February 4, 2012
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№ 7 (July - August 2011)

Russia, Europe Talk Energy&Gas

   As soon as the Third Energy Package gained force, European energy companies spoke out sharply against the document, which Russia, for one, had all along openly described as an anti-Gazprom document.

By Svetlana Kristalinskaya

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   Whether it was changes in the gas market that had made the Europeans more pliant or it was a double game they had played all along, the package has been adopted finally and time has come to make a deal with Gazprom – one way or the other – on natural gas deliveries. Furthermore, the EU has even voiced its readiness to support the Russian-backed South Stream gas pipeline project. Yet to this day, it is not at all 100 percent certain that the project will be free of EU regulation.

   The 6th International Conference “Energy Dialogue: Russia – European Union. Gas Aspect” held in Berlin created a certain feeling of enthusiasm in Gazprom. After all, for many years of Europe discussing and deliberating the Third Energy Package (TEP), Gazprom, with support from the Russian government, had strongly opposed the document. Adopted in July 2009, TEP only came into effect last March.

   TEP’s key provisions include the separation of the competitive and the natural-monopoly types of activities and the establishment of a special certification procedure for energy transportation operators that are controlled by foreign interests. The TEP’s structuring provisions differ for the existing and for the new gas transportation systems.

   Concerning the existing gas transportation systems, the EU member states are free, at their discretion, to apply any one of the established three separation models.

   The first, and also the strictest, separation model provides for complete separation based on ownership, meaning that a vertically integrated company will lose its rights of ownership and control of a gas transportation system in question.

   The second model provides that a vertically integrated company will transfer its functions of a gas transportation system control to an independent system operator while, at the same time, remaining the pipeline owner (medium level of strictness).

   The third, and the softest and most popular, option means that a vertically integrated company will transfer its right of ownership of a gas transportation system in question, together with all its control functions, to one of its affiliated companies, which has to be “reliably insulated” from other corporate segments.
Each of the EU member states is entitled to choose between the three existing options for incorporating the TEP’s provisions into the body of its national laws.
In respect of the new systems, only the third, and the strictest, option applies, with complete separation, in terms of ownership. The only possibility to avoid doing that is to achieve a waiver of regulation through a two-tier process: from an EU member state that allows the system to pass through its territory, and at the European Commission level.

   Gazprom has issued a statement saying that applying TEP principles may have negative consequences for the company’s execution of its long-term gas-supply contracts and for the prospects of attracting investments into construction projects for new gas pipelines in Europe.

   The European Commission replied saying that TEP regulations apply to all gas suppliers to Europe. It should be noted, however, that Norway soon is likely to lose its status as a major gas supplier due to its slumping gas reserves, while Algeria and Qatar are mostly in the business of supplying liquefied natural gas rather than pipeline gas and, as a result, they are not so closely tied to the pipeline infrastructures.

   On the whole, Europe has been urging Russia to allow foreigners much freer access to its gas production operations, based on their openly articulated concerns about Gazprom’s ability, on its own, to secure the massive investments into ensuring gas production capacity volumes necessary to satisfy the international market demands.

   Furthermore, some of Gazprom’s major customers have all along complained of what they perceive to be the Russian company’s overly high prices set in its long-term gas supply contracts tied to the oil price with a lag of six-to-nine months, with the spot prices in Europe being much lower. Tying the gas prices to oil prices had led to a situation where, in the midst of the world financial crisis, which had precipitated a sharp rise in world oil prices, Europe saw its natural gas prices begin to rise sharply. Little attention was given to the fact that the European spot prices had gone down not only because of the so-called “Shale Gale” sweeping the USA and the ensuing LNG glut in the European market, but also because, due to that crisis, the European spot market was flooded by unclaimed volumes of natural gas, which had been earlier contracted under take-or-pay conditions.

   Surprisingly though, immediately following the TEP provisions entering into force, Europeans’ public statements suddenly seemed to change dramatically in favor of Gazprom. However, the desire to get into the Russian gas production industry and to have the purchasing prices lowered is still very much an issue.
Also, it could be just a smart move of sorts, given that the measure has already been adopted, while the Europeans still remain in need of building long-term relationships with the Russian gas monopoly. This is particularly true given the sharp changes in the international gas markets caused by the tragedy in Japan and by recent political developments in North Africa.

   The first among the Europeans to address the conference was the Eurogas President Jean-François Cirelli, head of Gaz de France. He stressed that gas would play an even greater part in the European energy balance in the future, in particular due to further advances in technology. For instance, according to Eurogas forecasts, demand for gas in Europe will increase by 14-23 percent by 2030 reaching a volume of 640-690 billion cubic meters of gas, compared to current consumption volumes of 560 billion cubic meters of gas.

   These figures from European companies considerably exceed the forecast made shortly afterwards by the European Energy Commissioner Günther Oettinger, as part of the presentation of the Russian South Stream pipeline project. “According to different forecasts, by the year 2030, the predicted demand for gas in the European Union will vary between 370 and 600 billion cubic meters of gas per year and is likely to change due to recent events in Japan,” Oettinger said.

