If earlier Moscow and Brussels built their gas business on the model of “interpenetration and interdependence”, now they are moving to a model of “pure diversification”

In April 2015, at the conference “Europe and Eurasia: Towards a New Model of Energy Security”, organized by the Valdai Discussion Club, Energy Minister Alexander Novak and the head of Gazprom Alexey Miller presented a new concept of cooperation in the gas sector between Russia and European countries .

Among the main changes in the relationship is the need to take into account the Asian factor, which will increasingly influence pricing for European consumers, as well as the abandonment of the policy of mutual entry into assets between Russia and Europe.

We agree to play by European rules, but it is unknown whether this will be beneficial to the Europeans.

Turkish twist

The irreconcilable position of the European Commission on the construction of South Stream could cost the economies of EU countries dearly. The emergence of the Turkish Stream project puts them in front of the need to invest in a new infrastructure for importing Russian gas, an alternative to the Ukrainian transit corridor.

The decision on Turkish Stream and the termination of the transit gas agreement with Ukraine from 2020 was announced by Russia without prior consultation with the European Commission and, obviously, took European officials by surprise. The organization is accustomed to establishing new rules of the game that create barriers for Russian gas in Europe: the 3rd Energy Package , the target market model, and finally, the concept of the European Energy Union with the desire to intervene in commercial gas contracts.

The presence of South Stream, in which significant funds had already been invested, allowed the EU to keep Russia in limbo.

Our country had to constantly make concessions to numerous countries through whose territory the South Stream route ran; uncertainty remained regarding the possibility of the project receiving a special status, exempt from the rules of the 3rd Energy Package regarding the reservation of capacity for third parties. Now, instead of Russian investments in the construction of South Stream on the territory of EU member states, the European bureaucrats received in Turkey another transit country that is not part of the European Union, and the problem of building and expanding internal infrastructure to supply gas to the countries of Southern and South-Eastern Europe after 2019 of the year.

We can say that by announcing the end of gas transit through Ukraine, Russia launched an “early warning mechanism.”

A memorandum on an early warning mechanism in the energy sector was signed by Russia and the EU after the 2009 gas crisis to overcome energy emergencies, including transit risks, with minimal negative consequences. It is possible that Gazprom, appealing to the early warning mechanism, will declare force majeure on supplies in the Ukrainian direction upon expiration of the transit contract.

“Turkish Stream” was the result of a fundamental change in relations between Russia and Europe in the gas business. If earlier these relations developed within the framework of the model of “interpenetration and interdependence with elements of diversification,” today they will develop according to the model of “pure diversification.” While the European Union seeks to reduce dependence on Russian gas, Russia is trying to implement a full-scale pivot to the east and diversify its markets. With the implementation of the Power of Siberia project, Europe ceases to be the only market for Russian network gas, and in the case of the implementation of the Altai project, it will become a priority market.

We play according to European rules and win

Having announced the Turkish Stream gas pipeline project in December 2014, Gazprom announced that it would sell gas on a trading platform on the Turkey-EU border, and the task of the Europeans was to create the necessary transport infrastructure within the European Union to receive these volumes. The purchase of Russian gas at the hub instead of the delivery point fixed in the previous contract, the reversal of existing gas pipelines, the investments of the European system operator in the construction of new gas pipelines in the presence of supply contracts - all these principles correspond to the ideology and rules of the 3rd Energy Package.

Russia seems to be saying to its European partners: we sell gas to Turkey, then do what you want with it.

Gazprom’s demonstrative adherence to the letter of the 3rd Energy Package in the case of the Turkish Stream can be considered as a reductio ad absurdum, proof of the failure of the European regulatory system through the demonstration of absurd contradictions arising from their application.

