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

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

Sino-Russian energy relations play an critical role in Russia’s push towards East Asian oil and gas markets. China is, after all, the largest consumer of energy in the world and shares a 4,195km (2,607 miles) long border with Russia – one of the largest global producers of oil and gas. There is tremendous potential for a strategic energy partnership to materialize between the two countries, but current relations are plagued by price disputes and political calculations.

“Energy is the one area where Russia is a significant economic partner for China,” Dmitri Trenin wrote in a February 2012 report for Carnegie in Moscow. “[Russia] sells oil at far cheaper prices than Middle Eastern countries, and it holds the potential to become a large exporter of natural gas to China, too,” Trenin continues. Yet, energy trade between the two countries lags far behind its potential, especially when it comes to natural gas.

Yesterday in Moscow, a high level delegation from the Chinese National Petroleum Corporation (CNPC) and energy ministry held talks with Russian Energy Minister Alexander Novak and Gazprom’s Alexey Miller. At the annual “Russia-China Dialogue” (link in Russian), a government-to-government initiative started in 2003, Novak said that China is a “key strategic partner” of Russia in the energy sphere. Outside of signing a vague bilateral “Memorandum on cooperation in evaluating energy market conditions,” however, only two public mentions of specific projects were made the whole day: one agreement on increasing Russian electricity supply to China from 2.6 billion kWh in 2012 to 4.5 billion kWh in 2014; and a short reference to a minor gas pipeline project to China, made at the meeting between Miller and CNPC chief Tsao Tsipin.

While Gazprom’s press release of the event states that both parties emphasized “issues surrounding the set-up of Russian gas supplies to China,” only the minor Altai Pipeline project to supply gas to China’s western Xinjiang Uygur province was mentioned. The Altai pipeline would cross 6 Russian regions from Khanty-Mansiysk to the Russo-Chinese border, but “construction will start only after a gas purchase and sale agreement is inked with the Chinese side,” the press release states. No estimate of the projected cost of the pipeline was given.

Gazprom’s Altai Pipeline Project

Russian President Vladimir Putin originally proposed the Altai project in Beijing in March 2006. The 3,000-kilometer pipeline was envisaged as a 30-40bcm per year trunkline that would anchor Siberia’s oil and gas infrastructure development to long-term gas supply contracts with western Chinese customers. Here’s the potential problem for Russia, though: China already has enormous local reserves of underdeveloped natural gas in its western border region with Russia.

According to the U.S. Energy Information Administration (EIA), Xinjiang Province is one of the leading gas-producing regions of China already, with an annual output of 827 billion cubic feet (23 billion cubic meters) as of 2011. The region is believed to hold a further 15 trillion cubic feet (425 bcm) of gas reserves in two underdeveloped gas fields and projects are underway to develop these reserves for China’s industrialized and energy-hungry Guangdong Province in the east.

Map of China’s Provinces

“PetroChina’s two cross-country West-East Gas Pipelines, connecting Xinjiang Uygur Autonomous Region to Shanghai, Beijing and Guangdong, have greatly expanded the upstream potential of the Tarim Basin [in western China] to supply markets in eastern China,” the EIA reports. Beijing announced in October that it is building a third West-East pipeline that is expected to carry an additional 30 bcm of gas at a cost of $20 billion. If China is expanding local natural gas production in its western border region with Russia and already receiving 25 bcm of gas each year from Central Asia on top of that, does it really need additional gas imports from western Siberia?

PetroChina’s Pipelines (Source: EIA)

The answer is unclear. China has a high potential to see sustained gas demand growth over the long-term. But with the direction of gas demand hinging on global economic recovery, among other factors, it is difficult to predict actual demand growth trends over the long-term. Returning to the Altai pipeline, however, history points to another major factor in Sino-Russian energy relations: political motives.

