Highway commission: who writes European game rules for Gazprom

While the world community is focused on the Middle East, Europe is engaged in lukewarm gas conflicts – but they too may have strategic consequences. On Feb 16, the European Commission said that it is not sure yet if the Nord Stream 2 project is subject to the Third Energy Package or not. The same day, the commission received an energy security strategy stipulating even tougher rules for Gazprom.

That company’s interests in Europe are clear. The first goal is to stop being dependent on unreliable Ukrainian transit. Ukraine’s gas transit network is old and there is no money available for its upgrading. Besides, this route is more expensive than Nord Stream. One more factor is that they in Kyiv keep raising transit tariffs. And, finally, paying money to a hostile regime can hardly be called a good investment. Now that South Stream and Turkish Stream have failed, the only way to solve this problem is to build Nord Stream 2.

Gazprom’s second strategic goal is to pump its extra 100bn c m. Initially, the company’s expectations were that gas consumption in the EU would be growing, while own production in Europe would be dropping. The former one has not come true but dropping output is opening a window of opportunities for Gazprom to sell the Europeans more gas. But the problem is that they in Europe are trying to close that window.

Let’s see what the Europeans want from Russia in the energy sector. Historically, gas market is based on a presumption that bona fide investments must be paid. Today, large gas fields in accessible territories are almost exhausted, so, gas producers are forced to produce gas in quite remote and geologically and climatically problematic areas. As a result, transportation costs are growing.

According to European statistics, 1 km of a gas pipeline with a capacity of 36bn c m a year in ideal conditions costs $3mn. A 46.5bn c m pipeline in Alaska costs $12mn per km. And though being quite bad, the climate in Alaska is not as bad as that in the Russian Arctic.

An LNG terminal with a capacity of 5bn c m costs $1bn. This is the cheapest element of the chain. The cost of a gas tanker capable of carrying 200,000 c m of LNG is $200mn. The cost of an LNG plant is $11.5bn per 16.8bn c m.

In other words, investments in infrastructure imply long-term guaranteed (take or pay) contracts. This concerns both pipeline gas and LNG. The key LNG producer, Qatar, has quickly switched from strictly market regime with European consumers to classic long-term contracts in Asia.

But in the 2000s the EU decided to no longer endure suppliers’ tyranny and drafted a package of rules saying that brazen gas producers must pay for the very presence in the European market.

Adopted in 2011, the Third Energy Package consists of two directives and three regulations. The key requirements are to separate production from transportation and to provide rival suppliers access to pipelines (50% of supply). If no such suppliers are available, it means that a gas pipeline is underused. In other words, an investor (i.e. a producer) should give the pipeline it has built on its own to a third party, has no right to fully use it for its own needs and should take normally that it will be used by its rivals. For example, the idea that Russia MUST transmit Turkmen and Azerbaijani gas to Europe at the detriment of its own suppliers is regarded as something normal in Brussels. Incompliance with this rule has cost Gazprom billions of USD in fines.

And this is not all. According to the EU’s Energy Union concept, the European Commission has the right to check up contracts planned by EU members and can forbid them. This implies access to commercial information. And this practice covers almost all suppliers having a 40% on own market – that is, exclusively Gazprom.

This is aimed at ruining the system of long-term contracts and to impose monopoly on gas supplies in Europe. Any long-term contract can now be terminated.

If something goes wrong – if, for example, Gazprom refuses to overpay Ukraine for gas transit - the EU advises sharing gas with neighbors. This guideline obliges producers in Europe to re-export gas even though this is prohibited by existing contracts.

In fact, this is good old-fashioned neo-colonialism.

Let’s see what European officials have said about Nord Stream 2 over the last half a year.

While visiting Poland on Nov 29, 2015, German Vice Chancellor Sigmar Gabriel said that Germany will support the project only if Russia continues pumping its gas via Ukraine. On Jan 5, 2016, Bloomberg quoted the European Commission’s Directorate General for Energy as saying that Nord Stream 2 is subject to the EU’s energy laws.

On Feb 8, Deputy Head of the EU Delegation to Russia Sven-Olov Carlsson said that Russian energy companies must comply with EU rules just like European companies comply with Russian rules. But energy is not the only sector where the Europeans have requirements – they want Russia to stop protecting its home market and to subsidize Ukraine and its “European choice.”

According to Carlsson, the ongoing campaign urging the Russians to buy only Russian products is affecting foreign goods – even if they are better or cheaper.

Even more, according to Carlsson, Russia acted against the international transit rules, when it decided to restrict the transit of Ukrainian goods via its and Kazakh territories. Carlsson notes that by doing this Russia has unilaterally cancelled the trade preferences stipulated by the Eurasian Economic Union and has thereby made impossible the implementation of both agreements, which is possible, considering the examples of Serbia, who has free trade agreements with both the EU and Russia, or Egypt, who already has a free trade agreement with the EU and is negotiating a similar deal with the Eurasian Economic Union.

But Carlsson does not care that the parties to the agreements have different re-export chances. What he cares for is just the European producers’ inalienable right of access to the Russian markets.

