Luca Franza Koninklijk Instituut van Ingenierus, Den Haag 1 March 2016

1

Russian Gas Exports to Europe

A Discussion on Commercial and Geopolitical Drivers

Russian Gas Exports to Europe

A Discussion of Commercial and Geopolitical Drivers

PART ONE: THE ‘RUSSIAN STREAMS’

01.12.2014: Putin announces South Stream’s cancellation

From South Stream to Turk Stream: why?

• Main triggers: – Regulatory issues (compliance with Third Energy Package provisions)

– Geopolitical issues (stagnating EU-Russia dialogue due to Ukraine crisis)

• Additional reasons: – Financing increasingly difficult

– Changed outlook for European gas demand

– Russia’s willingness to safeguard position in Turkish market

What is the current status of Turk Stream?

Frozen, not cancelled, since jet downing incident IGA repeatedly delayed Only a non-binding MoU 100% Gazprom ownership of offshore section

Route is agreed see map

$9 billion in sunk costs from SS

Pipes purchased for two lines, maritime survey only needed on final leg Saipem contract (offshore work) cancelled – causing delays Original plan: 15 Bcm to be delivered to buyers in Turkey, 47 Bcm at a new “hub” located on the Turkish-Greek border. Summer 2015: decision to build only 2 lines (31 Bcm).

Source: Gazprom

What countries still depend on Ukraine transit?

Source: IEA. Note: Slight recovery in UKR transit in 2015

ITA: biggest offtaker at Baumgarten

SEE: small volumes but no alternatives

2019: Expiry of Naftogaz-Gazprom transport contract

In 2019, at least 118 Bcm of Russian gas will be sold to Europe under LTCs, which state specific points of delivery

(Russian LTCs)

LIBYA

1.8 3.1

5.5

3.2 N/A

2.4 76.4

66.7 92.1

Cross-border capacity of gas pipelines as of Oct.2015

Clingendael International Energy Programme © Unit: Bcm/y. Data: IEA GTF database (except figures in yellow from ENTSOG or company websites)

40.1

19.2 14.8

1.7

14

19.6

14.1 10.7

32.5 4.3

58.5

N/A N/A ↓

N/A 54.6 ↙

19.5 4.8

19.6

13.4 21.2 ↙

24

N/A 37.4

26.9 20.2

2.2

10.9

8.3 7.8

0.3 2.9 ↙

3.2

3.3 43.7

0.4 21

1.8

2.5

1.6 1.8 ↙

12.8

5.9

2.9 5.3

8.2 13.8

38.6

55 N/A

57 25.4

↙ 79 9.7

4.2

↙ 20.6 6.1

1.8 1.8

4.8

2.6

1

41.6

4.6 1.5

4.4

28.6

38.4

0.9

3.7

16.2

1.7

0.8

7

2.6

16

11.4

2.4 2.3 ↓

2.5

CIEP ©

6.9 6.9

3.9

C A P A C I T Y

LIBYA

0 1

0.4

0.8 0.6

14.2 29.4

16.8 37.5

Cross-border physical flows of pipeline gas (2015 est.)

Clingendael International Energy Programme © Unit: Bcm/y. Data: IEA GTF database

30.3

1.5 3.6

0.4

5.9

10

1.4 6.2

28.7 0.8

38.3

4.1 23.2 ↓

0 28.2 ↙

3.6 1.7

17.1

4.7 20.0 ↙

13.9

0 18

0.2 6.6

0.6

4.3

0.5 2.5

0 2.5 ↙

0.1

0.1 30.3

0.1 9.3

0.9

1.8

0 0 ↙

7.5

0.2

0 3.2

6.7 8.8

7.4

35.4 0

0 13.6

↙ 36.6 9.7

2.7

↙ 5.6 0.5

0 0

1.8

0

0

36.7

3.8 0.1

0

15.4

15.5

0.1

1.7

10.6

0.6

N/A

2.8

0.1

15.7

4.1

0.1 0.0 ↓

0.4

CIEP ©

2 0.5

2

F L O W S

LIBYA

1.8 3.1

5.5

3.2 N/A

2.4 76.4

66.7 92.1

Cross-border capacity of gas pipelines as of Oct.2015

Clingendael International Energy Programme © Unit: Bcm/y. Data: IEA GTF database (except figures in yellow from ENTSOG or company websites)

