Archive for March, 2013

Energy Champions League

Monday, March 11th, 2013

In the recent years Ukraine has been in the midst of a political football competition, or a metaphorical Energy Champions League. Its role now is based on being a trophy for two major powers. On one side, EU aims to win Ukraine to make sure its gas supplies are not undermined; on the other, Russia aims to make sure it maintains current gas prices by controlling more of the market, alongside nudging Ukraine into its Customs Union. If Russia triumphs, particularly in the latter point, it will restore 80% of the ex-USSR’s market as Kazakhstan and Belarus are already sitting on the substitute bench. If the EU wins it will break Russia’s Custom Union ambitions and push into the final of rejecting Gazprom’s energy grip.

Team EU:

Jose M. Barroso, president of the European Commission, has said that “one country cannot at the same time be a member of a customs union and be in a deep common free-trade area with the European Union” in late February, underlining that EU is not giving Ukraine a chance to play on both sides. Moreover, EU has given Ukraine just three months to carry out changes to its justice and electoral systems so it can qualify for the free-trade agreement – as Ukraine’s Verkhovna Rada (Parliament) is notorious for infighting and being slow, one wonders if this is at all possible. Bi-directional gas flow bypassing Russia, however, has been achieved amid Ukraine and the EU; with 2bcm expected to flow into Ukraine this year and 7bcm in the near future via Slovakia and Hungary. This will add to the existing bi-directional route from Poland. A recent comment by Energy Commissioner, Gunther Oettinger, underlines that the EU could work in a “trilateral consortium” with Russia and Ukraine, but its appeal to Gazprom is questionable – why have less when you have cornered the market?

Team Russia:

Russia’s ambition is a mixture of economic, political and military factors. It made no secret about its dislike of now gone Ukraine’s NATO inspiration, EU alignment, anti-Russian legislation and so on. Gas has played a key role, as even the Black Sea Fleet extension to 2042 has been based on Gazprom agreeing with Ukrainian Naftogaz, to reduce natural gas by $100 per 1000 cubic meters for the remainder of the ten-year contract signed by Yulia Tymoshenko in 2009. At the end, Russia emerged the winner as it managed to secure its fleet, whereas Ukraine failed to anticipate rising gas prices with experts calculating that it could have gotten a better deal. Due to Russia having a natural advantage over EU – it is more of a command economy with decision making being at the centre – it will likely be able to woo Ukraine more easily, and importantly quicker, especially as it has financial muscle and as a carrot it could drop gas prices.

Match Ball Ukraine:

Ukraine is hardly a team in its current condition, as the economy is declining and it is being drowned by gas debts at alarming rates. Its status as a player has continuously declined throughout the geopolitical tussle between EU and Russia. Today, it cannot be viewed more than a match ball; which will be taken home by one of the big teams. Aside from Ukrainian all-start player Tymoshenko now in prison, it is hard to imagine Ukraine working as a team. It is naturally split amid two sides geographically, and its political system leaves plenty of room for desire. It has made efforts to diversify with other regional energy powers like Turkmenistan, but it does not want to fully lose its status as a transit state for Russia – as on preferential terms it does gain, just not in the ones signed in 2009.

From the Sidelines – Yanukovich’s Speech:

Yanukovich’s latest press-conference, on March 6, has evolved into a speech not akin to a president or a statesman, but to a countryman, clearly in a dire situation searching for extra time. The answer was a result of a typically divisive and rather politically incorrect question of an Echo of Moscow correspondent – one is still astonished how Echo succeeds in being so controversial and pro-Russian opposition, even while being owned by GazpromMedia. Yanukovich blames Tymoshenko, while she was in power, for falsifying and then on covering up documents from investigators about the Russo-Ukrainian gas contracts – for which the actual government gave no permission. She is currently serving 7 years in Kharkiv for abuse of power in 2009 gas deal with Russia; she accuses Yanukovich of orchestrating her arrest and imprisonment, but avoids the maximum sentence of 12 years was not given.

It is the most horrific problem facing Ukraine, if not for it, we could have dealt with socio-economic problems”, says President Yanukovich in Russian about the 2009 gas deal; this “unique contract, as it was then called [and said it] will bring benefits to our nation – if not changed by 2019 it will cost Ukraine $6 billion in losses”; annually. As Yanukovich argues, the contract is cannibalistic as it takes away livelihoods from typical Ukrainians - who all must pitch in so their country does not breakdown – it is killing Ukraine.

