Saturday, 31 October 2015

Why do calls for diversification of European gas supplies divert attention from the financial interests of energy consumers?

When you are struggling to pay growing gas and electricity bills, about whom would you first think? Probably most often you are thinking about a rise in prices and your relationship with energy supply companies. It is unlikely that in this case you are more concerned about the changes in the global energy market and the current development of the global energy policy.

Of course, nobody doubts that there is a link between what is happening in these global spheres and the retail price of gas for heating systems in our homes. However, practically such an impact of the processes on a global scale does not look like those, which in our view should be according to the fundamental market laws.

Therefore, it is worth seeing the facts and trying to understand how, figuratively speaking, "messages" from the world market and the sphere of energy geopolitics really reach our energy consumers' finances.
Such an unprecedented strong "message" is the steep fall of oil prices, which became one of major events in the world development. According to “The IEA Oil Market Report”, oil prices sank to six-year lows in August 2015 as a supply overhang grew and concern deepened over the health of the global economy, especially in China. As before, oil prices were affected by high volatility, and the Brent crude oil traded in September slightly above 48 USD per bbl. and NYMEX WTI at 45.20 USD per bbl.
The fall of oil prices carries manifold implications. Low oil prices are said to be the key reason for the financial market instability, outflows from the energy sector and other harmful effects. It is nevertheless obvious that a significant decline in oil prices should bring tangible benefits to end users of energy.

Meanwhile media companies focused on seeking to confirm the existence of those benefits. For example, early this year the BBC News published an article "Oil price falls: Will consumers benefit?" The author noted that, in fact, adequate benefits could be hardly expected. He compares figuratively the price fluctuations in the market with launching missiles and falling feathers. “The cost of petrol and domestic energy are said to rise like a rocket when the oil price goes up”, he wrote. “However, the claim is that they only drift down slowly, like a feather, when the oil price comes down…”

In the EU gas market even the "rocket and feather" criticism is not sufficient to describe actual distortion of pricing in gas supply chain from production to end consumers.

It is well known that gas imports by pipelines strongly prevails in gas supplies in many EU countries. According to "BP Statistical Review of World Energy June 2015", natural gas was imported into Germany in 2014 exclusively by cross-border pipeline amounting to 85.0 bcm. Italy's imports of pipeline gas totaled 46.9 bcm of gas in 2014 and only 4.5 bcm in the form of LNG.

A distinctive feature of the pipeline gas trade is that many gas contracts are long-term covering periods up to 20 years. It is particularly important that prices in these contracts have commonly been linked to oil prices. European contracts use mixes of oil products or crude oil and usually include review clauses, specifying that either side can request a review – typically after three years.

Linkage of long-term contract gas prices to those of oil is based on price competitiveness of two main kinds of fossil fuels that end-users should have a real choice between burning gas and oil products, and would switch to any of them if given a price incentive to do so. An alternative is hub-based prices that have not been so widely used in Europe yet and they are applicable in general to other types of contracts and in other world regions.

There is no doubt that what it is written in the contracts of our European companies and their foreign partners - providers of gas to the EU are strictly observed and as a result due to oil prices decline import prices of natural gas have also moved downward with a certain time lag, usually from 3 to 6 months.

Despite these changes "Eurostat" data of the Figure 1 below shows that the decline in oil prices has not had adequately impact on the retail gas prices for domestic consumers in the EU. Brent has shown long dramatic decline since 2012 while the EU-28 average gas prices for domestic consumers continued to grow with some seasonal fluctuations.

So what is the reason, you may ask, behind the fact that oil prices has been falling, and contractual prices for gas imports follow the trend with a time lag, but average retail prices for gas in the 28 EU member states do not respond properly?

The point is that one of the main reasons for these inconsistencies is reduction of the relative share of gas cost in retail price. So what do citizens of the EU have to pay for?

Actually, besides the cost of gas there are another two components in retail price: one is network costs related transmission and distribution infrastructure costs and the other - taxes and levies. In 2014 the European Commission published a working paper "Energy prices and costs in Europe", which analyzed the changes in the structure of gas retail prices for households and industry in the EU for the period from 2008 to 2012. In particular, it is noted that the energy cost element is generally the largest, though its share is diminishing. At the same time on average for the EU the network component for households has risen within only five years by 17% and taxation went up by 12-14%.

According to "Quarterly report on European gas markets" (vol.8, issue 1; first quarter of 2015) published by the Directorate-General for Energy within the European Commission, the retail price has the following structure: on average, 50% of the price covers the gas itself, while the other half covers distribution/storage costs (25%), energy taxes (9%) and VAT (16%). However, there are significant differences across Member States.

