Europe’s addiction to Russian gas: How long before withdrawal symptoms set in?

by Leonid Krutakov for Odnako

(translated by: Robin)

In mid-January, EU Energy Commissioner Maroš Šefčovič held talks with Gazprom CEO Alexey Miller and Russian Energy Minister Alexander Novak in Moscow. After the talks, Mr. Šefčovič expressed surprise at three circumstances.

First, Gazprom has no intention of building the South Stream pipeline. Second, in the future natural gas will be delivered to Europe via Turkey. And, third, Russia is not prepared to discuss the terms of its gas deliveries to Ukraine.

To quote Mr. Šefčovič, all three circumstances, were “very surprising,” even though Russia’s decision to cancel South Stream and instead build Turkish Stream was announced in December of last year in Ankara at a joint press conference held by the Presidents of Russia and Turkey.

It’s easy to wax ironic about Mr. Šefčovič’s ignorance of South Stream in Turkey. And most commentators did just that. But his attempt to discuss new conditions for gas supplies to Ukraine with his Russian partners deserves much more attention. And confirmation of that was not long in coming.

Last week, Russian Prime Minister Dmitry Medvedev convened a meeting with Messrs. Miller and Novak. He asked them for the details of their talks with Mr. Šefčovič, Ukraine’s gas debt and the repayment period. The meeting was broadcast live almost in its entirety.

Mr. Miller reiterated to Mr. Medvedev that Europe had only a few years to build its own transmission infrastructure to the Greece-Turkey border, where it will have to connect to the Russo-Turkish pipeline system. If Europe fails to do so, the gas will go to other markets.

And Mr. Novak pointed out that, when last year’s agreement on a $100 discount for gas sold to Ukraine expires on April 1, there will be no new discussions or agreements. The contract is valid and no one has cancelled it.

If we compare these statements, the fact that they were reiterated and broadcast live makes it clear that Russia has given Europe a firm ultimatum, outlined the consequences and set a deadline. So what is the nature of the ultimatum?

It’s a long story. But, like any long story, it offers an advantage. It allows you to assess the Ukrainian events not in terms of the abstract and immediate concepts of a struggle for freedom and democracy, but rather in the concrete terms of profit and loss over the long run.

At first glance, the link between the recent events in the Ukraine (the Maidan protests, the coup and the civil war) and the supply of Russian gas to Europe and the gas contract that Yulia Tymoshenko concluded in 2009 seems improbable. But any event whose workings are hidden from us is bound to seem improbable and inexplicable.

The European Union’s Third Energy Package (TEP) also came into effect in 2009. The gist of this document is that it establishes uniform rules for the gas supply system within the EU. All gas purchases must take place on an “entry-exit” basis at the European border. In other words, it creates a sort of single virtual gas buyer able to dictate terms to the seller.

The document sets other parameters, but they are all generally based on the idea of unbundling gas suppliers from the EU’s internal infrastructure and retail market, where prices are often more than three times the price of the “entry” price.

The stated reason for TEP was the need to enhance competition and reduce costs at the expense of a free flow of gas within Europe. This statement didn’t fool anyone. It was a new instrument that targeted only Gazprom, which is tightly connected to the European system.

In the event that Europe adopted unacceptable conditions, suppliers of liquefied natural gas (LNG) could at any time redirect their deliveries. In fact, that is what happened after TEP was adopted. The main flows of LNG left for the Asian markets. Gazprom, whose gas deposits are far from ports and have to be shipped by pipeline, could not pull off this trick.

As a result of the adoption of TEP, European gas prices did not fall; in fact they went up. From 2009 to 2013, the price of gas in the EU rose by an average of 29% to 30%. At the same time, the average price of Russian gas fell from US$410 per thousand cubic metres in 2008 to US$385 in 2013. And the volume of gas increased.

The paradox of a rising domestic price along with a falling “entry” price is easily explained by the nature of the increase. The increase was due mainly to the higher cost of gas transmission within the EU, which rose about 16%, and internal taxes, which were up 13%.