According to a 2010 report by Shoichi Itoh for the Russian Analytical Digest, when Putin introduced the Altai project in 2006, “Moscow had neither calculated an estimated cost of the project, nor reached an agreement on gas prices with Beijing.” Instead, Itoh explains, Moscow just wanted to “brandish the ‘China card’ in order to influence its negotiations with the EU.” At the time, the EU’s long-term gas demand prospects were almost guaranteed, but questions were being raised about comparative advantages of oil indexation and hub-based pricing regimes. “Gazprom’s chosen strategy has been to keep its share of the very profitable European market, while using its contacts with the Chinese as a tool to pressure the Europeans,” Dmitri Trenin stated in his February 2012 report. “The Kremlin has backed Gazprom’s power politics vis-à-vis its EU customers as a source of leverage in its broader political arguments with European governments.”

It is striking that very similar conditions seem to hold true today. Gazprom has neither announced a pricing estimate on the Altai pipeline project, nor come to an agreement with China on gas supply prices. Yet this was the only concrete project mentioned publicly by Gazprom officials during talks with CNPC.

According to Trenin, all gas pipeline projects to China have been stalled since 2006 because Beijing continues to insist on a lower purchasing price than Gazprom is willing to pay. Itoh reports in 2010 that Gazprom ultimately shelved the original plans for Altai already in 2009 because of the project’s “economic non-viability.” Will this happen again? Altai has the potential to come online faster than other proposed pipeline projects coming from eastern Siberia due to already-existing infrastructure in western Siberia. But a lot depends on gas demand in China and infrastructure development in both countries. Gazprom projects Chinese gas demand to reach 300 to 400 bcm annually by 2020, but Beijing already has access to cheap Central Asian gas and is now trying to jump-start its own shale gas revolution.

The issue of geography should not be understated in this context. China’s industrially-developed southeastern provinces, where demand for gas is highest and supply is struggling to keep up, is far from both western and eastern Siberian oil and gas fields. The high level of capital expenditures needed for infrastructure development to bridge these distances will ultimately increase the price of gas deliveries from Russia, if gas were to be piped into China, according to Kevin Rosner in a report for the Journal of Energy Security in late 2010. This complicates the business dynamic of realizing gas infrastructure projects in Russia’s Far East.

Russia could perhaps stand to benefit from greater flexibility by increasing its LNG capacity. Gazprom, in fact, just completed the world’s first LNG shipment to Japan through the Northern Sea Route via the Arctic. But, as mentioned in last week’s post, Russian LNG will still be competing with (currently) cheaper Australian and Qatari LNG that is already supplying Asia-Pacific markets. On a related side note, just this week Shell announced that it is planning to shift it’s gas business to Singapore in light of projected future demand growth in Asia, signaling the growing interest among global gas producers to increase downstream activities in the Asia-Pacific region.

“We see the major gas trading, the growth of the gas market, the growth of the integrated gas business will be Asia-based,” Andy Brown, upstream director at Shell, told Bloomberg on December 5. “The LNG business is going to be in the Far East, and Singapore is a central part of the Far East trade.”

The direction of Sino-Russian energy relations is uncertain, but China will no doubt play a leading role in the Russian gas industry’s calculations as the Eastern Gas Program materializes. It is curious to see the Altai pipeline project as the headliner from Gazprom’s meeting with CNPC on Thursday. Is there a political motive behind this? Today, by the way, Gazprom officially began construction of its flagship 63 bcm per year South Stream pipeline through Europe’s Southern Corridor, the company’s latest project to strengthen it’s status as a major gas supplier to EU countries.

—
Ben Priddy
Central Asian Analyst

President Vladimir Putin has realized that his country’s gas industry has been heading in the wrong direction. At this week’s Eastern Siberian Oil & Gas Conference in Moscow, RusEnergy’s Mikhail Krutikhin said that Putin’s strong public warnings to Russia’s gas industry of a weakening Western vector at the end of October signaled this realization. The announcement is leading to a shift in strategy. Gazprom’s new task is to jump-start the implementation of the Eastern Gas Program.

East Asia Pipeline Map

The race is on to complete critical infrastructure projects in Russia’s Far East to support the development of a new gas export center to East Asian markets. Seemingly, the negative effects of the American shale gas revolution and uncertain European demand for Russian gas has finally come to the attention of industry analysts. Gazprom and other Russian gas producers have little time to tap into the lucrative Asia-Pacific markets before global competitors, including Australia, Qatar, and the United States, position themselves as the region’s leading gas suppliers, according to officials at the conference.

