A big gas war for Europe begins
The energy market in Europe is undergoing large scale changes. Taking a closer look at the gas sector, it becomes clear that a number of new factors will play a role in shaping its future.
On January 21st the 50th World Economic Forum in Davos took place. One of the highlights of which was the speech of US President Donald Trump. Amongst the speech’s many messages, the most significant were those related to energy: “We urge our friends in Europe to use America’s vast supply and achieve true energy security”. Trump also emphasized that the United States no longer has to buy energy from “hostile nations”, stating that “… with an abundance of American natural gas now available, our European allies no longer have to be vulnerable to unfriendly energy suppliers.” Trump’s optimism is supported by data from the US Department of Energy’s Energy Information Administration (EIA), which notes that in 2020 the country plans to increase its LNG export volume to 6.5 billion cubic feet per day (Bcf /d) and in 2021 up to 7.7 billion. This represents a 55 per cent rise in LNG deliveries compared to 2019.
Three weeks earlier, on the other side of the Atlantic, two other events of similar importance for the world energy industry took place with indirect US involvement. First, on December 21st the largest of the Leviathan gas fields, located on the shelf of the Mediterranean sea off the coast of Israel, was commissioned. Second, on January 2nd the Energy Ministers of Cyprus, Greece and Israel signed an agreement on the construction of the Eastern Mediterranean pipeline (EastMed). This will supply gas from the Mediterranean sea to Europe.
Both of these projects are being implemented with the active participation of the American energy company, Noble energy, Inc. The group has been engaged in gas exploration on the Israeli shelf since 1999. In cooperation with the Israeli companies Delek Group and Ratio it commissioned the Mari-B, Tamar and aforementioned Leviathan fields, to which the American side committed 3.6 billion US dollars. In early November 2019, Noble Energy, Inc. and its affiliates announced the acquisition of a 39 per cent stake in the Eastern Mediterranean Gas Company S.A.E. (EMG). This group owns the EMG Pipeline, a 90 kilometre gas pipeline linking Israeli fields to the Egyptian gas network. On January 15th the Israeli and Egyptian Ministries of Energy issued a rare joint statement announcing the start of Israeli gas deliveries of 85 billion cubic metres (3 Tcf) from this year. The declaration called this step “an important development that will serve the economic interests of both sides.” This cooperation will enable Israel to export some of its natural gas to the region via Egypt’s gas liquefaction plants, as well as promote Cairo’s status as a “regional gas hub”. Notably, the EMG gas line, which has not been used in recent years, was constructed in 2003 and was commissioned to supply gas from Egypt. Exports went to Jordan, Syria and Lebanon, as well as Israel as part of a separate branch. Despite this, regular terrorist attacks on Sinai pipeline infrastructure and later interruptions in Egypt’s gas supply itself forced a suspension of operations in the 2010s. At the same time, environmentalists have repeatedly protested the construction of gas infrastructure on the Israeli coast. Public protests ultimately resulted in the scrapping of plans for a terminal meant for the distribution of liquefied gas to Asia.
According to forecasts supplied by the Global Data analytical company, the commissioning of large gas fields on Israel’s Mediterranean shelf will likely turn the country into a major regional player in gas export by the mid-2020s. Current residual recoverable gas reserves in Israel are estimated at approximately 26.2 trillion cubic feet (Tcf). This is about 62 times more than the country’s expected gas consumption in 2019.
This situation raises concerns in Russia and Turkey. Experts estimate that, following its arrival in Europe, Eastern Mediterranean gas will be 20-30 per cent cheaper than that delivered from Russia via the Turk Stream pipeline. Five months before the Leviathan field was commissioned, Russian analyst Kamran Gasanov wrote an article under the provocative title “Israeli pipeline – the killer of Turk Stream”. In this he wrote that “… we must remember that the second thread of Turk Stream intended for Europe is nearing completion. Its capacity of 16 billion cubic metres is comparable with the volume of EastMed. The Americans understand that Angela Merkel will secure Nord Stream 2, but they can still stop the extension of Turk Stream in Europe. Erdogan will try to disrupt the EastMed project. Whether he succeeds or not, in this dispute Russia’s sympathies should lie with the Turkish side. EastMed is not a threat, but a challenger to the Russian Turk Stream. In the long run, Eastern Mediterranean reserves can fully compete with Russian gas in the Old World.”
