Russia tightens grip on Europe’s gas

Russia’s role as Europe’s dominant external gas supplier strengthened in the last 12 months as Russian gas giant Gazprom boosted its export routes to key central and western European gas markets. But tensions between Moscow and Brussels heightened as the European Commission challenged Gazprom’s operations in eastern Europe. Paul Whitehead reports*.

October 8 marked a new landmark in Russia’s gas exports as the second pipeline in the Nord Stream gas supply route began exporting gas to Germany. The twin pipelines, which run between Portovaya Bay near Vyborg on Russia’s Baltic coast, across the Baltic Sea to Lubmin in northern Germany, provide a direct route for Russia’s gas exports, which have been hampered in the past because of disputes with transit countries Ukraine and Belarus. “Nord Stream will meet Europe’s growing demand for energy resources. Gas will be supplied directly by the shortest route, linking the major Russian gas reserves to European markets without transit risks, steadily and smoothly. We can guarantee this,” Russian President Vladimir Putin said as the second pipeline was inaugurated at a ceremony in Portovaya Bay.

The second line came just 11 months after the first line was launched, and 30 months after construction began. Together they have enough capacity to ship 55 billion cubic metres of gas a year to Lubmin, where it is transported onwards to Belgium, Denmark, France, the Netherlands and other European markets, as well as Germany.

Gazprom has a 51 per cent controlling stake in the Nord Stream consortium with western partners German BASF/Wintershall and E.ON Ruhrgas owning 15.5 per cent each, while Dutch Gasunie and French GDF Suez each have 9 per cent stakes.

The partners now plan to sign a memorandum of understanding to build further lines along the route, Gazprom CEO Alexei Miller told the opening ceremony. Nord Stream feasibility studies concluded an extension of one or two lines would be technically and financially viable, with several routes being considered. And Miller said one of these could be a connection to the UK, western Europe’s biggest gas market, whose indigenous gas sources, whilst the biggest in the EU, are fast depleting.

Wherever the additional lines are built, they would take total Nord Stream capacity to 110 billion cubic metres/year. This would further tighten Russia’s grip on Europe’s gas supply at a time when political leaders in Brussels and EU capitals are grappling with concerns over security of supply as Europe’s existing gas reserves dwindle and other energy sources like coal and nuclear become less viable because of environmental legislation and safety concerns.

Pincer movement

And Nord Stream is just part of the picture in Gazprom’s quest to cut dependence on transit countries, which have caused it so

many headaches in the past. Before Nord Stream 80 per cent of Russian gas went through Ukraine and the other 20 per cent went through Belarus, both of which were involved in pricing disputes with Gazprom. A dispute with Ukraine in January 2009 resulted in a two-week suspension of supplies of Russian gas to Europe.

It is now seeking a direct route to southern Europe through the so-called South Stream pipeline, which will take Russian gas across the Black Sea to Bulgaria, from where the route will go to Serbia-HungarySlovenia and on to northern Italy. Gazprom project management chief Leonid Chugunov said on November 9 that work on the new line would start on December 7.

Like Nord Stream, it is being built by a consortium led by Gazprom (50 per cent) with other shareholders Italy’s Eni (20 per cent), France’s EDF (15 per cent) and Germany’s BASF/ Wintershall (15 per cent).

Once built it would bring up to 63 billion cubic metres/year, with four parallel lines and possible offshoots to Bosnia & Herzegovina, and Croatia. Gazprom expects the first line to open in 2015, the second and third by end 2016 and the last by end 2014.

The start of work on South Stream could spell the end of rival projects seeking to open up the so-called Southern Corridor. The EUsponsored Nabucco pipeline has already been drastically scaled back. The project, billed as an alternative to Russian supplies, aims to bring gas from the Caspian and Middle East into the heart of Europe – the Austrian hub at Baumgarten – and potentially on to Italy. But the eastern section has now been abandoned after the Azeris signed a deal with Turkey for their own TANAP pipeline to take gas from the huge Caspian Shah Deniz gas field through Turkey and on to Greece and Bulgaria.

