GAZPROM WILL BACKFIRE

What does the energy future hold for Europe amid the Ukraine crisis? Can the US LNG and shale gas become alternative for the Russian Gazprom gas in Europe? Is Russia to play the Gazprom card on the continent during the approaching heating season? Mikhail Krutikhin, a partner of RusEnergy, a Russian consulting company specializing in monitoring and analysis of tendencies in oil and gas industry of Russia, Central Asia, Azerbaijan and Ukraine, and also a renowned critic of the Kremlin and Gazprom policies agreed to answer the Natural Gas Europe questions.

What is your take on talks about a new energy future for the transatlantic community and Europe specifically? Are LNG export expectations to the EU founded?

It depends on the angle you're looking at the relations in the transatlantic community. The US shale gas export expectations in Europe are just simply unsubstantiated as the first US and Canada shale gas exports can reach Europe not before than two years from now.

Importantly, it is just too early to expect the supply volume to be high. The overseas shale gas exporters have already two contracts with the United Kingdom and one with a Spanish company. But, once again, it will take two years at least to have the first shipment done.

Speaking of the American liquefied natural gas, first, there's still no LNG facility in the United States capable to send it to Europe. Second, the US companies has already serious contractual commitments for Asian market, not Europe.

When recently a member of the European Commission - one of the commissioners, if I'm not mistaken - pleaded with the White House to facilitate and expedite US natural gas delivery to Europe, a bigger nonsense could have not come from anyone's lips.

I really believe the EC guy has missed his arithmetic lessons at school. He was obviously under an impression that the White House resident Barrack Obama can call up all the CEOs of the American oil and gas companies and tell them in an executive order to start exporting US natural gas to yet non-existent export direction. Furthermore, by the price twice lesser the price they get from the Asia exports.

The man perhaps was brought up in the Democratic Republic of Germany where the Communist Party would tell state companies whom to sell gas and what prices to apply, and et cetera.

Obviously, this does not work for the United States and Canada, so, please, stop expecting the US natural gas any time soon.

While the US alternative looms, where else do you see Europe's potential gas supply alternatives?

I'm not in a position to make the predictions, but the bottom line is the approach has to be diversified. Speaking of America's LNG, yes, indeed Europe can accept it in large quantities here, because half of the re-gasification facilities in Europe are not used. In other words, their storage capacity is much larger than the LNG export volume Europe sees now.

For Europe it is very important to find other LNG supply sources. For example, put hands on the deposits in the Caspian region. In fact, the Caspian region countries were about to launch a project at the end of September that would see the gas pipeline going from Azerbaijan through Turkey extended into Greece, from where it will supply all southern Europe when finished. To my estimation, the region will additionally receive that way roughly 10 billion cubic meters of liquefied natural gas per year, and the volume is said to double over the next two years.

If this happens, Turkey is going to become a major LNG distribution hub. Not only for the gas coming from Azerbaijan, but it is likely will it be getting it in the future also from Turkmenistan, a Central Asian republic. The talks on building a short pipeline linking the countries through the Caspian Sea are on the way. Plus, remember, Turkey is already buying gas from Iran and the latter is set to double the capacity of the Turkey-bound gas-mains.

To some estimation, Turkey can get as much as 20 billion cubic meters of gas yearly from Iran and sell it without the restrictions that are applied on Iran. And if we were to take a closer look at the Persian Gulf seeking a possible gas supply, there's Iraqi Kurdistan worth the attention. That region's potential is said to be around 30 billion cubic meters of gas yearly, and, importantly, the first short gas pipeline between Iraqi Kurdistan and Turkey is already operational and they are said to be readying to build more gas interconnectors.

To keep looking around the region, don't forget the vast LNG deposits in Israel and the reserves around Cyprus in the Mediterranean Sea. If all that aforementioned LNG reserves could be combined in a cohesive Europe-bound gas supply, it definitely would be a strong alternative to the Gazprom gas.

You definitely are aware of the strong will in the European Union chambers to see the alternative gas to Europe come first from the US and Canada, which would fit very well with EU and US interests. Can it happen any time soon? And what does it mean to the Russian gas monopoly, Gazprom?

Well, things are not as hopeless as they might to some to appear. Look, there's already a LNG gas supply contract between the US and a Spanish company and, as I said, two US contracts with the Britons. And the price formula they have come up seems quite convenient to the parties and Europe.

Europe is buying the US LNG on the old continent's spot markets, where the prices are hovering now in the range of 320-340 USD per 1000 cubic meter of liquefied natural gas, and the price past summer was even lower, around 250-270 USD. At that level it was below the level of the Gazprom gas production and transportation price. So on spot markets, due to the low alternative gas supply costs Gazprom is already becoming uncompetitive compared with the other suppliers. It just cannot deliver cheaper gas than now,. The reasons in the production and transportation costs- the Russian gas has to make the trip from Western Siberia to a distribution hub in Austria, over 5000 kilometers. So once again, with the operational costs it has, Gazprom is slowly becoming uncompetitive in the European gas market and it has already become such in Asia where it is planning to sell its gas. Russia has obviously pursued political goals in signing the gas supply contract with China, but Russia won't make any profitable business there, likewise from the LNG sales in the Pacific region.

Russia counts a lot on the new gas fields it is developing in Yakutia and Eastern Siberia. But the problem is they are not connected with the gas network that delivers gas to Europe. Nevertheless, Putin has announced in the beginning of September that Russia is going to connect the yet non-existent Eastern grid of the pipelines with the Western grid. The Russian President is very hopeful that Russia will be able to switch the supply to Asia and backwards when the market situation suits.

