Do we really need russian gas?
May 16th, 2007 by Christian von Hirschhausen, Dresden UniversityIt is sometimes argued that Russia is a strategic supplier of natural gas to Western Europe. However, the emergence of a truly global natural gas market, and some political strain over strategic issues with Russia have cast clouds on the relationship. Also, some recent modeling exercises indicate that liquefied natural gas (LNG) supplies to Europe may be more strategic than pipeline gas from Russia.
One of the driving forces of the European Commission’s Green Papers on Energy Supply Security (2001 and 2006) was the fear of dependence on Russian gas exports. The Russian share in European imports is indeed high with more than 35% in 2005 and it is sometimes estimated to increase even further to more than 60% (e.g., European Commission Green Paper 2001). The Russian-Ukrainian Gas Crisis of January 2006 has further pushed fears of overdependence.
Figure: Simulation results for European natural gas imports (Source: GASMOD simulation runs, DIW Berlin).
While we do not doubt the fact Russia is an important gas supplier for Europe, we think that its strategic role is exaggerated, and that the potentially adverse consequences of a supply disruption from Russia are lower than generally worried. This assessment is based on the following lines of reasoning:
• It is now generally agreed that additional capacities of gas exports to Europe are lower cost via LNG than through pipeline from Russia. Our recent modeling exercise shows that the share of Russian exports to Europe is likely to stay in the range of 25% to 30%, even by the year 2025 (Figure 1); by contrast, LNG will increase its market share above 20%. Total regasification capacity in Europe will reach at least 140 bcm per year by 2008 (IEA, Natural Gas Market Review, 2006), which are matched by large investments in liquefaction capacities during this decade. Although Eastern European countries are more dependent on Russian imports than Western Europe because of their geographic location, they also have the possibility to diversify their import sources as construction plans of LNG terminals in Krk (Croatia) and Gdansk (Poland) show.
• Russian natural gas reserves are located far away from the European consumption centers, the production and transport infrastructure is outdated and in dear need of updating, and the future natural gas deliveries from Russia will be expensive. The lack of legal security of investments in Russia, especially for foreign investors, is not helping to cover the need of 11 billion US Dollars per year estimated by the International Energy Agency (World Energy Investment Outlook 2003, pp. 213). The currently exploited giant natural gas fields in Western Siberia (Urengoy, Yamburg, Zapolyarnoye) are running out of gas; they already reached their peak production. There is need to develop new fields but Gazprom rather invests its profits of the last years of high gas and oil prices in European downstream industries or in unrelated businesses such as media.
• Future global gas production is unlikely to be concentrated in Russia, as was expected a few of years ago. Remember a peninsula called “Yamal”? In the 1980s, there was a general belief that Europe could not survive without natural gas from Yamal. Today, not a single cubic meter of natural gas has been produced there, and chances are that it will not be for a long time. The situation looks similar for the Shtokman field in the Barents Sea. By way of contrast, development of other fields in the world prospers, not only in the Persian Gulf, but also in Norway, North Africa, or offshore West Africa. These production regions are at a distance to Europe that they can supply our markets via pipeline (Norway, North Africa) or LNG at reasonable costs.
• While Russia threatens to divert its supplies from Europe to China, this is not a credible option given that there are no pipelines to China. Even though Russia is pursuing a couple of pipeline projects to the Far East, their capacity is unlikely to ever reach levels in the range of the exports to Europe. Russia needs its European customers to secure its national income. Although this is arguably not a sustainable long term strategy for economic development, it is obviously Russia’s prime interest today.
• Last but not least, there is increased political sensitivity about engaging in too close energy ties with Russia. On the one hand, there is a fear that the commercial reasoning of securing Russia’s export revenues may be supplanted by (geo-) political interests. On the other hand, the customers in Europe are sensitive about the stagnating democratization process in Russia and about the fact that Gazprom has become a State-controlled company. The Russian refusal to ratify the Energy Charter which could give a legal framework to the Russo-European energy relations is contributing to the unease in Europe. These feelings in Europe are giving a further push to import diversification efforts, ultimately leading to reduced Russian importance.
We believe that import dependence upon Russia is worth much less talking about than is currently done. The global gas markets have shown significant resiliency against changes of export patterns. Moreover, contracts have become more flexible with instruments like swaps and price indexation turning towards spot market prices. The market has become more liquid, capacity construction is abounding upstream (production and liquefaction) and downstream (regasification of LNG). This implies that the Nordstream pipeline from Russia may be less important than often considered. This also implies that geopolitical issues may be less important than generally acknowledged. And this implies that more resources can be spent for other important issues in European energy policy, such as natural gas market liberalization in the European Member States …
Christian von Hirschhausen and Franziska Holz
May 17th, 2007 at 12:51 am
According to the BP Statistical Review in 2005 Russia produced 538.2 million tonnes oil equivalent natural gas, but consumed internally 364.6 million tonnes, or 68% of it. If economic growth spreads out into the provinces, then the surplus third will soon be taken up. So not too much reliance should be placed on continuing supplies from Russia, especially if bad weather affects the Shtokman venture. The UK was once a net exporter, but rapidly turned into a net importer.
The problem with LNG for Europe is that once a gas tankship is on the high seas it is subject to international bidding and may never reach its originally intended destination, but will go where the best price can be raised, most likely North America.
As oil has passed its peak in production, more gas will be used in GTL processes to provide liquid fuels and this will bring the gas peak forward. Uranium supplies are running down, so the nuclear option will be abandoned. Global warming will be ameliorated by a lack of fossil fuels.
Energy saving and more renewables is the only long-term solution.
