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LNG competition in Europe: how could Russia stay relevant?

Posted by on 01 September 2017
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Last week, the first US LNG export arrived in Lithuania, a traditional importer of Russian gas. Deepening the international tensions, Europe is expecting more LNG to come from the US, turning away from Russia.

However, many experts see this positively, as the diversification of suppliers “contributes to the EU's energy security”, Monika Zsigri said. While experts do not expect US LNG to threaten Russia’s natural gas exports, the loss in market share could be particularly detrimental in an arguably tighter market. Experts share where Russia stands in the market as Europe plans to diversify and US exports keep on coming.

How do you think Russia could protect its market dominance?

Monika Zsigri, Policy Officer of the European Commision at DG Energy

“Russia is and remains an important energy supplier for the EU. Adapting to the needs of the market and competing on a level playing field with the other suppliers based on a value offer of each [energy source], is for any supplier on the European market the way to go. As clearly stated in the EU's Energy Union Strategy, diversification of sources is important both for competition and security of supply. Therefore, our diversification strategy develops around priorities such as the implementation of the Southern Gas Corridor, the development of a liquid gas hub in the Mediterranean and through promoting access to Liquefied Natural Gas and gas storage.”

Andrei Belyi, Associate Professor at the Centre for Climate Change, Energy and Environmental Law

“Arguably, we should not over-estimate Russia’s gas market share in Europe. With growing competition in European gas markets, Russian gas molecules compete with each other on hubs while being traded by various companies and traders. In fact, Gazprom’s dominance only persists in Eastern Europe for historical reasons; as most of the pipeline infrastructure built in the region was initially designed to ship Russian natural gas to the western part of the Continent. However, the development of reverse flows and an ever-growing gas glut create a context where a dependence on Gazprom is less significant than before. Gazprom’s willingness to find a compromise within the EU’s anti-trust case unveils the new market reality: European gas markets are leveraged by the buyers and traders, and incumbent producers need to adapt to these new market realities.

“So, it is not about a market dominance. Still, Gazprom has been attempting to preserve its traditional pipeline-based export model. For these reasons, Gazprom earlier rebuffed any rationale for contractual changes, and insisted on the long-term contracts with take-or-pay commitments and oil indexation. Meanwhile, Gazprom’s management claims that shale gas and LNG markets do not represent a significant threat to its business in Europe. Within this logic, Gazprom initiated new pipelines, namely Turkish Stream and Nord Stream II, both aiming at bypassing Ukraine without gaining new markets in Europe. Although the pipeline projects received vivid political attention across Europe, they did not reshape the market structures and trends. Instead, the new infrastructure facilitates a different route for gas flows to the delivery points in Central Europe, in accordance with the existing long-term contracts. Since the long-term contracts will gradually expire, and delivery points will be replaced by market platforms, the long run rationale for bypassing Ukraine to protect the long-term contracts might lose relevance.

“Finally, these new pipelines – if constructed – would be directed to a stagnating market. Although gas shipped by pipelines remains the dominant form of the supplies, the largest potential for incremental demand will be LNG. For example, in recent years, the European gas demand has rather declined, whereas small-scale LNG demand has been keeping upwards.

“Interestingly, the new US sanctions against Russia may target these new pipelines. In this context, one may hypothesize that the US is attempting to reduce Gazprom’s market power and instead reinforce market positions for the American LNG. The hypothesis might be built on solid grounds, since the new American Presidential Administration actively supports the idea of the US supplies to Europe. Nevertheless, a hypothetical cancellation of the newly projected pipelines would not change much for the market context because Russian gas would then flow through the existing networks via Ukraine. Additionally, the cancelation of new capital expenditures might even reinforce Gazprom’s competitiveness.”

Howard Rogers, Chairman of the Natural Gas Research Programme at the Oxford Institute for Energy Studies

“I would expect Russia to defend a minimum market share for the European region (including Turkey) somewhere in the region of 150 to 170 bcma. They could do this by

  1. enforcing the take or pay provisions in their contracts and
  2. selling gas from West Siberia directly onto the NW European trading hubs.”

Quinten Peer, Energy Project Developer

“In the energy market, it really boils down to two things: price and security of supply. Russia’s reputation as a reliable supplier has suffered quite extensively, due to the supply cuts it made in the past, resulting in the EU’s policy to diversify suppliers and reduce the dependence on Russia. To be less dependent of transit countries – mainly the Ukraine – Russia started to develop alternative transportation routes to Europe allowing it to have more control over transport of its gas to Europe. Nord Stream 1 (already operational) and 2, once constructed, allows it to supply up to 110bcm/a directly into Germany (and shipping onwards to other EU countries). However, the latest US sanctions on Russia (mainly for perceived meddling in US elections) have raised great concerns that Nord Stream 2 will not be realized. The timing with the ramp-up of US LNG has led to accusations that these new sanctions are instigated to promote US LNG over Russian gas, particularly as they are endorsed by Trump as part of his “America First” initiative.

“But Russia’s efforts in building alternative supply routes have already rebuilt some of its reputation of a reliable supplier and demonstrates its eagerness to protect its market share. And ultimately, there is a tipping point. Once Russia’s reputation has reached an acceptable level, price will again become more important – an area where Russia will always have the upper hand. With Nord Stream 1 and 2, Russia will have control over the entire value chain from well to market, giving it the ability to undercut the price of US LNG as costs for production and transportation are lower compared to US LNG (especially delivered DES in Europe). But even if Nord Stream 2 will not be built, Russia will always find different ways – just like it did when it cancelled South Stream and replaced it by Turkish Stream – to continue to be the biggest gas supplier to Europe as revenue from gas supplies remain critical for its budget.”

