Europe’s gas deficit has concentrated minds on the Yamal-Europe gas pipeline which runs from Russia to Germany via Belarus and Poland, built in the 1990s. Andrei Belyi at the University of Eastern Finland explains how the rules for booking capacity worked well during times when gas was in plentiful supply, but now works against Europe’s gas security since the shortages emerged in September. The rules are designed to maximise competition between suppliers, which means long-term contracts contend with short-term ones that can react to the market. What is lost is the security provided by those long-term commitments. Worse, whereas multiple suppliers exist in the north-west to provide actual competition, the dominant supplier in the east is Gazprom. That means Russia’s Gazprom can use short-term contracts to suit its interests rather than those of its European customers. Belyi goes into the details, and concludes that the EU’s blanket competition rules have reinforced Gazprom’s ability to tighten the markets. The one-size-fits-all approach applied to energy systems has backfired.
In recent months, the Yamal-Europe gas route has caught the attention of European gas markets sensibilities. Traders are carefully following when Gazprom books the pipeline capacity and subsequently engenders price relaxation or when Gazprom under-books the capacity and hence provokes a price hike.
The importance of the Yamal-Europe pipeline for Russian gas exports is evident as it allows the shipment of the largest gas volumes besides Ukraine and Nord Stream beneath the Baltic sea. It was actually built back in the 1990s, during an attempt of a political rapprochement between the former Russian President Boris Yeltsin and the former Polish leader Lech Walesa.
Back then, it was Russia’s first attempt to diversify gas transit from Ukraine, the biggest transit country of the former Soviet Union. It might be worth noting that since the 1960s the Soviet Union preferred to ship gas via Czechoslovakia as Poland was long considered to be a less trustworthy partner by Moscow. The relatively short period of political honeymoon driven by the Yeltsin-Walesa friendship ended with a deterioration of political relations between Poland and Russia. However, gas flows continued with maximum capacity of 33 bcm per year, which equates to 18-25% of Russian exports to Europe (depending on total export volumes, which yearly vary).
Prior to the EU liberalisation process, Russia’s approach to gas exports via either Ukraine or the Yamal-Europe pipeline had been based on the risk sharing mechanism of take-or-pay contracts. The idea is to exempt producers from demand fluctuations and reduce consumer’s risk of gas supply shortages. In other words, the consumer commits to pay for example 85% of supplies in order to have long-term supply regardless of short term fluctuations in demand. To export gas from Russia, Gazprom would then book 100% of the pipeline capacity on a long-term basis to ensure contractual commitments with European utilities. Transit routes such as the Yamal-Europe pipeline have thus been used for long-term deliveries to reach destination points located westwards.
Post-European market liberalisation
Since the early 2000s, the European market liberalisation challenged this system as the new EU legislation prioritises gas-to-gas competition over long-term commitments. The core liberalisation principle, the third party access, ensures that utilisation of pipeline capacity is de-linked from the ownership of the gas commodity. It also means that a supplier cannot book all the pipeline capacity to ensure implementation of the competition in the commodity market.
Furthermore, market mechanisms for accessing pipeline capacity introduced a possibility to trade the right to use the network by different gas suppliers. The core EU concern has been rather focused on situations where pipeline capacity cannot be made available for all competing suppliers, a situation called a contractual congestion.
Problems with pipeline capacity booking
To ensure that contractual congestion does not lead to an opaque capacity booking by a supplier, the EU developed a regulatory system of Network Codes, which include among others focused on various anti-hoarding mechanisms, that allow the freeing of gas transport capacity from contractors who do not supply gas via the network. Supposedly, the EU Network Codes have been mostly elaborated for systems where a number of suppliers compete for the pipeline network. For example, north-western European gas networks would have a number of suppliers, multiple entry and exit points and a competitive market structure. However, gas pipelines in the eastern part of Europe have been built with unidirectional flows from Russia to the west and with no competition for the available capacity because of Gazprom’s export monopoly. Yet, the EU liberalisation principle implies that the third party access is equally applied for transit pipelines dedicated for unidirectional flows from Russia to the west with only the one supplier available.
Different realities of gas flows through different networks across Europe has been repeatedly pointed out in expert literature. Although EU Network Codes and harmonised rules for market operations have been important steps towards the EU internal market, most of the dedicated transit pipelines in Central and Eastern Europe still have one major supplier, Gazprom. Before the implementation of the Network Codes, some representatives of Central and East European gas companies warned against a ‘one-fit-all’ approach as the set of rules for short-term capacity booking wouldn’t be appropriate for their systems. Companies feared that costs for capacity usage will increase without clear indications for increased competition between ‘physical’ molecules.
