Fragmenting the Gas Market: Perspectives on Russian LNG

September 20, 2016 | 00:00
Gas distribution station No.1 in Vladivostok.
Gas distribution station No.1 in Vladivostok.
The economic and political aspects of Russia’s Gazprom pipeline export projects have been oft-discussed in recent years. More particularly, the Nord Stream 2 pipeline project sparked academic and policy debates on whether new Gazprom export plans are mostly driven by geopolitical or business motives [1]. In fact, many observers express a concern about a further weaponisation of Russian external energy policies in the context of the EU Energy Union [2]. Still, the gas commodity glut, over-supply in underground gas storages and a persistent low price would mitigate anyone’s capability to dominate the market. However, the trend in the sector would also limit the economic rationale for new large-scale and capital intensive investments. In light of these discussions and market trends, this commentary attempts to outline an alternative path for incremental Russian gas exports. In particular, development of small-scale liquefied natural gas (LNG) may contribute to depoliticizing the business relations in trading the blue fuel.

Commercializing over-supplies by new pipelines
Despite an existing overcapacity in gas export pipelines from Russia, the latter’s main gas supplier Gazprom attracted European partners to pursue various pipeline projects to make new gas trade connections [3]. The projects include a Nord Stream extension, and two never-dying ideas of southern pipeline routes, South Stream and Turkish Stream. While Gazprom’s driving motivation is the diversification from Ukraine’s transit networks, its European partners look for a broader set of business opportunities in cooperating with the Russian supplier, including services, technologies and equipment. Some European companies (eg. OMV, Eon, Flyxis, Royal Dutch Shell), explicitly consider Russia as a potentially beneficial supplier and wish to tighten their business links with the main gas provider in the continent [4].

Moreover, a decline in price together with a sharp devaluation of the Rouble-to-Dollar exchange rate constituted the pivotal factors for reducing Russian capital expenses in production and supply. Subsequently, the context favoured an increase of cooperative attempts with the world's largest gas producing company including an increase of trade flows within existing infrastructures to Europe [5].

Challenges to Russia’s existing export model
However, challenges persist for new pipeline projects. Indeed, the longer infrastructural projects have been on the table, the more challenges for the Russian gas pipeline export strategy emerge. Since the spiral of political tensions between Russia and the west, and a persistent price decline, Gazprom experiences a serious profitability drop while its debt-to-share ratio has been rising. Significant financial difficulties have been combined with a constant requirement of budget cuts demanded by the Russian government at the domestic level. In addition, the overseas LNG flows challenge the old pipeline-related business model. Nowadays, the US LNG supplies constitute the most significant source of worry for the largest Russian supplier and its grid-bound exports. The competition has tightened with the slowing East Asian demand freeing surplus supplies for international markets. Adding to that, the willingness-to-pay for non-Gazprom supplies constitutes a pivotal factor for the EU Energy Union and its member states' national strategies. In this context, it would be naïve to anticipate any concession to Gazprom’s export projects in terms of the EU regulation on capacity access [6]. Instead, any new pipeline coming from Russia would become subject to regulatory demands to provide parts of the capacity to the markets via Open Season procedures. In turn, the competition-oriented regulatory scheme adds difficulties for Gazprom and its partners in finding loans with profitable interest rates for project financing. As a result, the supply glut, low pricing as well as security concerns (either perceived or real) vis-a-vis Gazprom’s supplies decreases the attractiveness of Nord Stream 2 and its southern sister-projects. For the similar reasons, Gazprom’s Baltic LNG project in Russian port of Ust-Luga stalled in various Memorandums of Understandings without any further development. Even more, a local chemical operator (ICT Holding) of urea designed for gas refrigeration recently decided to halt further development of their business maybe because of low probability of further large-scale liquefaction plans.

Towards more flexible and more fragmented supplies
A question regarding possible alternatives for the Russian gas export strategy has been in focus for a while. Growing domestic competition with newly emerging gas suppliers (eg. Novatek) constitutes an additional impacting factor for Gazprom’s weakening market positions. Noteworthy to mention, Gazprom's gas export monopoly applies to pipelines only, as the LNG export monopoly was lifted in 2013. The recently established Saint Petersburg gas trading platform provides a useful institutional framework for non-Gazprom exports to Europe, whereas LNG could eventually become the core export business for the physical exchanges. An interesting small-scale producer - Gorskaya LNG in Saint Petersburg - is one of the emerging projects of the kind.