The attitude towards the EastMed gas pipeline in Europe is rather ambiguous. For example, in November a researcher at the Berlin Science and Politics Foundation (SWP) Stefan Wolfrum criticised the project. Even though the author repeatedly claims that the article simply represents his personal opinions, it would be difficult to publish such an argument without his directorship’s permission. Wolfrum even presented a concrete plan of action designed to stop the EastMed pipeline’s construction. This amounted to attempts to ultimately include such matters within the agenda of the European Commission, which could exclude the gas pipeline from its projects of common interest. At the same time, he discussed the two so far underloaded gas liquefaction terminals in Egypt. In his opinion, Egypt and its gas industry, which is on the rise after development began on the massive offshore Zohr field, shows potential to become a regional hub. In order to achieve this the analyst believes that the country may “increase capacity of the existing gas pipelines between Israel and Egypt, as well as connect the Cypriot gas fields with Egyptian territory”.
A similar set of horror stories surrounding Mediterranean gas supplies to Europe, which also cited Wolfrum, were discussed by German newspaper Die Welt in January. The article was entitled “Europe’s troubled new pipeline could prove to be a monster”.
Germany’s final position on gas supplies to Europe became clear during a January 11th press conference following talks between Chancellor Angela Merkel and Russian President Vladimir Putin. The German leader called for the completion of the Nord Stream 2 gas pipeline and condemned American sanctions, which had forced project contractors to halt operations. Simultaneously, articles with alarming titles such as “Israel provokes Washington for another war” began to appear on the Russian internet. These articles helped to disseminate biased information regarding the prospects for gas production on the Mediterranean shelf and its supplies to continental Europe. One article states: “An understandable side effect is a closer attachment of Turkey to Russia in the gas issue, as the Turkish side has understandable geopolitical and geo-economic interests. It is also worth mentioning that at first glance, changes in the economy and geopolitics do not seem like a loss for Russia and her interests.”
But this story involves more serious factors. These are the geopolitical ambitions of Turkey, which is personified by its president Recep Erdogan, as well as the problem of delimiting marine water and shelf zones in the Eastern Mediterranean. Typically, these areas are assigned to states through negotiations and are demarcated from the coastline. It should be noted though that the shelf involved in the EastMed route is part of Cyprus’s exclusive economic zone and the Aphrodite gas field. This area was discovered in 2011 by Noble Energy and reserves are estimated at approximately 129 billion cubic metres. Some of this gas is also supposed to be delivered via EastMed pipes. However, the Cypriot zone “cuts” into the areas of neighbouring states. This territory falls in Lebanese and Syrian waters and is in the immediate vicinity of Israel’s zone to the south. The zones are located within the 200-mile economic zone and the Turkish coast is clearly located further than the others. At the same time, the Cypriot and Turkish shelf zones overlap each other. Consequently, in order to resolve disputes, agreements are needed regarding the delimitation of the shelf and the sea, as well as the location of operations in each of the zones. But this does not suit Erdogan, since in this case claims to a part of the shelf of the unrecognised Turkish Republic of Northern Cyprus, which comprises 38 per cent of the island, will not be taken into account. Nevertheless, Turkey turned to Israel in mid-December with a proposal to organise negotiations on the construction of a gas pipeline through which Israeli gas could be delivered to Europe. Moreover, in 2017 Turkey and Israel had already announced their intention to build such a gas pipeline to Europe. But as we have seen, this has not taken place.
The cherry on top was the US Congress’s adoption in December of a set of measures to counter Turkey, as well as the country’s hypothetical alliance with Russia in the Eastern Mediterranean. This took the form of the “Consolidated Appropriations Act 2020”, which amounts to 1.4 trillion US dollars. Republican co-author of the bill Marco Rubio stated that “By lifting the U.S. Arms Embargo on Cyprus and extending necessary Foreign Military Assistance to Greece, this legislation brings forth a comprehensive approach to the stability of key regional partners”. His Democrat counterpart Bob Menendez, a member of the Senate Committee of Foreign Relations, added that the law “marks the dawn of a new day for the United States’ engagement in the Eastern Mediterranean”.