The emerging competitive system has also been criticised by Gazprom as well. Accordingly, existing transit pipelines would not need short-term capacity booking as they serve to ensure long-term supply commitments. The Russian supplier feared that long term supply obligations might conflict with the short term capacity reservations for transit pipelines, leading to a risk of a supply-capacity mismatch. However, the EU market regulation aimed at transforming the unidirectional transit pipelines into an integrated part of the European gas market model. Despite criticism from both sides of the EU border, a possibility to book parts of the capacity (called interruptible capacity) even for unidirectional transit pipelines has been introduced.
In light of these transformations, Poland and Russia have agreed on new rules allowing third party access and short-term capacity booking of interruptible capacity at the Yamal-Europe pipeline. As gas surplus on markets grew (partly thank to LNG inflows and diversification projects), Gazprom’s market power in Central and Eastern Europe was not really felt throughout the last decade. Amid the persistent gas glut, the Russian exporter felt a need to secure competitive spot markets in addition to the existing long-term commitments.
However, in the aftermath of the pandemic, the situation reversed and the EU gas markets entered into a deficit particularly because of the declining LNG supplies to Europe and insufficient gas volumes in Gazprom’s underground storages. In fact, in 2020, during the year of the biggest gas surplus, Gazprom reduced exports to Europe by some 30 bcm. During the first nine months of 2021, the volumes slightly increased compare to the 2020 level, yet being well below the previous level of 2019. Then, during the fourth Quarter, from October to December, Russian flows further declined by 19.7% compare to the last Quarter of 2020 (from 33.8 bcm to 27.3 bcm).
Amid the fears of a serious supply crunch in Europe, Russian President Vladimir Putin issued a statement made at the end of October promising to fill-in more gas to European underground storages. However, as the existing EU regulation permits Gazprom to book pipeline capacity on a short term basis, the Russian supplier maintained a possibility to change capacity booking levels at almost any time. Meanwhile, being the only supplier for unidirectional pipelines, Gazprom does not feel a need to compete for interruptible capacity whilst supplying the long-term contracts through non-interruptible (firm) capacity. In the situation where Gazprom can change the capacity booking, European traders and consumers may have felt insecure about the effective implementation of Russia’s promise to fill the storages for the winter.
As a result of the short-term booking system, traders and consumers have fixated on Gazprom’s moves aiming at either increasing or reducing short-term flows via the Yamal-Europe pipeline. However, up to mid-December 2021, gas supplies via the Yamal-Europe pipeline show that variations are rather marginal (see chart 1) within the usual Gazprom’s flow rates. Yet, the instability of pipeline capacity booking via Yamal-Europe has fueled a sense of market instability.
As a result, the fixation on Russian gas pipeline flows, particularly for gas transited via Yamal-Europe, has reached unprecedented levels. Information about Putin’s promise to fill the underground storage capacity overshadowed rising LNG imports observed in October 2021 (see chart 2). However, later – when gas inflows have remained insufficient – new worries of winter gas deficit have stimulated the price.
Towards the end of December, Gazprom’s officials warned that German utilities and industrial consumers did not request additional volumes and finally decided to reverse the Yama-Europe pipeline flows eastwards. Technically, if Russian flows decline but German consumers still need gas, then supplies from Norway can easily fill the gap. Instead, gas flows from Norway to Germany slightly declined in the meantime (see figure 3)
This observation leads to a conclusion: the European gas crisis is not only about the supply structure but also about demand response amid extremely high spot prices. Indeed, consumers preferred to wait until better times, and some smaller ones have even been unable to afford the record-high gas prices. Only the announcement of new LNG supplies to Europe in late December helped indeed to attenuate the price hikes.
Yet, the demand side of the equation – or inability of consumers to buy new volumes – remains unresolved. As a result, the new decline in Russian flows – this time through Ukraine – further leads to a new price hike. Adding to that, geopolitical tensions between Russia and Ukraine reinforce a sentiment of reliance on alternative routes such as Yamal-Europe pipeline and the very controversial Nord Stream.
In circumstances where consumers do not rush to find an alternative – i.e. another expensive – supplier, Gazprom would not be pressured by the competition. As a result, Russia has not necessarily been interested in helping the EU get out of its own regulatory trap. Paradoxically enough, the EU norms initially aimed at decreasing Gazprom’s monopoly, reinforced the latter’s capability to tighten the markets. The verdict seems to be quite clear: the one-size-fits-all approach applied to energy systems can always backfire.
Andrei Belyi is founder and CEO of energy consulting firm Balesene OU, Estonia, and Adjunct Professor of energy law and policy at the University of Eastern Finland