A new report from the Oxford Institute for Energy Studies (OIES) contends that, in light of the Ukraine crisis, the EU should allow Gazprom to use its great new pipelines South Stream and Nord Stream for itself and not be required to grant access to third parties. But the Center for Security Studies (CSS) ETH Zürch, argues the opposite in a new report of its own. It says the EU should adopt a strict regulatory policy towards South Stream and subject all of Gazprom’s activities to intense legal scrutiny. Energy Post editor Karel Beckman believes CSS is right that the EU should play hardball with Russia. But it should not see Russia as an enemy.
The Ukraine crisis has led to a lot of debate about what the implications are for the European gas market and how to deal with possible threats to gas supplies, both in the short and long term. Fortunately, some real experts have now shone their lights on these matters (they tend to lag a little behind the quick but poorly informed newspaper pundits).
“What the Ukraine crisis means for gas markets”, a new paper from the Oxford Institute for Energy Studies (OIES), looks at the current gas supply situation with regard to Russia, Ukraine and Europe and also in detail at the precarious position of the Ukrainian national gas company Naftogaz. This company ran up debts of $3.3. billion in 2013 to Gazprom, of which only a part were paid back. Under the pro-Russian president Viktor Yanukovich the Russians were willing to accommodate Naftogaz, but they may not be so forthcoming with the new management.
OIES notes that Russian imports comprise some 30% of European gas needs. About 50% of Russian to Europe transits via Ukraine (a few years ago this was still 80%), meaning that a disruption of Ukrainian transit would affect just 15% of total gas supplies. However, some countries are more dependent on Ukrainian transit than others. The most affected EU member state is Italy, with substantial supplies also going to Austria, Hungary, Bulgaria, Greece, former Yugoslavia, Turkey and Germany.
Thanks to various measures taken since the last Ukrainian gas supply crisis in 2009 – in particular increased possibilities of “reverse flow” transit (i.e. from West to East) – Europe is in a much better position to diversify supplies than it was a few years ago. If Ukrainian transit is blocked, supplies through Nord Stream can be increased and shipped via the Czech Republic and Slovakia to the Baumgarten Hub in Austria, serving the South European market.
Italy has additional import options and today gets only 20% of its gas from Russia. Most countries also have built up storage capacities, e.g. Hungary and Slovakia over 80 days and Bulgaria and the Czech Republic over 40 days. Only Greece and Romania have no storage, but Greece can source additional LNG. OIES concludes that in the event of a disruption “Europe would be able to balance its needs through additional imports, use of storage and interconnections and, with Russia able to use alternative routes, to offset at least part of the volumes lost.”
Some might argue that the real threat is not disruption of Ukrainian transit but a Russian “boycott” of the whole of Europe, for political reasons. OIES, however, notes that Russia (and in particular Gazprom) is heavily dependent on gas export revenues. In 2013, Gazprom exported 86 bcm (billion cubic meters) of gas through Ukraine at an average price of $387/mcm (million cubic meters), implying revenues of $33.3 billion. This was 53% of all of Gazprom’s sales to Europe. “The company would clearly be hit very hard by any interruption to its European exports via Ukraine”, notes OIES.
In the long term the effects could even be worse, “if European customers decide to redouble efforts to diversify away from Russian gas to alternative sources of supply or alternative fuels”.
In addition, direct sales to Ukraine are also quite significant for Gazprom, estimated at $10.7 billion in 2013. The effect on the overall Russian budget would be much less of course, if only because oil is a far more important revenue generator for the country, as OIES notes.
All of this applies to the short-term outlook, which is reassuring in any case with spring and summer approaching in Europe. In the longer term, however, notes OIES, Europe needs to ensure stability of its gas supplies. The question is, how.
For OIES there is no question that Europe will remain dependent to an important extent on Russia. According to OIES, this implies that the EU should support Gazprom’s efforts to diversify away from Ukraine, in partciular through the Nord Stream and South Stream pipelines. “The current situation strengthens the rationale for the South Stream pipeline, which would bring Russian gas across the Balck Sea to Bulgaria,” notes the OIES report.
South Stream of course is being built by Russia with the express intention to circumvent Ukraine. Gazprom has already taken a positive final investment decision (FID) on the giant 63 bcm pipeline and is steaming ahead with the project. But, as OIES puts it, “a regulatory problem remains: Gazprom might not be able to book and utilise full capacity in the onshore extensions of both Nord Stream and South Stream, as the EU Third Package for gas requires inter alia third party access (TPA) unless an exemption is granted”.