40.1

19.2 14.8

1.7

14

19.6

14.1 10.7

32.5 4.3

58.5

N/A N/A ↓

N/A 54.6 ↙

19.5 4.8

19.6

13.4 21.2 ↙

24

N/A 37.4

26.9 20.2

2.2

10.9

8.3 7.8

0.3 2.9 ↙

3.2

3.3 43.7

0.4 21

1.8

2.5

1.6 1.8 ↙

12.8

5.9

2.9 5.3

8.2 13.8

38.6

55 N/A

57 25.4

↙ 79 9.7

4.2

↙ 20.6 6.1

1.8 1.8

4.8

2.6

1

41.6

4.6 1.5

4.4

28.6

38.4

0.9

3.7

16.2

1.7

0.8

7

2.6

16

11.4

2.4 2.3 ↓

2.5

CIEP ©

6.9 6.9

3.9

C A P A C I T Y

Limited cross-border capacity in Southeastern Europe make it difficult to eliminate Ukraine transit risk

C A P A C I T Y

Option A

Construction of one line of Turk Stream

2017+

12

(Assuming Russia-Turkey talks resume)

• Mostly a rerouting of volumes from Western Line (12-13 Bcm)

• Takes into account small incremental demand around Istanbul (2-3 Bcm)

• Together with higher Blue Stream offtake, averts gas shortage in Turkey in 2016

• Price discounts to Turkey

• Target date of December 2016 will be missed (Saipem contract cancelled)

• No big financing headaches (sunk costs), no regulatory complications

• No impact on other flows

Option A – impact on rerouting options

Map: CIEP Data: GTF (IEA)

Option B

Construction of two lines of Turk Stream

Direction of Western Line reversed

2017+

14

(Assuming Russia-Turkey talks resume)

Option B – impact on rerouting options

• Romania, Bulgaria, FYROM and Greece freed form Ukraine transit

• Turk Stream 2nd Line underutilized in our static scenario

Map: CIEP Data: GTF (IEA)

Option C

Construction of two lines of Turk Stream

Direction of Western Line reversed

Construction of minor infrastructure in SEE: • Interconnector Bulgaria-Serbia (Kalotina-Dimitrovgrad)

• Reverse flow Romania-Hungary (Csanadpalota)

• Connection of hub on Turkish/Greek border with Greek network

2018-2019+

(Assuming Russia-Turkey talks resume)

Option C – impact on rerouting options

• This scenarios includes small interventions, all included in list of PCIs

• Romania, Bulgaria, FYROM, Greece, Serbia and Bosnia H. freed form Ukraine transit

• Hungary can reduce exposure to Ukraine transit by 30%

• 50% utlization of Turk Stream 2nd Line in our static scenario

Map: CIEP Data: GTF (IEA)

Option D

Construction of two lines of Turk Stream

Expansion of TAP to 20 Bcm • And construction of ancillary infrastructure IGB (Interconnector

Greece-Bulgaria) to allow contracted Azeri deliveries to Bulgaria

2020+

18

(Assuming Russia-Turkey talks resume)

Option D – impact on rerouting options

• Russia could use TAP+ to supply Greece and reroute 8 Bcm of shipments to Italy, reducing Italy’s exposure to Ukraine by 40%

• Alternative rerouting: 3 Bcm to Bulgaria and FYROM through IGB and 5 Bcm to Italy

• 2/3 of Turk Stream 2nd Line utilized in our static scenario

Map: CIEP Data: GTF (IEA)

Numbers in yellow: capacity reserved to Azerbaijan on the basis of the TPA rule exemption

Source: OSW

Option E

Full-fledged Turk Stream

Construction of new pipelines inside the EU

(Assuming Russia-Turkey talks resume)

Regulatory issues include:

1) Can Russia unilaterally change delivery points stated in LTCs?