And the Azeris have signed a similar deal to supply gas to Italy via the Trans Adriatic Pipeline proposed by Swiss utility Axpo, casting doubt on the remaining part of Nabucco, now dubbed Nabucco West. The rival Greek-Italian ITGI pipeline looks increasing unlikely without Azeri support. All of which means that Russia’s Gazprom will dominate at least two of the new supply routes to Europe, and Azerbaijan’s SOCAR the other.

Shale gas no saviour

None of this would matter if Europe were not becoming increasingly dependent on imported gas. But any hope that Europe could replicate the success of the US in developing unconventional shale gas resources is fading fast. The discovery and exploitation of shale gas resources in states like Texas and Pennsylvania has transformed the US energy economy – in just a few years turning it from a net importer to potentially a net exporter.

Europe has promising shale resources too, particularly in Poland, but also in other countries including Germany and the UK. However, several reports commissioned by the European Commission into the potential and risks of shale gas exploration in Europe concluded that shale gas would never be the ‘game changer’ it has been in the US.

Estimates of how much recoverable shale gas there is in Europe vary widely from 4 to 18 trillion cubic metres. But one of the reports commissioned by the EC found that, at best, indigenous shale gas would allow the EU to cap its imports at around 60 per cent of total gas use – with shale gas and dwindling conventional gas resources allowing Europe to meet just 40 per cent of its gas needs from indigenous sources.

The other two reports focused on the many obstacles that shale gas exploration faces in Europe. The EU would need to adapt its existing legislation to reflect the environmental impacts of hydraulic fracturing, or ‘fracking’ – the water-intensive process used to extract gas from shale formations. They also identified issues with regard to access to water and land – Europe does not have the vast open expanses found in the Texan desert – and other obstacles including public acceptance.

France has already ruled out shale gas exploration on its territory because of environmental concerns. Concerns about a potential link to seismic activity is driving public hostility in other countries – the link between fracking and earthquakes was confirmed when the UK concluded that two minor earthquakes near Blackpool in north-west England were caused by exploratory fracking by Cuadrilla Resources in the area.

In any case, there is a growing consensus that shale gas will not deliver energy independence for Europe.

EU and Gazprom in final showdown

Against this backdrop, the EU has launched a new assault on Gazprom’s supremacy, challenging the Russian utility’s existing position in central and eastern Europe.

In early September, the European Commission’s competition directorate launched competition proceedings against Gazprom on three suspected anti-competitive practices. The EC is concerned that Gazprom may have divided gas markets by hindering the free flow of gas across members of the 27-country bloc. Secondly, it believes that Gazprom may have prevented the diversification of gas supplies. And finally, the EC is investigating whether Gazprom’s practice of linking gas prices to oil prices had led to unfavourable prices for Gazprom’s European customers.

This last challenge could have the most wide-ranging impact since for decades Russian gas (and gas from other sources like Algeria) has been priced into Europe using a formula that links the price to the price of oil, usually with a six-month timelag.

Under EU competition rules, if found guilty, Gazprom could face fines of up to 10 per cent of its turnover in the EU, which given that Gazprom has European gas sales of around $60 billion a year, would amount to $6 billion.

But Russia has strongly denied the allegations and warned the EC that in taking on Gazprom, it is effectively taking on the Russian state. Just days after the EC launched the probe, President Putin signed a new decree “protecting Russian interests in Russian legal entities’ foreign economic activities,” stressing that the Russian state would protect the interests of strategic enterprises abroad, namely Gazprom.

Meanwhile Russia says that the EU is seeking to unfairly apply its own rules to gas transit projects like Nord Stream and South Stream. Speaking at the Gastech gas conference in London in October, Russia’s deputy energy minister, Pavel Fedorov, said EU insistence on third-party access to Nord Stream and South Stream – meaning Gazprom had to open up the pipelines to all comers – was wrong.

“Infrastructure investments were and are being made. You can’t come in with legislation that has retroactive impact and does not allow gas producers to make a return on investments,” he said, as the tug of war between the world’s biggest gas producer and its biggest customer reached a new intensity. n *Paul Whitehead is managing editor of European energy policy at energy news and pricing agency Platts.