But even if Gazprom is able to build the necessary infrastructure in the medium term, Krutikhin and others believe that the cost of the projects - the most pessimistic estimates are in the range of $127 billion dollars – means that Russia will likely end up subsidizing it’s gas exports to Asia, where the price of imported LNG might out-compete that of Russian piped gas.

“Russia wouldn’t be able to sell this gas for market price if the [Eastern Gas] program costs this much,” Krutikhin said at the conference. “Russia would already have to sell to China this gas lower than its production costs, subsidizing gas consumers in this country.” But the direction of global gas prices hinges on a lot of uncertain factors. Setting other questions aside for now, how real is the possibility that the United States will become a net exporter of LNG to markets that Gazprom is targeting in it’s Eastern Gas Program? My most recent article for OGE ended with this possibility. Could American LNG exports outpace Gazprom’s new project?

Several interesting reports released by the Harvard Business Law Review and Rice University’s Baker Institute for Public Policy have addressed the prospects of LNG export from the United States.

According to Rice University’s Kenneth Medlock, this issue must be considered within the context of international trade, where implications for domestic and international pricing for regional gas markets come into play. “Currently, in the U.S. alone there is over 17bcfd of [LNG] export capacity in various stages of proposal and development, which represents over 50 percent of current traded volume [globally],” Medlock writes in report U.S. LNG Exports: Truth and Consequence. “If even one-third of this capacity is built and placed into operation, it will dramatically alter the ability to supply the Asian market with natural gas.”

Still, according to Medlock, the long-term natural gas supply curve outside of North America indicates that global gas prices will likely drop in the future, bringing into question the economic benefit of U.S. LNG exports to the region. Prospects for shale development in Europe and Asia, mainly China, recent offshore finds in the Eastern Mediterranean and East Africa, and the rise of competing pipeline import projects from Russia and Central Asia (like South Stream and TANAP/Nabucco West), might lead to a global gas glut and downward pressures on gas prices. “To make matters more complex, supplies from Central and South Asia already or soon will enjoy pipeline links to China, and discussions continue regarding alternatives for Central Asian supply routes to Europe,” writes the professor.

In East Asia, after the March 2011 tsunami and phasing-out of Japan’s nuclear power plants, the regional gas hub price in Japan and Korea climbed to near-oil parity as a result of the need to replace indigenous nuclear fuel with imported gas. Under these conditions, “if one adds supply to a supply-constrained market, the price in that market will fall precipitously, all else equal,” according to Medlock. “In the case of the Asian natural gas market, supply will almost certainly be added – whether it is as LNG exports from the U.S. or other sources of supply via pipeline or LNG to Asian consumers – precisely because the high near-term price encourages such a response.”

Medlock concludes: “In general, regardless of the number of export licenses granted, U.S. LNG exporters face risks associated with exchange rate movements, the development of alternative foreign supplies, and the relative price impacts of introducing U.S. LNG volumes into a currently tight international LNG market. In fact… the apparent profitable export option from the U.S. market based on current market conditions is transitory, as current market conditions beget a supply response abroad that erodes current price differentials.”

Medlock’s remarks imply that Russia could become a leading supplier to Asian markets, contributing to the “transitory market conditions” that might preclude large-scale U.S. LNG exports to the region. But this also raises questions regarding Russia’s own long-term economic benefit of spending billions of dollars on the Eastern Gas Program. If the Asia Pacific region experiences a drop in gas prices due to an increase in imports from other suppliers (i.e. Australia, Qatar, etc.), will Russia receive enough revenue in the long-term to offset it’s enormous capital expenditures in the short-term?

That was one of the big questions raised at Wednesday’s forum in Moscow. Currently (in Russian), the following ideas on infrastructure development in Russia’s Far East are under consideration:

• Expand the Trans-Siberian Railroad to support a transit capacity of 100 million tons of goods per year (currently it can transport 16 million tons/year)
• Increase the 2011 Capital Expenditure Fund for the Development of the Far East and Baikal Region to 100 billion rubles
• Eliminate the federal income tax for new industries that invest no less than 500 million rubles in regional infrastructure projects
• And increase public-private partnerships for the development of the Far East

Stay tuned to OGE for further coverage of Russia’s Eastern Gas Program.