Today, due to this contract, this money goes to Russia, it is an unfair price – it is not a market price, but I do not blame Russia, as it defended its interests, but I just cannot understand how it did it”, says Yanukovich. He again reaffirms that albeit disastrous, he does not fault Russia by asking rhetorically: “What is the fault of Russia? – It is not at fault, as it was only defending its interests – Ukraine signed it and it is now trying to realise the contract”.

Yanukovich further says that, “for us this is like being noosed in the gallows by a $7 billion debt”, as he adjusts his tie in a clear sign of emotion. However, he stresses that “we do not want to bargain with our sovereignty, but it is obvious we have to find a way, somehow, to agree a reduction in price with Russia”. In the following comments he describes Ukrainian efforts to diversify from Russian gas to cheaper substitutes; as “how can we defend our self’s in this situation? - all we can do is lower our demand”.
An internal shift to electricity, being the popular way; with the imperative metallurgy industry making particularly long-strides forward. EU’s gas spot market being another way, but as Yanukovich underlines “it is not a lot cheaper, but still about $50 cheaper [per 1000 cubic meters] than Russian gas”.

Naftogaz’s Deputy Chairman Vadim Chuprun, on February 27, has said that Ukraine will reduce Russian gas imports to 18bn-20bn m³ this year, in contrast to 24.9bn m³ in 2012. But, it will activate the take-or-pay minimum clause in the contract with Russia – as a baseline of 52bn m³/yr exists with Naftogaz required to import 41.6bn m³/yr or face penalties which today amount to $7bn owed to Gazprom.

It is clear that Yanukovich is tied by the gas contract and naturally sees Russia as the only real saviour. It is questionable quite how far Ukraine will manage to maintain its sovereignty as Russia will unlikely to yield from its strong position, as Tymoshenko has certainly acted in the latter’s favour. EU will remain an ‘alternative’ team it could join, but due to its own economic crisis it is uncertain to what degree the union will go. One thing is for certain that there is not country in the world, as Yanukovich argues, where there are “penalty sanctions of 300% for not drawing enough gas”.

Full Time – Zavidova Meeting between Putin & Yanukovich:

Yanukovich has felt that his predecessors have dangerously pushed Russia aside and from the start begun working on a closer relationship with Moscow. The meeting with Putin was postponed in December 2012, so Ukrainian counterparts could take time to analyse the possible Customs Union with Russia. Quoting Yanukovich to then saying: “today, we’re looking for a model of cooperation between Ukraine and the customs union… From an economic point of view, it’s very interesting for us to integrate with the customs union.


Naturally, the follow-up meeting generated a lot of attention and expectation. It was even hinted that Yanukovich is ready for compromise with Putin. As Ukraine cannot sustain crippling debts due to gas being priced at $505-515 per 1000 cubic meters, an economic recession and a lack of infrastructural investment; as its energy sector needs to be upgraded. Unlike Russia, Western institutions require more progressive reforms making it harder and slower for Ukraine to work with them (e.g. Urengoi-Pomary-Uzhgorod Gas Pipeline Modernization).

At the end, the no-ties meeting did not reach any serious conclusions, although it has been reported throughout the media that gas was discussed – Echo of Moscow Radio defined it as tit-for-tat type discussion. Gazprom tried to play down expectations of any imminent deals, as although Ukraine is in a dire state it cannot afford to repeat yet another mistake on par with 2009. Neither side wanted to give away their formation and strategy, adopting a poker face in the discussions. One could make further jokes or metaphors about this situation: i.e. Ukraine is at least well for prepared for the next World Cup – after such political football. But in reality, I hoped to emphasize in a metaphorical fashion that the geopolitical duel between Europe and Russia must end. Unlike a trophy protected by its cabinet or a specifically designed football, it is unfair and unjust that the Ukrainian people are taking the brunt due to a decision years ago.

Igor Ossipov
OGE Blogger and Freelance/Special Correspondent

Russia’s Eastern Strategy: Dream or Reality?

Tuesday, March 5th, 2013

The rising politicization of Euro-Russian energy relations is casting doubt over future volumes of oil and gas supply to Europe, according to two researchers from Masaryk University. Their recent article evaluates the difference amid policy ambitions shown by Russia and the official “Energy Strategy to 2030” (ES-2030) publication; released in 2009. M. Mareš and M. Laryš argue that China’s rise is creating a great opportunity for Russia as an extra energy market, but at the same time, current conditions could quickly alter into economic as well as political risks. Both want to make sure that their interests prevail, which causes stumbling blocs like price formula renegotiations or substitute suppliers: be it from Turkmenistan and Burma, or internally from shale gas.