As regards Nord Stream, the German regulator, the Bundesnetzagentur (BnetzA), has already granted an exemption to Gazprom for the OPAL pipeline, a crucial extension of Nord Stream running through Germany alongside the German eastern border. The Germans permit Gazprom 100% access to OPAL. The EU, however, has yet to rule on OPAL. Indeed, the European Commission announced on 10 March that it wants to further investigate this project before making a decision.
The same applies to South Stream. Energy Commissioner Günther Oettinger said on 10 March that the EU would “delay” a decision on South Stream in response to Russian actions in Ukraine. In December of last year the European Commission announced that the “intergovernmental agreements” concluded between Russia and the governments of EU member states which the pipeline crosses, are not in line with the Third Package. Meanwhile, Gazprom has not yet applied for an exemption for South Stream, despite the fact that it has already taken an FID on the project.
According to OIES, there are now two possible outcomes of this issue: what it calls an “economic” and a “political” outcome. The “commercially logical” outcome, says OIES, would be that “the uncertainty surrounding Ukraine would be a decisive factor contributing towards speeding up the development of regulatory procedures (as part of the Third Package and without the need for an exemption) enabling construction and utilisation of new cross-border pipeline capacity in Europe”. In other words, the EU should do what it can to ensure that South Stream gets built as quickly as possible, and not require third-party access to the pipeline.
But OIES fears another, “political” scenario may develop: “a reduction of EU-Russia cooperation on gas issues, and about the routes by which gas can brought into Europe”. This would happen if the EU decided to retaliate against perceived Russian agression in Ukraine, and would throw regulatory obstacles in the way of South Stream. According the OIES researchers, such a political scenario should not prevail over the “more economically rational solution”. They warn that this could “have very substantial economic costs for both Europe and Russia.”
With their recommendation, OIES finds itself in direct opposition to Jonas Grätz of the Center for Security Studies (CSS) ETH Zürich and Iana Dreyer of the European Union Institute for Security Studies (EUISS) in Paris.
In a new paper published by CSS, “After Ukraine: Enhancing Europe’s Gas Security”, the two authors argue that the EU should rather throw the full regulatory weight of the Third Package at South Stream.
They note that Europe’s dependency on Russian gas “poses security risks, which are magnified by attempts of Russia’s Gazprom to hold sway over Europe’s gas deliveries”.
Russia, they say, follows a deliberate policy aimed at maximum control over the European market. It actively resists “market reforms in the EU that would increase competition and interconnectedness”. Its new pipelines, Nord Stream and South Stream, are part of a strategic Russian plan to “cement dependence”, “neutralize Ukraine”, “enhance Russia as a centre of gravity in the post-Soviet space” and “to align the Balkans and EU states with Moscow’s foreign policy.”
The EU “cannot afford to be complacent” about this behaviour, say Grätz and Dreyer. “The EU’s key aim should be to subject the gas relationship with Russia to the logic of its internal gas market. Competitive markets should do the job of determining imports and exports, and not company monopolies and foreign interests.”
They point out that Russia is also the EU’s main supplier of oil and a large supplier of coal, but this does not affect political relations, since Russia is not in a position to dominate these two “more competitive and fungible markets”. This is the kind of relationship the EU should aim for in the gas market as well, they argue – and “competitive gas markets are the primary tools to get there: By better leveraging Gazprom’s dependence on the EU’s gas demand, Gazprom should be nudged towards competitive behavior. The ultimate goal is to reduce monopoly profits, incentivizing Russia to become more competitive in its natural gas sector.”
Grätz and Dreyer note that EU market reforms have already led to remarkable results. “Spot markets have spread from the UK all over northwestern Europe, helped by the current economic slump and a global boom in sea-borne LNG trade. LNG diversifies sources and routes of supply, reducing gas markets’ traditional exclusive reliance on pipelines. In light of these markets, European utilities have recently been able renegotiate some of their long-term contracts with the big three suppliers – Norway, Algeria and even reluctant Russia. And thanks to interconnections, the EU’s capacity to react to supply shortfalls has been enhanced.”
But they warn that “Gazprom’s clout in the EU could be growing again: Liberalization also meant that Gazprom was able to invest directly or indirectly in national utilities or gas trading companies throughout the EU. In contrast to the previous national monopoly model, this meant that Gazprom would control investment and gas sourcing strategies in the EU, whereas EU companies cannot do the same in Russia. Enforcement of the EU’s rules is thus of paramount importance to keep Gazprom’s power in check.”