No matter how much Russia has tried to include Turkey into its “gas orbit”, it has failed to do so and is unlikely to succeed in the future. Despite the fact that there are already two gas pipelines (Blue Stream and Turk Stream) transporting Russian gas through the Black sea to Turkey, the gas supply to the Turkish market is steadily declining. In 2017 it reached its peak (29.03 billion cubic metres), with Putin stating that in 2019 it amounted to only 24 billion. According to Vygon Consulting’s research director Maria Belova, the drop in demand for Russian gas in Turkey is the result of the economic slowdown and rising domestic gas prices. She estimates that in 2019 this led to a decrease in potential gas demand by 3.1 billion cubic metres. At the same time, Russia acts as a final supplier to the Turkish market, yielding only to its liquefied natural gas (LNG) and the Azerbaijani gas. Azerbaijani gas supplied via the Trans-Anatolian gas pipeline (TANAP) in some cases may be 23 per cent cheaper than Russian gas. In addition to supplies from Azerbaijan, an increase in the supply of liquefied gas to Turkey can play a significant role. The current load of the four available LNG receiving terminals in the country (with total capacity of 19.7 million tonnes) is at 42 per cent. According to Vygon Consulting, the import of LNG into the country in 2019 will grow by 1.7 million tonnes. This is primarily due to increased supplies from Algeria. Interestingly, the Russian analyst kept silent about the fact that according to Anadolu Agency, a Turkish news service, the share of LNG in Turkish gas imports for the first time exceeded 30 per cent. Turkish LNG imports from the US increased by 363 per cent in the first half of 2019. Gas pipeline imports from Azerbaijan increased by 38 per cent over the same period whilst those from Russia decreased by 36 per cent.
Serious damage to the budgets of Gazprom and the Russian state will be caused by the rejection of transit gas supplies through Ukraine to the south. Starting January 1st of this year, Gazprom launched Turk Stream and simultaneously cut off gas supplies via the Trans-Balkan pipeline through Ukraine to Bulgaria, Greece, North Macedonia and Turkey. This route currently supplies Romania with only small volumes. Nevertheless, the Russian holding company will still pay the Bulgarian and Romanian gas transmission systems in line with previous volumes of transit, as the company is contracted until 2030 and 2024. This was announced by the new operator of the gas transmission system of Ukraine and confirmed by the data of its colleagues in Bulgaria and Romania. The empty pipeline will cost Gazprom a total of 140 million US dollars annually, amounting to 1.2 billion until 2030. This will consequently affect the price of Russian gas for other buyers and lower its competitiveness. Bulgaria was the first to react to this situation and in late January Energy Minister Temenuzhka Petrakova announced Sofia’s intention to receive 50 per cent of its gas from new sources by the end of 2020. This is a drastic move considering Bulgaria currently receives almost all of its gas from Russia, amounting to 3 billion cubic metres. Ultimately, Russia’s Black Sea pipelines face the real threat of becoming unprofitable.
On the northern flank
While in the south of Europe Russia suffers one defeat after another, Gazprom does not lose hope of exporting Russian pipeline gas to the countries of north-western Europe, by trying to use Germany, the largest European consumer, as a Trojan horse. Is it possible? Probably not. According to forecasts of the International Energy Agency, the next decade may see Gazprom lose more than a third of its pipeline export volume to European countries. At the same time, the Russian company’s share in the European gas market may be reduced by almost a half. The demand for gas in the European Union (EU) will decrease by almost 10 per cent to 442 billion cubic metres. Taking into account non-EU countries demand will fall further by up to 607 billion cubic metres. The EU’s demand for imports at that time will increase to 400 billion cubic metres, primarily due to a fall in its own European production. Assuming that the export of Russian gas to the countries of the former USSR and the rest of Europe will decrease proportionally, Gazprom’s pipeline deliveries to Europe will amount to 110-123 billion cubic metres per year. Based on the IEA forecast, these values correspond to 18.6–20.8 per cent of the European gas market share by 2030. For comparison, Gazprom reported in 2018 that it exported 201.8 billion cubic metres of gas to Europe. The company at this time accounted for 36.7 per cent of the total market. According to the IEA, the main reason for the decline in pipeline gas imports in Europe will be an increase in LNG supplies. LNG will account for more than 53 per cent of the global market by 2030 (44.6 per cent in 2018).