Jane Rangel, Gas Analyst at Energy Aspects

“The amount of hub indexation in Russian long-term contracts (LTCs) has increased in recent years. This means European customers with contracts that are TTF/NBP indexed are indifferent to buying at the hub or nominating under contract. Indeed, buyers may prefer contract gas to hub gas, as it has fewer transaction costs and reduces the risk of facing take-or-pay charges for under-nominating contract gas.

“Additionally, European customers seem to have managed to retain the flexibility on their Russian annual contract quantity (ACQ). In allowing customers so much flexibility, Gazprom has isolated itself from competing with LNG.

“When LNG volumes into Europe rise, the gas will be sold at the hub, softening European hub prices and pushing more gas into power. Since utilities still have some flexibility on Russian flows, utilities will be able to meet that higher demand by calling on remaining contract flexibility, as well as the LNG volumes being sold at the hub. This bidding down process continues until the Atlantic arb with Henry hub closes.”

Chris Goncalves, Chair and Managing Director of BRG Energy Practice

“In the past, Russia has sought to maintain a moderate share of the EU natural gas market to mitigate the risk that Russian gas will compete with Russian gas in the European markets, and thereby erode its value. As the EU market liberalization has been implemented and deepened, hub market trading has increased and contract destination clauses have been removed. As a result, European buyers of Russian gas can freely resell and trade that gas in the market and on the hubs. Therefore, increasing the market share of Russian gas supplies would run the risk of oversupplying the market and reducing the value of Russian gas.

“As European production declines and demand grows, the overall market share of natural gas and LNG imports of approximately 270 bcma in 2016 will naturally increase. Over the last 9 years, EU imports increased by 1%, while Gazprom’s share of EU imports increased by 18% to 179 bcma in 2016. As a result, the overall European gas market share for Russian gas in Europe grew from 26% to 33%.

“To maintain its overall market share in the future, Russian gas will need to keep pace with rapid import market growth. If Russian gas exports to Europe keep pace with European import growth, Russian imports will naturally obtain a growing share of the overall market. If they fall behind import growth, then Russian imports could stagnate and maintain a relatively constant, rather than increasing, share of the market.

“But it is not clear if Russia intends to, or even can, keep pace with import growth and thus increase its overall share of the European gas market.

“How Russia may seek to capture Europe’s growing import market, and thus to increase its overall market share is tied to critical pipeline projects. With approximately 40% of all Russian pipeline gas exports flowing through Ukraine, the transit country’s ongoing political and military conflict, and ongoing commercial supply and price disputes with Russia, Russia has a substantial incentive to diversify its natural gas export routes – not only to increase exports but also to mitigate the risk associated with existing exports via Ukraine. In 2016, Russian gas transit volumes through the Ukraine were 82.5 bcma, as compared to 116 bcma in 2010. The chosen alternative routes are provided by the 55.0 bcma Nordstream 2 and 31. 5 bcma Turkstream pipeline corridors into Northwest and Southeast Europe, respectively.

“Both of these projects have become intensely political due to a mix of factors, such as Russo-Turkish political tensions regarding Syria, EU policies regarding Ukraine and natural gas supply diversification, US and EU economic sanctions on Russia in general, and most recently the passage of additional US sanctions that prohibit US companies from involvement in energy projects in which sanctioned Russian partners hold more than a 33% stake. Such provisions could also affect non-US firms involved in these projects, potentially increasing the cost and delaying the completion of Russian energy export projects.

“The last point has become extreme. Russia and other Nordstream 2 investors and buyers are as upset with the export market and supply security challenge posed by the new sanctions, which have been driven by the US Congress in response to the alleged Russian meddling in the recent US presidential elections. Given the intensity of political and economic convictions held on both sides, it is difficult to imagine that a resolution will come soon or easily.

“In the near-term environment of abundant, cheap LNG and challenging economic sanctions, Russia’s opportunities to increase its exports to and overall gas market share in Europe confront substantial economic and political headwinds. The result could be that Russia will struggle to capture a leading share of the incremental import market, and thereby not increase its market share overall. If this occurs, Russian gas will be subject to ever greater import competition from US LNG and LNG in general.

“Another consideration is Russia’s own strategic priorities regarding market share and market dominance. As a national exporter, Russia has historically pursued economically and commercially rational policies aimed to optimize the export volumes and value of its natural gas, but with occasional use of its gas exports to pursue political and/or geostrategic aims. It is not accurate to say that Russian gas exports are managed either in a strictly economically rational or politically purposeful manner, because in reality, Russia pursues both approaches by turns.

“The goal of an increased market share and/or market dominance may be an important geostrategic goal, but depending on market conditions may not prove to be economically or commercially optimal or rational in terms of long-term netback revenue to Russian producers. Therefore, the critical question to analyse will be: how will Russia choose to navigate the mix of economic and political priorities, challenges, and opportunities on the horizon, and whether Russia’s future course will lead toward an aggressive pursuit of European market dominance or a more measured competitive approach designed to be economically optimal.”

The opinions expressed in this presentation by Chris Goncalves are those of the individual author and do not represent the opinions of BRG or its other employees and affiliates.

Vivek Chandra, Chief Executive Officer of Texas LNG

“Russia will continue to exert political and pricing pressure to build more pipelines and lock in customers. It is up to the customers to push back on Russian dominance.”

Next week, experts will discuss what the European energy market wants in its suppliers. Keep an eye out for more updates on Facebook, Twitter, and LinkedIn.

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