—
Ben Priddy
Central Asian Analyst

China Increases Domestic Gas Production Forecast, Questioning Future Import Deals
China’s Ministry of Land and Resources released a new outlook for petroleum output to 2030 at the beginning of this month, which increased gas production forecasts by 50% year-on-year. The Ministry expects China to produce over 450 billion cubic meters (bcm) of gas by 2030, compared to 300 bcm it projected last year. The announcement signals a potential warning to gas suppliers in the region, particularly Russia, who looks to the growing energy markets in East Asia as future anchors for the Russian gas industry.
Radio Free Asia, November 12

China’s Wind Energy Outlook
At the end of last year, China had a total installed wind power capacity of 62.36 GW, generating 1.5% of total national electricity output. By 2020, China seeks to increase this capacity to 200-300 GW, according to Greenpeace’s latest report. Greenpeace claims that wind power is projected to displace coal consumption in China, but the country coal made up 70% of the country’s total energy consumption in 2009, according to the EIA. There are several formidable barriers to increasing wind energy capacity in China: building infrastructure to deliver this energy to the country’s densely population regions in the east and southeast; and overcoming resistance by China’s two state-owned electric grid companies to accommodate new wind energy capacities. They have traditionally opted instead to rely on fossil fuel inputs, which comprise over 90% of the country’s energy mix, for power generation.
The Diplomat, November 14, 2012

China Holds World’s Largest Shale Gas Reserves, But Faces Challenges in Finding Upstream Shale E&P Expertise
Earlier this year, China’s Ministry of Land and Resources announced that China is home to over 25 trillion cubic meters (tcm) of exploitable onshore shale gas. But the country still lacks the technology to unlock it’s shale potential. Last month, China held it’s second shale gas auction, this time allowing foreign companies with technical expertise in shale production to participate. 83 companies made 152 bids for licenses to explore shale plays in 20 blocks across 8 different provinces. Winners of the tenders will be announced after a group of experts considers each bidding package. However, foreign companies will only be allowed to operate through joint ventures with domestic state-run companies.
Energy Tribune, November 12

Gazprom Pushes Forward With Plans for South Stream, Despite Uncertainty of European Gas Demand
South Stream partners made a final investment decision last week on the 900-kilometer Black Sea offshore section of the pipeline. Gazprom signed an agreement with Slovenian representatives on November 13 in Moscow, and with the Bulgarian state energy company on the construction of the onshore section of South Stream on November 15. On November 13, European gas demand has declined due to the economic slowdown and imports of cheap coal from the United States, which has displaced natural gas in power generation. Still, South Stream seeks to supplant Western-backed pipeline projects slated to deliver Caspian gas to Europe’s Southern Corridor. Construction of the 16 billion euro pipeline with an eventual capacity of 63 billion cubic meters is set to begin on December 7.
FT.com beyondbrics, November 15

U.S. Coal Exports Continue to Displace Natural Gas in Europe
According to the U.S. Energy Informaiton Administration (EIA), approximately 75% of U.S. coal exports were shipped to markets in Europe and Asia in 2012. American coal exports to Europe this year are expected to reach a record high.
U.S. Energy Information Administration, November 15

China to Direct Wealth Fund Investments Toward Asian Markets
The head of China Investment Corporation announced last week that the company will begin investing the country’s enormous sovereign wealth fund into projects in fast-growing Asian economies over Western countries. Increasing regulatory and investment barriers, like in Canada and the U.S., have frustrated Chinese bids to acquire shares in a number of energy and infrastructure projects. Canada has repeatedly delayed a decision to allow China’s CNOOC to takeover Nexen for $15.1 billion. Policymakers in Washington have even blocked a privately-owned Chinese company from investing in a wind power project, citing concerns that the site is located too close to a military base.
The Sydney Morning Herald, November 12

Afghanistan Selects Companies for Oil Exploration Projects
The Afghan government selected Dubai’s Dragon Oil, Kuwait Energy, and the Turkish Petroleum Corporation as partners last week in an oil exploration project in northern Afghanistan, near the Tajik border. The region is projected to hold more than 1 billion barrels of oil. China’s National Petroleum Corporation became the first foreign company to produce oil in Afghanistan and is expected to build the country’s first oil refinery within the next 3 years.
Associated Press, November 12

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Ben Priddy
Central Asian Analyst

Shale gas production has the potential to bring about a “Golden Age of Gas,” according to the International Energy Agency’s (IEA) annual World Energy Outlook report. But in order to realize the full global economic potential of shale gas, producers and governments alike must play by a set of ‘golden rules,’ the IEA’s Chief Economist, Dr. Fatih Birol, stated at the Atlantic Council’s Energy and Economic Summit in Istanbul today.