Problems with Heading East: 

The East Siberian and Far East regions hold about ¼ of Russia’s oil and gas proven reserves, but the regions are extremely underdeveloped making casing, extraction and transport difficult. Key gas fields, like Kovykta, are isolated by the taiga or encircled by canyons – these are not Gazprom friendly areas due to a lack of piping expertise. Besides technical issues, political factors have also strained development. Like the 10 year dispute amidst TNK-BP, Interros, Gazprom and other stakeholders, but a light at the end of the tunnel seems nearer.


Japan has indicated that it may partake in Kovykta if its status is reaffirmed, due to its importance for the Asian market. In 2012, Interfax reported that Gazprom’s CEO, Alexei Miller, has launched a plan for “a pipeline from Kovykta… towards Chayanda and, in the end, gas from Kovykta will be transported through the Yakutia-Khabarovsk-Vladivostok gas pipeline… [it’s] slated for 2016”. In February 2013, ITAR-TASS reported that Gazprom has started to consider bringing forward the 2016 aim – has energy elite realised the need to hurry? Mareš and Laryš would caution, as the dynamic diversification into Asia is somewhat abandoning the traditionally lucrative Europe, than actually providing additional customers.


Road to 2030:


The reason behind China’s appeal to energy exporters is its booming economy, which requires disproportionate amounts of energy: to create $1 of GDP China uses 5 times more energy than the US, or 12 more than Japan. Just by 2015 China’s consumption will near EU’s at 490 Mt. ES-2030 shows that by 2030 Russia aims to supply 20-25% of Asia’s oil from the current 6% – with China being the main consumer. Further, by 2020-2022 the figure should be around 14-15%. Gas wise, it is amazing that Russia, the energy superpower, sells no pipeline gas to Asia, and only marginally sells LNG from 2009. By 2020-2022 Russia ambitiously aims to reverse this trend by supplying 16-17% of Asia’s gas – with the figure rising to 19-20% by 2030. In all, this shows a positive trend as Russia must diversify its eggs among more than one basket. Its main European market accounts for 90% of its export – which is a serious security issue.


ES-2030 is quite versatile with internal ambitions as well as export intentions. Russia aims to integrate its export capacity into developing political and economic solutions for the regions. However, it is facing constraints like population decline and organized crime (e.g. Primorsky Krai). But on the bright-side the former problem is improving as Russia has begun to break the continuous declining trend, which plagued it for two decades. Demographic revival in Eastern Siberia and the Far East will be vital as the sparsely populated regions will need to develop their own internal energy markets to reduce the pressure from initially expensive exports – fixed costs will need to spread. ES-2030 aims to do this by institutional methods (e.g. changing the legal system) and FDI, which will rise to around 12% of the overall Russian total. As a result, proven oil reserves will rise by 10-13 billion tonnes and gas will rise by 16 trillion cubic meters. 


Bumpy Road Ahead – Oil:


ES-2030 success will depend on the interactions between the Russian energy elite and politicians, who tend to interrelate greatly, especially at the top. The Pacific Ocean Oil Pipeline (ESPO) is even viewed by some experts as a personal aim of Russia’s current president. The central factor behind ES-2030 and ESPO’s success will be the Vankor Oil Field and its interrelation with subsidies and taxation. Rosneft cunningly managed to reclassify its geographic location as an Eastern Siberian oilfield, which initially resulted in zero and then little taxation; plus $4-5 billion subsidies. Geographically it is not in the eastern sphere, but this was not unnoticed as a fierce lobby battle ensues over its favourable taxation status. Mareš and Laryš argue that if Vankor or other fields lose their battles, they will not be able to raise output or develop. Both direct and indirect assistance is vital to cash-flow as most of these fields are situated in environmentally harsh and remote places. But, on a positive note there is a domino-effect present as by developing larger fields and their infrastructure will push smaller fields online. Vankor should hit its peak around 2014 with an output of 45 Mt.


