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Alexander Khurshudov: Long-term agreements on gas supply with the EU makes no sense for Russia anymore

March 22/ 08:11

Moscow, 13 March 2017. Threatened with fines from the European Commission… Gazprom agreed to drastically reconsider the pricing for the Eastern Europe and the Baltic countries, according to the European Commission press center’s report issued on Monday.      

The price of gas supplied under the contracts with Poland, Lithuania, Latvia, Estonia, and Bulgaria, where Gazprom has more than a half of the market-share, will from now on be tied to the prices in the Western Europe. A clause, which provides for the price revision in case of its significant deviation from the price established at the border of Germany, France, Italy or the West European gas hubs, was added to the supply agreement.  

These were the terms on which the European Commission agreed to settle the claims imposed on Gazprom in 2012, accusing it of monopoly abuse. Besides, Gazprom agreed to drop all direct and indirect restrictions preventing its clients to resell gas over the state borders in the European Union, which will also lead to price equation in the EU. Finally, Gazprom agreed not to impose any financial claims on Bulgaria for its decision to refuse constructing the South Stream project.

Alexander Khurshudov, the Oil and Gas Information Agency expert, comments on the news:

The western mass media happily called this piece of news a big victory over the Russian monopoly, but we won’t jump into conclusions and go deeper into the issue. It covers the following facts.

1. It makes no sense for Russia to enter into long-term agreements on gas supply with the EU countries anymore. They are not self-reliant. Having made an agreement, they, like spoilt enfant terrible, run to their daddy European Union, which has its own laws and very loyal courts. The worthy disciples of Hitler, they make agreements only to break them. It’s only that Hitler had an army to do the robbery, they have their legal system.      

2. Some clauses of the existing contracts are really outdated and need changing. I’ll add some details.

From time immemorial Russian gas has been the cheapest in Europe, so some had been making money reselling it. That is why the prohibition on its reselling was quite reasonable. But it has been broken many times. Unfortunately, tracing such deals and recovering the damage is impossible.      

The main participant of this black marketeering is obviously the Ukraine: in 1991 it imported as much as 95 billion cubic meters of gas, in 2009 under the new higher prices - 27 billion, but last year it contented itself with 10 billion. Now Slovakia, Poland and Hungary are reselling gas to the Ukraine, but this is impossible to dispute in any way. The ban on reselling should be lifted because it is impossible to comply with. All it takes to stop fueling the black marketeering is to REDUCE  SUPPLY.

Gas projects are expensive, they pay back in 10-15 years’ time, so the investors needs guaranteed sales. Nobody is going to build a long pipeline without a long-term contract with the customer. But our pipes in Europe have been working for 30-40 years now, they have long ago returned the investment. Thus the principle “take or pay” in the contracts with the EU can be replaced with softer sanctions. The customer is concerned that during a warmer winter they won’t need excess gas. We’ll change that. However the gas price should grow a little. If the customer wants a benefit, he should pay for it.   

That is what the European partners’ cheating is all about: first they negotiate a low price and then go to their home courts to discharge from their obligations.

3. The chances to recover compensation from Bulgaria for their refusal from the South Stream project are pitifully small. Bulgaria is the poorest EU country, depending on loans; besides, winning the case in the hostile courts is hardly possible.     

4. During the recent years the situation on the European gas market has changed a lot. Let’s look into the details. 

This market is losing its once dominant position. Gas consumption in Europe has declined by 90 billion cubic meters (18.3%) over the last 10 years. Material production in Europe is declining, and banks, stock exchanges and media holdings do not need gas. Though, gas production has also decreased by 80 billion cubic meters. Besides, gas became expensive, they started saving it.   

Europe is persistent in the idea of a free gas market. 9 virtual gas hubs (trading floors) have already been created there. The biggest ones are in the Netherlands, England and Germany, but in the Czech Republic and Poland the trade is slack. The idea is to reduce the prices by means of virtual trading and tie the big suppliers to these prices. At the moment 3 trillion cubic meters of gas (85% of the global consumption!!!) are sold in the EU every year, but only 10% of them are actual deliveries. And a good half of them accounts for secondary sales of gas, including Russian gas.

The European Commission managed to force the domestic gas producers to play by these rules easily – they have no other markets. They were accused of the same thing as Gazprom, that is of overpricing. Their logic is simply fascinating. First the customer signs the contract, receives the gas, pays for it and consumes it and then goes to court, asking back the money he “overpaid”. They are nothing else but swindlers.        

Nevertheless, the Norwegian Statiol and the Dutch Gas Terra, when threatened with penalties, agreed to amend their contracts and feasibly reduced the sanctions for insufficient gas consumption and partially tied their prices to the spot market.

Foreign supplier proved to be more difficult. The Algerian Sonatrach unwillingly makes some minor concession to the customers even after the fine of $300 mln. Gazprom, which has amended its contracts for 65 times now, holds to the same approach. They agree to some temporary benefits and discount for their customers just to save the contracts’ basis. Now is the time to change even the basis.

I have the impression that Gazprom’s managers understand the core of the problems and are preparing to change their strategy in advance. The strategy is not widely discussed, so I’ll present it as I see it.

It has to be admitted that competition has appeared on the European gas market. It is weak and humble, but it does exist. Previously Gazprom couldn't halve the supply or the customers would have been freezing, now it can. So, it would be good it use this fact.

Gazprom has to stop working as a monopolist. They should reduce the supply to Poland, the Baltic counties and Bulgaria, so that it does not exceed half of their consumption. This measure will have a double benefit. First of all, there won’t be further lawsuits and along with that the angry rumours about “Russian gas weapon” will subside. Secondly, some shortage of gas will cause the prises to rise on the spot market.

The prices under long-term contracts must under no circumstances be tied to the spot gas market. This means resigning oneself to the stockjobbers' control. During the last 10 years (see the picture) the spot price changed fivefold, from $100 for 1000 cubic meters to $540. How do you like this “guideline” for a ten-year contract?

Picture

Since Europe is going to insist on this tying, we need to stop making long-term contracts with it. We should work under standard 2-year contracts flexibly tied to the petroleum products prices. We should decrease the amount of guaranteed supplies, so that it wouldn’t put pressure on the supplier and the customer. The excess gas shall be sold at auctions. If gas is expensive on the spot market, we’ll offer it for sale. If it is cheap, we’ll keep it, it won’t go bad. Last year Gazprom tried this strategy and got good results.      

Supplies under gas swaps are also perspective. For example, we can trade gas with India via Iran, and Iran can trade with the EU via us. By doing this both sides benefit from cheaper transport. Seeing the weakness of their position, Europeans are trying to awkwardly intimidate Russia. They have been threatening us with shale gas supplies from the US for a long time. Then Lithuania, like a rich man's daughter, contemplated about breaking the contracts with Gazprom. Now Polish officials are blabbing about it, having increased the import of Russian gas by 24%. Let’s pretend we believe it, let them have fun for a while. The birdie twitters, but the caravan moves on.

P.S. Gas production in the pioneer Barnett field declined by 14% last year. The decline rate in the Netherlands are even higher, 23% a year. There is still an increase only in Norway, due to the deepwater shelf. 

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