Gas war for Europe: Is Gazprom playing checkers or chess?

Gazprom is winning the war for Europe - but at the expense of its revenues and with no hope for super-profits in future. On the one hand, the Americans are enlarging their LNG supplies. On the other hand, if Gazprom minimizes its supplies via Ukraine, it will not be able to meet its obligations to European consumers as the southern gas route, Nord Stream 2 and Baltic LNG are on paper yet and may remain there because of Europe’s reluctance to accept any Russian initiatives.

Sales up, revenues down

In 2015, gas consumption in Europe grew by 4%. In Italy it rose by 10%. According to Eurogas, the Europeans consumed a total of 426bn c m.

As a result, Gazprom’s exports grew by 8% to 159bn c m. This year its supplies to the EU have grown by 14%.

“The growth was due not only to low prices but also to growing advantage over other fuels,” says Alexey Grivach, Deputy Director General of the National Energy Security Foundation. “In recent years, coal has been forcing gas out of the market. But now things are changing. One more reason why the Europeans are buying more gas from Gazprom is that they are beginning to produce less at home.”

Today, Gazprom’s share in the European market has grown to 31%. But this is not reflected in growing incomes. In 2013, Gazprom’s net profit was 1,139bn RUR. In 2015, it was just 403bn RUR. In US dollars, this is equivalent to $36bn and $6bn, respectively.

There is nothing strange here. In Apr, EADaily quoted the IMF that this year Russian gas on the German border costs $130 per 1,000 c m against $236 per 1,000 c m a year ago and as much as $379 per 1,000 c m in 2013. One more problem is that Gazprom has lost the Ukrainian market. Some 5-6 years ago it sold Ukraine as much as 50bn c m (almost 1/3 of what its supplies to Europe). In 2013, it sold just 26bn c m, last year just 6.1bn c m. And even though a certain quantity of the gas re-exported to Ukraine from Europe is also Russian, it is not big (just 10bn c m).

Gazprom’s opponent, CEO of East European Gas Analysis Mikhail Korchemkin says that the company has wasted as much as 234bn RUR on the South Stream project. “The king’s men are very zealous in pushing the interests of patriot contractors,” ironizes the expert.

According to Reuters, Gazprom has looked to bolster demand in Europe through discounting and renegotiating its 25-year, oil-linked supply deals. “After years of tough negotiations, it has reached deals with long-term buyers including France's Engie and Germany's Uniper, a unit of E.ON... Like Saudi Arabia has done in oil, Gazprom has shown it can use its market dominance to squeeze its competitors.”

Quoting Poland's Centre for Eastern Studies, Reuters says that Gazprom seems to be willing to fight for greater share of the EU market given dwindling sales in former Soviet states and still distant prospects of piping gas to China.

To satisfy Europe

According to Gazprom’s CEO Alexey Miller, by 2025, Europe’s gas needs will grow by at least 100bn c m. Oxford Institute for Energy Studies says that by 2040 the EU will consume as much as it consumed in 2010 – 594bn c m.

“One should be cautiously optimistic though. First, the power sector lost about 75 bcm between 2010 and 2015, and even in a theoretical scenario for 2016 of a return to the level of competitiveness between coal and gas seen in 2010, this would probably translate into only about 30-40 bcm of additional gas demand due to the rise in renewable generation in the mix in the meantime,” says Anouk Honoré, Senior Research Fellow at Oxford Institute for Energy Studies.

She notes that gas-fired generation will also benefit from expected closure of firm capacity (coal and nuclear), especially in the 2020s. “Although the exact amount of retiring plants is yet unknown, this will leave some space for gas in the mix as renewables will not be able to compensate the entire loss and new coal, nuclear and even large hydro power plants will be limited,” the expert says.

There are lots of suppliers wishing to sell gas to Europe. Gazprom’s key rivals here are LNG producers like Qatar, Libya and Algeria, senior analyst at Aton Alexander Kornilov has told to Vedomosti newspaper.

According to Eurogas, in Italy LNG supplies have redoubled, in France they have risen by 34%.

But the key rival is the United States. According to the Oxford Institute for Energy Studies, by 2019 Cheniere Energy and other US LNG producers will have 73bn c m for sale, which is equivalent to 20% of Europe’s annual consumption.

Reuters notes that Gazprom has resources for producing some 100bn c m more and cutting the prices. Even if the Russians lose some of their revenues, this will make American LNG supplies unprofitable.