On the same day, the legal service of the European Commission said that the Third Energy Package does not apply to the Nord Stream 2 project. On Feb 10 Vice President of the European Commission Maros Sefcovic urged the parties to restart their debates on the project, with the possible solutions being either building Nord Stream 2 or better using the existing capacities and developing new sources, like LNG. Sefcovic expressed doubt that Nord Stream 2 is a commercial project and that it complies with the European laws. He also called on Russia to continue pumping gas via Ukraine.

What does the European Commission’s victory mean to this project?

In 2011, Ukraine’s gas transit network pumped 104bn c m, in 2012, 84bn c m, in 2014 59,4bn c m, in 2015 67bn c m. Nord Stream I can pump 55bn c m. During peak periods this pipeline is fully loaded but in 2014 it used just 66.4% of its capacities because of restrictions.

We can see that even in theory Nord Stream 2 cannot pump more than Ukraine’s network pumped last winter. The second problem of Nord Stream 2 is that it will not be able to supply gas to consumers in the south. Nor will it be able to cover peak demands. So, even if using 100% of its capacities, Nord Stream 2 will not be able to substitute for Ukraine’s network.

The rumors that South Stream can be resumed are not true – for neither the European Commission nor Bulgaria have changed their attitudes. According to the EU’s Ambassador to Russia Vygaudas Usackas, it was not the European Union that decided to abandon the South Stream project. “Just as before, we stay committed to the principles of diversifying the routes and sources of energy resources’ deliveries. The European Union is ready to resume talks with Russia on the South Stream natural gas pipeline to southern Europe, but the project should fully comply with the rules of the Third Energy Package,” he said.

Thus, the Europeans want to see Gazprom sinking billions in the sea and paying heaps of fines. In exchange, they offer quite vague prospect of larger presence in their market.

Let’s see what policy the European Commission has on social closer and less geopolitically ambitious supplies. Before developing its network, Norway asked the European commissioners to decide if the EU wanted extra gas. On Feb 5, EU Climate Action and Energy Commissioner Miguel Arias Cañete said that Norway was a highly valued partner, especially compared with Russia. “EU demand will stay roughly stable at 380 to 450 billion cubic meters per year, of which Norway provides roughly one quarter. However, consumption will shrink if the EU increases its energy efficiency. Commission projections show a 30 percent increase in energy efficiency would cut gas demand by 24.5 percent,” Cañete said. In other words, the EU refuses to guarantee anything even to its closest partner, Norway.

This approach makes pendent any Europe-oriented energy infrastructure project.

Let’s consider the history and the prospects of this problem. In 2000-2010 gas consumption in the EU grew by 14% while in 2011-2014 it dropped by 20% (from 523bn c m to 411bn c m). But Europe’s argument that it is cutting gas and oil consumption and is developing alternative sources just because it is concerned for nature is not true. The key factor here is that cheap shale gas in the United States and concerns for nature in China have pushed coal prices down. As a result, most of thermal power plans have switched from gas to coal and the most active here are the “greenest” countries, where actively subsidized expensive “green” energy is forcing out gas but is keeping afloat much dirtier coal.

Today, Europe is actively cutting its gas output – down from 241.9bn c m in 2000 to 178.1bn c m in 2010 - but the problem is that in the next few years it will face a growth in gas demand. In 2015, it was already higher than in 2014.

In 2013, Europe produced 162bn c m, in 2014 143.5bn c m. The National Energy Security Fund expected that in 2015 gas output in Europe would be 150bn c m, in 2020 115bn c m and in 2025 as little as 90bn c m.

In other words, in the next nine years Europe will lose 53.5bn c m of own gas.

But gas is not the only growing gap in the EU’s energy mix. France is going to shut down 17 nuclear reactors and to cut the share of nuclear energy from 75% to 50%.

What ways-out of this gas crisis is the European Commission suggesting?

The first solution is to save energy (to ensure 30% rise in energy efficiency). Now that industry in Europe is on decline, chances are high but 30% is a very unrealistic goal set by the “greens.”

The second solution is to develop alternative sources. The Europeans are planning to increase their share from 16% in 2014 to 20% in 2020 and 27% in 2030. In 2014, renewables grew by 1%, while this year investments in renewables dropped by 18%. In Germany the drop was 42%. In other words, here too we are dealing with “green” fiction. But one thing is clear: “green” energy will keep restraining gas consumption.

The third solution is to increase LNG imports contrary to Gazprom’s interests. The EU has invested in LNG as much as Gazprom has invested in gas, so, it can import much more than it needs for filling its energy gap. In 2014, however, LNG imports dropped from 41bn c m to 33bn c m, with only 16% of terminals used. In other words, exporters preferred the EU to long-term contracts and saner importers.

The fourth solution is a breakthrough in coal production and a 90% cut in emissions.

In other words, if we set aside the “greens” fancies, the EU’s priorities are as follows:

to fully use available LNG terminals by importing LNG from the United States. ENGIE of France has already signed a contract for receiving 12 LNG tankers a year from Cheniere Energy of the United States in 2018-2023. And be sure that the European Commission will have no questions about this deal;

to continue producing coal (especially as the United States is enlarging its coal exports).

So, priority is given to imports from the United States, while Gazprom here is just a whipping boy. As a result, Europe will get expensive gas, clean coal and subsidized renewables as symbols of triumphant democracy.

In any case, there are no good scenarios for Gazprom in Europe. The Europeans already have their priorities and they are very far from economics.

EADaily analysis