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Are the EU’s Concerns about Gas Imports from Russia Rational?

May 22nd, 2012 by Yuri Yegorov, Faculty of Business, Economics and Statistics at the University of Vienna

Over the last few years we have been observing an irrational political confrontation between European and Russian energy strategies, something not even heard of at the times of the USSR. So let’s look at the irrationality of these confrontations from an economic perspective. Yes, Russia and Europe participate in a kind of monopolistic-monopsonistic relationship (where each side either has control of supply or control of demand) – these are naturally prone to debates about the division of the economic surplus, as both sides want to get the best possible deal out of it. But it should be possible even in these circumstances to come to some kind of rational equilibrium, where both sides benefit equally.

European rhetoric often identifies the need to diversify its gas supply and gas import routes. This is usually supported by an argument about “energy security”. We agree that some natural gas delivery routes are not secure enough because of some unpredictable gas transit countries and so called “gas wars”. The last such outbreak was due to a dispute between Russia and Ukraine over gas export prices in January 2009. And indeed, Europe was the major loser that time. From today’s perspective, this threat is diminished due to much better relations between Russia and Ukraine. Moreover, with North Stream starting operating in autumn 2011, Russia is able to reroute its gas transit flow in the case of any gas conflict with a transit country, enabling secure gas deliveries to the EU market. It is only the lack of spare capacity inside the EU gas network that may disturb the secure delivery of gas to all EU countries.

When we look at the long run (or the future market structure) in Europe, we can easily find that European dependence on Russian gas will persist. Having 26% of proven world conventional gas reserves, Russia will remain the major gas exporter for several decades. Any attempt made by Europe today to diminish the Russian share of EU gas imports at the expense of other countries (such as Norway, Nigeria or Algeria) will lead to a faster dry-up of their modest gas reserves (not exceeding 3% for each) and subsequently to a higher dependence on Russian gas in the future. That is, more diversification today would lower today’s exposure to risks, but only at the price of increased future dependence. As a consequence Russia is primarily, if at all, “punished” temporarily but not over time, since the same gas volumes will be sold later. Since Gazprom with over 70 years’ worth of reserves should apply low discount rates, the net present value loss seems negligible if accounting for increasing real energy prices. In addition, costs are saved by delaying the very expensive exploitation of new Arctic fields, and it offers Russia the possibility to play with the re-export of Central Asian gas in the meantime. The Chinese market is also growing fast, and the Fukushima catastrophe of 2011 has pushed up gas demand in Japan, which can also be satisfied by Russian exports.

As indicated above, the present struggle for diversification could be costly for the EU considering the then remaining options of alternative long run suppliers: Iran (15%) and Qatar (14%). They are Russia’s major competitors in the long run, when the reserves of other gas exporting countries will be depleted. At present, the role of Iran is negligible due to political sanctions. Qatar is only present with LNG in the world gas markets. Worse for the EU, with then only 3 players in the game, some kind of open or at least tacit cartel agreement could be very likely. There are many uncertainties here. The second is a choice between cartel type behavior and competition between Iran, Qatar and Russia. However the current forum, where these countries cooperate, the so-called Gas Exporting Countries Forum (GECF) has always highlighted to have neither the intention nor the interest to become an OPEC for gas. This makes in so far sense as unlike for oil, there is no such thing as a globally integrated gas market, which would allow a global cartel like OPEC.

The second issue is the timing of active participation of Iran in world’s gas market. Although Iran has around 15% of proven gas reserves worldwide, Qatar 14%, and Russia 26%, there is a different story when it comes to current production levels. Here, Russia is topping the list, producing 18.4%, whereas Qatar and Iran produce 3.6% and 4.3% respectively, according to the latest BP Statistical Review of World Energy. Consequently, even if Iran would invest heavily to raise production levels it would take Iran over two decades from today to reach Russia’s output. Effectively, this means that competition between Russia, Qatar and Iran will take place only in the longer run and will most likely focus on the question whether South Pars-North Dome gas field in the Persian Gulf or the Russian Shtokman field will be developed first.

There is another important issue today: non-conventional (shale) gas. The USA has managed to substantially decrease extraction costs. In the mid-term, they will become self-sufficient. This is a shock to the world LNG markets that grew in the last decade largely on the American gas demand outlook. We believe, however, that shale gas will not cause a revolution in European gas markets due to much higher land prices and environmental concerns. In a few years, surplus LNG capacities will disappear. Along the way, of course, LNG prices will be below pipeline prices, but this will diminish with eroding LNG surplus. The only, but very costly and questionable, exit strategy for Europe from its energy import dilemma is a faster transition to renewable energies. We remain skeptical about the viability of this path, however.

For all these reasons, therefore, we expect Europe’s dependence on Russian gas to remain well into the future and recommend rather to invest in a solid relationship with Russia now.

Dr Yuri Yegorov and Professor Franz Wirl, Faculty of Business, Economics and Statistics at the University of Vienna

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One Response to “Are the EU’s Concerns about Gas Imports from Russia Rational?”

  1. Herve Says:

    Yuri,

    I share most of your statements. Trying to explain european’s behaviour:
    For too many decades our politicians are driven by media, opinion polls and so on. They live, believe, behave and decide in a virtual world in their mind made of many “politically correct motos”:
    * Greenhouse, CO², socially correctness, minorities, protective State, wijnd energy, solar enregy, nuclear is bad, biomass is bad, and so on.
    Due to an increasing lack of technical baseline knowledge a 18-yeard old bachelor knew in the past, politicians are only communication specialists and not country leaders. Main target is “re-election”.
    * This is why they more and more neglect to develop true long term solutions at their disposals: biomass, shale gas, nuclear, electric transportation, home insulation, mixing home houses with business centers in order to drastically reduce daily transportation needs, cutting State taxes on property transactions (which pump a severe capital amount every time someone wants to move his home to reduce transport effort)…
    We are out of reality and media + polls driven: No hope before a complete political collapse.

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