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Russian gas and European energy policy

by Jerome a Paris Sat Apr 28th, 2007 at 10:07:31 AM EST

I've been struggling for two weeks with the article in the Economist about Russian gas (A bear at the throat) as it takes legitimate (if often poorly informed) worries about Russia's sometimes blustering behavior on the energy markets to peddle the usual insane crap that market liberalisation is the only solution to promote energy security (I'll get to why I think it is insane below).

But two days ago, I spoke at a debate on Gazprom at IFRI, a French think tank. That conference was organised after the publication of two quite different articles about Gazprom:

Gazprom as a Predictable Partner. Another Reading of the Russian-Ukrainian and Russian-Belarusian Energy Crises by Jérôme Guillet
Gazprom, the Fastest Way to Energy Suicide by Christophe-Alexandre Paillard

The titles give a hint that the papers start from pretty different positions - as you can see in the executive summaries of each that I am posting below:

The recent crises over oil & gas deliveries from Russia to Ukraine and Belarus have triggered alarm and virulent criticism in the West. This article describes how these conflicts are in fact not very different from those that took place in the early 1990s and reflect behind-the-scene conflicts between powerful factions inside the Kremlin and in Ukraine rather than the exercise of an “energy weapon.” In the context of a European energy policy driven by Britain’s panic at becoming a gas importer and by the ideological zeal to liberalize, the West should worry less about the exercise of a purported aggressive geopolitical strategy and more about Putin’s lack thereof, and his inability to control his warring lieutenants. Above all, the West should stop considering that Russia owes Europe any gas beyond its contractual obligations, which it fulfills with alacrity.

Jérôme Guillet is an investment banker in Paris, specialized in structured finance for energy projects, and the editor of the European Tribune, a website on European politics.

Russia is an unavoidable actor in world energy geopolitics. It is also the biggest energy partner of a European Union (EU) that is becoming ever more dependent on outside sources for its energy needs. However, the future of Russia's largest company-Gazprom-and the development of its future production capacities are at the center of a complex financial and political game dominated by numerous uncertainties, including Gazprom's actual reserves, its ability to invest in exploration and production, and its very capacity to develop production. Indeed, back in state hands, Russian gas and oil companies-Gazprom included-do not appear to be in a position to meet their future production commitments. Gazprom's ability to honor its contracts with gas companies in the EU is in fact already the subject of numerous interrogations.

Christophe-Alexandre Paillard is Head of the Industrial and Technological Trends Department within the French Ministry of Defense's Strategic Affairs Office.

But the most interesting thing, in fact, is that both in our papers, and during the debate, we ended up agreeing on many, if not most, things, the most important of which being:

  • European energy policy is inexistant and what passes for policy (the liberalisation of markets) is indeed considered insane by all;
  • Russian behavior is driven to a large extent by the personal strategies and interests of a few individuals at the very top. There is no overarching geopolitical plan, but a lot of political infighting and short term asset-grabbing strategies. That may be even more worrying in itself than purposeful strategies to use the "energy weapon", but the motivations are different. It is true however that the global energy situation allows Russia to be a lot more assertive, or even brutal, on the international stage, and there's little that can be done about that;
  • there is indeed a lot of uncertainty of what medium and long term production of gas in Russia will be - because of the decline of its existing "workhorses" (the huge fields that current provide most of its production) and the lack of incentives for Gazprom and/or its managers to invest in upstram assets. There are more or less optimistic views on this, but the question definitely exists for all - and brings us back to the lack of European strategy in the face of uncertainty.

The unanimous conclusion is that Europe can actually do something: it controls its own demand, and should focus its efforts on that.

That would mean, for instance, having an energy policy that does not encourage almost exclusively the construction of gas-fired power plants... And yet that's exactly what liberalisation does, as I explained in in this article in the Financial Times, by making it easier to invest in generation assets that are cheap to finance - i.e. those with lower upfront investment costs and higher running (fuel) costs like gas-fired and coal-fired plants.

