. Minsk demanded an exorbitant sum for the controlling stake in this enterprise, while Gazprom evaluates these shares at $ 500-700 mm. Minsk's figure is different, and without an audit this problem cannot be solved.

Since the merging of the two gas systems has stalled, Moscow has no reason to sell gas at preferential prices to Belarus, when it is in high demand on the domestic Russian market. Finally, Belarus has not yet repaid its debts for the previous supplies.
However, these problems, it should be re-iterated, concerned supplies to the domestic Belarus market. But after Gazprom ceased supplying gas to Belarus, Beltransgaz redirected some of the Russian gas on its way to Europe to meet its internal needs. The result was a reduction in Russian gas supplies to Europe. Under-supplies of gas to Germany, Poland and Lithuania can partly be compensated by its exports along other routes, in particular via Ukraine.

Nevertheless, the cessation of transit suppliesof natural gas to Europe threatens the implementation of Gazprom's obligations to its Western partners. This, naturally, may lead to financial penalties, since there are not enough alternative supply channels.
Some considerable damage has also been done to the economy of the Kaliningrad region, where the reserves of energy resources are extremely low. Supplies there fell by 60 %, and the region had to turn to its reserve sources of energy. Of course, Belarus has been the biggest loser in this episode, whose power industry and economy are 90 % dependent on Russian gas. (Russian gas to Belarus has been supplied since January 1, 2004 by the private companies Itera and Trans Nafta, but they do not meet the state's needs in full).

Moscow and Minsk have now started complicated negotiations. In our view, the critical situation with gas supplies to Belarus, and its unquestionable transit to the Kaliningrad region and Europe, must be solved in a principled way, and as soon as possible. We hope the Belarussian side will be constructive in this respect. Without a principled solution, there is no guarantee that the situation will not be repeated.
The question is how to learn from this lesson. To ensure that gas supplies go direct to consumers and do not depend on unstable transit countries, export routes and transportation methods need to be diversified. In particular the construction of the North-European gas pipeline (NEG) must be accelerated, and technologies for transporting Russian natural gas in liquefied form /LNG/ have to be introduced.

Prior to the Belarussian episode, Western investors were not keen to play any role in the construction of the NEG. Firstly, it is an expensive project.
Secondly, eastern Germany, the final destination of the gas pipeline, does not have the infrastructure to receive gas.
Thirdly, Western investors are hoping that Russia will bear the main costs of construction, and that they will only have to expect gas to reach terminals on the coasts of Germany, Poland, The Netherlands, and the Scandinavian countries.

Today, no comprehensive feasibility studies have been completed for the North European gas pipeline. It is going to be a unique project: about 2,000 km of pipelines are to be lain on the seafloor. We have so far only the experience of the Blue Stream gas pipeline on the bottom of the Black Sea from Russia to Turkey, but its submerged section is just 400 km long.
In addition, Western investors are waiting to evaluate the progress of a joint Gazprom and ConocoPhillips project to build an LNG plant on the Kola Peninsula with a capacity of 22 mm tons. Only then they will decide which option is more profitable -- this project or the North European gas pipeline.

Of course, supplies of LNG are primarily orientated to the American market. The US is the leading consumer of energy resources, and it has a developed infrastructure for handling LNG. The plant on the Kola Peninsula will mainly work for the US and Britain, which will become a gas importer in 2006.
Japan, with its considerable fleet of tankers, may act as an operator for transporting LNG from Russia to the US and Europe. Apart from Britain, potential LNG buyers in Europe are France, Spain, and Portugal. For them, gas supplies by tankers may come cheaper than via a pipeline system. But this is a matter for the future, while now we are discussing the traditional routes of Russian gas exports to Europe.

For Russia, Europe will long remain its main market. The country supplies about 130 bn cm of gas to Europe every year, but this figure is a distant reality for eastern markets. Therefore, it is highly important for us to reach a mutual understanding with our European partners.
Experience shows that finding a common language is an easy matter when it comes to bilateral contracts, for example, with Germany, but when matters concern a single European policy towards Russia, complications arise. We are aware of united Europe's desire as a consolidated consumer to secure preferential terms for itself in energy dealings with Russia, gain access to our oil and gas fields, and then to the gas transporting system. The Europeans are upholding their interests, which is only natural.

But as a counterweight to the cartel of European consumers, a cartel of gas sellers could be created, based on the OPEC model. Russian President Vladimir Putin has spoken about the expediency of creating a CIS gas alliance, which is to include Turkmenistan, Uzbekistan, Kazakhstan, Russia and -- as transit countries -- Ukraine and Belarus. It is also possible that Azerbaijan and Kyrgyzstan will join. Negotiations to this effect are being held at the government level.
Gazprom, in its turn, is already consolidating gas producers and transporters, a gas transport consortium is being formed in Ukraine, as is a joint venture with Beltransgaz, although some problems have been experienced. Negotiations are under way on Russia's serious role in modernising gas supply systems in Central Asia.

The negotiating process with regard to the gas alliance is far from simple, because the parties need to reach agreements that would not create any conflicts of interests, and that would ensure that they are all equally interested in the project. European companies, too, can join in.
As president of the Russian Gas Society and head of the State Duma's committee on energy, transport and communication, I often have to engage in energy diplomacy. I frequently meet European parliamentarians and businessmen. In Western parliaments, professional energy experts are few and far between, and when we explain technical and economic matters to them, they gain fresh insights into many problems.

In 2003, EU Trade Commissioner Pascal Lamy put forward six demands to the gas sphere, which, apart from all else, must be met by Russia before it can be admitted to the WTO. These are:
-- internal prices should correspond to real costs of gas production and transportation, i.e. there should be no subsidising the domestic market of energy products;
-- thirdcountries should be allowed access to our pipeline system;
-- foreign companies should be allowed to build gas pipelines in Russia;
-- Gazprom's export monopoly should be abolished;
-- export duties should likewise be abolished and

-- transport tariffs on internal gas consumption and its export must be brought into line.

Russian President Vladimir Putin described these requirements as unsubstantiated and unlawful. For example, Russia has the full right to a state monopoly on gas exports, as this does not contradict WTO rules. Moreover, on three points advanced by Lamy we are making progress anyway, without having to meet the EU requirements.
These requirements coincide with our internal requirements and the interests of the Russian economy. Namely, we are gradually raising domestic gas prices and formulating a procedure for granting access to our gas transport system.
A week after Lamy's "ultimatum", I happened to address French parliamentarians. And they understood my explanation. They saw that Europe would be the first to suffer if Russia aligned its domestic gas prices with European ones. This would make it unprofitable for us to export gas, and Russian gas companies would be able to make the same profits inside Russia, without incurring any transportation expenses.

So the question is not to even up prices, but to make sure they do not become tantamount to dumping. And Europe is gradually beginning to understand this, especially as 80 % of gas contracts should be long-term. Previously, the EU had insisted on a complete switch to short-term gas contracts.
As we carry on our negotiations and gradually bring our positions closer together, we are travelling along the road of integration, rather than assimilation. Our priority has been and remains to be Russia's interests.

Valery Yazev is chairman of the State Duma committee on energy, transport and communications and president of the Russian Gas Society.