“Shale gas production in the U.S. reached about 200 billion cubic meters (bcm) over the past five years. This is roughly equal to Russia’s current gas exports,” Birol said. The emergence of new shale gas production capabilities could lead to fundamental shifts in energy markets over the next 5 to 10 years, but a major issue remains: the environmental consequences of shale production, Birol explained.

“Exploration and production of shale gas may have environmental consequences. Some of the concerns are legitimate, in terms of water and chemical issues,” Birol stated. “Therefore, what I would say, is that shale gas operators must apply ‘golden rules’ in order to see the ‘golden age of gas.’ If not, an incident may have an unintended negative consequence on unconventional gas production in the future.”

The potential economic benefits of shale production are enormous. According to MIT’s Melanie Kenderdine, the U.S. economy can expect to add 870,000 new jobs, $118 billion to GDP, and over $1,000 savings in energy costs per household by 2015 due to America’s shale gas revolution. More countries, including Russia, are looking to tap into shale technologies to maintain and, eventually, increase production at their own maturing oil and gas fields. But the shale revolution in the U.S. didn’t happen over night, and these countries shouldn’t expect a rapid increase in shale production if the economic and political conditions are not ideal.

“Assured funding [through government and private financing of R&D] and a targeted time-limited tax credit for producing shale gave the U.S. the technologies for shale production today…[which] took about 20 years to implement,” according to Ms. Kenderdine. “Another factor was the doubling of the floor price of natural gas in the U.S. in the early 2000s. Without this environment, the shale revolution wouldn’t have happened,” Kenderdine said.

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Ben Priddy
Central Asian Analyst

BP’s Shah Deniz Development Group is set to make it’s final investment decision on constructing the first pipeline from Azerbaijan’s offshore Shah Deniz II in the first half of 2013, according to the group’s Vice President, Al Cook. Over the past 12 months, the Europe’s Southern Gas Corridor has “…moved from sheets of paper to sheets of steel,” Cook said at the Atlantic Council’s Energy and Economic Summit in Istanbul today.

The Shah Deniz Development Group made a number of key milestone decisions on the project this year, breathing new life into Caspian gas transit projects to Europe. First, the group agreed with Azerbaijan’s SOCAR company on the exact scope of the proposed pipeline. According to Cook, the first pipeline coming from Shah Deniz II will be 56 inches in diameter, which “demonstrates the confidence that greater amounts Azeri gas will transit the pipeline to Europe in the future.” But several other decisions must be made before pipeline construction starts.

“We need to put in place commercial decisions that build on the political framework and intergovernmental agreements that have already been made [like the TANAP agreement between Turkey and Azerbaijan],” Cook said. “Secondly, we need to move forward with European pipeline selection. In the first phase, we can only support a single pipeline to Europe,” Cook explained. Currently, there are two competing pipeline proposals to transit Caspian gas from Turkey to Europe via the TANAP pipeline.

The Trans-Adriatic Pipeline (TAP) is a proposed 800-kilometer, 10 billion cubic meter (bcm) pipeline that would connect to TANAP at Turkey’s western border and cross Greece, Albania, and the Adriatic Sea before reaching Italy. Nabucco West, a much smaller version of the original Nabucco pipeline that was planned in 2002, is a proposed 1300-kilometer, 48-inch pipeline, with a starting capacity of 10 bcm, gradually to increase to 23 bcm.

U.S. Ambassador to Azerbaijan and former Special Envoy for Eurasian Energy, Richard Morningstar, voiced strong certainty that Europe’s Southern Gas Corridor will soon be realized. After the commercial aspects are finalized, the only question remaining is the potential effect of Russia’s South Stream project European plans. Does South Stream pose a threat to Western-backed pipeline projects? Morningstar doesn’t seem to think so.