Of course, that is a topic that is conspicuously absent from the Economist's article, which must sadly be presumed to better reflect the state of mind of our political and business leaders about European energy and Russian gas than the papers of academics or inlookers.

That article focuses on two things, which will not come as a surprise, despite their inherent contradiction:

  • Europe must take a tougher, more united, line against Russia
  • Europe must break up its cartelised market and open up to real competition in order to provide alternatives to Russian gas;

You can stop here for now; I add below some comments on various offensive bits of the article in the Economist.

:: ::

A bear at the throat

The European Union is belatedly grasping the riskiness of its dependence on Russian gas, but it is disunited and short of ideas for how to reduce it

Again, right from the first sentence, boiling blood. It is not the "European Union" that has decided to be worried about its dependence on Russian gas, it is the UK government, nudged by Cheney & co in Washington. France, Germany and Italy, as well as the Central European new members, who are the main importers of Russian gas in the EU, have long been aware of the the significance of importing large volumes of gas from Russia while being completely or mostly dependent on imported gas for domestic needs, and have managed the issue accordingly. Those Central Europeans that are wary of Russia are happy to use the issue to get the rest of Europe to worry more about Russia, but, in practice, as they are the first to be served on the pipelines, it is impossible to cut them and not the rest of the EU, so the risk for them is actually no worse than it is for France or Germany. Even better, they can 'force' solidarity by simply turning the taps.

Thus, as usual for the Economist, "disunited" just means that not all Europeans are on the US line (inspired by hawks around Cheney and helped by Condoleeza Rice's apparent nostalgia for the Soviets), as channelled by the Blair government (and the Poles, all too happy to pile in on anything that can be used to bash Russia).

RUSSIA'S president, Vladimir Putin, must be feeling smug. His strategy of using the country's vast natural resources to restore the greatness lost after the break-up of the Soviet Union seems to be paying off. If power is measured by the fear instilled in others—as many Russians believe—he is certainly winning.

"As many Russians believe"?? Or as the gang in Washington has proven is the only rule they ever follow? Bluster, threats, unilateral action, the odd bombing or occupation of countries, blatant disrespect for the domestic laws of vassals, encirclement by bases, etc... Anybody that refuses to let American oil majors invest in their country declared an enemy and treated as such? Fearmongering at home and attempts at brutish dominance outside have been the trademark tools of the Bush administration. That the Russians respond in kind, especially when they have a strong bargaining position, is hardly surprising nor shocking, if unpleasant from our pespective.

And yet, in this case, to fear him is our choice, because gas trade is a fundamentally bilateral endeavour: the interdependence is mutual, structurally created by expensive infrastructure which hard to replace and impossible to divert to other uses - and codified in long term contracts that reflect the need for each party that the other side perform its obligations for a very long time.

The EU has few ideas for how to deal with its chief energy supplier. “We know we should do something about Russia, but we don't know what,” one Brussels official says. “In the EU we negotiate on the rules, whereas Russia wants to do deals.”

Heh, guess what: the EU does not set the rules for what it does not control. Russia's position is a lot more realistic: the two blocs can only do bilateral deals. But that's a market for you: you only enter into deals that are favorable to you, right? We should never forget this: the Russians have no obligations to sell us any of their gas, only to deliver when they contracted to do so - and they will only contract if it is of any benefit for them. Being bound by EU rules might be beneficial for them, but that's not, as of today, how they see the future of Russia, and there's little we can do about that. Threatening noises are not going to help, there.

Yet dependence cuts both ways. Europe may depend on Russia for half its gas imports, but Russia is dependent on Europe for the bulk of its export revenues. Repeated threats by the Kremlin to divert the flow of gas to China mean little without pipelines that it would take many years to build. Switching off gas to Europe will never make commercial sense for Gazprom. The fear in some EU countries is that commercial interests may one day become secondary to political ones.

A rare moment of sanity in that article (even if it suggests that the disputes with Ukraine and Belarus were about political issues rather than commercial ones, something I vigorously contest and debunked exdtensively in my text above). And yet the Economist continues to encourage the fearmongering and the strategy of alienating the Russians politically, by refusing to take their point of view into consideration, by blatantly provoking them with the missiles in Central Europe, and generally treating them as dangerous neighbors.

