EUROPE WILL SHOOT ITSELF

The growing tension between the West and Russia over the annexation of Crimea accentuated all problems that have plagued gas ties between longtime partners. The West threatens to introduce serious economic sanctions against Russia, including the halt of purchase of Russian energy, a ban on technology transfer to Russian companies working in the fuel and energy sector, investments in field development and infrastructure construction. Experts and businessmen are inclined to think that neither Russia nor Europe would benefit from deteriorating ties.

Today, a set of sanctions is in effect against Russia over its annexation of Crimea. In particular, talks on a new Russia-EU framework agreement and visa regime liberalization have been halted, visa bans have been imposed on a number of Russian officials and their assets frozen. If the situation deteriorates further the West threatens to introduce economic sanctions against Russia. Potential backlash might hurt Russia's banking sector, trade, services rendered by European firms to Russia's oil and gas companies. Sanctions on the oil and gas sector could include bans on technology transfer, investment into new fields development and infrastructure facilities, as well as insurance and logistics services.

Russian Dominance

Russia supplies around 150 billion cubic meters of gas to Europe annually, covering approximately a quarter of the European Union's (EU) gas demand, and providing one-third of EU's gas imports. Russia is linked to Europe via pipelines and some 80 percent of its Europe-bound gas is shipped through Ukraine where recent events have sparked a blaze. In Europe, Gazprom markets a third of all gas it sells and European sales account for more than half of the company's revenue. Ukraine, one of the largest consumers of Russian gas, is not able to pay for it.

As the events in Ukraine escalated, European politicians rallied support to reduce dependence on energy supply from Russia. Despite talking about that for several years and taking specific steps such as the adoption of the Third Energy Package and open lobbying of gas pipeline construction from Trans-Caspian states to counter Russia's own trunkline projects, today those calls trigger a rather sensitive reaction. Particularly painful was the European Commission's move to postpone its decision (after almost agreeing upon it) to grant Gazprom exemptions from the Third Energy Package in regard to the use of OPAL gas pipeline (an offshoot of Nord Stream), which had been built on German territory by local companies. However, such stance of the European Commission has met resistance of its own business community. In his recent interview with the Moscow-based Vedomosti newspaper, Wintershall chief Rainer Seele said that as the gas transit crisis looms, Europe more than ever needs supply from both Nord and South Stream, Russia's Europe-bound trunklines by-passing Ukraine. The OPAL trunkline's throughput capacity totals 36 billion cubic meters per year, which represents one-third of Germany's current gas demand and is slightly less than the volumes shipped to Germany by Gazprom.

Industry experts and entrepreneurs maintain in unison that Europe won't be able to quickly reject Russian gas supply and, moreover, would be hurt itself if it did so.

Seele, who heads the Russian-German Chamber of Commerce, spoke "on behalf of German members of the chamber" against any sanctions on Russia since they could disrupt existing ties between the two countries on the largest scale.

Sberbank CIB analyst Valery Nesterov thinks that EU can't substitute Russia's gas with supply from other sources and in such case energy prices would significantly rise. It needs to be noted, he adds, that European economy is less competitive than U.S. economy from the point of view of energy, particularly in the petrochemical industry.

In March, James Ratcliffe, the chairman of INEOS chemicals giant, told European Commission head Jose Manuel Baroso that he was concerned the U.S. "shale revolution" was threatening European petrochemical and gas chemicals industry. According to Ratcliffe, the reasons behind European chemical companies' weakened competitiveness in the global market were prices of raw materials (gas) and electricity: gas in Europe is three times more expensive than in the United States, and European electricity prices are 50 percent higher. In Ratcliffe's opinion, if appropriate measures aren't taken, the majority of European companies could shut down in the nearest 10 years. He noted that in UK 22 chemical plants have closed since 2009, and new plants are not being built while China intensively builds new facilities.

Fitch Ratings said that EU's potential ban on imports of Russian gas would cause further complications for the European economy and industry.

According to the agency, immediately after introducing such a ban Europe would face a shortage of gas on the backdrop of high prices caused by limited ability to reduce demand, provide supply from alternative sources and ship gas to the countries that would be the most vulnerable under new conditions. As the aftermath of the ban, the gas price jump would trigger a chain reaction that would see a surge in electricity, coal and oil prices. The worst hit due to shortage of gas would be steel and chemicals industry, add Fitch analysts.

Grounded Skepticism

EU politicians assert that Europe would be able to substitute Russian gas with U.S. supply since Washington had been trumpeting for long about its grandiose plans to export LNG in coming years.

However, experts are unanimous on this issue as well: this cannot happen in the near future. Yelena Fyodorova, deputy chairwoman at the Refining Equipment Chair of the Gubkin Oil and Gas University in Moscow stresses that conversion of U.S.-based LNG reception terminals into export terminals would take at least 18 months to two years. In addition to this, there is also the lingering issue of shortage of tankers that would deliver that LNG.

This point of view is shared by Seele. "It's unclear what amounts of excess U.S. gas are being talked about and what the final cost of that gas would be at European terminals. It's difficult to assess how ready the existing infrastructure is for shipments from the United States, whether there is a sufficient number of tankers, for instance. Mass shipments of U.S. gas are definitely a remote prospect, not the near future forecast," he said.

