- Russia and China agreed to a second gas deal this month. This time, it is for the same supplies that flow towards Europe.
- Together with the decline in natural gas production in the North Sea, a potential loss of Russian gas volumes could cause a one third drop in current EU supplies.
- Russia’s shift towards the East will shift the main LNG market to Europe, which is not economically as prepared to deal with the higher prices, hurting Europe and LNG exporters.
Only a few months ago, we witnessed a huge $400 billion gas deal signed between Russia and China. Western media largely greeted the deal with some partisan dishonesty, falsely claiming that Russia was taken advantage of by China, despite the fact that most indications are that China agreed to pay a similar price of around $360 per 1,000 cm as the EU currently does, with the price fluctuating in tandem with oil prices. Now we have news about another deal that I warned about in an article in September, which has the potential to pit the EU against China for the same Western Siberian gas supplies. Back then it was just talk about a deal in November with unspecified details, while now we are presented with the reality of a deal having been agreed to for 30 billion cubic meters per year in addition to the 38 billion cubic meters agreed to in the previous deal.
It is news that very few people paid attention to, despite the dramatic long-term effects this will have on Europe’s already struggling economy. Even as the deal was made public, there has been very little reaction. Very few people in Europe are jumping to launch a public debate about its ramifications. It is as if it does not matter, even though it matters greatly.
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The main ramification of this is that Russian gas will no longer be the price setter in the EU. More expensive LNG will be the new price floor, because the EU will not be able to do without it, just as it currently has no way of doing without Russian gas. This means that the EU, which already pays on average more than double that Americans pay for natural gas, are facing an increase from around $350/1,000 cm to a price in the $450-500 range, which is what countries like Japan are willing to pay. The EU already has the installed capacity to import about 200 billion cubic meters of LNG, which is more than the roughly 160 billion cubic meters of gas it currently imports from Russia. It does not import that LNG because it has such an uncompetitive price. Only about 20% of the capacity is put to use.
As I pointed out in my September article, in the absence of much better relations with Russia, the EU is looking at the prospect of a 150-200 billion cubic meter gap between demand and supply by 2030. The principal cause of the gap is the North Sea production decline in countries such as Netherlands and to a lesser extent Norway, as well as possibly losing about 50 billion cubic meters out of the 80 billion that currently flows through Ukraine.
The Nord Stream, as well as the Yamal pipeline, with a capacity of 55 and 33 billion cubic meters respectively can pick up about 30 billion cm of the flow that currently goes through Ukraine, due to current excess capacity. In the absence of South Stream which is being obstructed by the EU and the US through pressure on EU member states, the remaining 50 billion cm currently flowing through Ukraine are put into doubt, due to Russia’s reluctance to continue to rely on the route. Even if Russia were willing to continue to export gas through Ukraine, it would not be able to in the future due to technical issues related to the aging pipeline infrastructure which Ukraine cannot afford to fix and no one else is willing to invest in fixing it either.
Given the prospects of losing about one third of current EU supplies and only a few viable alternatives for pipeline delivered gas, with comparatively small potential supply additions, such as perhaps 10 billion cubic meters from Azerbaijan, massive LNG imports will be the only alternative. The shale gas revolution which may turn the United States into a net gas exporter is not taking off in Europe. Legal barriers set up by individual states are most often cited as the main reason behind the lack of shale gas drilling. Unfortunately, very little attention is being paid to the fact that shale gas exploratory drilling did take place in countries where the EIA estimated massive potential reserves, such as in Poland, Hungary and Romania, yet so far results have been very disappointing.
Just this month, Romania’s prime minister declared that there is no more point in debating the issue of shale gas in Romania, because results from Chevron’s exploratory work show that there likely isn’t any commercially viable shale gas worth talking about. Chevron did not comment on the specifics of the drilling results yet. The EIA estimated technically recoverable shale gas reserves in Romania of 1.4 trillion cubic meters (45 trillion cubic feet).
Long before this latest shale gas disappointment in Romania, Poland also showed us that the shale gas revolution happening in the United States may not be replicated to as great of an extent in other parts of the world, including in Europe. The EIA originally estimated Poland’s shale gas reserves at 148 trillion cubic feet (4.6 trillion cubic meters). As of this fall, it has been announced that commercial production cannot be achieved due to very poor gas flows per well, and most fracking companies already pulled out (link).
Winners and Losers of Russia-China gas deals.
The obvious winner of the deals is of course China. It is also the victim of recent bad news in regards to its domestic shale gas potential, which the EIA claimed China has more of than any other country. Recently it was disclosed that China’s ambitions of reaching 60-100 billion cubic meters of shale gas production per year will not come close to being met. The best they can hope for is about 30 billion cubic meters (link).
This news could not have come at a worse time for China, given the pressure it is under to do something about its emissions. China needs to at the very least stop increasing coal consumption substantially. Preferably, China should reduce coal demand in order to mitigate its smog issues. Within this context, the Russia deals should have been expected and should not be put into the false context of deals that China was able to pull off thanks to the difficult position Russia is in, because these deals obviously meet the urgent needs of both parties to the agreements.