Well, this is a very simplified thinking. As I said, the Russian gas costs on the Asia market are just too high. If you have the Vladivostok LNG project completed on the Pacific coast, for example, the costs of gas transportation from the Vladivostok LNG facility is going to be somewhere between 10 or 11 US dollars per one million British thermal units. And you have to add to it other multiple costs, like storage, freight, insurance, regasification in Japan, and so on.

Tersely, Asian Russian gas sales cannot replace the revenues Russia is getting from the sales in Europe.

And then here comes the Europeans' shale resources hopes. The US shale gas revolution does make impact on the European market, but it is not a direct impact though.

I do believe the shale gas fad is tapering off in Europe. The only European country that can produce commercial amounts of shale gas is the United Kingdom, I believe. But this will not happen soon.

I'm really skeptic of the shale gas bid in Europe. There are too many divisions surrounding the matter, all the environmental concerns, intricate technicalities and the public's anxiety- all that are too much to overcome.

You sound pessimistic about Gazprom's future though the Kremlin and Gazprom itself seem to be upbeat about it and the company's strategic importance in shaping up the energy politics in Europe. Do you believe Europe will start seeing the Gazprom gas card played with the heating season nearing?

I do believe that some hard times might lie ahead both for Gazprom and Europe, to which Russia supplies one-third of its gas needs. For the Europeans, gas supply disruptions would undoubtedly be painful. I'm not saying possible disruptions can take place due to the political reasons one is aware of. But my concern is the Gazprom underground gas storage facilities in Ukraine, which seems to be first preoccupied with securing necessary Russian gas reserves for its own needs this winter. And since there're quite few gas storage facilities in Russia and Europe, the issue of the Ukraine-located gas storages can get very heated.

How might a drastic fall in Gazprom revenues impact the entire Russian economy? Are there any ways to mitigate the imipact?

In fact, it is already impacting Russian economy. Gazprom has just released a report stating that the company's net profit went down 41 percent during the first half-year of 2014. This is a big decrease, one has to admit.

It means that the domestic gas tariffs for Russian households may go up. And then subsequently the power tariffs are likely to go up. With the heat and power utility prices going up, the other consumer prices will also start soaring. In any way, it just promises nothing good for Russian consumers at the end of the day.

Do you believe the potential consumer price growth could trigger social unrest and shake up the Kremlin?

If this happened, I reckon we'd see it unfolding in the future, not immediately. Perhaps in three, or so, years. What should be disturbing for the Russian authorities that the Russian oil production is on a decline and many believe the process can pick speed after 2017. Some of the Lukoil top managers have already hinted the oil production reduction will be quite tangible starting 2015. Obviously, this is not a healthy situation for the Russian economy and budget revenues. So forget Russia as a reliable oil exporter. It will be becoming less and less reliable, I am convinced. Particularly concerning are the increasing Russian gas production and transportation costs.

What Russia ought to do- or will be made to do in the near future- is to thoroughly review its oil and gas sector tax system. The current system doesn't encourage exploring new reserves of the natural resources. The second thing that logically needs to be done is dismantling all huge state companies like Gazprom or Rosneft. Allowing small producers getting engaged in the oil and gas production would create more competition in the market and spur a different thinking.

The big Russian oil and gas companies cannot-or often are not interested- in developing small oil or gas fields. Namely small innovative companies using advanced technologies could take on the exploration and mining the small fields.

But the Kremlin obviously likes to play with the big guys...

Yes, indeed. The approach they're taking behind the walls in that regard I deem really wrong. I reckon some big shots in the Russian government believe that sticking with the old way of doing things will make the country- and them themselves- quick. But we have to think of what will happen in three or four years from now, and the future is not promising.

Are you seeing signs that Gazprom might turn off the gas supply for Ukraine this winter?

This is possible; I'd not be surprised if that happened. Remember, it already happened in the year of 2009, when some European countries were left off guard. Some European countries, like Bulgaria, experienced an acute shortage of gas supply in the year. Look, the rhetoric that Ukraine is stealing Russian gas has already been kicked in, so now, logically, the thief has to be punished. But the accusations are false, as the transit of Gazprom gas through Ukraine is continuing. If it happened that due some reasons there were Russian gas shortages in Europe, it will start accusing in a single voice Gazprom for failing to commit to the contractual obligations. It isn't a good scenario for the Russian supplier through.

If Russia nevertheless turns off the taps, can Ukraine make it through the winter with its own gas reserves?

Yes, I think so. To my estimation, Ukraine can hold on as long as March with the gas reserves it has in the underground gas storage facilities. Ukrainians say they can get extra 15 billion cubic meters of gas from the West should Gazprom cut the supply, but I think the number is too high. Plus, let me remind that Ukraine produces every year 20 billion cubic meters of gas itself. They also can get some gas on their own from other countries, like Germany, Hungary, Slovakia and Poland. But we all see Putin getting increasingly unhappy with the re-exports, so, again, it yet remains to be seen how it will play out.

Personally, I do not see the gas as re-export. Once the Hungarian or German companies receive the gas they pay for it is already theirs, not Gazprom's. But this is becoming already a much contested issue between the parties, and it yet remains to be seen how it will play out. If Gazprom decides to disrupt the supply to Europe, the political reasons will definitely be seen behind such a decision, and Gazprom will be punished by the Court of Arbitration.

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