If all this is not worrying enough, there is another, more immediate source of concern for the EU: that Russia may be physically unable to produce enough gas to satisfy demand. Even worse than being dependent on a company like Gazprom may be to be dependent on a Gazprom that is short of gas.

The output of Gazprom's three super-giant fields, which account for three-quarters of its production, is declining at a rate of some 6-7% a year. Output from a new gas field brought on stream in 2001 has already peaked. Last year, Gazprom decided to develop a massive field in the Yamal peninsula—frozen and barren Arctic land—but that will take years. Meanwhile, Russia's domestic demand for gas is growing by more than 2% a year. For all its swagger, Russia is short of gas, a problem that is already affecting its electricity-generation capacity. This does not reflect any lack of reserves—Russia has the world's biggest—but rather a longstanding failure to invest enough in their development.

Gazprom has argued that it will invest in new fields only if it can pre-sell the output to Europe. Instead it has been spending lavishly on pipelines and downstream assets.

This reflects the pessimstic view on the long term prospects for Russian exports to Europe, in that the Russians are not doing what they should to deliver all the gas that will be needed (of course, the underlying assumption is that such need itself is not even open for discussion - we need the gas, dammit!). It does reflect an interested agenda as, again, the view that underpins this is that the Russians are really too corrupt to take care of that important business, and they should let "serious" people (like Shell or BP) take care of it.

It also reflects a fundamental ignorance of the structure of the gas business, where the downstream transport infrastructure is the single most important bit of it (being both the most expensive and the most complex, politically and commercially, to set up). Thus blaming Gazprom for investing in export pipelines - and even in distribution capacity at the end of the chain - is like criticizing an icecream merchant for investing in refrigeration capacity...

And it ignores both the way Gazprom behaves (it has always sought to export as much gas as it could), and the point that Gazprom has been repeatedly making (the upfront investments needed to increase production require predictable future flows and thus long term contracts). So far, Gazprom has always produced enough to ensure that it can both export and supply the vital domestic needs. There is no compelling argument yet to say that this will no longer be the case, other than the self-interested lobbying of the Western energy majors and their shareholders. On the other hand, as has been discussed on the Oil Drum (for instance here), there is some doubt on the long term availability of reserves, but that's not the point made by the Economist, which focuses on investment capacity in the medium term (an argument also used on the oil side, to blame the national oil companies and avoid the "peak oil" debate).

Vladimir Milov, the head of the Institute of Energy Policy in Moscow, says that the links between Gazprom and its European counterparts amount to a cartel between wholesale buyers and sellers. The losers in this game are European consumers who are forced to pay gas prices that are several times higher than the wholesale price which their national companies pay to Gazprom.

Considering that gas prices are linked, for very obvious reasons, to oil prices (oil products being the simplest substitute to gas for many of its uses), wholesale prices are what they are. The issue here seems unrelated to Gazprom, in that the Economists lambasts "national companies" (read: the evil French government) for making money off domestic customers. But hey, blame Gazprom anyway.

The best way to increase the EU's energy security would be for it to liberalise its own market and unbundle its national utilities. This would cut profit margins in gas distribution, and thereby reduce Gazprom's appetite for European domestic assets.

I thought the problem was the domination of national markets by former incumbents? Surely Gazprom coming into these markets would provide more competition and lower prices? But in any case, while I understand how that might lower prices for consumers, I fail to see how it would impact in any way wholesale prices, and thus Gazprom's willingness or not to sell us gas.

The European Commission has been urging EU members to break up their vertically integrated energy companies, but France and Germany are resisting. The problem, says the commission, is that national governments do not understand the link between liberalisation and greater energy security.