Paradoxically, the rules of the 3rd Energy Package were never fully applied when building new gas infrastructure in the European Union. In order to interest investors, the European Commission was forced to provide exceptions to the rules regarding the reservation of 50% of gas pipeline capacity for third parties. A good example here is the Trans Adriatic Pipeline (TAP) project with a capacity of 10 billion cubic meters. m per year for the supply of Azerbaijani gas to Europe. The creation of an interface to connect the Turkish Stream with the European gas infrastructure will, in fact, become an experiment to test the new rules of the game in the European gas market for adequacy and strength.

What does Russia gain from the implementation of the Turkish Stream? Firstly, reducing transit and commercial risks compared to transit through Ukraine, the situation with gas supplies through which has become completely unacceptable and requires constant negotiations with the involvement of the European Commission as a guarantor of the Ukrainian side’s ability to negotiate.

Secondly, Turkish Stream is proactive and creates competition for gas supplies to Europe within the Southern Corridor with transit through Turkey (for example, the Trans-Caspian Pipeline), taking away potential demand from competitors.

Finally, having reached an agreement with Turkey, which is not a member of the European Union, Russia is freed from the need to coordinate the construction of a gas pipeline with the European Commission, as was the case with Bulgaria within the framework of South Stream.

In order for many European consumers to be able to receive Russian gas in 2020 through Turkey, it is necessary to create a transport infrastructure within the European Union. The 3rd Energy Package deprives Russia of incentives to build gas infrastructure within the EU, but there remains the possibility of Gazprom's minority participation in gas transportation consortiums in conjunction with European companies. Moreover, Russia could benefit from European rules on 50% access to transport capacity for third parties by demanding access to European gas infrastructure, such as the planned second TAP line.

The problem with the requirement of mandatory reservation of 50% of capacity in new infrastructure in the EU can be solved by agreeing with European companies to move the gas delivery point from Baumgarten to the Turkish-Greek border. True, most likely, on the terms of providing a discount to the price of gas in Baumgarten, comparable to the cost of transportation from the Greek border.

Motivation and risks of the European Union countries

Many countries in Southern and South-Eastern Europe are heavily dependent on Russian gas supplies via Ukraine and are interested in reducing the associated transit risks. At the same time, the European Commission made it clear that it is categorically against the Turkish Stream. Is there any logic to the position of the European Union and who in the Old World supports it?

There are a number of countries in the European Union for which the problem of stopping Russian gas supplies through Ukraine is not relevant, so they can safely take a neutral or hostile position regarding the Turkish Stream. For example, Slovakia and the Czech Republic, located at the outlet of transit gas from Ukraine, prefer to drive it further to the west, purchasing Russian gas from Nord Stream. France, which also got rid of Ukrainian transit with the help of Nord Stream, or the Baltic countries, which have never depended on it, can lobby for as long as they like to block the construction of gas pipelines bypassing Ukraine.

A reduction in the transit of Russian gas through Ukraine means a loss in Naftogaz’s income, and, accordingly, a lack of funds to maintain the gas transportation system in working condition. After this, it is also possible to revise contracts for gas supplies, up to a complete refusal of direct supplies from Russia in 2020. As a result, Ukraine will be forced to buy reverse gas, possibly of Russian origin, through the Turkish Stream or Nord Stream. This will mean higher gas prices for Ukraine and, ultimately, additional financial assistance from the European Union as part of the implementation of association agreements with the EU. On the contrary, Russia will have additional arguments in favor of the full use of Nord Stream’s capacities.

In the best years (for example, in 2011, when transit through Ukraine amounted to 103 billion cubic meters, and the volume of imports of Russian gas was 45 billion cubic meters), Ukraine “paid for loyalty” from the transit of Russian gas and discounts on gas supplied to the country gas amounted to about $7.8 billion per year, of which $3.6 billion was transit fees, and $4.2 billion was a discount to the contract price for gas. However, over the past 10 years, Russia has managed to more than halve its dependence on Ukraine as a transit country.

The European Union continues to count on reducing dependence on Russian gas through alternative supplies, primarily LNG. The bet is on a structural surplus of gas, which may develop after 2016 with the entry of American and Australian LNG into the world market.

