Speech by Alexey Miller at conference “Europe and Eurasia: Towards the New Model of Energy Security”

Conference “Europe and Eurasia: Towards the New Model of Energy Security” (arranged by Valdai International Discussion Club), Berlin, Germany

Video provided by Russia Today

 

Europe and Eurasia: towards the new model of energy security. The gas market profile. Referring to the words that have been recently ringing in the gas market, some might say that we are not ‘on the way towards’, but rather ‘on the march towards’. However, we will say ‘on the way towards’, understanding that a way is a motion vector, particularly, for Gazprom it is a motion vector from the European strategy to the Eurasian strategy of the marketing business. We should also bear in mind that a new gas megamarket is shaping – the Eurasian one.

A new gas megamarket is shaping – the Eurasian one.

Actually, there are some objective prerequisites for it. Firstly, Gazprom has started constructing gas transmission capacities in Siberia, which will not only provide for Russian gas export to China but also connect the gas transmission system of the East and the West. Another crucial point is that these two markets will have a single powerful large-scale resource base – the resource base of Western Siberia. In addition, it is quite important for Gazprom that the Company will most likely execute the Eurasian strategy involving new strategic partners in the new megamarket.

There is no doubt that it will directly affect our European strategy. It should be understood that the Eurasian strategy will not appear overnight, it will be due to our efforts and our business activities. It can’t be said that someone sat down, took a pen or sat at a computer and wrote or typed some new strategy to underlie further activities and target setting. It is not so, we know full well that we base on the market conditions and the factors and risks we observe in the market.

It is quite important for Gazprom that the Company will most likely execute the Eurasian strategy involving new strategic partners in the new megamarket.

But I know that during the talks that have been held today, the pricing trends in the European market were discussed. Traditionally such talks touch upon such issues as whether oil and oil derivatives will still affect gas prices, what the role of spot markets will be, whether it will grow or weaken. However, it should certainly be understood that in the short term it will be the Asian market that will serve as the pricing factor for the European market. It is only objective reality.

Speech by Alexey Miller at conference “Europe and Eurasia: Towards the New Model of Energy Security”
Speech by Alexey Miller at conference “Europe and Eurasia: Towards the New Model of Energy Security”

Conference participants

As for the energy security model, it can be said that it has already undergone rather dramatic changes. During the recent ten years an energy security model based on ‘interlocking and interdependence’ with the elements of diversification has been implemented. The most vivid representation of this ‘interlocking model’ is a chain formed by a producer and customer – from geological exploration and production through transmission, storage and distribution to an end consumer. There are some demonstrative successful examples, for example, cooperation with our German partners with whom we have been in a strategic relationship for many decades. It is a totally winning project which provides for the participation of producing companies and consumers in every link of this chain.

Unfortunately, in the recent years this model has been receding into the past, being replaced by the model of pure diversification. Both customers and producers talk a lot about market resource base and supplier diversification as well as diversification of transmission routes, end manufacturing products and end consumption products. Time will show whether it is good or not, but we surely see some very grave risks posed by this model. I should mention it at once that this diversification-based model of energy security is a cornerstone of the European Energy Union project.

As for the energy security model, it can be said that it has already undergone rather dramatic changes.

It must be said that Gazprom is ready to work with the European Commission in the European market even within this model. We will stick to the models and rules of the European market. Moreover, speaking of the European Energy Union project, we think that it contains many interesting ideas and provisions. I think that objectives and goals outlined there are our common objectives.

For example, let us touch upon the issue of fair pricing. Fair gas prices, unfair gas prices – the issue is serious. In particular, Gazprom is accused of setting different gas prices for consumers in different countries. It is an objective situation. However, Gazprom is being accused of setting extremely low prices for some consumers and extremely high prices for others. Thus, we should be thinking and moving towards an equal price. But having a sound idea of the European market, we know that it is fragmentary. As for gas prices in each particular country, they are determined by the energy balance of each specific country and the role of gas in this energy balance as well as an understanding that these prices also depend on the contribution made by the companies of this country to creating the security chain within the previous energy security model pursued during the recent ten years. Germany can serve as a vivid example here. We set the lowest prices under long-term gas supply contracts for German consumers. Is it accidental? No, it is not. We know how important gas is for the German market. In our pricing activities in the German market we have always based on the German market itself, being aware of the role of gas in the German industry and economy.

A question arises: why are we being reproached with setting higher prices for other EU countries as compared to Germany? If someone proposes that these prices should be equal, let us see whether we can do it and whether it should be done. If we say that these prices are different, let us have a look at how they were formed, why we ended up at this level, why prices for the companies of certain countries the prices were lower and for other companies – higher. Supposing that the European Commission decides that the prices should be equal, it is to be understood that an equal price is not the lowest one at which we supply gas to the EU; most likely the cut-off price will be the highest one.

