What should Gazprom fear in Europe: Russian gas in “price scissors”

Europe will always need the Russian gas, and the U.S. LNG will never replace it, GECF Secretary General Dr. Seyed Mohammed Hossein Adeli told Handelsblatt. “I cannot understand the European Union’s skepticism about the Nord Stream 2. Europe will further need the Russian gas. The U.S. influence on the European gas market is still not high. U.S. will never be able to replace Russian gas supplies to Europe due to restricted export capacities,” the GECF Secretary General said.

There is really no competition between the U.S. LNG and Russian gas. In the first half of the current year, Gazprom supplied 95.7bln cubic meters of gas to Europe. LNG supplies from U.S. to Europe totaled 1.28bln cubic meters for Jan-Jun, according to EIA. This is lower than the Russian gas supply growth indicator for Jan-Jun – 10.5bln cubic meters. Half of the U.S. LNG was consumed in Portugal, Spain, and Malta, the countries having no access to the Russian pipeline.

Are things really that good for Russian gas and Gazprom?

Will green energy affect Gazprom?

So far, Gazprom leadership anticipates good times for the company. Export of gas is predicted at record-breaking 190bln cubic meters. After Power of Siberia gas pipeline is put into service, export will exceed 200bln cubic meters, says Alexey Miller, Gazprom CEO. Gas extraction inside EU is also in favor of Gazprom, not to mention France’s plans to refuse from oil and gas extraction in the country by 2024.

“If sanctions imposed on Russia are lifted, in case of fair competition with European companies of U.S., renewable energy sources may dominate on the European market,” says Igor Yushkov, senior analyst at the National Energy Security Fund. He thinks green energy may affect Gazprom’s position in the market in the long-term outlook.

Germany, as the largest consumer of the Russian gas, may be indicative of that impact. Last year, Germany companies purchased almost 50bln cubic meters or 27% of the total gas exported by Russia. So far Berlin’s environmental policy is good for Gazprom. 40% of the country’s electricity is generated from coal and Germany plans to reduce carbon dioxide emissions by 40% by 2020 as compared to 1990 by shifting to natural gas. According to Wood Mackenzie, gas consumption will peak in 2025 and then fall, as Berlin plans to receive 80% of energy from renewable sources by 2050. Gas will be used as a transit technology.

Does it look impossible? Statistics suggests the opposite. In 2004, the EU received 8.5% of electricity from renewable energy sources, in 2015 – 17%. Green energy generation capacities accounted for 90% of total generating capacities put into service last year.

Alexey Grivach, Deputy Director of the National Energy Security Fund, also believes that renewable energy sources may certainly hamper Russian gas supplies to Europe. “In electrical energy sector, for instance, gas and renewable energy sources are partners, not rivals. Instability and unpredictability of renewable energy sources, these systems of generation need duplication. In chemical utilization of natural gas, renewable energy sources are not competitive unlike in systems of individual heating,” the expert says. In his words, gas and renewable energy sources can and should be used to replace dirty fuels to achieve environmental standards set in long-tern development programs. “If renewable energy sources start ousting gas instead of coal, as it happened a few years ago, EU’s environmental policy will fail. So, much will depend on regulation standards and their application,” Grivach says.

Electricity generation from renewable sources of energy is more expensive than from gas. The share of green energy has increased during the last 10 years not only due to EU’s programs but also due to high gas prices. Fuel prices have more than halved in Europe during the recent years, and transition to green energy has become quite expensive comparing to natural gas. Wealthy Germany is one of few European countries to afford green energy.

For instance, last year, Berlin spent $26bln to pay subsidies to producers of electricity from renewable sources of energy. They took that money mostly from the pockets of ordinary citizens. The average electricity bills of a household in Germany in 2016 totaled €1,060, which was by 50% more than in 2007. Citizens of by far not all the European countries can afford such bills, the more so as there is alternative source – gas, which is much more environment-friendly than coal is.

This option depends on gas prices, of course. If they are back to the level of 2010-2013, alternative energy will become profitable again. Yet, experts anticipate no gas price hikes at any time again.

Price scissors

On the one hand, Russian gas prices in most contracts still depend on oil price. On the other hand, it was the low price of Russian gas that helped boosting supplies to Europe.

Gazprom says average export price of gas may increase to $190 per cubic meter in 2017 in 2017, Yelena Burmistrova, Gazprom Export Director General, told TASS. However, even the increased price is not high. For example, look at data for June. The Russian gas price on the border with Germany totaled $179 per 1,000 cubic meters, according IMF. The price of the import gas in Europe averaged $192, according to WB. At the same time, Asia Times reports that the U.S. LNG prices for Europe is as high as $213.

In such situation, Gazprom has found itself in “price scissors.” Export is growing subject to low prices, which is not so profitable for the company. In 2012, the Russian gas holding supplied 138.8bln cubic meters of gas at the average price of $385 to non-CIS states and profits from export totaled $53.4bln. This year, the Company plans to sell as much as 190bln cubic meters. However, the profits will not exceed $36bln, since the maximum rate set is $190.

Experts say Gazprom and Russia will have to get used to low gas prices. Firstly, supply exceeds and will continue exceeding demand. Secondly, a rise in prices may result in rapid expansion of alternative energy and stiff competition of pipeline gas and LNG.

Anyway, analysts no longer anticipate high gas prices and fat years for Gazprom. “Gas price will hardly reach $400-$500 again,” Igor Yushkov says. “It may reach some $300.” The expert anticipates a growth of the world’s gas prices only in case of an extraordinary event. “If, something happens with gas supplies from Qatar or if South Korea, a large consumer of gas, closes down its NPP and increases gas import as promised,” Yushkov says.

Experts have been speaking about changes in the market caused by gas supply growth during the recent years. The sellers’ market has turned into a buyers’ market, which has increased pressure on prices dramatically. The last example: ExxonMobil had to reduce prices of LNG it delivers from Australia to India. According to Reuters, ExxonMobil has agreed with Petronet LNG, India, to increase annual supplies to 7bln cubic meters, but LNG cost will be lower by 15%.

RBC Analyst Ben Wilson told Reuters: “If ExxonMobil had not agreed to renegotiate, Petronet might have scrapped the agreement, leaving the major to pursue damages and resell the volumes on a weak spot market. They’ve probably taken the lesser of two evils,” said Wilson. South Korean and Japanese companies are also going to negotiate with suppliers for revision of prices.

Alexey Grivach is sure that LNG cannot have any impact on the Russian gas price in the European market. He is sure that only very cheap gas from a reliable source may compete with the Russian gas, but there are almost no such sources now. At the same time, the expert says, LNG supplies will have to reduce prices to compete with other LNG producers and natural gas suppliers, which is not good for the Russian gas.

The situation with LNG in India also suggests that no gas price hikes should be expected. That is why, Gazprom will have to wage an accurate price policy even if oil prices rise. Gazprom has already demonstrated its “safety margin” to work on lower prices. However, the holding and the government of Russia are not happy with potentially falling gas prices. The government has again rejected independent gas producers’ request for access to Gazprom’s export gas pipelines not to create additional competition in the European market.