Inside CEE natural gas markets – a new status quo

Nabucco, Nord Stream, TAP and TANAP were the projects under the public spotlight during the past years, amid concerns on security of gas supply to Europe in general and to Central and Eastern Europe (CEE) in particular! In the shadow of these great projects, during the same years, stood a number of small projects, without a special meaning if taken individually, that had already radically changed the status quo of the European gas market by the end of 2015.

Special focus ENThe repeated incidents of political-economic disputes in the Europe - Ukraine - Russia relationship resulted in several occasions in syncope in Europe’s supply with gas. Such problems have led the EU officials to seek solutions in order to ensure the security of gas supply on the continent; obviously, those large projects in terms of investment and transport potential have received higher attention, being the fastest and the easiest perceived as having the capability to change the energy status at European level generally and in Central and Eastern Europe (CEE) in particular - this region being identified as the most vulnerable in terms of gas supply safety (both due to their overwhelming dependence on Russian gas and due to the inadequate infrastructure to meet these challenges). Therefore, projects like Nabucco, Nord Stream, TAP and/or TANAP were the ones that monopolized the attention of the natural gas industry and of the public in general.

SMALL PROJECTS

Besides the major projects, both in Western Europe, but especially in the central, eastern and south-eastern Europe, several smaller, less visible and often almost negligible projects were born and developed almost imperceptibly (both in terms of investment value and in terms of the contribution to the European gas market). However, precisely those projects were the ones that, put together, have already produced a radical change in CEE’s situation. Their combined effects have reduced the dependence of the countries in the region on a sole provider outside the European Union, have rendered to a more flexible gas transfer along and across the entire region, and gave a strong impetus to the market to align and standardize the gas prices. Hence, e.g. in 2015 the price of gas in the Czech Republic and Slovakia had already come very close to the prices of the natural gas traded in the hubs in Germany (the country that can be considered a reference for the rest of Europe, not only because it is one of the largest markets in Europe, but especially because it is best regionally connected to the surrounding states, and also one of the most important gateways for Russian gas in Northern Europe – on the Nord Stream route).

Thus, according to the latest European Commission report – ‘Quarterly Report on European Gas Markets’ (Volume 8, Q3 2015), at the end of the third quarter of 2015, the price of imported natural gas, at the border of the Czech Republic and Slovakia was of EUR 20.79/MWh and EUR 21.33/MWh respectively, while the price of imported gas at the German border was of about EUR 19.9/MWh (see the table ‘Gas market in CEE, in the price alignment process’). In other words, by the end of the third quarter of 2015 the price of imported natural gas at the Czech border was only by 4.5% (EUR 0.89/MWh) higher than in the hubs in Germany and the price at the border of Slovakia was only by 7.2% (i.e. EUR 1.43/MWh) higher than this benchmark.

The differences were thus significantly lower than about three years ago when, for comparison, according to the ‘Quarterly Report on European Gas Markets’ (Volume 5, April - September 2012), the price of imported natural gas under long-term contracts was about EUR 37/MWh and EUR 30/MWh respectively at the Czech and Slovak borders, while the price paid by Germany was only about EUR 24/MWh (see the table ‘Gas market in CEE, in the price alignment process’). Therefore, by mid-2012 the import price at the Czech Republic border was by 51.8% (i.e. EUR 12.7/MWh) higher than at the German border, while the import price for Slovakia was by 24.1% (EUR 5.9/MWh) higher than the German benchmark.

Gas market in CEEMoreover, by the end of Q3 2015 against the end of Q2 2012, important cuts in differences against the gas price in Germany could be also noticed for the other European countries (including many of those situated at the margins of the European energy system, but also for countries forming the old Europe - like Italy, France and/or Greece). The alignment trend is thus noticeable in the rest of Europe (and in the rest of CEE!), although the price decreases occurred at a lower pace and/or magnitude than those registered in the Czech Republic and Slovakia.