Let's consider the calculation of the Figure 2 below made for 15 EU countries on the basis of data of «Eurostat» and one of main suppliers of gas to Europe, Russia's Gazprom. This calculation shows that the share of gas cost in retail price varies widely by country - from 31% in Italy and the Netherlands to 92% in Romania. Meanwhile, in this case, the average share of gas cost also amounted to about 50% as in the above-mentioned "Quarterly Report on European Gas Markets". As you can see, on average, a half of the retail price is intended for paying for imports of gas and the other half - for services provided by our local gas distribution companies and taxes. Moreover, as the Figure 2 shows, revenues in the EU countries - leading importers of gas have been impressive. In 2014 Germany imported 40.3 bcm of gas from Russia obtaining by those means about 19 billion Euro, while Italy's import of gas accounted for 21.7 bcm and revenues - almost 16 billion Euro
 It is not a random choice of gas supplies from Russia. Сommissioner Arias Cañete emphasized at the European Parliament Plenary in Strasbourg on 7 October 2015, that the EU still imports around a third of its gas from Russia. In his opening remarks Commissioner Arias Cañete also said, “We would like to see Russia as a reliable supplier of natural gas in future; but we would also like to see that the transport of Russian gas fits into our diversification strategy”.

The question that arises then given the facts presented above what do you think Brussels should remain focused on implementing the EU energy policy in favour of end users of gas and their current well-being?
On the one hand, no one denies that the diversification strategy is aimed at protecting the interests of gas consumers in Europe, as it should serve to strengthen the guarantees of security of supply. It should also then be recognized that Russia also is fulfilling, as if in line with the wish of the European Commission, its own strategy of diversification of supply enhancing the existing gas pipeline network to the EU by launching new projects Nord Stream 2 and the Turkish stream.

But on the other hand, we may wonder whether it is impossible at the current diversification of supply, which allows our countries to make good money from gas imports, to maintain reasonably justified level of retail prices, consistent with global trends? In other words, geopolitical aspirations initiated by Brussels and their transatlantic allies should not overshadow and override vital financial interests of the Europeans.

Why is it hard to provide gas consumers with guarantees that the energy policy of the European Commission does not leave aside the issue of an unjustified level of retail prices and does have a positive impact on the financial well-being of EU citizens?
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Thursday, 1 October 2015

Can it happen that the Turkish Stream pipeline will be implemented only by half? Why?

In December last year, Russian President Vladimir Putin and his Turkish counterpart Recep Tayyip Erdogan agreed to build a gas pipeline, known as "Turkish Stream". As is well known, this pipeline should be built in place of the canceled “South Stream” under the Black Sea through Turkey to the border with Greece.
Turkey enthusiastically embraced the initiative of Russia. “Turkey and Europe will be taking as much gas as they need, this means Turkey will serve an energy hub for the entire region”, President Erdogan said at an oil and gas sector workshop in December in Ankara.

After ten months, it becomes clear that there is the frustration of many regarding the negotiation process, as it has gone on for too long. In all that time passed since the official launch of the project “Turkish stream”, the parties have not yet signed an Intergovernmental Agreement (IGA) to formalize what was agreed at the highest level in December. It has already given rise to a wide speculation for mass media and expert community about the prospects of the project implementation and even its inexpedience for Turkey.

Yet logic suggests that the remarks stating that the project is not even profitable for Turkey clearly look false. Obviously, Turkey will be able to obtain from the “Turkish Stream” both economic and political benefits. Apart from meeting the growing demand for gas in the Turkish domestic market, the economic attractiveness of the project is ensured by possibility of obtaining annual payments for gas transit services to the border with Greece. “Turkish Stream” onshore section is 180 km. With a total capacity of gas supplies of 47 bcm, transit payments received by Turkey will amount to about 250 million USD per year.

Along with such revenues, there are political benefits that entails the growth of Turkish influence in both the Balkans and the EU although it is difficult to quantify them.

Of course, multi-billion-euro international projects are not organized "overnight," and haste would not be productive at all, if it is necessary to achieve an acceptable balance between the interests of both parties. However, there is another kind of balance in the basics of business philosophy which is characterized by the expression "time is money", attributed to Benjamin Franklin. It is considered an axiom that the loss of time is equivalent to the loss of money. In other words the attempts to mark time in order to induce more benefits to their advantage, increasing the risk of losing at least part of their interests and capabilities.

Following this logic in relation to the project "Turkish stream," it can be assumed that 2015, especially its first half, in the future will also be called as the time of missed opportunities when the process of decision-making and bilateral agreements on the project has been suspended.

As a result, if you are keeping track of developments, you know that in September Gazprom officially announced about the postponement of the "Turkish stream" launch, as it is not feasible to put into operation the first string in December 2016, as originally planned.

The political crisis in Turkey, where after the elections in June, the ruling party failed to form a new government, is used as a reason of the delay. Under the circumstances, the signing of the IGA will be possible only after the early parliamentary elections in November and the subsequent formation of a new government in Ankara.

Nevertheless, this is not the only reason for the postponement of construction plans, since the IGA could have been inked earlier in the first half of the year before the beginning of the political crisis. Other reasons are caused by the desire of Turkey to use its position in negotiations with Russia, because, as it seemed, Russia had no other alternatives to developing a new route of gas supplies to Europe in replacement of the canceled “South Stream”.