2) Is the Western Line’s reversal compatible with the Third Energy Package?

3) Can Russian gas be transported through TAP?

4) Will the EC grant TPA to the proposed long-haul pipelines that will carry RU gas?

5) Can the current antitrust probe have an impact on Russian plans?

Financing issues include:

1) Can Gazprom afford to build all the lines of Turk Stream?

2) Who can fund all the proposed pipelines within EU?

• TSOs invest using public money – exempted from TPA, but can they afford?

• Private investment (merchant model) – not automatically exempted from TPA

3) Would cooperation among regional TSOs help?

4) EC unlikely to grant funding, given political support to Ukraine transit upgrade

Even if talks between Russia and Turkey resume, there are regulatory and financial obstacles

22

Recent evolutions to take into account

• Nord Stream expansion (Nord Stream-2)

• Softening of Russia’s stance on Ukraine transit post 2019

PART TWO: THE BIGGER PICTURE

Three decisive trends affect Russia’s commercial position in Europe:

• Recent decline in EU gas demand and uncertainty on future demand

• Profound changes to EU gas market and way in which gas is traded

• Renewed geopolitical tensions

Clear downward trend in Russian gas exports to the EU…

Compensated (and often hidden) by higher exports to Turkey

134 131,9 134,2 142 145,3

161,7 161,8 154,4

158,4

120,5

107,4

117,2 112,7

138

124

135,8

0

20

40

60

80

100

120

140

160

180

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Russian gas to EU

Source: CIEP Graph on Russian Central Bank and Gazprom data

…but, overall, Russia maintained its market share…

Stable around 30% of EU gas consumption and 40% of imports

0

100

200

300

400

500

600

2009 2010 2011 2012 2013 2014

Bcm

/a

Other

Nigeria

Algeria

Qatar

Libya

Algeria

Russia

Norway

Other

Italy

Germany

Romania

UK

Netherlands

Pip

elin

e im

po

rts

Do

me

stic

LN

G

Source: CIEP Graph on BP data

R U S S I A

…as European1 gas demand also fell

-120 Bcm since economic and financial crisis

1 = here including Turkey and EFTA

2009-2012: Russian gas under LTCs not competitive

Midstreamers launching renegotiations and arbitrations

Reconvergence

Long-term gas contract renegotiations (since 2010)

Facing the threat of arbitration, European gas suppliers:

1. Fiddled with traditional formulae without changing them structurally

– One-off price discounts

– Frequent adjustments to P0, α, b1 , b2

2. Accepted lower off-take from customers

– One-off derogations to meeting ToP requirements

– Structural reduction of MCQ (lower ToP requirements)

– Structural reduction of ACQ (rare)

3. Offered more opportunities for renegotiations (‘joker’ clauses)

4. Shortened the backward indexation time lapse (‘12.0.6’ ‘3.0.3’)

5. Introduction of hub indexation J F M A M J

AVERAGE

APPLICATION

-15%

+15%

MCQ (take-or-pay)

ACQ (100%)

Cmax

Pt = Po + x a1 x b1 (Got – Goo) + (1-) x a2 x b2 (HFOt – HFOo)

Recent evolution in European gas prices (notably Russian contract prices vs spot)

$/M

MB

tu

Source: EEGAS (graphically adapted)

0,2

0,5

0,5

0,7

2,0

2,0

2,4

2,8

3,1

3,8

4,0

4,2

4,4

5,9

8,9

9,7

11,1

24,4

45,3

0,0 10,0 20,0 30,0 40,0 50,0

Romania

Slovenia

Estonia

Denmark

Greece

Latvia

Netherlands

Finland

Bulgaria

Slovakia

Lithuania

Czech Republic

Austria

Hungary

Poland

France

United Kingdom

Italy

Germany

2015 was a relatively good year for Gazprom in the EU

Record sales to Germany, Italy. Increased activity on NBP in the UK.