THE UKRAINE EFFECT

This levelling trend for the gas price is however just one of the important effects of the European gas market’s transformation process. Another effect of major importance (although less visible and less spectacular for the public) is that in just a few years’ time Ukraine has reduced its dependency on the gas supplied by Gazprom, even affording to give up such imports for a while. A first decision in this regard was taken by Ukraine by mid last year, after the failure of the trilateral talks (Russia - Ukraine - European Commission) on a new agreement for gas supply; thus, starting July 2015, Ukraine withstand for several months without gas imports from Russia.
With no impact on the flow of Russian gas transiting Ukraine on the way to Europe, the halting of Gazprom’s exports generated fears on both parties about the country’s ability to set up reserves in order to overcome the 2015 - 2016 winter; consequently, the talks resumed, and on September 25 the three parties reached an agreement on the supply of gas to Ukraine in an agreement valid from October 1, 2015 to March 31, 2016. Simultaneously with this ‘winter package’ Ukraine has resumed imports from Poland and from Hungary, which were also stopped in July to conduct maintenance works.
Shortly afterwards, at the end of October, Andriy Kobolev, CEO of Naftogaz (the Ukrainian national gas company), went public saying that Ukraine could totally give up the imports of Russian gas in 2016, as the domestic consumption reduction and the development of gas transmission capacities from the European Union to Ukraine will make possible to cover the domestic gas needs. “I think in 2016 we will be able to avoid buying Russian gas, by increasing the imports from Europe and by reducing domestic consumption, so that we could buy all the needed gas from Europe, if necessary,” Kobolev told the journalists of Ukrainian periodical Sputnik. At the end of November, Ukraine once again suspended the import of gas from Russia, stating it no longer needs it.

As of that moment, as mentioned by the European analysts quoted by the ‘Quarterly Report on European Gas Markets’ (Volume 8, Q3 2015), Ukraine already had enough reserves to cover the 2015/2016 winter demand, without operating imports – neither Russian, nor European – even in the event of a cold winter. In this regard, the data released by Gas Storage Europe revealed that, by September 20, 2015, Ukraine had reserves of 15.7 bcm, by only 1 bcm less than in the same period of 2014; in October the level of reserves exceeded 17 bcm and on November 30 the gas stocks reached 16.2 bcm, by 2.2 bcm larger than a year ago. (Gas Storage Europe is an association made up by 30 companies operating natural gas storage facilities in Europe, representatives of 101 storage facilities in 16 countries, amounting overall to 91 bcm, i.e. more than 80% of the storage capacity at European level).

In this context, given the repeated stops and resumptions of Russian gas imports, and Ukraine’s increased interconnection capacity to the EU countries (and of these countries between themselves, in turn), during the entire year 2015 Ukraine has doubled imports from Europe to 10.3 bcm (according to data submitted by Ukrtransgaz – the national company). However, it has halved the volume of direct imports from Russia (from 14.5 bcm in 2014 to only 6.1 bcm).

The major change in the structure of natural gas supply flows has led to Ukraine’s increased independence on Russian gas, but also to a lower import bill, as the price of gas imported from the western countries is lower than the price of gas imported from Russia; according to Naftogaz – the national company for oil and gas, Ukraine paid in January 2015 some USD 322.5/thousand cubic metres for the gas imported from Europe against USD 335.7/thousand cubic metres for the gas imported from Russia, in the same month. Negotiations with Russia were, and still are, extremely harsh: earlier this year, given that the price of gas on the spot market in major hubs in Europe stood at around USD 180/thousand cubic meters, Russia offered Ukraine gas at a price of USD 212/thousand cubic meters, while Ukraine aimed to get a price below USD 200/thousand cubic meters. In this context, Ukraine’s connection to the gas flows from Western Europe is a priority more than ever. Such developments show that Europe has made serious steps in the process of interconnection, flexibility and modernization of the gas transmission infrastructure at pan-European level; and removing Ukraine from its captivity to Gazprom (or at least to strengthen its bargaining position in this relationship) meant an unprecedented change of the energy, political and economic environment status quo in CEE and Europe alike.