   Meanwhile, a consensus forecast presented by Gazprom predicts that, by 2020, Europe’s demand for imported gas is likely to be 380 billion cubic meters of gas, reaching 440 billion cubic meters of gas by the year 2030.

   Russian Deputy Energy Minister Anatoly Yanovsky was quick to note the considerable difference in the gas demand volume estimates saying that Russia and the EU had agreed to come to an agreement of opinion and to compare notes and verify calculations.

   Quite predictably, however, the main topic of discussion at the conference was the Third Energy Package. As if finally heeding the voices of the European gas consumers who, like Cirelli, had appealed “not to over-regulate” the industry so as not to scare off the investors, Philip Lowe, Director-General of the European Commission’s Directorate-General for Energy stated that investments into the construction of gas pipelines needed to be protected. He said that the Third Energy Package was not enough to get European energy markets back to work again. “We need cooperation between suppliers and consumers,” Lowe said, adding that this was “necessary to make sure that investors (into gas pipeline construction projects – editor’s note) be offered sufficient incentives to invest in Europe.”

   In his opinion, Russian companies should be invited to participate in the discussion of the TEP provisions so that their own proposed models could be put to good use. “This is not an end but only a beginning with a view to spelling out a legal framework (for the application of the TEP provisions – editor’s note),” Lowe said, stressing that TEP concepts should be grasped clearly by all of the market players.

   At this point it is worth mentioning that, in Lithuania, both Gazprom and the Germany’s E.ON. have suffered as a result of the application of TEP provisions. Both corporations had earlier acquired interest in Lietuvos Dujos (the owner of the country’s gas trunk pipelines – editor’s note), which, in the words of Valery Golubev, Deputy Chairman of Gazprom Management Committee, had started applying the TEP provisions “blindly”, without having any alternative gas delivery options, thus putting both Gazprom and E.ON in danger of losing their investments there.

   Philip Lowe stressed that, within the framework of company separation based on ownership, it was necessary to make arrangements for a return of investments made earlier by pipeline owners.  “This is something that needs to be made quite clear,” he said, adding that “the Third Energy Package is a fairly flexible instrument.”

   He also predicted that the demand for natural gas would continue to grow and, consequently, efforts would be made to allow investors “to have greater certainty” in the business. Lowe noted that the European Union saw a number of technological and economic obstacles to the wider use of renewable energy sources and spoke in favor of pipeline gas deliveries in parallel with liquefied natural gas. “Whatever the advantages of liquefied natural gas in terms of route diversification, gas delivered by trunk pipelines remains one of the more reliable sources,” he added.

   At the same time, Philip Lowe spoke in support of efforts to attract more foreign investments into the Russian gas industry and voiced his opinion that the relationships between gas suppliers and gas consumers should be built on a basis of long-term contracts that would allow investors to have greater certainty. While saying that, he also added that the spot-price component should be allowed to have its place, too.

   In turn, Golubev said that while in light of the current situation in the world gas market Gazprom had modified some of its gas delivery contracts introducing a spot-price component, on the whole the company was not considering the possibility of establishing the spot price as the basis for its gas price formation policies.

   This puts Gazprom is a strong position. The international gas market has recently seen some dramatic changes: Libya had stopped its gas supplies to Europe, while Germany and Italy had given up the use of nuclear power in the wake of the tragedy at the Fukushima Nuclear Plant. According to estimates of the International Energy Agency (IEA), as a result of the earthquake, Japan’s requirements for gas will increase by 11 billion cubic meters. Furthermore, Germany, which now needs to find replacements for its nuclear energy projects, will additionally require a minimum of 16 billion cubic meters of natural gas, compared with its current gas consumption needs. Italy, which had stopped using nuclear power following the Chernobyl Nuclear Plant accident, has now extended its moratorium on the use of nuclear power in the wake of the disaster in Japan.

   The above may be some of the reasons why the EU is now taking a softer approach to the South Stream saying that it will support the project. However, in the words of Günther Oettinger, “Given that the South Stream will cross the European territory, it will have to comply with TEP requirements.”

   What makes the process of excluding the South Stream from TEP regulations difficult is the fact that some of the countries across which the pipeline will pump gas have concluded intergovernmental agreements with Russia that include an investment protection clause, which is in contravention to some TEP provisions. “Nonetheless, those countries will have to apply their internal market regulations and should harmonize their intergovernmental agreements with the EU legislation. The only practical way of doing that is to conclude an agreement directly at a European Union level,” Oettinger said.

   In that case, Russia would have to cancel its bilateral agreements and to outline its sensitive issues in a global agreement with the EU. The Russian Energy Minister Sergei Shmatko indirectly confirmed that, saying that Russia had already offered the European Union to conclude an intergovernmental type of agreement that would take into consideration the specifics of large-scale investment projects implementation.

   Gazprom and its partners have already succeeded in having OPAL, a Nord Stream branch pipeline, excluded from TEP regulation, though no such permission was granted to NEL, the second branch pipeline. Nevertheless, if statements already being made by some European politicians are anything to go by, it might be expected that Russia does indeed have a good chance of achieving the agreements it needs also in respect of the South Stream project.

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