According to Fitch, growth of gas production in the EU and gas supply from North Africa could compensate only a fraction of deliveries from Russia, while the global LNG market can offer only limited volumes since LNG is supplied on long-term contracts and the entire global LNG output equals only 50 percent of Russia's natural gas deliveries to Europe.

Even if LNG reaches European terminals located primarily in the south and north of the continents, where dependence on Russian gas is smaller, sufficient pipeline infrastructure would be required to deliver that gas to buyers in central and eastern Europe, maintains Fitch.

Europe is unlikely to give up Russian gas over a longer term and that could happen only if the Ukrainian crisis seriously deteriorates, adds Fitch. Temporary disruptions in supply shouldn't be ruled out in case of a "transit crisis," but that problem could be minimized by using the Nord Stream pipeline. In that case, the European Commission's permit to use the OPAL trunkline to full capacity would come in handy. OPAL is currently pumping only half of its total capacity. Seele notes that supply disruptions aren't a major issue for the time being since Europe has enough gas in underground storages.

Russia Going East?

Preparing their response to the West, Russian authorities have been talking about imposing their own sanctions, as well as about their plans to reroute energy deliveries to the East. Moreover, Russia has been long targeting the Asia-Pacific region in its attempt to diversify gas exports: Gazprom is in protracted talks to deliver pipeline gas and LNG to China and South Korea, and a number of Russia's independent gas producers have pledged to build LNG plants that would cater to Asia-Pacific buyers. Industry experts agree that Russia's current clash with the West could accelerate Moscow's decision to accept China's offer for the purchase of 38 billion cubic meters of Gazprom's gas per year and build a Russia-China gas pipeline, which has been discussed for over 10 years now. According to Tatiana Mitrova, head of Russia and World Oil and Gas Sector Dept. at the Energy Research Institute of the Russian Academy of Sciences, Russia needs this deal very much under current circumstances, as much as China needs it in its attempt to access Russian energy resources. At the same time, adds Mitrova, the key aspect in talks with China is not the price, since Beijing is buying gas from other suppliers at even higher prices than Gazprom's, but the access to Russia's upstream assets, as China's major goal is to have control over the entire supply chain. Mitrova hasn't ruled out that the potential agreement could expand beyond the gas business and include cooperation in other sectors, too.

Meanwhile, foreign firms aren't rushing to leave Russia. Total representatives said they were ready to increase the number of oil and gas projects in Russia, while Seele noted that "it would be better to launch another project in Russia" before going to new petroleum "Meccas" such as Iraq, Iran and Mexico.

"What If" Scenario

Though Russian President Vladimir Putin thinks that it's impossible for Europe to give up Russian gas as certain European importers completely depend on deliveries from Russia, he did say that such a move could cost the federal budget $28 billion. It's still many times less than revenues from oil sales, which range between $191 billion and $194 billion, and oil is traded globally.

By the way, $28 billion is approximately the amount of debt, which Russia is nudging the new Ukrainian government to repay. Putin clearly stated that if Ukraine fails to pay the bills for current gas deliveries amounting to $2.2 billion, starting from June Kiev would have to furnish 100-percent down payments for new supplies. This, in turn, could trigger disruption in gas transit to Europe.

Besides this, Russia is seeking around $11.4 billion from Ukraine, which is the amount of the gas price discount provided to Kiev as part of the deal to let Russia's Black Sea Fleet lease Crimean naval facilities (the so-called Kharkov Accord, signed in 2010, was annulled after incorporating Crimea into Russia). Russia also invoiced Ukraine for the gas it didn't draw from the pipelines in 2013 under the take-or-pay agreement. Additionally, late last year Moscow loaned $3 billion to Kiev through the purchase of government bonds, so Ukraine could use the cash to repay its gas debt. All in all, debts amounted to $28 billion. Russia is calling on the Western nations, which are threatening to impose sanctions on the Kremlin, to provide loans to Kiev so it could pay for Russian gas and not disrupt deliveries to Europe. That is, if Europe decides it doesn't want to disrupt them itself.

Foreign Presence

Currently, the interests of European and U.S. business community are widely represented in the Russia's oil and gas sector as all global majors have operations here. Germany's Wintershall и E.On are involved in ongoing gas projects in Russia (joint gas production projects with Gazprom and participation in the Nord Stream gas pipeline by-passing Ukraine), France's Total is involved in Yamal LNG and Termokarstovoye gas field project with NOVATEK, another French company, Gdf, is also involved in Nord Stream, as is the Netherlands-based Gasunie, Anglo-Dutch Shell is one of the stakeholders in Russia's first LNG plant as part of the offshore Sakhalin-2 project and has a joint venture with Gazprom Neft to produce tight oil, U.S.-based ExxonMobil is part of the Sakhalin-1 offshore project and a partner of Rosneft in geological exploration projects, Norway's Statoil participates in the Kharyaga production sharing agreement, and also partners with Rosneft in geological exploration, Italy's Eni recently earned huge revenues from the sale of its stake in the SeverEnergiya production asset and is also Rosneft's partner in several projects, while the UK-based BP holds shares in Rosneft, which today is Russia's largest oil company. Besides these companies' participation in Russian projects, an enormous chunk of equipment and technology supply market is held by Western companies, and numerous EPC contracts in Russia's oil and gas industry are awarded to foreign engineering firms. 

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