EUROPE LINK TO RUSSIAN GAS

Europe is the biggest importer of natural gas in the world, and the European Union sees natural gas as the key contributor to its transition to a lower carbon world over the next two decades. Russia currently provides about a third of Europe’s gas.

A number of Member States, including Latvia, Lithuania, Estonia, Finland and Slovakia, are fully reliant on Russia for gas. Bulgaria, Hungary, Slovenia and Greece are dependent on Russia for more than two-thirds of their gas while Poland relies on Russia for more than half. Russian gas also accounts for 46% of national gas consumption in Germany, Moscow’s biggest single EU gas customer and the largest EU consumer of gas, one that accounts for nearly a fifth of the total annual gas demand of the 28 Member States.

Popular and political opposition to expanding further nuclear power in the EU has left natural gas as the most credible energy source for Europe’s transition to a lower carbon future , this despite opposition from environmentalists and Green parties arguing that the European Commission should focus less on gas and more on renewables and energy efficiency to meet its long term climate targets and reduce dependence on foreign supplies.

The EU remains vulnerable not just to Russia but to other key suppliers that could interrupt their flow of gas for geopolitical or technical reasons. Algeria, for example, which has been a reliable and secure supplier, could cut supplies in the event of unpredictable regional political turbulence. The Maghreb country is also expected to become a net energy importer by 2030 due to rising domestic demand driven by population growth, and that could further squeeze gas supplies to Europe. Elsewhere, Azerbaijan has faced growing domestic discontent, while Turkmenistan has the Taliban along its 750 km long border with Afghanistan. In the Middle East, terrorists and extremists have targeted oil and gas infrastructure provoking inevitable supply disruptions. The EU thus needs to adapt to a changing and increasingly troubling landscape of geopolitical risk.

The initial shipments of US shale gas to European refineries by Ineos, a privately owned multinational chemicals company based in Switzerland, are not going to make a significant difference in EU gas supply requirements, at least not at this early stage.  There is still considerable debate over the extent of the impact U.S. gas exports to Europe will have in changing the current balance of EU-Russia energy transactions. Some estimates suggest that the U.S. could match Russian exports to Europe within 10 years. Wood Mackensie, the energy consulting firm, has projected that 55% of U.S. LNG volumes, or about 32 million tons per year, will be sent to Europe by 2020. Others are less bullish. They believe the impact on Europe will be felt very gradually as U.S. LNG will probably go initially to markets in Asia and Latin America where LNG spot prices tend to be higher. However, most experts tend to concur that LNG from the U.S. will probably be one of the most, if not the most, important single developments to transform the future of the LNG market by making it truly global.  By providing a major source of competing gas supply on the market, U.S. LNG exports to the EU and elsewhere should make gas pricing much more competitive and put pressure on Gazprom, the giant Russian state-owned gas monopoly, to adapt and lower the prices it charges to its European customers if it wants to maintain its market share. Gazprom is hardly going to sit back and accept the loss of its best customers; it has already accepted the U.S. LNG challenge by announcing a few months ago that it intends to ramp up gas exports to Europe to record levels. The Russian group’s strategy is to retain a market share of at least 30% in Europe between now and 2035. Gazprom believes that imports of North American gas to Europe would be limited, as the cost of U.S. LNG is expected to be higher over the next five years than forward prices at the UK’s National Balancing Point (NBP) hub, Europe’s long established spot traded natural gas market. The Russian gas group certainly has considerable market power to undercut competing sources to preserve its market share, especially since its pipeline gas has in the past been relatively cheaper than LNG imports, although prices have been converging. Russia has also sought to expand its pipeline connections to Europe to secure more buyers on longer term contracts

Gazprom Exports to EU countries (2015)

Billion Cubic Meters

1. Germany: 47.4
2. Italy: 24.4
3. UK: 22.5
4. France: 10.5
5. Poland: 8.9
6. Netherlands: 8.4
7. Hungary: 6
8. Austria: 5
9. Slovakia: 3.8
10. Lithuania: 3.2
11. Finland: 2.8
12. Greece: 2
13. Bulgaria: 1.9
14. Belgium: 1.5
15. Latvia: 1.2
16. Czech Rep: 0.9
17. Denmark: 0.7
18. Croatia: 0.6
19. Estonia: 0.6
20. Slovenia: 0.5
21. Romania: 0.3
22. Switzerland: 0.3
23. Ireland: 0.2

Member states vary considerably in terms of the role of gas in their economies, in the relative importance of gas markets and national economies to major external suppliers (such as Russia).