Or maybe they actually understand it, because they've been working on security for the past 40 years? Liberalisation can help those that did not make the effort to set up long term contracts, diversify sources, build storage capacity to freeride on those that did. No wonder the careful planners are a bit wary of seeing their insousciant neighbors, who have spent the past 30 years scoffing at their prudence while sitting on the North Sea treasure, now claiming their "solidarity" now that the treasure (which they did not share for the greater good of European energy security) is gone.

Origin of natural gas, France. Source: Gaz de France

Source: Financial Times

Europe is also talking of building more LNG terminals that can be stocked by other suppliers.(...) But LNG is expensive, and generally involves inflexible long-term sales contracts. Moreover, the IEA's projections assume that the Europeans overcome their squeamishness about building ugly LNG terminals. Equally improbably, they assume that Russia will not find some way to impede the emergence of rival exporters.

Another unguarded moment of clarity: LNG requires inflexible long term contracts, just like pipelines... It is usually touted as the way to bring spot markets to gas by the most breathless enthusiasts...but in fact it creates almost the same kind of highly interdependant relationships as pipelines. Arbitrage will take place to some extent (by diverting a cargo from one destination to another, when profitable), but will remain a small part of the business.

But the comment about Gazprom being able to "impede the emergence of rival exporters" somehow attributes a lot of power to Gazprom. Or is it an unwlling acknowledgement that Gazprom dominates the European gas market because its gas is, you know,... cheaper? That it's more competitive than alternatives? Hmmm... Of course - that's why we hate them for sitting on that treasury and not letting us grab a slice of the pile.

Russia's ability to cause harm to itself and to others in the cause of proving its greatness should never be underestimated.

Yeah, stupid Russians. Better to blame them rather than ourselves for our inability to even consider burning less of the stuff.


(might not be posted yet, but will be in the near future; the link will work then)

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Apr 28th, 2007 at 10:27:29 AM EST
Thanks for your support.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Sat Apr 28th, 2007 at 11:10:00 AM EST
[ Parent ]
Wikipedia has some data on LNG:


In 1964 the UK and France were the LNG buyers under the world's first LNG trade from Algeria, witnessing a new era of energy. As most LNG plants are located in "stranded" areas not served by pipelines, the costs of LNG treatment and transportation were so huge that development has been slow during the past half century. The construction of an LNG plant costs USD 1-3 billion, a receiving terminal costs USD 0.5-1 billion, and LNG vessels cost USD 0.2-0.3 billion. Compared with the crude oil, the natural gas market is small but mature. The commercial development of LNG is a style called value chain, which means LNG suppliers first confirm the downstream buyers and then sign 20-25 year contracts with strict terms and structures for gas pricing. Only when the customers were confirmed and the development of a greenfield project deemed economically feasible could the sponsors of an LNG project invest in their development and operation. Thus, the LNG business has been regarded as a game of the rich, where only players with strong financial and political resources could get involved. Major international oil companies (IOCs) such as BP, ExxonMobil, Royal Dutch Shell; and national oil companies (NOCs) such as Pertamina, Petronas are active players. Japan, South Korea and Taiwan import large sums of LNG due to their shortage of energy. In 2002 Japan imported 54 million tons of LNG, representing 48% of the LNG trade around the world that year. Also in 2002, South Korea imported 17.7 million tons and Taiwan 5.33 million tons. These three major buyers purchase approximately 70% of the world's LNG demand.

In recent years, as more players take part in investment, both in downstream and upstream, and new technologies are adopted, the prices for construction of LNG plants, receiving terminals and vessels have fallen, making LNG a more competitive means of energy distribution. The standard price for a 125,000-cubic-meter LNG vessel built in European and Japanese shipyards used to be USD 250 million. When Korean and Chinese shipyards entered the race, increased competition reduced profit margins and improved efficiency, reducing costs 60%. The per-ton construction cost of a LNG liquefaction plant fell steadily from the 1970s through the 1990s, with the cost reduced approximately 35%.

So Asia Japan, South Korea and Taiwan are 70% of the LNG target market (France is just before Taiwan in importance). Prices are down. Interesting.

Jerome do you know if there are factual errors in the wikipedia stuff?