Market developments also favour Russia at the moment. As a result, the EU’s reforms are “at risk of being undermined.” This makes it all the more important that the EU “strictly adhere” to its internal market policy. In this context, Russia’s big pipeline projects in Europe, Nord Stream and South Stream, are “central test cases”, as is the antitrust lawsuit against Gazprom.
So what should the EU do? One recommendation of the authors is that the EU should clearly “set the rules of the game” for interdependency: “According to current scenarios, the EU will likely be relying on more Russian gas in the future. This would not be a disaster, if the EU does its homework. The EU’s hand will be strengthened if decision-makers do not shun other energy sources. The EU and its member states should thus make clear to Moscow that they have a choice: If Moscow continues to refuse the free market, the future role of gas in the energy mix will be limited in order to reduce risks. As a positive roadmap, the role of gas could grow if Moscow liberalizes its exports and investment regime, protects EU investors, opens up access to its pipelines, and stops hindering EU attempts at diversification.”
Secondly, Grätz and Dreyer call on EU leaders “to stay consistent in the vision of a competitive EU gas market. Even if key companies from Italy, France, and Germany are lending Gazprom a helping hand, the EU has to be clear that this pipeline [i.e. South Stream] is value-destructive both from an economic and foreign policy viewpoint.”
If the EU cannot stop this project, they add, “there can be no compromise on exemptions for South Stream. The public interest in a competitive market is more valuable than corporate interests. Any exemption will help Gazprom to turn the pipeline into a tool for monopolizing gas markets, even more so as its new final destination will likely be the Baumgarten hub in Austria. The EU Commission has to bring the bilateral pipeline agreements with Moscow in accordance with EU rules.”
In addition, “the EU antitrust case must be drawn to a conclusion thoroughly. All of this needs the firm backing of European capitals. They must become fully aware of the negative geopolitical implications of compromising with Gazprom on these issues.”
Clearly, the recommendations from CSS and EUISS are the polar opposite of what the OIES suggests. The reason for this difference of opinion is apparently that OIES regards implementation of the Third Package as a “political outcome”. The Oxford researchers instead prefer an “economic”, i.e. market-based approach. From a market perspective, it may be argued that the new Russian pipelines enhance security of supply for Europe, because they cretae additional transit routes. This is so even if Gazprom reserves these routes for itsef.
The problem with the OIES’ line of thinking is that it can hardly be denied that Russia uses gas in many ways as a political instrument. Thus, for example, while Gazprom is able to expand downstream in Europe, the Russian gas market is not open in the same way to European companies. A genuinely competitive market, therefore, has to come about through the implementation of regulations aimed at creating a level playing field, as Grätz and Dreyer argue. It seems odd that the OIES researchers ignore this.
If Grätz and Dreyer are surely correct that the EU should play hardball with the Russians, this by no means implies that Europe should regard Russia as an “enemy”, as many commentators in western media would like to us to do. Western countries have always approached energy issues in political and strategic terms, but according to some people for Russia different rules apply. That is nonsense. As Grätz and Dreyer write, “the EU has to stick to its vision of a competitive market and not deviate from its own rules”. That is all there is to it. In that sense, fortunately, both reports refrain from cheap moralising.
See also this article by Valentin Stoyanov on Energy Pots: “The real prospects for South Stream: it’s all about exemption“. And Peter Poptchev, “It is too early to give up on Nabucco“.
Editor’s Note: OIES responds
The authors of “What the Ukraine crisis means for gas markets” have sent a detailed response to the article above, which I reproduce here in full:
For the benefit of the Energy Post wider readership and for the sake of getting our view understood correctly (expressed in the OIES comment paper “What the Ukraine crisis means for gas markets”, 10th March 2014), we would like to respond to some assertions contained in your article “Ukraine fallout: how to deal with South Stream and Nord Stream” (12th March 2014) which we disagree with and believe have misinterpreted some of our arguments.
“A new report from the Oxford Institute for Energy Studies (OIES) contends that, in light of the Ukraine crisis, the EU should allow Gazprom to use its great new pipelines South Stream and Nord Stream for itself and not be required to grant access to third parties.”
1) Our report suggests that the development of regulatory procedures for new pipeline capacity in Europe which would form a predictable regulatory framework allowing construction and utilisation commercially viable new pipeline capacity needs to be speeded up. Our report does not suggest that 100% of that capacity should be booked by Gazprom or anyone else. In respect of South Stream, such procedure should enable utilisation of its capacity to transport gas volumes currently transiting across Ukraine, should such transit be (partially or completely) halted in the future. In other words, under such procedure, Gazprom should be able to book capacity in South Stream in the amount sufficient for transportation of these re-routed flows. Nothing in this statement suggests that this amount needs to be equal to 100% of South Stream capacity. If Ukrainian transit is halted, a failure to allow access to matching capacity in South Stream would create an artificial barrier preventing contracted gas deliveries from reaching their European buyers (some of which have only limited or absent supply/route diversification).