We set the lowest prices under long-term gas supply contracts for German consumers. Is it accidental? No, it is not.

As for the transparency of energy markets: reproaches are heard that these markets are not transparent enough. Let us have a look at it within the single Energy Union project. Particularly, let us regard the transparency of gas prices. Let us look at the transparency of electric power prices. Everyone in this audience today knows well that the price at which Gazprom supplies gas to the EU market accounts for only 45 to 50 per cent of the price for end consumers. Up to 30 per cent is made up by taxes and levies and the remaining part is the interest margin of the companies working in the country’s domestic market. Consumers should be aware of how the end price is formed and that the price of gas supplied from Russia, Gazprom’s price is less than half of the end price for the end consumer. All the rest is not Gazprom’s component. A consumer should know what subsidies are granted on renewables. A consumer should know what factor determines the growth in power prices. As you know, it is not the gas price factor. An open discussion should be held clear for everyone, including the market players. Often such populist affirmations trigger questions from people related to other countries’ gas industry, who do not know well how the gas price for Germany is formed.

Let us tell you how the gas price for Germany is formed. Is Germany ready to have a gas price different from the one it has now based on the energy security model underlain by the ‘interlocking and interdependence model’? I will stress it again that it should be an absolutely open fair discussion, not a one-way street case. Today it happens so that due to switching from an old energy security model to a new one, an imbalance occurred between the risks which previously have always been distributed between a supplier and consumer. Currently we see that all the risks are being intentionally transferred to a supplier on a unilateral basis. These include price risks, demand risks, regulatory and transit risks. But the main thing I would like to dwell on is the risks of constructing the production capacities and transmission capacities.

It is common knowledge that presently Gazprom as a supplier has certain difficulties seeking take-or-pay penalties. Lines of reasoning are most diverse, but in the end it is clear that economically they are based on a tight economic situation. But it should be understood that take-or-pay penalties are actually capacity payments. So, we make advances, we do not levy take-or-pay penalties, thus, we put off the withdrawal for future periods, and so on, and so forth.

Currently we see that all the risks are being intentionally transferred to a supplier on a unilateral basis.

But, esteemed colleagues, Gazprom has constructed production and transmission capacities exceeding the take-or-pay volumes. The created volumes provide for supplying annual contracted amounts of gas to our consumers in Europe. A question arises then: who pays for it? The answer is: Gazprom does, because we continuously bear the costs of operating these capacities. Their current volumes are colossal. Today Gazprom’s production opportunities come up to 617 billion cubic meters of gas. The volume of gas produced by the Company in 2014 totaled 444 billion cubic meters. What does it mean? It means that we can easily just double the volume of Russian gas export, Gazprom’s export to Europe.

What does it mean for us? For us it is certainly a risk. We haven’t heard about such a demand or, what is most important, any statements that Europe would draw upon Russian gas. But then it is only reasonable that in order to eliminate the risks for ourselves we have plans and ideas to use the excess capacities to supply gas to other markets, particularly, to the Asian market. Otherwise, the European Union, European Commission should tell us that they need these capacities and count upon them, that these capacities constructed by Gazprom under long-term contracts will be marketable. But presently nobody provides such a guarantee and we bear all the risks both of constructing new gas transmission and production capacities and those concerning the existing capacities. You know that we’ve created a new gas production center in Yamal, which is to replace our traditional gas production center in the Nadym-Pur-Taz region. The volume of gas production there will exceed 300 billion cubic meters of gas a year. We constructed new gas transmission capacities: the Bovanenkovo – Ukhta, Ukhta – Gryazovets, Ukhta – Torzhok gas pipelines. As for the Bovanenkovo – Ukhta gas pipeline, it is the most advanced onshore gas pipeline in the world. But all these capacities were targeted at the European market. Europe should give us a clear answer, whether it needs these production capacities and resource base, or not. Actually, abandoning the ‘interlocking and interdependence model’ has aggravated the transit risks.

Today Gazprom’s production opportunities come up to 617 billion cubic meters of gas. The volume of gas produced by the Company in 2014 totaled 444 billion cubic meters. What does it mean? It means that we can easily just double the volume of Russian gas export, Gazprom’s export to Europe.

We all well know Nord Stream, a very successful project. No one says today, particularly in Germany, that the project is not profitable or doesn’t serve the interests of suppliers and buyers. As we opted out of the ‘interlocking model’, we had to withdraw from the South Stream project, although we tried to build up the relationships with our traditional European and also German partners using exactly the mentioned ‘interlocking model’ – I mean the chain from exploration and production to end consumer. We’ve launched the Turkish Stream project and this time we use another model – it’s not the ‘interdependence model’, it’s a model of pure diversification, I mean the diversification of transport routes. As for the transit risks – well, they go up if you don’t stick to the ‘inter- model’.