Investment don't seem that high to me. Pipelines prices quoted here on ET have been in the 10 billions range., here it's less than half, more flexible and going down. I don't know what the relative value of a LNG tanker shipment and oil tanker are though.

by Laurent GUERBY on Sat Apr 28th, 2007 at 10:54:41 AM EST
Prices have gone down, but they are still pretty damn expensive.

It costs you about $3bn for the whole "chain" - for 5bcm (billion cubic meters)

Pipelines cost that much for about 1,000km - to carry 40bcm. Pipelines can be flexible when they plug in a dense network (as in Europe), just like LNG can be flexible when theyre are already more than a few physically accessible alternatives - in the Atlantic basin, for instance (a cargo from Nigeria canbe diverted to the US instead of Europe, for instance, or vice-versa)

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Apr 28th, 2007 at 11:14:23 AM EST
[ Parent ]
5bcm vs 40bcm, what is the unit of time? year?

I assume the LNG limit is the producer LNG terminal, right?

Useful tables:


by Laurent GUERBY on Sat Apr 28th, 2007 at 11:36:07 AM EST
[ Parent ]
The limit can be any of the links of the chain (the gas feed, the liquefaction plant capacity, the total tanker capacity given the number of tankers you have and the length (and duration) of the rotation, the capacity of the regazification terminal, or the size of the purchase contract at the end.

Most LNG producers engage in "de-bottlenecking" at all times - i.e. precisely increasing the capacity of the limiting link at that time.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Apr 28th, 2007 at 12:04:14 PM EST
[ Parent ]
The issue here seems unrelated to Gazprom, in that the Economists lambasts "national companies" (read: the evil French government) for making money off domestic customers.
I'd've thought that profits from sale by national companies goes into the national coffers, and therefore towards the public good, rather than into the hands of already rich Capitalists. I don't see how this would be a bad thing... Why is profit only good if it lands in private hands? Thus, a nationalised arrangement, while perhaps not benefiting 'consumers' certainly benefits 'citizen-persons', who are the ones the 'nation state' ought to care for, right?

For all its swagger, Russia is short of gas, a problem that is already affecting its electricity-generation capacity. This does not reflect any lack of reserves--Russia has the world's biggest--but rather a longstanding failure to invest enough in their development.
Could there be some long term strategic benefit to not develop gas fields as quickly as possible? I mean, the stuff will run out some day, right? If the fields are developed then the gas would be there, available for immediate consumption, driving demand higher. Whereas unavailability of all the gas we could schlurp ought to stimulate development of alternate energy sources, which can only be a good thing.

So, hey, economist guys, maybe you should know to think that the gas fields of Russia are not an all you can schlurp buffet...

(Thanks for enduring in bringing these atrocious pieces to our attention, Jérôme. I do enjoy the rage they engender...)

by someone (s0me1smail(a)gmail(d)com) on Sat Apr 28th, 2007 at 11:43:11 AM EST

For all its swagger, Russia is short of gas, a problem that is already affecting its electricity-generation capacity.

Actually, this specific point is just typical EU innuendo. It is as simple as this: no, you can not have a piece without symmetrical Russian money being put into EU distribution; no, you will not set Russian gas prices and no, you will not have a piece of nuclear pie without symmetrical access to EU market, and yes, you will have to compete on market terms with access to CA gas with Russian gas-operated utilities.

by blackhawk on Sun Apr 29th, 2007 at 06:13:03 AM EST
[ Parent ]
In today's WSJ Op-Ed pages, this pretty reasonable article (probably behind sub. wall)

The Mirage of Energy Independence

(...) The goal of energy independence is simply an illusion in an age of global interdependence. The goal of U.S. energy security through diversification is not.

Start with a reality check. In 1974, when President Nixon first called for energy independence, America was importing about six million barrels of oil a day from other countries -- a bit more than one-third of consumption. Today, daily imports are around 14 million barrels, two-thirds of our consumption. The Bush administration's prescription, more rapid exploitation of America's own dwindling reserves, could make a difference. But not a big difference: A combination of stepped-up production from offshore wells and successful exploitation of reserves in the Arctic Wildlife Refuge could pare dependence on foreign oil by, at most, a few percentage points over the next few decades. The priorities of the domestic oil industry shouldn't be confused with the priorities of the nation.