In fact, the energy component of the final gas price increased by no more than 2%, and even that was due to LNG. At the same time, the significant increase in the price of LNG was offset by the discounts that the EU obtained from Gazprom, taking advantage of Gazprom’s lack of wiggle room. And this occurred despite long-term contracts linked to the price of oil, which increased four-fold from 2008 to 2011.

In fact, TEP ultimately ended Gazprom’s access to the internal European market and, moreover, obliged it to sell 50% of its gas while still in the pipeline, even before it entered the EU. Under TEP, gas carried by the pipeline system has to come from at least two suppliers.

As for the timing, Gazprom’s long-term contracts with its European customers were renegotiated in 2004, and the following year saw the beginning of the TEP discussions. The peak of the discussions took place in 2008-2009, and precisely at that time the second Ukrainian-Russian gas war broke out.

Kiev, which was behind in its payments for Russian gas deliveries, began to siphon off transit volumes illegally, and in response Russia cut off the flow of gas. The EU had to take urgent action, brokering a gas contract signed by Yulia Tymoshenko almost entirely on Russia’s terms. Six months later, when peace prevailed, TEP was adopted, and so began the systematic effort to squeeze out Gazprom across the board.

South Stream was blocked on the grounds of non-compliance with TEP, even though the contract for its construction was agreed to before TEP was adopted on the government level. In point of fact, TEP was created to prevent individual countries from taking such “initiatives” in the future.

It should be noted that South Stream was blocked immediately after the start of the events in the Ukraine. The structure developed in such a way that the Ukraine retained its status as a major transit country for Russian gas and became a sort of gas reservoir for Europe. With the advent of TEP, under any new contract Gazprom had to halve its gas supplies to the EU or sell half of the volume to the Ukraine on the Russian border.

Simply put, Russia ultimately was expected to pay from its own pocket the cost of the Ukrainian coup and the formation of a Russophobic government in Kiev. That is why the United States initially tried to bail out Naftogaz of Ukraine. The son of U.S. Vice-President Joe Biden even became a member of the Ukrainian gas monopoly’s board.

Vladimir Putin’s visit to Ankara and his agreement with Recep Tayyip Erdoğan on the construction of Turkish Stream has put paid to all that. The role of European transit country has now shifted to Turkey; moreover, in accordance with TEP rules, to fulfill a contract all Gazprom has to do is deliver the gas to the EU border. Moving it any farther is not Gazprom’s responsibility.

It was a calculated, well-aimed blow. Turkey is the only communication corridor offering an alternative route for Russia’s gas. For example, the proposed Nabucco pipeline to supply gas from Central Asia and the Middle East to the EU, bypassing Russia in the process, is based exclusively on Turkey as a transit country. But now there’s no getting around Russia.

The only question without a public response is the deadline attached to Russia’s ultimatum to Europe. Mr. Miller did not specify any period, saying only that Europe has little time left, in fact only a few years. This is understandable because contract terms and conditions are confidential.

But, not being bound by any confidential agreements, we are free to speculate about the deadline. Most of Gazprom’s European contracts, as already stated, were concluded in 2004. Earlier on, in the 1980s, such contracts had a term of 30 years. The term of the last contract was reduced to 15 years. It follows that D-Day – the time for renegotiation of contracts under the terms of TEP – will arrive in 2019, in other words, in only four years.

Four years is a political framework that limits Europe’s decision-making time. The choice is very difficult. In fact, there is no choice. Rejecting Russian gas supplies to Europe is tantamount to suicide. Switching to LNG, which is from one and a half to two times more expensive, would instantly make all European industries uncompetitive.

Europe needs Russian gas. All it can choose is the routes and the means for its delivery. It can negotiate with Russia on clear and transparent conditions, or it can break Russia’s resistance in order to gain access to the gas on its own terms. And the conductor standing behind the EU finds only the second scenario acceptable.

