RUSSIA-MOSCOW – The gas market of the European Union that remains the main destination for Gazprom gas exports has been growing for the second year in a row. Despite continuing decline in domestic production in the EU-28, a 4% rise in the demand for natural gas in 2015 had been the first after a four-year depression. In 2016 gas consumption is expected to add some 4% to 6% and reach approximately 445 bcm to 450 bcm. There is a number of factors that contribute to restoration of the gas demand, including significant decline in wholesale gas prices following reduction in oil prices, colder weather and measures limiting the use of coal in electrical energy production in some EU member-states.
Nevertheless, the gas market has not restored its previous size; it is smaller than it was in 2013, let alone the peak level in 2010 when the EU used 20% more gas than the expected 2016 result.
Growth in the demand was accompanied by stronger decline in domestic gas output in the EU that fell by 30 bcm from 2013 to 2015. The main reason was the plummeting output in the Netherland at small deposits, as well as at Groningen that is the only giant field in continental Europe.
The tendency continued in 2016. The EU natural gas output eased back 5% (3.5 bcm) in January to June. Gas production in the Netherlands dropped by approximately 2.5 bcm; Germany, France and Romania lost some 600 to 800 mcm. However, it was partially compensated by the launch of a new offshore block in Ireland that added 1.1 bcm to the output in this country in the first six months of 2016. However, the Irish effect is not significant and long-term on the EU scale; the launched deposit has already reached its maximal level of 2 bcm per year, and it will enter the declining production stage in 2018.
In 2016 the demand for gas imports in the EU continued. In the first 11 months of this year EU member states imported over 321 bcm, which exceeds the result of 12 months in 2015. Compared to the same period in 2015, the increase was 32 bcm, including 19 bcm contributed by Russia (the increase in net imports of Russian gas was higher, because reverse supplies to Ukraine somewhat retreated year-on-year) and 10 bcm by Algeria. LNG imports went up by only 3.5 bcm, despite increase in production at Australian LNG plants and the beginning of LNG exports by the USA (the first project in the Gulf of Mexico). Lower prices of liquefied natural gas in Europe did not attract LNG suppliers that preferred shipping their produce to South America, the Middle East and Asia. Norway expanded gas exports to the EU just by 1 bcm.
In 2016 Gazprom is expected to have record high exports to the EU – more than 150 bcm, which corresponds to its maximal contractual obligations on annual supplies to European markets.
But there is still one very important issue – future transport routes. Ukraine is still a problem. There is a conjuncture risk posed for Russian gas transit via Ukraine in addition to small reserves in UGS, the refusal to buy gas from Gazprom, numerous legal restrictions like introduction of sanctions, illegal decisions of antimonopoly authorities on penalizing the Russian concern by $3.4bn for abusing its monopolistic position in the sphere of gas transit via Ukraine that Ukrainian courts increased to $6.6bn, as well as restructuring of Naftogaz of Ukraine that is responsible for implementing the current transit contract, to meet the EU requirements on separation of spheres of business. The growing demand for Russian gas in Europe significantly increased physical quantities of transit via Ukraine to Europe and Turkey in 2016. In the first 11 months the advance was 13.6 bcm, which generated about $400m in additional transit revenues to Naftogaz and strengthened Europe’s dependence on Ukrainian transit from 40% in 2015 to 43% in 2016, according to our preliminary estimations.
Meanwhile, other routes of gas supplies to the European market operate at their maximal technical (Yamal-Europe) and regulatory (Nord Stream) capacity. Moreover, before this heating season the European Commission approved an agreement suggested by the German gas network regulator Bundesnetz on settling the problem of Gazprom’s restricted access to OPAL. In the previous five years Gazprom had been permitted to utilize only 50% of OPAL capacity, although there is no other supplier, except Gazprom, that wants to use this branch pipeline.
According to agreements, 50% of the transit capacity is reserved exclusively for Gazprom within the exception from the Third Energy Package (TEP) rules; the other 50% is to be distributed at auctions. However, now Gazprom has the right to take part in such auctions and book up to 40% of the capacity. The remaining 10% is left for some hypothetical third entities. It will enable Gazprom to increase gas transmission through the Nord Stream and OPAL by 10 to 12 bcm next year. Ukraine’s gas transmission system, built largely in the Soviet time, is operating close to its maximal technical capacity. Transit routes of the central corridor lead to Slovakia, Hungary and Poland. In October to November 2016 some 6 bcm per month was transported in this direction. In reality it was 4.5 bcm, because 1.5 bcm per month was supplied in the reverse mode from Slovakia, Hungary and Poland reducing the real transit load on the system, because part of transit gas is consumed in the country, and the amount taken is offset on the border by reverse supplies. It means there is almost no capacity left either to increase Russian gas supplies to Europe, excluding the Trans-Balkan route that will be described later, or to act as some backup in case of technical problems at one of the routes. About 10 bcm to 12 bcm of Nord Stream capacity that will be used next year account for just 8% of the whole transmission flow to the EU. Besides, the current transit contract with Ukraine expires in 2020; its prolongation is hardly possible on acceptable conditions, and, secondly, the Ukrainian GTS, considering its age, requires substantial investments in its modernization and renovation to ensure its reliability in the long-term. Given that the transit flow to Central Europe remains at 60 bcm per year, we estimate such investments at $10bn to $12bn, which is comparable to the costs of laying the Nord Stream-2.
The number of active opponents of the project has significantly reduced lately. The campaign staged by representatives of the US administration has weakened due to the presidential elections in the USA. Besides, Gazprom managed to agree with Slovakia that can suffer more than any other country from suspension or reduction in gas transit through Ukraine. Slovakia’s GTS will be used (fully or partially in the reverse mode) to pump gas from Nord Stream-2 to Baumgarten in Austria, as well as to Hungary and Serbia. Opponents in the European Commission, including Vice-President for the Energy Union Maros Sefcovic, have admitted that Nord Stream-2 is a commercial project that can be implemented in compliance with the European law. It is Poland and Ukraine that currently oppose this project rigidly; they agreed to jointly resist plans of laying two new lines in the Baltic Sea. However, problems with domestic gas output in Europe, the growing demand for gas imports, obvious competitiveness of Russian gas and constant instability around supplies through Ukraine strengthen positions of those promoting the project.
Another project aimed at minimization of Ukrainian transit risks for Russia is the Turkish Stream. Over the past year it has gone through radial changes from indefinite suspension caused by the downing of a Russian bomber by Turkey to the singing and ratification of an intergovernmental agreement on its construction and obtaining all the permits from Ankara within several months after normalization of Russia-Turkey interaction. Moreover, Gazprom’s subsidiary South Stream BV signed a contract with Allseas on laying the first line of the gas pipeline from Russia to Turkey through the Black Sea in H1 2017 and an option to build the second line. South Stream was originally established to build the sea section of the South Stream; in the past it bought pipes for the sea section and sealed a contract on laying them with Italy’s Saipem.