The Ukrainian gas transmission network is the today’s weakest link in our relationships. Ukraine’s gas transmission network has an explosive confrontational potential. It’s important to understand that 90 per cent of Russian gas transits to Europe via Ukraine – I mean this precise transit amount – was actually a nice gift to Ukraine made by the USSR back in the early 1990s. When a gift becomes a manipulation tool, peace will not last long.

Firstly, I’d like to note that it’s not fair to say that Ukraine was left ‘empty-handed’ and zero gas transits go through Ukraine, and bypasses have emerged all of a sudden. It’s not true. The Turkish Stream project is not the first of its kind. Yamal – Europe was a pioneering pipeline bypassing Ukraine, which was built together with our Polish partners. Blue Stream was a runner-up, constructed to Turkey together with our Italian partners. In this regard, Turkish Stream is not a unique or a brand new gas pipeline aimed to bypass Ukraine.

The Ukrainian gas transmission network is the today’s weakest link in our relationships.

If we go back in recent times, South Stream was cancelled exactly like it happened to the Yamal – Europe 2 project. We were forced to give it up in early 2000s. Well, instead we’ve delivered an absolutely marvelous and successful project – Nord Stream. Some people suggest now that maybe it’s worth coming back to the South Stream project. History repeating, because back in times when we were building the Nord Stream pipeline, there were also suggestions to pull back to the Yamal – Europe 2 project and stop the Nord Stream project.

Hence I can make a single conclusion out of it that gas transmission facilities are built in required quantities and right in time. We pursue a clear and simple approach to the Turkish Stream project – we made a decision to construct a gas trunkline to be laid to Turkey across the Black Sea as well as build gas transmission facilities up to the boundaries of Turkey and Greece, up to the EU border. And we will build these facilities. All the risks, particularly, the temporary risks related to the construction of new gas transmission facilities from the Turkish-Greece border are laid on the shoulders of the European Union and the European Commission. The deadlines are very tight – these facilities are expected to be created before the 2019 end. In order to get this done in time, we should start the construction immediately. Unfortunately, we have not been able to initiate the process so far. We stated that if we start now, we’ll meet the deadlines and the required facilities will be built. Otherwise, it will not be possible. As we say in Russia, “forewarned is forearmed”.

We’ve been asked whether Gazprom plans to invest in new gas transmission facilities on the Turkish-Greece border. Well, in my opinion, the initiation of the Turkish Stream project is a real blessing for the entire European gas market. As we all well know, there is a lack of transborder gas transmission facilities in Europe, and the emerged Turkish Stream project kicked off other transborder projects, namely East Ring and a project for constructing a gas pipeline from Greece to Baumgarten via Serbia, as well as other projects from Greece to Baumgarten via Italy. This is a sign of a really, really great impetus made by the Turkish Stream. However, if we receive any proposals to participate in this or that project, we’ll think it over and may enter a project in case it’s profitable for us. If such a situation is to occur, it’s very important to stress that Gazprom will carry on its businesses under the rules of the European market and will strictly adhere to the Third Energy Package.

All the risks, particularly, the temporary risks related to the construction of new gas transmission facilities from the Turkish-Greece border are laid on the shoulders of the European Union and the European Commission. The deadlines are very tight – these facilities are expected to be created before the 2019 end.

When we made a decision to cancel the South Stream project there were a lot of rumors – I mean speculations – about the fact that Gazprom didn’t plan to stick to the Third Energy Package. Well, excuse me for being straightforward, but it’s a real nonsense. Construction permits, and I’m not talking about operation permits, are issued by the project participating countries. Another story is about complying with the European law – and, believe me, Gazprom’s experts are well in the know of the Third Energy Package provisions – and we do understand that Gazprom is able to run its business on the European market under the Third Energy Package terms and conditions. Under this document, we may use various models and options. It’s not true that we had to give up on the South Stream project because we were not able to comply with the Third Energy Package and the European law. We aimed to keep our status quo on the gas transits via Ukraine and there are no hidden pitfalls in cancelling the South Stream project.

If some people think that by blocking the Turkish Stream project they will hit their target – well, I’m afraid they are wrong. In fact, they are deeply mistaken, because – firstly – we can shift gas volumes to other markets and, secondly, we can take a little break and wait. This is our competitive advantage, I mean our ability to wait, and we will wait if we are forced to do so.

As for prompt decision-making, I would like to say that it is another competitive advantage of ours. The Company quickly makes strategic decisions and is able to implement them effectively. There are many examples. I believe that those who keep track of the gas market situation are aware of Gazprom’s ability to make quick and efficient managerial decisions as well as implement various projects.

If some people think that by blocking the Turkish Stream project they will hit their target – well, I’m afraid they are wrong.

