NORD STREAM II: MORE GAS
Russian energy producer Gazprom is preparing to offer to sell more natural gas to Europe at spot prices to ensure European companies' support for a planned pipeline bypassing Ukraine, industry sources say.
Worried that conflict-ridden Ukraine is not a reliable transit route, the state-run company signed a shareholders' agreement with five European firms last month to build the Nord Stream II pipeline under the Baltic Sea to Germany.
But Gazprom is under pressure from the European Union to change its policy of selling gas through long-term contracts linked to the price of oil because the European Commission, the EU's executive, says this leads to overcharging.
Gazprom sources said the firms that signed the shareholders' agreement - Germany's E.ON and BASF, Austria's OMV, France's ENGIE and Royal Dutch Shell - had done so in expectation of a change in the huge Russian company's export pricing policy.
"There are some agreements between European partners and Gazprom that they will be guaranteed more gas will be sold on a spot basis if Nord Stream II is supported (by them)," a Gazprom source said.
"In fact, more flexible pricing may be introduced, without a rigid link to the oil 'take-or-pay' (condition)."
A second Gazprom source said the European firms that had shown support for Nord Stream II had largely done so because they had "a hope" of receiving more gas at spot prices.
Gazprom has already tested a new pricing mechanism, by selling just over 1 billion cubic metres (bcm) of gas through a tender - its first ever - in the former imperial capital St Petersburg last month.
This, industry sources say, paves the way for introducing a new trading and pricing model more widely, especially now the peg against oil is less profitable because the oil price is low.
"Only Gazprom can say how the new gas volume shipped via NS2 will be commercialized, as it will be able to sell gas via big long-term contracts, directly on the European hubs, or via public auctions," an Engie spokeswoman in Paris said.
The gas price set in Gazprom's long-term contacts is now lower than the price on the European spot market - where buyers pay the price on the day of purchase or a price set in the future, rather than being locked into a contract where the gas price usually lags oil price moves by six to nine months.
Changing the terms of the contract appears intended by Gazprom to boost sales by offering gas priced in a way that encourages consumption in Europe and so appeals to Gazprom's European partners.
It could also help defend Gazprom's gas market share in Europe from LNG exporters such as those in the United States and Qatar who might try to dump supply in Europe due to a global glut of the fuel.
DIVISIONS OVER NORD STREAM
Gazprom is fighting to defend market share in Europe, which is now oversupplied, betting on rising long-term demand as Europe's indigenous gas sources decline.
It is also looking for ways to deliver gas to Europe without sending it through Ukraine.
Russia provides around a third of EU energy needs but about half the gas the EU imports from Gazprom is shipped via Ukraine, whose relations with Moscow have soured since Russia annexed the Crimea region in March 2014 and pro-Russian rebels rose up in eastern Ukraine shortly afterwards.
Gas pricing disputes between Moscow and Kiev have at times led to disruptions in supplies to Europe but Russia, whose relations with the West have sunk to post-Cold War lows over its role in the Ukraine crisis, says there is no political motive in trying to bypass its fellow former Soviet republic.
"Nord Stream has no connection to (Ukrainian) transit and does not harm anyone," Russian President Vladimir Putin told an investment conference on Tuesday.
European countries are divided on the project, with some opposing the route as it may result in lower transit fees. The European Commission has underlined that the project must comply with EU laws.
Nord Stream II would consist of two lines, doubling the 55-bcm annual capacity of the Nord Stream offshore pipeline which already runs from Vyborg near Russia's border with Finland to Greifswald in Germany.
The new pipelines are due to start transporting gas by the end of 2019. Gazprom which has put the cost of the plan at up to 9.9 billion euros ($11.28 billion).
Gazprom had planned another route known as South Stream but scrapped it last year following objections by the European Union and proposed a new project, TurkStream, under which gas would flow under the Black Sea to Turkey and then on to the EU.
The TurkStream project is also now in doubt after Gazprom altered the proposed capacity and postponed its launch.
"Industry doesn't trust Ukraine. We don't know how good or bad its pipeline infrastructure is," said Thierry Bros, energy analyst at French bank Societe Generale.
"Gazprom's transit contract with Ukraine expires in 2019 –you will see further muscle-flexing and arm-twisting around that time by Ukraine to extend the deal on identical terms. This will raise transit risks."
Gazprom has little option but to take into account calls in Europe for more gas sales based on spot prices, a European industry source and two Gazprom sources said.
"What I can say is that it would be more preferable for Gazprom's European counterparts to take the gas based on market-hub prices. For sure it's a more welcome model," the European industry source said.
A source at Engie said: "If they (Gazprom) want to increase volumes sold into Europe then they have no choice but to sell at market prices."
Gazprom has not disclosed the pricing mechanism for its auctions, saying only that the first tender had a price higher than in its long-term contracts.
The average cost of gas on European spot markets for delivery this winter is around $231 per 1,000 cubic metres, compared to Gazprom's average of 195.9 euros ($223) for the winter of 2015/2016.
An industry source told Reuters that the auctions planned for this and next year should result in "establishing a mechanism for the regular sales of more spot-based gas with long-delivery terms".
Citing International Energy Agency forecasts that European gas production will fall while demand grows, BASF told Reuters in e-mailed comments that "gas imports have to increase tremendously with a need to create new infrastructure."
"The project Nord Stream II ... would contribute as secure and direct energy supply to close this gap," BASF said.
It, and OMV, did not comment on the gas pricing mechanism.
Gazprom, Shell and E.ON did not respond to requests for comment.
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