Source: CIEP Graph on Gazprom data (2016)

Total: 135,8 Bcm

Bcm

LNG vs Russian gas competition dynamics at play in 2015

Deliberate Russian gas purchase minimization in Q1

600

500

400

300

200

100

0

EU

Demand

Domestic

Production

Non-RUS

Russia

T-o-P

Russia

Flex

LNG to be absorbed

by EU

LNG

Surplus

Europe as market of last resort. Its capacity to absorb LNG

(determined also by Russia flex) provides support to world gas prices

Here balanced market: there is margin. But what if Russia flex is exhausted?

EU demand

Pipeline supplies

Inflexible

LNG

Flexible

LNG

‘Niche’ markets

Japan

Korea

Taiwan

India

China

Non-EU LNG

demand

Global LNG

supplies

Bcm

/y

Global market balance hinging on Russia-LNG dynamics

Source: Timera Energy (graphically adapted)

600

500

400

300

200

100

0

EU

Demand

Domestic

Production

Non-RUS

Russia

T-o-P

Russia

Flex LNG to be absorbed

by EU

LNG

Surplus

Europe as market of last resort. Its capacity to absorb LNG

(determined also by Russia flex) provides support to world gas prices

T-o-P volumes must be taken This bit cannot be absorbed by Europe! Possible downward price spiral

EU demand

Pipeline supplies

Inflexible

LNG

Flexible

LNG

‘Niche’ markets

Japan

Korea

Taiwan

India

China

Non-EU LNG

demand

Global LNG

supplies

Bcm

/y

Increase in flex LNG

Global market balance hinging on Russia-LNG dynamics

Clearly, an increase in European, Chinese or Indian demand would push away the tipping point

Source: Timera Energy (graphically adapted)

• Russian contracts support EU hub prices (see CIEP December 2014 study)

• EU hub prices support Asian prices

• So Russian contracts provide support to global gas prices

• Russia is thought to have >100 Bcm of spare capacity ready to land in Europe for ~3$/Mmbtu, LNG can also come in cheaply (~4$/Mmbtu)

• Unable to protect value in last years, Russia may go for volume to deter further FIDs – particularly on LNG projects

• Europe trying to complete internal market, diversify away from Russia and maintain Ukraine route

• Russia considering new ways of doing business (e.g. hub deliveries), trying to diversify away from Europe and get rid of Ukraine route

Russia’s positioning in European and global gas markets

Russian gas appears competitive with US LNG

Source: Howard Rogers (Oxford Institute for Energy Studies)

(delivery to Europe)

Even in low gas demand growth scenarios, Europe’s gas import needs are expected to increase

0

100

200

300

400

500

600

700

2015 2020 2025 2030

Demand (NPS)

EU + Norway production

Demand (CPS)

Demand (450)

Demand (Statoil)

Demand (Exxon)

Demand (Cedigaz)

Import 2015: 236 Bcm

Import 2030 (e): ~260-390 Bcm

Graph by CIEP. Sources: WEO 2015 (IEA), Statoil, ExxonMobil, Cedigaz

• Not EU producers, Norway and Algeria because declining or flat.

• Azerbaijan, but limited volumes

• Turkmenistan, but obstacles to TCP and commercial misalignments

• East Mediterranean, but high local demand and geopolitical risk

• Iraqi Kurdistan, but high perceived regulatory and geopolitical risk

• Iran, but very high local demand and LNG more likely

• Flexible LNG, notably from US and Qatar, but not a guaranteed flow

• Russia, but against goal of diversification

So who could fill the gap?

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