A procedure for new capacity is under development by European regulators, TSOs, and the Commission, this procedure is expected to be in force in 2017/18. In absence of this procedure, an exemption for South Stream could also be a solution – but South Stream has not applied for it; also it needs to be stressed that exemptions granted to other projects e.g. Nabucco or OPAL have been partial i.e. only for 50% of capacity, which suggests that even if South Stream applies for an exemption and if the Commission approves it, it is likely to partial as well (i.e. not for 100% capacity). The new procedures could follow the following logic: to require TPA but only to such an amount of capacity and in such a way as to not prevent Gazprom from fulfilling its contractual obligations in the event that transit across Ukraine is partly/fully halted. Overall, the new regulatory procedures could provide treatment similar to that that might have been provided under exemption (Art. 36), had the South Stream partners applied for and been granted such an exemption.
So, all what we are doing in our comment is to think how the Russians will be able to deliver gas to Europe if Ukrainian problems continue. And we say that if the South Stream partners decide to build South Stream, they should not be prevented from fulfilling their contractual commitments by the Third Package rules. In the – now very unlikely – event that they decide not to build it, and this can be blamed on the Third Package rules, then in the event of a future crisis through Ukraine, the EU may need to ponder whether it was wise to have imposed such rules on the project.
Our report does not question the idea that the Third Package rules must be respected, it concurs with it. But it stresses that the rules should first be created and only then adhered to – it can hardly be argued that the rules must be respected before they are in place. Currently, there is no legally-binding procedure within the Third Package for new capacity, and our report calls for its speedy development. An exemption is not a rule – it is, as its name suggests, an exemption from the rules.
In respect of Nord Stream, the amended OPAL exemption decision (which is awaiting the Commission’s decision, which has been delayed in the aftermath of the Ukrainian crisis) is worded in such a way as to enable Gazprom to use 100% of capacity unless wanted by a third party. Nord Stream is different from South Stream in respect of potential third party access requests – given that Nord Stream carries gas from the Russian coast straight to the German coast and then further through OPAL, it is not obvious who else might want capacity in OPAL. However, there are potential third parties which would be interested in South Stream capacity in the future.
Specifically, we do not agree that with the assertion that the content of our statement “the uncertainty surrounding Ukraine would be a decisive factor contributing towards speeding up the development of regulatory procedures (as part of the Third Package and without the need for an exemption) enabling construction and utilisation of new cross-border pipeline capacity in Europe” is equal to the content of statement “In other words, the EU should do what it can to ensure that South Stream gets built as quickly as possible, and not require third-party access to the pipeline.”
2) While our report sketched out two possible outcomes – one of which is commercially logical and one is not – it does not advocate one or another. What it does, however, is stating clearly that the second option would come at a very high cost for both sides and that before this option is taken the extent of this cost needs to be fully appreciated by all parties.
It needs to be stressed that points (1) and (2) are all very complex points and require significant research effort into the details of the Third Package and the network codes and their relevance for Russian gas (and we have made that effort and published its results in the Gas Programme’s previous studies).
3) We see the following statement as problematic: “it can hardly be denied that Russia uses gas in many ways as a political instrument. Thus, for example, while Gazprom is able to expand downstream in Europe…” – we do not agree that expanding downstream is a “political” issue, in fact Gazprom has not significantly expanded downstream because it has been discriminated against by all EU countries (where it has tried) from taking equity in all energy sectors – exceptions being the Baltic countries (which happened a long time ago and where Gazprom is now being ejected) and storages. The difference under the Third Package is that Gazprom will be able to sell to European customers just like all other suppliers – precisely because the Third Package will create a level playing field.
4) We also disagree with the following statement: “the Russian gas market is not open in the same way to European companies…” – on the contrary, there far more investment by European companies in the Russian gas (and energy) market than vice versa (e.g. South Russkoye, Urengoy Achimov and Sakhalin 2); and if one adds European investment in the Russian power sector (not to speak of the oil sector) there is a huge imbalance of investment in the two energy sectors in favour of Europe.