INFRASTRUCTURE DEVELOPMENT

The status quo change, however, was the result of a complex process, conducted on two main areas: infrastructure, on the one hand, and changing the market operational pattern, on the other hand.
At first, the interconnection, the flexibility and modernization of gas transport infrastructure in CEE was targeted and the improvement of the interconnection level and the networks flexibility in the region to the ones in Western Europe. In this respect, the interconnections between the national networks have been modernized to allow gas flows in both ways and new pipeline sections have been built, increasing the transport capacity of some of the existing ones; also, elements/equipments specific to transport infrastructure have been built and upgraded (such as stations for network balancing, pressurisation and control, etc.), concomitantly being built and modernized several gas storage facilities.

The interconnections between countries have been upgraded so that gas flows can go both ways, targeting the gas transfer from Western Europe to Central and Eastern Europe and the achievement of bidirectional transfer points between the CEE countries. Thus, according to ‘IPA Industry Insight’, in its report ‘New sources of growth in CEE’ released by Erste Bank (in November 2015), late last year the gas transfer capacity from north-western Europe to central and eastern Europe had reached 147 bcm/year; of this volume, interconnections amounted to about 42 bcm.

At European level, the number of interconnections between national gas transmission networks (between EU Member States or between them and non-member states) has increased from 59 (sometime in 2012), to 76 in 2015, according to the European Network of Transmission System Operators for gas (ENTSOG - agency of the European Commission aiming to facilitate the development of relations between regional/local gas transporters towards the development of a pan-European natural gas transmission system).

The transmission capacity of these interconnections totalled more than 26,700 GWh/day in 2015 and thus by 16% (3,660 GWh/day) higher than in 2012, when the interconnections’ aggregate capacity was just over 23,000 GWh/day. The capacity of interconnections between the Member States and other non-member countries also increased in the same period of the last about three years from 13,000 GWh/day to over 14,400 GWh/day, and have been built (developed on the framework of the existing ones at level national) 28 regional points for rebalancing and control of the transmission networks (the new entities are designed to manage the directions and volumes of gas flows in the region and to maintain the respective flows within the necessary parameters for transmission).
Last but not least, the number and capacity of the facilities needed to import liquefied natural gas (LNG terminals) has increased. According to the same ENTSOG statistics, in 2012 their number was 17, and the import capacity was the equivalent of about 6,150 GWh/day; in 2015 the number of LNG terminals was of 19 and their total capacity of approximately 6,350 GWh/day (many other projects for new LNG facilities being in various stages of development).

In conclusion, in just three years, both Europe as a whole as well as Central and Eastern Europe have become not just better interconnected, but also benefit from significantly increased additional flexibility in directing the gas flow in the region (according to the needs). Moreover, the number of transmission lines projects was significantly higher in 2015, as were the number and capacity of natural gas storage facilities (see ‘Map of the European infrastructure for the gas transmission system’).

Romania can be a good example in the region in terms of infrastructure development - although a less relevant example in terms of its effective capacity to provide gas to the European network (given the lack of export connections!). According to the ENTSOG maps, in 2015, no less than four natural gas storage facilities were in different stages of design in Romania (some more advanced than others): two in Transylvania, one in the south and a new one in northern Moldavia; only three years ago they were depleted gas deposits.

Also in 2015, unlike 2012, as the Ungheni interconnection has been completed, Republic of Moldova had access, as well as Ukraine, to the European gas network. Finally, let alone the six operating rigs in the Black Sea (compared to none three years ago)... the start of the works on the LNG terminal in Constanta (terminus for no less than three possible projects of gas imports, namely LNG, from outside the EU, from sources other than Russia), place Romania in a position of possible important player in the establishment and diversification of gas supply sources in CEE.
However, Romania is a special case, not only due to the above mentioned developments (increase of import capacity, production and storage - but without having a consistent export capacity) but also through a series of legal specificities. Thus, on December 31, 2015 an agreement concluded in 1996 between Romania and the Russian Federation on the transit and deliveries of Russian gas on Romanian territory has expired; this Convention was one of the many legal issues for Romania, because it banned using the infrastructure in Romania by other operators than Gazprom (provisions contrary to EU law).