Some other winners in these deals are Norway and the Netherlands, both of which are net natural gas exporters to EU members. For the remainder of the years that these countries will be net gas exporters, they will likely be able to fetch a much better price. The Netherlands will only enjoy this for a relatively brief period, because it will become an net importer in about a decade or so. Norway will be able to enjoy for much longer, given that presently it uses very little of its own production, so it will be able to export long after production will start to decline. Many companies involved in North Sea gas extraction also stand to benefit, such as Shell (RDS.A, RDS.B) and Exxon (NYSE:XOM), which among other projects in the region are joint developers of the Giant Groningen gas field in the Netherlands. Other companies of note which are involved in the North Sea are British Petroleum (NYSE:BP), Connoco Philips (NYSE:COP), Talisman Energy (NYSE:TLM), Statoil (NYSE:STO) and BHP Billiton (NYSE:BHP).
The higher price will be courtesy of the increasing role that LNG will play in the European market, which will provide a price floor that will be significantly higher than current Russian supplies. Unfortunately for LNG exporters, the price will most likely not be high enough to prevent at least some of them from losing money. The European economy is extremely fragile and there is only so much it will be able to take in terms of higher natural gas prices before demand destruction begins to set in. Asia would have been a much better customer for LNG, because the Asian economy is far more solid, with robust growth helping to cushion the negative effect of higher commodity prices, including natural gas.
Companies such as Chenniere (NYSEMKT:LNG), which is heavily invested in building LNG export infrastructure in the US, can end up suffering from having to cope with rising natural gas prices in the US as well as lower pricing power as Russia shifts its gas away from Europe, causing a shift for the LNG market to the EU. Companies like Shell and Exxon, which may benefit from higher natural gas prices in Europe thanks to their North Sea projects, will also lose due to depressed LNG prices due to the shift of the market from Asia to Europe due to their involvement in LNG projects in North America. Companies such as ConocoPhillips can also be affected due to its involvement in Australian LNG, which is specifically geared towards the Asian market.
The Asian market may be further undermined as Russia continues its shift to the East. A pipeline to Japan has been something on the minds of the Russians as well as the Japanese for a few years now. Japan is currently following the West’s lead on sanctions against Russia, but it would not take much of a relaxation of tensions before Japan would turn and follow its own interests. After all, Ukraine is a very distant issue for Japan, while its economic competitiveness is something that its leadership is very eager to restore. Cheaper natural gas, especially in the aftermath of the Fukushima nuclear disaster, would be a very welcome development.
Just how fragile and price-sensitive the European market will be for LNG can be better understood if we look at who the main customers will be. Germany, Britain, Netherlands and other stronger economies will still be supplied by Russian gas via Nord Stream and Yamal, as well as continued exports from Norway. These countries are stronger economically. The current Ukraine transit route supplies countries such as Slovakia, Romania, Hungary, Bulgaria, Italy, Greece, Slovenia, Croatia, Serbia and Austria. Aside from Austria, all these countries are economically vulnerable and fragile, with little ability to tolerate a higher natural gas price than the already more solid and more competitive northern EU countries will pay. The last thing these countries need is another competitive disadvantage. Austria may look solid on the surface, but given its huge banking sector exposure to many countries I listed as being already relatively uncompetitive, it is pretty much in the same boat with the rest.
These countries do not need LNG to replace Russian gas. They need the South Stream project to bring cheaper Russian gas for which they can afford to pay. In the absence of such a project, the only alternative will be an even more uncompetitive European Union, which will become the main market for LNG. That is bad news for the LNG industry, especially in the light of more and more reports of cost overruns in places like Australia and the United States. The last thing the industry needs is a feeble, sickly economy as its main customer.
Given the results already evident in the events of the past year, there is only one way to prevent the EU as well as LNG producers from becoming the victims of current events. The EU should approve the South Stream project as soon as possible in order to prevent further loss of future Russian supplies, which Europe will need in increasing volume given the expected production declines in the North Sea and disappointing shale gas results thus far. With the South Stream pipeline in place, the EU would not increase its dependence on Russia, but merely make up for expected losses from Ukraine ceasing to continue to be a transit country. In order to make up for significant production declines in the North Sea, it should also consider other suppliers such as Iran and Iraq, in addition to Azerbaijan and North Africa. I should point out however the obvious disruption risks to these potential sources.
Moving potential Russian Iranian future gas away from Asia would also benefit LNG exporters in places such as the US, Canada and Australia. The Asian market would be a much better fit for them than Europe. It is a market that is growing, with economies that are also growing at a pace that is robust enough to be able to absorb the higher cost of LNG. That is in sharp contrast to the EU customers, many of whom are undergoing a process of dis-industrialization, as is the case with Italy for instance.
I understand the geopolitical view and desire of the Western leadership to keep Ukraine in play as a gas transit route between the EU and Russia, which is causing them to ignore the negative economic consequences. It is perhaps time to understand however that Russia already made the decision to eliminate Ukraine as a transit route for its gas. The first step was taken when Nord Stream was built. South Stream was going to be the next and final step. Given the obstructions put up by the EU and the US for South Stream, Russia decided to divert the gas East. Any further actions taken to obstruct the South Stream project will only end up hurting many EU members economically and indirectly harm the interests of LNG producers. Geopolitically speaking, there is nothing left to play for.
Zoltan Ban is the author of Sustainable Trade and has a double honors degree in history and anthropology, as well as a BA in economics.
The statements, views and opinions expressed in this column are solely those of the author and do not necessarily represent those of Oceania Saker.