“If [European] countries want to participate in the South Stream project, so be it. There is still a long way [towards realizing South Stream]. There are any number of regulatory issues that need to be worked out with the EU, and there are financing issues as well,” Morningstar explained. “I’m not sure that South Stream will have much of an effect at all on the Southern Corridor. Where it’s going to have the most effect is the Balkans, but Russia is not going to roll over, they’re going to compete in the Balkans regardless,” Morningstar said.

Two weeks ago, Serbia made it’s final investment decision in support of Gazprom’s South Stream Project. Bulgaria, Hungary, and Slovenia are expected to follow suit very soon. Gazprom announced November 14 that it plans to start construction of the pipeline on December 7 and begin commercial operations as early as 2015. South Stream is double the capacity of proposed Western-backed TANAP, TAP, and Nabucco West, and all Western-backed projects are planned to come online in 2018.

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Ben Priddy
Central Asian Analyst

Turkey will play a key role in strategic energy projects to connect European gas markets to the Caspian basin. At the Atlantic Council Energy and Economic Summit’s first session on Caspian natural gas and European energy security, top government and industry leaders discussed the benefits of pursuing pipeline projects being planned in the region.

“The energy game in the Caspian has been going on for almost two decades now and what we are seeing is a shift from a merely notional to the concrete,” Steve LeVine, Quartz correspondent and New America Foundation Schwartz Fellow, said at the summit. “There is the decision in Azerbaijan to finance and to get commercial players behind the TANAP [Trans-Anatolian] pipeline and the decision on the competition between Nabucco West and TAP [Trans-Adriatic pipeline]. We have other [gas] volumes coming out at the same time. There is a PSA that will be signed next month in Ukraine, increasing potential for offshore gas and shale gas to come [to European markets] from the Black Sea region. And there’s the potential for natural gas to come from Iraq,” LeVine continued.

As Europe moves closer to diversifying it’s gas supplies and decreasing dependence on Russia, transit countries are moving to center stage in the strategic discussion on Europe’s future energy security. “Azerbaijan is committed to developing mutually beneficial avenues for increasing [regional] energy security,” Rovnag Abdullayev, President of the State Oil company of the Azerbaijan Republic (SOCAR), said. “After ratification of parliamentary documents [concerning TANAP] in Azerbaijan and Turkey, a legal setting is in place. This could become a reality in one year…and we are finalizing preparations for full-scale overall investment of $25 billion [on projects to transport gas to Europe],” Abdullayev explained.

But Turkey is the key transit state at the strategic crossroads of energy projects coming out of the region and will play an important role in bringing partners together, according to Turkish Minister of Energy and Natural Resources, Taner Yildiz. “Nabucco, ITGI, TANAP, and TAP are important projects that will help increase security of supply for Europe,” Yildiz said. “South Stream is another project that is also important because it goes through Turkey’s exclusive economic zone [in the Black Sea]. We look favorably upon all of these projects and believe that they will complement each other in the long term,” Yildiz stated.

Industry and government representatives agreed that Turkey will play an important role in bringing partners together, but it is unclear if all of these projects can overcome the challenges of the current financial climate, as well as the political challenges that have delayed the realization of Caspian energy projects over the past 20 years. “The need for gas in Europe is [currently] more than the supply of gas in the total of these projects. But feasibility studies will show us which are realized first,” according to Yildiz. “Some were considered unfeasible in the past, but are now moving forward. Large projects always pose threats and opportunities and it is important that governments consider all aspects of projects,” Yildiz said.

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Ben Priddy
Central Asian Analyst

I’m coming to you this week from Istanbul, where the fourth annual Atlantic Council Energy and Economic Summit is set to kick off this morning. The two-day summit will cover a range of issues important to European and Eurasian oil and gas industries.

“Istanbul, with its geographic location, as well as ease of access to the whole of Europe, the Middle East, and Turkic Republics, is quickly becoming the region’s energy transmission network,” according to Summit Director Orhan Taner.  Over 400 industry and government representatives from around the world are gathering here to discuss topics like Caspian Gas and the future of Europe’s Southern Gas Corridor; implications of Iraqi oil production on regional energy developments; and Eastern Mediterranean Gas and Transit.