May 18th, 2007 at 11:48 am
It is not true that investments in upstream activities are abounding! Of course there are projects being studied and under construction, but not as many as required. Today liquefation capacity is about 186 million tons per year, while regasification capacity is 221 million tons per year (Petroleum Economist, 2006). According to LNG journal and Petroleum Economist databases, by 2015 World regasification capacity will probably double global liquefation one. So, without heavy investments in liquefation activities, which are difficoult for many geopolitical reasons, it’s not possible to rely on LNG as a major source of gas to Europe!
As for european LNG import capacity, your expectations are too optimistic. For example, the terminals you talk about, are merely speculative! It is not sure that total regasification capacity in Europe will reach at least 140 bcm per year by 2008, as problems with italian and english terminals are arising.
But even with that capacity, we cannot say that LNG import volumes will match the nominal capacity. US rigasification terminals are working at a mere 25% to 30% of their capacity (LNG journal); even Spanish LNG terminals are at just 78% of their capacity (CNE annual report). The explanation is simple, there is not enough liquefied gas!
I too hope that LNG will be the solution to Europe gas problems, but the situation is more complicated than the one you discribe.
May 21st, 2007 at 7:16 pm
Your pregnant examples and arguments lead to one clear conclusion: Europe needs a robust, flexible and open gas infrastructure. Use of pipelines, LNG terminals and storage facilities should be as open as possible in order to enable European suppliers and consumers to diversify their portfolios as much as possible. That’s why ownership unbundling is so important; European legislators should go ahead in this direction with firm determination, not allowing infrastructure to be captured by a few vested interests.
October 12th, 2007 at 10:02 pm
Today Europe relies much on gas from Russia. it gets it via two supply routes, one going through Ukraine, the other, through Belarus and Poland.
That’s why when the crisis between Russia and the Ukraine in 2006 because of Unkrainian debt broke out Europe tried to influent the both sides to settle the dispute as soon as possible. Maybe Germany wasn’t really troubled with this situation, because of huge gas reserves, but east and south Europian countries, which get gas through the Ukraine were really troubled about the conflict. After that for Europe arose the question whether it depends too much on russian gas, many proposed other gas exporters or other energy sources to reduce this dependency.
I think its also much more a political question. Europe is now toomuch conserned with the political situation in Russia and the so called “lack of democracy” that’s why the relationship are very tense. Unfortunately it has its impact on economic sphere.
And what conserns the situation with foreign investments in Russia, I’m afraid your information is out of date. For exapmle french investors consider Russia today, especially its energy sector very perspective. The french president Sarcozy, who has visited Moscow this week, also submitted the willingnes of french companies to invest in russian energy sector, to develop new gas fields and particularly buy shares of Gazprom. I think the possibility of foreign participation in russian
companies can make Russia more attractive for foreign investors.
April 24th, 2008 at 10:04 am
The European Union has settled three energy objectives: competitiveness (third energy liberalisation package, 2007), environmental sustainability and security of supply. The last issue represents a permanent challenge since the European countries have not yet ensured their supply. Concerning natural gas, the EU imports nowadays 45% of its total consumption (of which 63% comes from just two countries, Russia [43%] and Algeria [20%]) and the import volume might double by the year 2020 in order to compensate the decrease in European production (BP, IEA, UE, AT Kearney, 2007). There is no doubt that Russia is currently the most important European supplier; however this dependence should be reduced due to several reasons:
• The costs of importing from Russia are higher than those from other countries such as Algeria. Russia has remained a strategic supplier due basically to political reasons; nevertheless, in order to watch over European interests, other import patterns should be developed, and an intensive dialogue must take place with this traditional supplier;
• Russia controls about 24% of the world’s gas reserves whilst the Middle East controls up to 40% of them (World Natural Gas Industry and the Financial Times, 2005). Europe should therefore focus on more reliable long-term sources, which implies the expansion of the pipeline network. The enlargement of the present European network (extra 150 bcm, Wingas, UE, E.ON, King & Spalding, 2007) predicts a reinforcement & development across Turkey (imports from both the Middle East and Russia) ;
• Russian internal consumption is increasing steadily, and this could lead to a decrease in exports;
• Most of the pipelines coming from Russia were built between the 1970s and 1990s. The average life of pipelines is 30 to 50 years, so most of the network will need to be replaced in the years to come; however, this may be difficult if political relationships with Russia are delicate.
On the other hand, LNG is another potential solution to ensure gas supply, especially when long distances are involved. It would reduce dependence on Russian, but more investments should be done to improve downstream and especially upstream technologies and capacities. According to Wingas, UE, E.ON, King & Spalding (2007), the EU regasification capacity will be enlarged by 95bcm by 2020 (the actual capacity is 110bcm). The liquefaction capacity increased by 24.5million mt/year in 2007. Besides, the energy market liberalisation makes contracts more flexible and allows shortening their duration (before 15-25 years), increasing the LNG trade and reducing costs.
However, whereas natural gas combustion emits 40-45% CO2 less than coal combustion (which makes it the most environmentally friendly of the fossil resources), the production, transport and conversion back to a usable form make LNG a major source of greenhouse gases. This fact does not match the will of reducing carbon dioxide emissions.
To sum up, the need of Russian gas at this time is certain. LNG may reduce this dependence if it is substantially developed in the next years. The strengthening of other suppliers such as Algeria (which is actually increasing its liquefaction capacity) and the Middle East is also important. But none of these strategies will succeed if the European Union does not set common and figured objectives putting national interests aside. A functioning internal energy market is fundamental to the competitiveness of the economy of the EU, and it also reduces the total cost of a supply disruption. But the task is not yet accomplished and more effort should be put to reach a balanced situation.