In the spirit of diversification it makes sense to provide incentives for R&D in liquid fuels from coal, oil shale and biomass -- though not open-ended commitments to production subsidies like the Brazilian ethanol-from-sugar program or, for that matter, America's ethanol-from-corn program. (...)

The other, more controversial, leg of a fuel diversification program would promote fuel production from more reliable foreign sources. (...) it might well make sense to offer financial incentives and technological assistance to Mexico to develop its deep undersea reserves beneath the Gulf of Mexico. To the same end, it might be useful to extend a hand to Venezuela to exploit its humungous deposits of viscous, high-sulfur heavy oil.

Venezuela's current government is, of course, no friend of the U.S. But the producer-consumer interdependence between the two economies transcends ideology. And in any event, the broad goal is security through diversification -- making oil-consuming countries less dependent on oil from far less reliable, politically problematic sources like Saudi Arabia, Iran and Iraq.

This still focuses only on increasing supply as opposed to working on demand, but at least the proposals are extremely pragmatic, and the focus on the interdependence between suppliers and consumers, even if political enemies, as not a bad thing, is very important (just like it is in Europe with Russia with respect to gas)

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Apr 28th, 2007 at 12:59:35 PM EST
has to serve its masters otherwise this media outlet would be closed long ago.
I believe that serious politicians are not guided by media outbursts in their actions. There is no doubt desire among Brussels frequent visitors to find alternative suppliers of gas. But it's not easy. And I understand Jerome chide these Eurocrats for their childish attitude - they hope that Uncle Sam will negotiate with evil Russkies and will not forget to throw some bones for them if they show enough servility to Washington and they do nothing on their own to diminish consumption of gas or support alternative sources of energy.
by FarEasterner on Sat Apr 28th, 2007 at 01:17:41 PM EST
Some info from Belgium :(was fully reported here in the press as if they wanted to say not to panic for shortages.)

  • Fluxys LNG   29 March 2007
    Today at the Zeebrugge LNG reception terminal a celebration was held to welcome the first ship to dock under the long-term contracts signed with Qatar: for the period 2007-2026 an annual capacity of 7.2 billion cubic metres of natural gas has been booked at the terminal for imports from Qatar.

  • Fluxys LNG

    The Interconnector is operated by Interconnector UK and has curently a capacity of 20 million m³(n)/year in forward flow (Bacton-UK -> Zeebrugge-B) and 8.5 billion m³(n)/year in reverse flow (Zeebrugge-B -> Bacton-UK)

    The UK is expected to become a net importer of gas as early as 2005/2006 as domestic production falls below domestic consumption. By 2010, it is expected to import up to 60 billion m³(n) of natural gas, which represents up to one third of its total gas needs.

    In order to meet such predicted increase in demand from the UK market, the Interconnector operator has recently decided to add further compression capacity at the Interconnector Zeebrugge Terminal (IZT).

    This would increase the Interconnector's reverse flow capacity between Zeebrugge and Bacton to 16.5 billion m³(n) per year, enabling transport of an additional 8 billion m³(n) per year of natural gas into the UK market. This reverse flow capacity can be increased by a further 6 billion m³(n)/year by adding 2 additional compressors.

  • Fluxys LNG
    Considering the strategic location of the terminal, Fluxys LNG launched in early 2003 an open season market survey for LNG companies to express interest in booking capacity as from 2007.

    As a result of this market campaign, an overall capacity of approximately 9 billion cubic metres per year has been booked at the terminal as from 2007. In order to meet this demand, Fluxys LNG has decided to invest €165 million in doubling the terminal's throughput capacity.

The struggle of man against tyranny is the struggle of memory against forgetting.(Kundera)
by Elco B (elcob at scarlet dot be) on Sat Apr 28th, 2007 at 01:52:27 PM EST
[ Parent ]

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