By Viktor Katona
It is doubtful that there could be a less appropriate time to increase Russian gas exports to Europe, yet that is exactly what Gazprom is doing. Despite sanctions from both the U.S. and the EU, and Europe’s determination to reduce its reliance on Russian gas, Russia has been
setting all-time highs in its exports throughout the past eight months. Although Gazprom has not yet surpassed its January 27, 2017 daily exports record of 636.4 MCm per day, it has been setting all-time summer season export records, with current gas flows oscillating within 580-590 MCm per day levels. What is the catch in this seemingly counterintuitive trend? It is a combination of three factors – the balancing of the interests of political and economic actors in Europe, Russia’s incredibly profitable gas pricing, and Gazprom’s new and improved marketing strategy?
Gazprom has been slowly mending its ties with the European Union, to the benefit of its business activities. After the October 2016 decision of the EU Commission, authorizing Gazprom to use up to 80 percent of the OPAL pipeline, which transports gas from Nord Stream’s final point, Greifswald, to the Czech-German border, the Russian export monopolist gained access to 12.8 BCm/year of additional export capacity. Although the new OPAL modus operandi has certain limitations – Gazprom’s share by default cannot reach 100 percent as at least 10 percent ought to be granted to 3rd party suppliers – it is a significant step towards a gradual, yet all-encompassing arrangement between Brussels and Gazprom. It is telling that the OPAL resolution will be in effect until 2033 (i.e. much longer than the Gazprom-Ukraine transportation agreement which runs out in 2019) and that the EU General Court denied the Polish PGNiG’s appeal which claimed that the OPAL deal would disrupt Poland’s gas supply.
Closely connected with the OPAL and Nord Stream matter, the EU’s antitrust investigation is gradually drawing to its logical end, reportedly, a draft deal was already concluded this March. The investigation was founded on three provisions in which Gazprom has been incriminated – unfair pricing vis-à-vis Central and Eastern European countries, pegging the prices to oil and banning the resale of gas. The gas resale issue, along with the one delivery destination clause, was cleared up with Gazprom’s December 2016 commitments fully satisfied the EU Directorate-General for Competition. The oil-peg claim is practically unprovable, as pegging gas prices to oil ones is still a very frequent practice and Gazprom can hardly be imputed with malfeasance. For instance, the current Polish LNG supply contract with Qatargas is oil-pegged, yet there are no complaints from Europe over this issue. The unfair pricing claim is the toughest nut to crack, as it is quite difficult to compare pricing conditions in Western and Eastern Europe, but Gazprom has committed to introduce hub benchmarking into its long-term supply contracts, as well as to enhance price revision flexibility.
Despite manifest success in the perennial negotiations, ramming through the whole EU-Gazprom deal will require much more time. Countries that oppose Russian gas, like Poland will inevitably politicize the issue, thereby seeking to upset the apple cart. In a very similar vein, the Nord Stream 2-related quarrels risk to be protracted into the upcoming decades and will put a sporadic crimp into the EU-Gazprom relations. The latest spat seems to be taking form around the Danish government wanting to amend legislation in order to be able to ban Nord Stream on the grounds that it allegedly jeopardizes EU supply security. The problem with this endeavor is that Copenhagen only have the ability to ban the project due to environmental concerns, of which there are none (during the construction of Nord Stream-1 the two sides addressed all relevant issues, including but not limited to the avoidance of chemical munition dumping sites and fishing areas in the Baltic Sea). If the Danish Folketing decides against Nord Stream-2, German business interests will make sure to react swiftly, causing considerable friction along the Danish-German border.
Still, against such a volatile background, with old disputes making only tiny strides towards resolution whilst new ones appear at a worrying pace, Gazprom is on the verge of having a historically good year. In January-August 2017, Gazprom exported 126.3 BCm of gas to countries outside the Commonwealth of Independent States (CIS), a 12.1 percent increase year-on-year. Considering that gas supplies this year have been a constant 12-13 percent higher than last year, Gazprom is intent upon bringing its 2017 export volumes within the 190-200 BCm interval, an all-time high for the Russian energy giant (see Graph 1). The underlying cause of “dogs bark but the caravan moves on” phenomenon lies in an overall very agreeable gas pricing environment. Russian pipeline-supplied gas is cheap – hovering around $182-187/MCm in the last six months – and will remain so in the near future. Sure enough, Gazprom cashed in significantly more in the pre-oil crash years when the average gas price in Europe was around $350/MCm (as in 2014) – its H1 2017 net profit was a mere $3 billion (17.4 billion RUB) on the back of a weakening ruble and asset revaluation.
Thus, even if its profits are getting are slimmer, Gazprom seems to be winning the market share competition. As the largely anticipated advent of U.S. LNG into Europe failed to lead to any substantial changes in Europe’s LNG imports (last year they grew to only 38.1 mtpa from the 2015 level of 37.5 mtpa, preceded by four years of demand decline), Gazprom was not forced to go all out on its pricing conditions and could stick to the traditional script. Largely thanks to this benign market trend, Gazprom’s market share within the EU-28 area, which amounted to 34 percent in 2016, will challenge the 36 percent rate this year. And one has to bear in mind that Gazprom is uniquely positioned on the European market – whilst Norway and the UK produce as much gas as they have production capacities for, Gazprom still wields a massive 150 BCm/year surplus capacity. Russia has been trying to depoliticize the issue of gas supplies to Europe, for it understands that the more politics prevail in gas-related decision-making, the more difficult it will get to market its abundant reserves in Europe, which despite ambitious projects in Asia remains its key outlet.
By Viktor Katona for Oilprice.com