Three groups can be distinguished :

1. “Neutral” Member States : these nations do not import gas from Russia directly and therefore have no formal contracts with Gazprom.
2.  “Secure” Member States : these states import gas from Russia but are protected from disruptions, whether because they have sufficient storage capacity, because they have a very strong, long-lasting, and established commercial and political relationship with Russia (Germany and Italy), because they possess indigenous supplies and enough LNG facilities to diversify away from Russia (France, the Netherlands, Italy, and Greece), or because Russian gas in their energy mix is marginal.
3. “Insecure” Member States : these countries are either already very dependent on Russian gas supplies (more than 80 percent of their total annual consumption) or are expected to become more dependent on Russian gas (Poland).

In addition to the Member States already dependent on Russian gas, in a few others, coal consumption dominates the energy mix. If European climate policy is effective in driving these Member States to reduce CO2emissions by diversifying away from coal consumption, then their exposure to natural gas supply security will grow: gas is likely to be the next fuel of choice because of its relative competitiveness when compared to other low-carbon energy sources (renewables, coal with carbon capture and storage, nuclear and so on). This could apply to Estonia, Poland, Czech Republic, and Bulgaria. Coal dominates their economies, contributing more than 30 percent (the largest share) of their energy mix. Therefore, Poland is classified alongside countries that are very dependent on Russian gas. However, it should be noted that Poland is completing the construction of an LNG terminal, which, in theory, could replace up to 80 percent of Russian gas supplies.

Another dimension that should be considered in examining the energy situation of Member States is the degree of market deregulation and liberalisation. Most of the northwest European countries – the United Kingdom, the Netherlands, Belgium, and to a lesser extent Germany, France, and Austria – have deregulated and liberalised markets with established liquid trading and gas market exchanges. The advantage of having competitive trading gas market exchanges (such as the National Balancing Point, NBP, in the UK, or Title Transfer Facility, TTF, in the Netherlands) is that the price discovery process is based on a more transparent and fair basis (markets with many commercial sellers and buyers) than bilateral contracts negotiated between companies and often involving their respective governments. These bilateral negotiations often involve non-market considerations.

Grouping countries according to their exposure to energy insecurity, based on broad energy security metrics (gas import dependency and storage capacity as a percentage of supplies from the largest sources), helps to make clear the high-level differences that exist in Europe. However, a detailed analysis of the security situation in each country is necessary to avoid “over-insuring” and underestimating the ability of each energy system to cope with a potential gas crisis. Below, we focus on the key features of the energy policies of “insecure” countries.

Baltic States and Finland

The Baltic States and Finland are unique in that they import their entire natural gas consumption from Russia, either directly or through Belarus. This separates them from the rest of Europe. This isolation is problematic not just for the four countries themselves, but also from the point of view of a common European energy market.

Central and Eastern Europe

The countries of Central and Eastern Europe (Poland, Hungary, the Czech Republic, and Slovakia) are more exposed to energy supply disruptions from Russia than most other EU Member States. However, they are still better positioned than either the Baltic States or Bulgaria. The Central and East European countries still import a large proportion of their natural gas from Russia: Hungary imports around 89 percent of its annual consumption from Russia; Poland imports 53 percent (2013); the Czech Republic, 99 percent; and Slovakia, 95 percent. Because some of the region’s gas from Russia comes via Ukraine, it risks transit disruptions due to Ukraine’s situation as well as Russia-related risks. Despite this high exposure, the risk is somewhat mitigated by the region’s interconnectors to other EU Member States and the countries’ storage facilities and LNG terminals (Poland).

Romania

Romania is almost completely self-sufficient in gas consumption and imports only around 10 percent of its gas from Russia. The country has also recently installed an interconnector with Hungary, although this might not help much if Russian gas supply were to be halted, since Hungary itself is dependent on Russian gas. Although the country’s exposure to Russian gas is quite small, some operational issues with the gas system in Romania mean that loss of Russian gas supply could in fact endanger supply in the country: a drop in pipeline pressure could make it impossible to deliver indigenous supplies to the market.

Bulgaria

During the 2009 gas crisis, Bulgaria was the country affected most by the crisis, because all of its gas comes from Russia via Ukraine. In contrast to many other Member States, gas contributes about 15 percent of Bulgaria’s entire energy mix and most of its gas is used for district heating. Thus, the loss of the country’s supply in winter 2009 was not only an economic but also a humanitarian crisis. The country has interconnectivity to Romania, but progress on building an interconnector with Greece (with reverse flow capacity) has been very slow. If this interconnector were built, it could potentially contribute not only to security of supply but also to breaking Russia’s supply monopoly position in the country.