The Eurasia gas market is a paradox: declining consumer demand and ample reserves live side-by-side with potential gas shortages. Already hit hard in early 2009, consumers in a good dozen EU countries may be up for another cold spell this coming winter.
The reason will not be a lack of gas reserves or an inability to pay, but rather a combination of bad policies and mismanagement that has become a problematic for the European consumer, EU governments and the transatlantic community.
Eurasia is blessed with a third of the world’s proven natural gas reserves. It also boasts a huge gas-producing infrastructure that extracts over 35% of the global gas output; an extensive system of natural gas pipelines, spanning from West Siberia and Central Asia to the Atlantic Ocean; and plenty of underground gas storage. Eurasia is also the leading consumer of natural gas: its share of global gas consumption is approximately 39%. One might think all these chips would fall in place and result in the smooth operation of the world’s premier gas market. But Eurasia’s gas sector is not an efficient market.
In early June 2009, Gazprom, the Russian government-controlled gas pipeline and export monopoly that produces more than 50% of Eurasia’s gas and over 80% of Russia’s gas, projected its output to fall by some 20%, citing a lack of demand from European and domestic markets due to the economic crisis. But gas production in Europe, by far the largest export market for Gazprom, is forecast to stay flat or even grow in 2009: Norway’s SatoilHydro, a major producer, is about 5% ahead of its 2008 production, and Shell’s output has remained flat.
As a result, Gazprom was forced to cut its exports by as much as 40 to 60% in the first half of 2009 and lost some of its market share in Europe. Although Europe is expected to start buying more Russian gas now that Gazprom’s formula-priced gas has become significantly cheaper, the company is still likely to sell 20% less gas to Europe than it did in 2008.
Gazprom seems to believe that Europe’s moves to diversify its gas supply are tantamount to pushing Russia out of its major and most lucrative market. Alexander Medvedev, the company’s deputy chairman, recently sniffed that “Europe should decide how to handle this situation… and if Europe doesn’t need our gas, then we will find a way of selling it differently.” But by insisting on being the unavoidable supplier, Russia has not only lost market share but damaged its reputation as a trusted supplier.
Falling sales volume, lower prices and continuing purchases of gas on netback pricing terms from Turkmenistan, Uzbekistan, Kazakhstan – and now Azerbaijan, too – strain Gazprom’s budgets. In mid-June, Gazprom announced that the development of the giant Bovanenko field on the Yamal peninsula, which would largely offset the depletion of other big fields, will be pushed back a year to the end of 2012. Despite earlier claims that there would be no cuts in 2009, Gazprom said it would reduce its overall 2009 capital expenditure budget by at least 20%. In addition to Bovanenko, other major projects have also been delayed: construction of a 30 billion cubic meters (BCM) per year pipeline to China, where the pricing of gas has yet to be agreed, and the South Stream project, where capacity, markets and investors are yet to be defined.
The financial difficulties of Gazprom, which sits atop the world’s largest gas reserves and produces by far the largest amount of gas globally, are a paradoxical consequence of its fairly successful quest for domination of the Eurasian gas market: when the market goes down, there is nowhere to go. A corollary of Gazprom’s becoming a monopoly in Russia and a dominant supplier in many other countries is the company’s unintentional adoption of the role of swing supplier. When markets head south, it hurts: the capitalization of the company fell from $350 billion in 2008 to about $120 billion now.
Moreover, tensions remain between the EU, Gazprom and Ukraine’s Naftogaz, which handles transit deliveries of Russian gas to Europe. Large volumes of gas have to be stocked in underground storage facilities located in west Ukraine to enable the balancing of seasonal variations in gas demand and to assure deliverability to customers in Europe during the winter, when gas demand in Ukraine also shoots up. Estimates put the volume of gas in west Ukrainian underground storage facilities needed to ensure deliverability at around 20 BCM. However, Naftogaz would need about $4.2 billion to purchase this gas and inject it into storage, but is bankrupt for all practical purposes.
At the 23rd EU-Russia Summit in Khabarovsk, Russia suggested that the EU foot the bill by extending a $4.2 billion loan to Naftogaz in order to solve this problem. Another idea calls for European gas companies to purchase the gas and put it in storage in Ukraine. The EU’s response to these suggestions so far has linked the loans to Ukraine with the restructuring of its gas sector, a long-standing request which Ukraine seems to have finally embraced. The European Commission chaired a meeting on stronger coordination of energy supplies to Europe within the EU, expressing concern over the latest warnings on gas shortages; it also called for budgetary prudence and warned against taking on more in difficult economic times.
That a shortage of gas supply to Europe from Russia may very well materialize later this year at a time when the world’s biggest gas producer must reduce output, citing a lack of demand, is apparently illogical. But taking a closer look at the strategy of the parties may help resolve some of this seeming ambiguity. The EU seeks to promote an efficient, transparent, competitive gas market served by transportation infrastructure operated along competitive market rules, including third party network access and an independent operator. The EU also supports the Energy Charter, a treaty signed by more than 70 countries that establishes common rules for investment, trade and transit in energy as well as energy efficiency. Furthermore, the EU’s priority is to establish a common space of transparent and fair rules for natural gas flows in which Russia would be a natural – and very important – partner.
However, Russia, on at least a few occasions, seems to have insisted on being the partner in an exclusive and privileged energy relationship with the EU, tossing aside both the internal market rules of the EU and the Energy Charter. Apparently, as argumentation goes, the reason for this privilege is the fact that only two countries apart from Russia can boast gas reserves of similar magnitude, and these countries – Iran and Qatar – are not likely to become major suppliers to the European market soon. Seen as the decisive factor, Russia’s natural gas endowment is used as an excuse for achieving “natural” gas market dominance as well. That this does not sit very well with the idea of competitive markets is obvious; that it may simply disregard the fact that Europe does have choices when its energy security is at stake looks like a serious blunder.
Boyko Nitzov is a Dinu Patriciu fellow for transatlantic energy security and director of the Eurasia Energy Center at the Atlantic Council.