The recent contract with China looks hopeful as Russia is getting a unique deal with a $25 billion loan for the ESPO pipeline. Under this contact, interest rates given are half the price of the ones available on the world market. However, the ESPO is not trouble free. Konstantin Simonov, the Head of the National Energy Security Fund, argues that the ESPO is too ambitious with the goal to increase oil transit to 50 Mt by 2015 and by 70-80 Mt in 2025 being unlikely. As even by official data by 2030, Eastern Siberia cannot produce more than 700 Mt from its 3000 Mt total, whereas 2500 Mt is needed – one must also keep in mind that estimates foresee new fields being opened in 2016 which may not occur. ESPO’s full output will never be reached as only about 50-80 Mt will be available; also it is only economically viable to use pipes instead of rail if over 50 Mt is shifted. Political dialogue with China and the end price (which is a trade secret) will determine the result; it is estimated that the sum is about $60 per barrel for Urals oil – surely one must question the validity of the win-win situation at that price?


Uneasy Passengers – Gas:


China’s feat of securing Urals oil for half the market price and being a peculiar victor amid the taxation squabble in Vankor highlights its shrewdness. However, its constant desire to change the pricing formula and its outstanding oil debts, go into the territory of poor relations; which will aggravate Moscow. Gas wise, China again acts as a hard client as experts believe that it links gas to coal prices, which differ a lot, particularly when Russia aims to receive European type sums. Mareš and Laryš argue that China’s gas market is a questionable venture, as it is traditionally orientated towards coal with gas only account for 3% of the energy mix. China has begun to move towards natural gas only 10 years ago. It is estimated that the overall total will rise to around 10% by 2020, but with increasing competition and Beijing’s strategy of diversifying imports as much as possible, it is uncertain how far Russia can penetrate the market.


China’s unconventional resources over the recent years further fuelled uncertainty, as it has equally huge reserves of shale gas (biggest in the world) and coalbed methane, and large reserves of tight sand gas. It has planned originally to extract the former in 2015, but in good news for natural gas exporters, this is unlikely to happen as over the last year shale prospects have plummeted. China’s reluctance to introduce free market mechanisms into the sector is credited as one of the main causes. Bloomberg reports that the original shale gas goal “of 80 billion cubic meters by 2020, or 23 percent of total expected demand” now appears like a far off dream. Recently, China has even hinted at increasing cooperation in developing of new fields, geological prospecting, extraction and building with Russia which could indicate a new trend.


Mareš and Laryš argue it makes no sense for Russia to supply China for the sake of a market share. In fact, it is damaging to supply it in the same fashion as Turkmenistan, which takes a huge dent in the federal budget by selling gas at half the market price. Russia has currently played its cards well, as fears of Turkmen market takeover did not materialise, but only time can tell about the possible effects of Australian, Omani, Nigerian, Egyptian, and Qatari imports. All 4 projects aimed at supplying China have not materialised even though discussions have been ongoing since 2006-2007, but it is only a matter of time before a deal is concluded as China is naturally the biggest client and Russia is the largest supplier. Talks have intensified as Gazprom realises it cannot wait forever and it even requested a 40% upfront payment by China for gasification.


Russia has options to supply Japan and the Korean Peninsula. However, Gazprom’s modest LNG expertise limits sizeable deliveries in the near future, to the heavily LNG focused Asian states. Still, Gazprom made good progress by shifting 9% of Japanese LNG and 7% of its oil in 2011. Vladivostok LNG terminal, due for launch in 2017, will increase capacity matching the rising demand, particularly as recent events have benefited Russia (e.g. Fukushima Disaster). North Korea will likely to remain a thorn in the future energy deals as shipping LNG will be at increased risk. North Korea’s recent leadership change sparked a flash of optimism, but even with a tempting $100 million in annual transit fees could it be a reliable partner and would SK ever agree? – Perhaps in the perfect world, where the last delegate to DPRK is not Denis Rodman.


At a junction – ES-2030:

ES-2030 follows a tradition of Russia’s psychological affection to large scale projects. It offers opportunities, but Russia must place its interests first and not enter the market for the sake of involvement, as its policies will make it hard to turn back. Also, China holds somewhat the upper-hand as it realises Russia has little room to manoeuvre. But a lot depends on the accuracy of forecasts and on China, which is worrisome as the latter’s forecasts are at best questionable; the secretive state is by no means a stranger to manipulating its statistical data. It will be vital to attract an additional player, most likely Japan, but as Mareš and Laryš highlight ES-2030 offers little concrete facts and mainly shows a roadmap with some directions. It will be decisive that who ever takes Russia into whichever direction, will have the right license and will not be dreaming behind the wheel.

Igor Ossipov

OGE Blogger and Freelance/Special Correspondent