According to Claudio Descalzi, CEO of ENI (the biggest buyer of Russian gas in Europe), Russian gas is cheap and will stay cheaper than American LNG is.

But there is one more problem that can prevent Gazprom from enlarging its exports to Europe. If Gazprom minimizes its transit via Ukraine, it will not be able to meet its existing contractual obligations unless it builds alternative routers.

Gazprom’s new tactics: gas guarantees

So as to minimize its transit via Ukraine and still to satisfy Europe, Gazprom has to carry out two projects - Nord Stream 2 and Southern Gas Route. This is a hard task, considering Europe’s resistance. Gazprom has lots of lobbyists in Europe. One example is former German chancellor Gerhard Schroeder, who has been appointed as Chairman of the Shareholders’ Committee at Nord Stream AG. Today, anti-Russian moods are stronger, but Gazprom is also more flexible and partner-oriented. So, there are hopes that Nord Stream 2 will be built.

“This is not only Gazprom’s project. It is to be carried out by five big European energy companies. Those companies do have resources for convincing their governments that this project is good not only for Russia but for whole Europe,” says Alexey Grivach, Deputy Director General of the National Energy Security Foundation.

And they are already doing this. Shell CEO Ben Van Beurden said that Shell was in dialogue with the host governments in the UK and the Netherlands and with the EC in order to find a solution for Nord Stream 2. "We consider that Nord Stream 2 brings a real support to the energy security of Western Europe, and for these reasons we are trying to convince all the European policymakers that they should not only accept but support the construction of Nord Stream 2," Chairman of Engie's Board of Directors Gerard Mestrallet added. "We had a project South Stream and other projects, they have been forgotten, and now our only hope - is the Nord Stream – 2," head of OMV Rainer Seele concluded.

German Chancellor Angela Merkel has backed up the businessmen by saying that Nord Stream 2 is a commercial project.

But even this support may prove ineffective.

“Nord Stream 2 AG is ready to launch this project. And only political factors can curb it. Its opponents are seeking to make the whole pipeline subject to the Third Energy Package, even though its underwater section is not subject to it. So, now it is for Finland, Sweden, Denmark and Germany to decide if they will let Nord Stream 2 run through their sea waters. I think the EU will pressure them. So, we can’t be 100% sure that Nord Stream 2 will be realized,” Grivach says.

In its turn, Gazprom is trying to convince the Eastern European opponents. For example, Slovak Economy Minister Vazil Hudak complained that his country might lose $400mn if Nord Stream 2 was built, but last week Gazprom agreed with Eustream of Slovakia to use its gas pipelines for Nord Stream 2 project. So, now Slovakia will not lose anything and will hopefully support the project. Poland is more resistant, but here too much will depend on the price Nord Stream 2 will offer the Poles.

Things are much more complicated with the Southern Gas Route. On the one hand, Russia has improved its relations with Turkey and now the Turks are competing with the Bulgarians for the pipeline. At least, both Turkish and Bulgarian foreign ministers discussed this with Sergey Lavrov in Sochi.

“Bulgaria has realized that it has acted against its economic and strategic interests and is now trying to remain a transit country. Today it is strongly dependent on the Ukrainian transit. It will be the first to freeze, if something happens,” Grivach says.

On the other hand, Russia has made it clear that now that South Stream has failed, it will agree to build only if there are gas guarantees.

“If we are talking about one line, we better build it via Turkey. But if we want to supply gas to the south of Italy and to the Balkans, we should prefer Bulgaria. Here we will need the EU’s permit. And now it is for Bulgaria, Greece and Italy to try to convince them in Brussels. Russia will just wait to see if they can do it,” Grivach says.

This makes Turkish Stream much more attractive.

According to Igor Yushkov, senior analyst at the National Energy Security Fund, both projects have both advantages and disadvantages. South Stream was almost started, while Turkish Stream is just on paper. On the other hand, Turkey is more independent in its decisions than Bulgaria is.

Turkish Stream will be good for Gazprom as it will help it to stably supply gas to Turkey.

One more idea is to build one pipeline via the Black Sea and then to lay different lines for Turkey and Bulgaria.

Which versions will win and will this project be realized at all? Russia insists on guarantees. But will they be enough for the EU to make an exception for South Stream – the way it did for the Southern Gas Corridor? Today, there are lots of factors that may have a role in this game. And the result will show if Gazprom is playing checkers or chess.

EADaily Fuel and Energy Analysis