The results of Russian gas deliveries to Europe in the first month of 2020 are indicative of these trends. Gazprom’s natural gas production fell by 6 per cent in January to 44.3 billion cubic metres (a fall from 47.32 billion in January 2019). But what is even more striking is the pace of export decline, which has reduced to 13.3 billion cubic metres (from 17.55 billion in January 2019). Of course, excuses involving the warm winter and excess gas reserves in underground storage facilities can be made to explain this. Though LNG deliveries from third suppliers to Europe in January increased by about one third compared to last year. The increase in January deliveries compared to last year amounted to approximately 3 billion cubic metres. Furthermore, it is not only Gazprom that has problems, but all gas suppliers and in particular Algeria, which is the second worst performer after the Russian company. Apparently, supply structure continues to favour a long-term change towards liquefied gas. This is also recognized by the Russians. As an article in Kommersant states: “…in the coming years the EU is going to almost double the number of large-capacity regasification terminals. If by September 2019 there were 28 terminals with a capacity of 227 billion cubic metres of gas per year, in the coming years there are plans to build another 22 points for receiving liquefied gas, including in Albania and Ukraine (Odessa FSRU LNG)”. In addition, the segment of spot deliveries is growing at a significant pace with respect to long-term contracts. It is the spot deliveries that create market conditions for the entire gas market. In spite of the obvious problems of this type of trade (first of all, gas exchange trading fails during periods of peak consumption), it allows consumers to dictate terms to the sellers and for traditional pipe deliveries.
If the downward trend in the share of pipeline deliveries continues then only in 2020 can we expect a decrease in export volumes through gas pipelines by at least 10-15 per cent. Moreover, larger suppliers will face greater falls than most. Gazprom may well lose up to 20 per cent of the last year’s exports and possibly even more.
Russia’s desire to punish Ukraine by using other routes for gas transit ultimately resembles a cruel joke made at Gazprom’s expense. In January Gazprom gas deliveries to Europe through Ukraine (amounting to 2.55 billion cubic metres) fell by two thirds compared to January last year, while transit service fees were paid at the rate of 5.52 billion cubic metres. This was announced on February 3rd by the head of the Gas Transportation System Operator of Ukraine Serhiy Makogon, who stated that “46 per cent of paid capacities are being used”.
It is assumed that Poland may deliver another blow to Gazprom. On May 18th this year, the contract for transit through Poland by means of the Yamal-Europe pipeline will end. But Gazprom has still not expressed any desire to discuss a new agreement with the Polish side. This means that 32-33 billion cubic metresof gas will have to be delivered through another route. Nord Stream Two’s capacity will not be enough to ensure export deliveries to Western Europe and since only Ukraine and Turkey will remain the main transit countries, it will be important for Poland to coordinate its actions with Kyiv. This will allow the country to pre-empt any Russian attempts to encourage the Ukrainians to allow their gas to travel at an increased rate.
Bulgaria, Poland, Turkey and Ukraine are all reducing the import of Russian gas. No matter how much Gazprom’s spokesmen talk about its benefits and low costs, this decision is political. These countries view the risks of relations with Russia to be significantly higher than the economic benefits. The Kremlin, using hydrocarbons as an instrument of terror and blackmail, has inevitably received a strong rebuff from those whom it attempts to manipulate. Already there are insider estimates, according to which in 2020 Gazprom may reduce its exports by one third – from 200 billion cubic metres last year to 130-140 billion.
The gas war for Europe has just begun. But the Europeans, despite the lack of a coordinated pan-European gas policy, have managed to achieve their main objective. They have maintained all existing gas supply routes, including transit through Ukraine and are likely to receive new ones. Capacity reserves allow the EU countries to saturate their market with gas while also gradually lowering prices. It seems now that the Europeans will solve the last problem of pricing. It is expected that the diversification of Europe’s gas supplies will lead to an understanding that gas prices will be formed on the basis of solely economic factors. This will deprive Russia of the opportunity to use gas prices as a pressure tool on the intractable entities of international politics. I have no doubt that Gazprom (or indeed the Kremlin) will no longer be able to maintain its primacy in the European gas market. Although, it is too early to talk about bankruptcy.
Translated by Margarita Novikova
Aleksander Kowalewski is an expert on trade between Poland and Ukraine. He previously served as a former specialist with the Commercial Advisory Office as well as an expert of economics at the Republic of Poland in Kyiv. He is currently a consultant with the Chamber of Commerce of Ukraine.