Although speaking of the gas market in general – it’s extremely volatile. If we consider the current situation – the situation in Q2 – the first thing we notice is a sharp increase in the Company’s export gas supplies to the European Union. The growth exceeded 11 per cent during the first decade of Q2. There is an explanation to this: firstly, the price level in the European market. The prices have declined significantly. We should understand that European consumers have withdrawn relatively large, if not to say very large, volumes of gas from underground gas storage facilities in Europe this winter – it is the second reason. Thirdly, I think that, thank God, there were no major disasters caused by transit via Ukraine last winter, but European consumers, particularly consumers in Germany, realized even better all the risks presented by transit via Ukraine. So, I believe that the preparation for the autumn-winter period, including that of 2015–2016, and gas injection into underground gas storage facilities in Europe, by Gazprom among others, will be even in larger volumes than a year ago. We clearly see that according to the price dynamics, prices in Q3 might be even lower than in Q2. But as for Q4, considering the trends existing in the oil and oil derivatives market, we still expect the gas price to be higher than in Q2 and Q3. Our consumers and customers realize it, so in 2015 we expect an increase in the volumes of Gazprom’s export gas supplies to Europe.

Early in Q2 I immediately paid attention to two publications by the leading analysts from well-known financial institutions monitoring the situation in the energy market. They forecast the volumes of Gazprom gas supply to Europe to be higher than our target figures. In particular, the forecasts range from 156 to 177 billion cubic meters of gas. Let me remind you that Gazprom supplied 147 billion cubic meters of gas last year. But in the present situation we deem it possible to hit the 2013 level or even exceed it.

The market environment also changed dramatically due to reverse gas supplies to Ukraine. Everything changed very quickly. As you know, the current gas price for Ukraine is significantly lower than that for a number of European countries and it immediately affected the reverse supplies. The level of reverse supplies to Ukraine in Q2 is 15 per cent lower in comparison with the maximum figures of Q1. At the same time, Hungary completely halted its reverse supplies – they were simply unprofitable. We may suppose that the amount of reverse supplies to Ukraine is due to the fact that the contracts for reverse supplies to Ukraine have been signed for a longer period.

In 2015 we expect an increase in the volumes of Gazprom’s export gas supplies to Europe.

Referring to the Ukrainian issue, I should certainly say a few words about the 2009 contract, which from the point of view of energy security and in terms of the situation stability is a sound foundation of our work. It is a very serious guarantee, very serious support in eliminating the Ukrainian transit risks for European consumers. The 2009 contract works. We operate strictly in line with the contract. This contract will be executed in full before the end of its validity, that is the end of 2019.

To date, everything concerning the conditions of gas supplies to Ukraine in the near future is absolutely clear. There are no crucial issues, omissions, ambiguities as to how gas will be supplied to Ukraine. The first thing is contract terms and conditions. The second one is the price. The contract provides for the possibility of granting a discount by the Russian Government. The discounts are being granted. The rate of discounts to be granted in the future will be based on the price level in the countries bordering on Ukraine.

As for the take-or-pay penalties, presently we do not plan to bill Ukraine for them. Therefore, the current situation with gas supplies to Ukraine is absolutely clear. I would like to stress that this situation is absolutely clear to Naftogaz of Ukraine. For today there are no issues in our relationship, which might be a subject for any additional negotiations.

Returning to the energy security model, it’s worth mentioning that the energy security model for our European market is certainly still to be formed. Firstly, in my opinion, there is still time to review in what direction we are moving with regard to the European model. There are some positive moments that make us think that major adjustments may be introduced into the European Commission business strategy. The reason for such a reasonably optimistic opinion is that some of the projects under discussion are still based on the principles of the energy security, ‘interdependence and interlocking model’. It can’t but please us, so I believe that our joint fair activities will eventually lead to restoring the confidence undermined by phobias, which are often stirred by mass media. Gazprom has been and will remain a reliable partner for European consumers. What is most important, nothing can happen that might prevent Gazprom, Russia, European consumers and the European Union from being important partners for each other in the gas market in the future. This is the first thing.

Gazprom has been and will remain a reliable partner for European consumers. What is most important, nothing can happen that might prevent Gazprom, Russia, European consumers and the European Union from being important partners for each other in the gas market in the future.

The second thing concerns Russian gas. As you all know, Russian gas will remain an essential element of the European gas market. But now we see how Russian gas is being fought against. Particularly Russian gas is being fought against. On the one hand, we see the aspects of this struggle. On the other hand, we see the result, which is very simple. We observe an increase in the share of Russian gas in the European market year by year. This trend will develop. Speaking about our reliability – our reliability in gas supplies to the European Union is proved by over 40 years of joint work and this experience is worth a lot. Therefore, I believe that we should look forward to our gas future. We have all reasons for this.

Thank you for your attention!