Upon the statements of high-ranking officials in Ankara, Turkey continues to insist on granting with no delay a discount over prices of Russian gas. Initially this discount was part of last year's agreement between Moscow and Ankara over the construction of the “Turkish Stream”. President Putin, during his visit to Turkey on December 1, said that Russia is ready to give a discount of 6% for the supplied gas. In the course of further negotiations, the Turkish side held out for a higher discount, supposing that it should be not less than 10.25%. According to Reuters, the talks between Ankara and Moscow on the construction of the "Turkish Stream" were suspended in late July due to the lack of a key agreement on a discount. Looking back, most likely, if the IGA had been signed before the political crisis, then the discount would also have been approved.
Besides that, Turkish Minister of Energy Taner Yildiz said that Turkey would like to sell itself gas from the Turkish stream. It means that Turkey wants to buy Russian gas at its border and then to carry out its own sales to the EU.

A similar story had already taken place in Ukraine, where Kyiv twice in 2009 and in 2014 declared its desire to buy gas at the border with Russia and sell it on their own to Europe. Russia did not accepted the Ukrainian initiative. There were no enough supporters of the Ukrainian initiative in the EU either, because obviously it is contrary to the European principles of gas trade, aimed at restricting the activities of intermediaries and resellers.

No doubt reselling of gas by Turkey for supplies to Europe would lead to an increase in prices and pose an additional financial burden on our European consumers. So it is unlikely acceptable and it seems to be widely understood in Turkey, especially, in light of Turkish declarations to enter the European Union and to join the European energy legislation.

Alongside with the reasons for changes in the construction schedule of the “Turkish stream”, it is interesting to be aware of its implications.

Turkey's attempts to squeeze more preferences in exchange for further promotion of the "Turkish Stream" project and an indefinite prolongation of talks has led to the fact that Turkey's plans to become one of major transit countries for gas supplies to Europe now are losing a solid ground.

Russia has reacted to such walking of Turkish partners at a tardy pace by means of a new step in collaboration with partners in Europe. Early in September, the Russian gas group Gazprom signed a shareholders' agreement with BASF/Wintershall, E.ON, Engie, OMV and Shell to build “Nord Stream 2” pipeline system to increase gas supplies to the EU. The new project company “New European Pipeline AG” for the construction of the “Nord Stream 2” has already been registered in Switzerland with a share capital of 1 million CHF. The “Nord Stream 2” project envisages the construction of two offshore pipelines with the aggregate annual capacity of 55 bcm of gas to be installed from Russia to Germany through the Baltic Sea and its implementation has been targeted by the end of 2019.

Now, let us recall that under Gazprom's plans, the “Turkish Stream” pipeline will be split into four offshore pipeline strings with a total capacity of 63 bcm a year. The laying of the first string was planned to start in mid-summer this year, and complete the construction of all four strings by the end of 2019.

At the same time with public announcements regarding the project "North Stream 2", there were reports that "Turkish Stream" can be reduced up to two strings. Meanwhile Moscow sent two offers to Ankara relating to the “Turkish Stream” project, apparently showing readiness to untie a negotiations jam regarding the pipeline for gas deliveries to Turkey. Russia’s Energy Minister Alexander Novak said that Moscow is ready to sign an IGA for the construction of one string of “Turkish Stream” that will supply gas for the Turkish market only which is to take about 14 bcm. A separate IGA can be concluded for the construction of pipes 2 to 4, which are projected to carry gas to the EU via Turkish territory. Obviously, the final number of the offshore pipeline strings will depend on the readiness of Turkey as well as demand for gas in the Eastern European countries. It does not clarify how much the new initiative on the “Nord Stream 2” would affect this decision but anyway it occurs.

The whole world witnessed how our European companies once again demonstrated their business acumen, and how Germany is seizing the initiative from Turkey to receive a new powerful stream of Russian gas and new opportunities for transit services.

It is important that significant volumes of gas from the "North Stream 2" can be intended for consumers who expect to receive it through the "Turkish stream." This is especially refers to Italy, since the end point of the "North Stream 2" on the Baltic Sea coast near Greifswald is much closer to Baumgarten where the biggest import and transfer station for natural gas is located in Austria. The currently effective contracts with Italian companies stipulate Baumgarten as the natural gas transfer station. Naturally, a shorter route of gas supplies is more attractive because it allows reducing the transportation costs and favorably affects the utilities prices.
Thus, if the "Turkish Stream" remains only with two instead of four strings of the pipeline, Turkey will have to say goodbye to the expectations of the large transit incomes, which in this case will accrue to Germany and Austria, as well as with a challenging opportunity of being one of major transit countries for gas supplies to the EU.

It is said that a well-known, especially in business circles, proverb "strike while the iron is hot" perhaps came to Europe from the old eastern folklore. Maybe so, because, in fact, this common saying, which sounds as an abstract from an instruction for business, can be found online in Turkish language - «Demir tavında dövülür».

Meanwhile, the question is still open: why this time is Turkey missing to take advantage of their native saying while Europe really makes that?
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