We have not addressed points (3) and (4) in our report – as its main focus was on the Ukrainian crisis and its potential impact – but they are based on research and are covered in significant detail in the OIES Gas Programme new book “The Russian Gas Matrix” (forthcoming 2014)
We hope this response clarifies our position and we are happy to accept the Karel Beckman’s offer to conduct an interview on this subject for a subsequent publication on the Energy Post website.
Authors (S. Pirani, J. Henderson, A. Honoré, H. Rogers, K. Yafimava)
Oxford, 24 March 2014
Here is my reply to the comment from OIES:
First, you object to my assertion that “A new report from the Oxford Institute for Energy Studies (OIES) contends that, in light of the Ukraine crisis, the EU should allow Gazprom to use its great new pipelines South Stream and Nord Stream for itself and not be required to grant access to third parties.”
Specifically, you write that “we do not agree with the assertion that the content of our statement ‘the uncertainty surrounding Ukraine would be a decisive factor contributing towards speeding up the development of regulatory procedures (as part of the Third Package and without the need for an exemption) enabling construction and utilisation of new cross-border pipeline capacity in Europe’ is equal to the content of the statement ‘In other words, the EU should do what it can to ensure that South Stream gets built as quickly as possible, and not require third-party access to the pipeline.’
The best I can do in reply, to explain my interpretation of your assertions, is to quote your report. I have italicized the parts that are particularly relevant here.
You write on page 17 that “the current situation strengthens the rationale for the South Stream pipeline, which would bring Russian gas across the Black Sea to Bulgaria.” You then state that the “new transit avoidance infrastructure – the Nord Stream pipeline and potentially South Stream” has made Europe “more resilient to potential interruptions to gas transit across Ukraine”.
However, you continue, “a regulatory problem remains (…) Gazprom might not be able to book and utilise full capacity in the onshore extensions of both Nord Stream and South Stream, as the EU Third Package for Gas requires inter alia third party access (TPA) unless an exemption is granted.”
A few paragraphs later, you write that “a commercially logical outcome [of the current crisis] would be that the uncertainty surrounding Ukraine would be a decisive factor contributing towards speeding up the development of regulatory procedures (as part of the Third Package and without the need for an exemption) enabling construction and utilisation of new cross-border pipeline capacity in Europe.”
So your point seems to be that the “regulatory procedures” of the Third Package should be implemented without any kind of exemptions. Now this can mean two things: either those regulatory procedures require TPA or they don’t. If they require TPA, and there would not be any kind of “exemptions” anymore, this would imply that Gazprom could not ever utilise full capacity anymore – i.e. it could never be ensured of being able to utilise full capacity, as it would always have to grant TPA. But that would make “the regulatory problem” that you referred to earlier only worse! When there were still exemptions possible, they at least could obtain full capacity. Now apparently not anymore.
If this is what you were arguing, this seems to contradict the second part of the sentence, where you speak of enabling construction and utilisation of new cross-border pipeline capacity. Such construction and utilisation will be enabled presumably only if the “regulatory problem” is resolved.
Thus, the only way your statements make sense to me is if the “regulatory procedures” would henceforth allow the use of full capacity without a TPA requirement – and there would be no need for Gazprom to obtain an exemption. Only then would the “regulatory problem” be resolved.
If this is an incorrect interpretation I apologise, but then please explain to me how the “speeding up the development of regulatory procedures (as part of the Third Package and without the need for an exemption)” would solve the “regulatory problem”, which you described as “Gazprom might not be able to book and utilise full capacity in the onshore extensions of both Nord Stream and South Stream, as the EU Third Package for Gas requires inter alia third party access (TPA) unless an exemption is granted.”
Your second objection to my article you formulate as follows: “While our paper sketched out two possible outcomes – one of which is commercially logical and one is not – it does not advocate one or another. What it does, however, is to state clearly that the second option would come at a very high cost for both sides and that, before this option is taken, the extent of this cost needs to be fully appreciated by all parties.”
Well, let me again quote your report and give the full context of what you write about the second option:
“The latter outcome [the second option] could have very substantial economic costs for both Europe and Russia given their interdependence in the gas sector (…). It would indicate that the military and political crisis over Crimea and the change of Ukrainian government had catalysed an additional crisis in EU-Russia relations in the gas sphere. It would also indicate that political priorities had prevailed over a more economically rational solution.”
Note that you also state about the first option that it would “strengthen European transit security”, with no mention of any costs.
I leave it to the reader to decide whether or not this implies the “advocacy” of one or the other solution.
As to your third and fourth points, I will admit that my assertions here are based on impressions not on research. I will look into this and hopefully will be able to address these points sometime in the future.