These problems culminated in a lawsuit at the European Court of Justice against Romania filed by the European Commission (lawsuit eventually postponed). Besides the 1996 Convention, another one is in force, signed with Russia (at the time USSR) in 1986, which covers the gas transit on Romanian territory, due to expire on December 31, 2016. Consequently, starting from January 1, 2016 Romania has taken a first step in terms of eliminating the Russian monopoly on the use of transit pipelines, and by the end of 2016 another one will be taken, so it could actually proceed to the resale of natural gas coming from Russia, an operation which could not be done so far.
Another very relevant example for the profound transformation through which the natural gas market in Europe is ongoing is given by the developments of Czech and Slovak companies for natural gas transmission, Net4Gas and Eustream respectively; both have lost a large part of the business since 2011 with the redirection by Russia of the gas destined for Germany and France from corridors transiting Ukraine to the newly built Nord Stream pipeline. But in recent years much of the lost business (represented by transporting gas from East to West) was recovered by taking gas flows from Europe to Ukraine (i.e. from West to East).

SHIFT IN PATTERN

The infrastructure modernization at regional and/or pan-European level, is just one of the important components for ensuring the proper functioning at the level of a larger part of Europe (particularly aiming CEE) of the British model (on its implementation the Union European is still working). A pattern based on competition stimulated by the free interaction of supply and demand, established in Britain after the deregulation of the energy industry (gas, electricity) in the ‘90s.

In the UK gas is traded at the National Balancing Point (NBP), which is a virtual trading centre; similar arrangements are now functional in north-western Europe, in virtual hubs, such as ‘Title Transfer Facility’ (TTF), Zeebrugge in Belgium and Netconnect (NCG) and Gaspool in Germany. (The British model has replicated the United States one - the Henry Hub centre in Louisiana, where nine interstate pipelines intersect, wherefrom the gas is distributed to end users and where the price benchmark is set for America).

The implementation of this pattern in Europe, though still ongoing, has already produced effects. Thus, the increasing share of natural gas volumes purchased on the spot market to the detriment of classic contracts (signed on long term) is both a result and a prerequisite for changing the functioning of the European gas market, although the process does not seem to be smooth or very fast (at least for now). This is because, after a record of liquidity in the first quarter of 2015, the trading activity in major European hubs (which make up the spot market) has decreased almost to the levels seen a year ago.

The spot market transactions in Q3 2015 totalled 9,000 TWh, by 2% less than in the same period of 2014. Moreover, despite the EU’s consistent efforts to develop this system in the rest of continental Europe, the transactions on the spot market are still carried out mostly in the hubs in the UK and the Netherlands - two countries accounting for about 88% of total European volumes on the spot market.

Anyway, this whole range of changes and adverse developments on the specialized markets (such as falling oil and gas prices) have forced Russia to make a number of concessions to its European Union partners. And if usually the price of Russian gas was set in all long-term contracts by reference to the price of oil, in recent years Gazprom has agreed to renegotiate the prices of certain contracts on other criteria, giving up also some clauses such as ‘take or pay’ or like those prohibiting resale of purchased gas without Gazprom’s consent (‘take or pay’ - a contractual clause requiring the buyer to pay the entire contracted quantity, whether he further wants to take it or not). This is another step forward made by the EU on the road to a price calculation system which has as benchmark the prices in the gas hubs in Europe. The prices, in turn, are experiencing (in a greater or lesser extent, yet obvious) the downward pressures coming from the imported LNG.

CONCLUSIONS AND PROSPECTS

Looking at the picture as a whole, one can say therefore that the trend of reducing the price gap between Europe’s ‘centre’ and the ‘periphery’ is likely to remain: on one hand, as a result of the ongoing infrastructure upgrading in the direction of increasing the interconnection capacity and its flexibility (European programs for prioritization and funding in this area are many and financially consistent); on the other hand, as a result of the more rapid opening and/or market liberalization in the region (a consistent process, stimulated by the infrastructure progress, but also by the changing of the legal framework).

Hence, beyond the failures of the large projects, it can be said without fear of error that the natural gas European market (in particular the gas market in CEE) has registered in recent years the greatest success of the last decade, virtually going through a revolution, without exaggerating too much.

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