However, even at current Henry Hub prices of $2.8/MMBtu, American LNG in Europe will cost about $300/thousand. cube m and is uncompetitive in comparison with pipeline gas from Russia, sold under contracts with oil price indexation, and other sources. In any case, the priority for American LNG will remain the premium Asian market. The same applies to the more expensive Australian gas, 80% of which was contracted in the Asia-Pacific region.

Scenarios for the development of events

The transit of Russian gas to Europe through Ukraine in 2014 amounted to 59 billion cubic meters. m. This means that in the case of full-scale implementation of the Turkish Stream in the amount of 63 billion cubic meters. m (similar to the planned South Stream), a possible scenario is that the Ukrainian transit pipe will be turned into scrap metal.

The first two branches of the Turkish Stream with a total capacity of 32 billion cubic meters. m will make it possible to redirect to Turkey, Bulgaria, Greece, Macedonia, Romania and Moldova those contract volumes that go there through Ukraine with minimal modification of the existing transport infrastructure (in particular, the reverse of the Trans-Balkan gas pipeline will be required). With gas supplies to these countries at the 2013 level (which in total corresponds to the total contracted gas volumes), almost 85% utilization of the two lines of the Turkish Stream can be achieved. And given the growing demand for gas in Turkey and in the case of supplies to Ukraine via this route, the load level may be even higher.

The third and fourth branches of the Turkish Stream are designed to supply gas to Italy, Hungary, Austria, Serbia and Slovenia. Under existing contracts, the main delivery point for gas supplies to these countries is Baumgarten in Austria. Theoretically, Turkish Stream gas could be delivered to Baumgarten from the Greek-Turkish border. Moreover, the 3rd Energy Package provides for the construction of the necessary additional gas pipeline capacities by European system operators in the event of supply contracts. However, judging by the position of the European Commission, it is precisely these 30-35 billion cubic meters. m of the Turkish Stream there will be major disagreements.

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The transit contract between Russia and Ukraine expires in 2019, while many of Gazprom’s contracts for supplies to European buyers, which currently carry gas through Ukraine, have a significantly longer validity period (in particular, the largest of them is the contract with Italian ENI for the supply of up to 25 billion cubic meters valid until 2035).

Obviously, there are three options for the development of events.

The first is the expansion of the European gas infrastructure within the framework of the European rules of the game and with European sources of financing. Countries friendly to Russia (Italy, Austria, Hungary, Serbia, Slovenia and Croatia), which supported the Turkish Stream, are building infrastructure as part of the 3rd Energy Package. Ukraine is finally ceasing to be a transit country for Russian gas.

The second is the extension of the transit contract for 2019 with the transfer of Russian gas transfer points for contract volumes that are in the zone of uncertainty to the Russian-Ukrainian border. At the same time, Gazprom’s European counterparties will have to assume transit risks for transporting gas through the territory of Ukraine. Russia will sell gas on the border with Ukraine until the relevant contracts expire. These contracts will not be renewed, so European consumers will have to either look for alternative, most likely more expensive suppliers, or change the gas delivery point in existing contracts with Gazprom, taking into account new routes.

The third is the signing of a new transit agreement between Russia and Ukraine on different terms, while the volume of transit will be sharply reduced and Russia is unlikely to agree to the “download or pay” condition.

In fact, most likely, by 2020 some combination of these three approaches will emerge, for example, the implementation of two or three branches of the Turkish Stream and the partial expansion of receiving transport capacities for this gas in the EU. At the same time, it is possible to modify some of Gazprom’s contracts as part of changing gas transfer points to the Russian-Ukrainian border and/or concluding a new transit agreement, in which transit volumes will sharply decrease and the obligations of the parties will be revised.

As existing contracts expire, the detailed contours of mutually beneficial cooperation will emerge more clearly. The commercial terms of the new Russian-Hungarian gas contract (the current contract expires this year) will serve as a certain indicator of which path the movement towards the future configuration of Russian gas exports to Europe will take.

Russia - EU: change of course in gas relations