In fact, Europe has even less time (just making a decision is not enough) because it has to build a pipeline to the Turkish border. Otherwise it will have to “surrender” Ukraine. We do not want to play the role of Cassandra, but in four years anything can happen – even attempted assassinations of top politicians, in both Russia and Turkey.

By the way, one curious detail is that the Russian-Ukrainian contract signed in 2009 by Yulia Tymoshenko and Vladimir Putin has a non-standard term of 10 years. And, like most of Gazprom’s European contracts, it ends in 2019. Would that be by coincidence or by design?

Russia Leaves the European Commissioner for Energy Union out in the Cold

by Aleksei Kettunen

GAZPROM–EU: 6–0

Yesterday on Wednesday the EU negotiated with Gazprom in Moscow. The EU negotiators had three aims:

1. Pressure Russia into extending the special winter pricing on gas supplies to Ukrainian due to end in March,
2. Force Russia to further unilateral concessions by forcing all European energy purchases to happen through a new “European Energy Union”,
3. Pressure Russia to resurrect the canceled South Stream gas pipeline project and build it in accordance with the restrictive rules of the Third Energy Package.

The Russian response was a cold shower.

Firstly, Gazprom said there is no need for a special summer agreement on Ukrainian gas purchases, as a valid contract already exists.

In practice, this means that all the concessions Kiev has received for the winter season are temporary and there is no space for negotiations. If the EU wants to ensure their gas transits through Ukraine then it must put pressure on Kiev to comply with existing agreements. If Kiev needs gas it cannot afford to pay – thus endangering transit deliveries to EU countries – it is not Russia's problem. The same applies to Kiev's gas debts; the EU will have to pay both the Ukrainian gas debts and any future gas purchases.

Secondly, Gazprom announced that the South Stream gas pipeline project is dead and will not be realized. The project collapsed under US and EU pressure. The greatest obstacle turned out to be EU's Third Energy Package. It heavily restricts how Gazprom could use their own pipeline; Gasprom could only use 50% of South Stream's capacity and would be forced to offer the remaining 50% of the transportation capacity to third parties. Although all of the agreements between Gasprom and the various transit and consumer countries were made before the Third Energy Package entered into force, the European Commission now demands that it is applied retroactively.

Russia's solution is as follows: Gazprom will build the pipeline to Turkey and extend it the Turkish-Greek border. The pipeline will end in a gas distribution hub near the EU border. If the EU wants to buy gas, it will have to build a pipeline to Turkey at its own expense. It will also need to expand the gas transport capacity between its South European member countries – and do so under the constraints imposed by its own Third Energy Package.

The final punch to EU arrogance was Gazprom's declaration that after the completion of the gas hub and the Turkish pipeline Gazprom will end all gas transit through Ukraine. Russian gas will only be available through Turkey! The Ukrainian pipeline network will be used exclusively supply gas to Ukraine. Gazprom based its decision on Ukraine's instability and the high transit risks.

Maroš Šefčovič, the week-old European Commissioner for Energy Union must have had the worst day of his life. EU arrogance hit a brick wall. A major scandal is brewing about how Germany ruthlessly secured its own gas supply through the Nord Stream Pipeline and then used all means possible to sabotage the South Stream pipeline. There is no better cause inflame the North-South conflict in the EU. The prospective users of the South Stream pipeline are sure to feel “eternal gratitude” to the United States for killing the project.

The perpetual EU candidate Turkey will feel Schadenfreude watching the EU's plight while calculating the future revenues from gas transits. Turkey also happens to be Gazprom's second-largest customer after Germany. The biggest loser will be Ukraine, the world's preeminent gas siphoner and blackmailer.

Despite all the arrogant talk the EU has no real alternative to Russian natural gas. Brussels has to swallow it pride and come to its senses.

Now we are anxiously waiting for the Western mainstream media's spin on the story.

Sources:

ЕК: Россия решила перенаправить идущий через Украину газ на новую трубу в Турцию

Миллер: Снять риски транзита через Украину ЕС поможет только «Турецкий поток»

See also:

Russia Cuts Off Ukraine Gas Supply To 6 European Countries