The point of conjuncture between the international gas market trends, Russia’s domestic changes in the sector and European business interests concerning the latter would be located in the development of Russian LNG exports instead of the capital intensive and long pipeline exports. This would create a better balance between long term interests advocated by private players and short term uncertainties as well as the EU Energy Union strategy aiming at decreasing Gazprom’s monopoly impact on the market.

Indeed, the Russian LNG strategy has been lagging behind with regards to global trends and Gazprom has been rather slow in advancing into this highly innovative industry. Short distance LNG has been fiercely criticized in recent years, observers considering it to be highly uncompetitive compared to the pipeline-based supplies. But the markets and industries seem to transform faster than the observers react to the changes. At first glance, a demand for small LNG volumes in the European region has accelerated lately. In particular, gas demand has been declining, while small volume LNG demand has increased by at least 25%. Bunkering and liquefied storage business gained popularity for a number of reasons, from economic benefits of decentralized supplies, to regulatory difficulties related to pipeline capacity markets. Adding to that, a decline in shipping costs and ammonia-based refrigeration technology have unveiled a potential for cost decrease in small scale liquefaction and supplies. In fact, a possible model is the 20.000 tons-per-annum liquefaction plants owned by SkanGas that started to operate in Finland’s Porvoo to process Russia’s oversupplies.  


Ground for a positive interdependency?
Positive sides of the trend are significant. In fact, more flexible marine supply solutions decrease economic and political dependence on Gazprom’s pipelines and on Russia-Ukraine political disputes, instead, the LNG-focused business direction would provide the market flexibility consumers are currently searching for. Moreover, Russian independent gas suppliers would then become alternative options to Gazprom, while the latter’s share would not dramatically increase. Political sensitivities surrounding the interests of European corporations contrasted with the EU Energy Union objectives would become much less significant. At the end, increased flexibility for both suppliers and buyers would ideally lead to more economically motivated decisions without political and regulatory barriers. 

Conclusion
The present commentary attempts to draw attention to a perspective distancing from “business vs geopolitical” motives of Gazprom’s pipelines and to suggest to consider a less noticeable trend of Russian non-Gazprom supplies to Europe. Obviously, this option would not alter large-scale supply volumes exported via existing pipeline networks. But its relevance should be assessed particularly for the incremental demand growth in decentralised gas markets of Baltic and North European regions.

The main challenges to the business scheme that provides an alternative to pipelines, are the commodity's over-supply and unfavourable price. Hence, only the most competitive solutions would make sense in current uncertain conditions. Still, the small volume LNG business model in relation with Russian companies might provide better mid-term opportunities compared to the overly politicised new gas pipeline projects.  

1. See a discussion published at Centre for Global Interest, Commercial Project or Geopolitical Threat, June 17 2016.
2. A. Riley, Kaunas Energy Lecture on Nordstream.
3. For details, see East European Gas Analysis.
4. Among others, a summary of the potential business interests in the Nord Stream 2 are highlighted by A. Goldthau, Nord Stream 2 and the Role of the EC”, Natural Gas Europe, 12.07.2016.
5. A. Belyi, ”Gazprom: slow to adapt and unable to exert influence” a Policy Brief 1016-05, Florence School of Regulation.
6. For an analysis of regulatory difficulties faced by South Stream project, see I. Kustova, “A Transformational Crisis”, Natural Gas Europe, 20.06.2014 ; for an analysis of regulatory difficulties related to Nord Stream onshore continuation in OPAL, see Interfax, 06.09.2016 ; and for incompatibility between Gazprom strategy and EU regulation, A. Belyi and A. Goldthau, “Between a rock and a hard place: International market dynamics, domestic politics and Gazprom's strategy”, Working Paper RSCAS 2015/22 for Florence School of Regulation.

Andrei V. Belyi is an Associate Professor at the Centre for Climate Change, Energy and Environmental Law at the University of Eastern Finland. He is the author of Transnational Gas Markets and Euro-Russian Energy Relations (London: Palgrave Macmillan, 2015). To contact the author email: andrey.belyy@uef.fi

Image: Gas distribution station No.1 in Vladivostok. Courtesy: Gazprom.
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