Several current and former U.S. Ambassadors are set to discuss the implications of the November 6 elections on U.S. energy and foreign policy in the region. Industry representatives, like former BP chief (and current CEO of Genel Energy) Tony Hayward and VP of Shah Deniz Devlopment Al Cook, will discuss key issues regarding Iraqi oil production and Caspian gas projects.

In addition to this, German and Turkish officials are set to sign a new energy cooperation agreement on the sidelines of the summit this afternoon. Details of the agreement are not yet known, but will likely hold significant implications for future gas transit projects in Europe’s Southern Corridor.

Follow me on Twitter @ben_priddy for live updates from the summit. I will be posting updates here on key news for Eurasian energy industries. You can also visit www.atlanticcouncilsummit.org for photos, audio, and session summaries.

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Ben Priddy

Central Asian Analyst

What the Russian Papers Say:
This week’s kickoff is a day late, due to yesterday’s unity day holiday in Russia. But there’s no lack of regional energy news.

Russian State Controls 45% of the Energy Sector:
Vedomosti reports today that the share of state holdings in key sectors of the Russian economy has risen dramatically since 1998-99. In 1998, the Russian government owned approximately 10% of the oil sector. Today it controls 40-45% of oil production, 49% of the banking sector, and 73% of the transport sector, according to Vedomosti. And wasteful spending of some of Russia’s leading national oil companies, including Gazprom, has contributed to insufficient upstream investment. For example, Gazprom is the largest investor in the 2014 Sochi Olympic Games, after the Russian government, and has spent more than 100 billion rubles so far. Only 31.5 billion rubles were spent on projects directly related to the company’s activities (the Dzhubga-Sochi gas pipeline). At the APEC summit this year, Gazprom spent 300 billion rubles. This money was officially used for gasification projects, but the Sakhalin-Khabarovsk-Vladivostok (APEC was held in Vladivostok this year) pipeline is only at 20% capacity. Vedomosti reports that between 2013-2015 gradual privatization of the Russian economy should produce about 1.24 trillion rubles (approximately $40 billion). But this is less than the value of the recent deal between Rosneft and TNK-BP (around $60 billion).
(Vedomosti, November 6)

Latest Figures of Gazprom’s Annual Gas Production:
2006: 556 bcm
2007: 548.6 bcm
2008: 549.7 bcm
2009: 461.5 bcm
2010: 508.6 bcm
2011: 513.2 bcm
(Vedomosti, official Gazprom data, November 6)

Gazprom Facing Lower Mineral Extraction Taxes in Far East/Eastern Siberia:
Russian Ministries of Finance and Energy are currently in negotiations to lower, or even abolish, mineral extraction taxes on Russia’s biggest gas projects in the Far East: Chayanda, Kovykta, and Sakhalin-3. According to Vedomosti, officials stated that a more flexible tax formula is needed to increase investment in these fields by 2014, considering the technical challenges and economic costs of producing gas in Eastern Siberia and the Far East. Chayanda ($13 billion), Kovykta ($20-25 billion) and Sakhalin-3 are Gazprom’s largest projects in the region and are the focus of the Eastern Gas Program to open a new gas export center to the Asia-Pacific region.
(Vedomosti, November 6)

Serbia Announces Final Investment Decision on South Stream Pipeline:
On October 29, Serbia became Gazprom’s first partner to officially announce it’s final decision to participate in the South Stream project. Gazprom plans to transit up to 63 bcm of Russian natural gas through South Stream into southeastern Europe. South Stream’s planned capacity (63 bcm), combined with Nord Stream’s (to Germany) 55 bcm capacity and Blue Stream’s (to Turkey) 16 bcm, will almost equal the total amount of Russian gas exports to Europe in 2011 (140 bcm). Gazprom owns 50% of the project, Italy’s ENI holds 20%, and Germany’s Wintershall and France’s EDF each control 15% of the project. Bulgaria, Hungary, and Slovenia are expected to officially announce their support for South Stream over the next two weeks.
(AsiaTimes Online, November 2; Beyondbrics, FT.com Blog, October 30)

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Ben Priddy
Central Asian Analyst