Pavel Oderov: Europe to Asia

December 10, 2012, the interview was taken by Sergey Pravosudov
Published in the corporate Gazprom Magazine, Issue 11

Pavel Oderov, Head of the International Business Department of Gazprom answers the questions posed by the corporate Gazprom Magazine.

Mr. Oderov, the European Commission has recently been trying to obtain the functions of the international gas supplies regulator. What do you think about it?

In autumn 2012, the European Parliament and the Council of the European Union approved a draft Decision on setting up an information exchange mechanism with regard to intergovernmental agreements between Member States and third countries in the energy sector, vesting the European Commission with authority to ensure that all existing and prospective intergovernmental agreements in the energy sector complied with the norms of the European legislation.

Moreover, the EU Member States have the possibility to invite the European Commission to participate as an observer in negotiations related to conclusion of intergovernmental agreements in the energy sector. However, it is within the sole competence of each state to achieve energy balance on its national level. Certainly, today it is possible to say that a part of these functions is transferred to the supranational level. For example, the EU undertook obligations to increase by 2020 the share of renewable energy sources by 20 per cent and reduce the level of greenhouse gases emission by the same quantity as compared to 1990. But defining a specific way of reaching these ambitious goals is still up to each of the states.

Gazprom operates in the European market in compliance with long-term gas supply contracts concluded with major purchasers and economic entities. In a number of cases such contracts are seconded by intergovernmental agreements with the corresponding EU Member States.

We carry on our business in the EU regarding the fact that international agreements, particularly those which regulate relations in the gas sector between Russia and other states, have precedence over national legislation, can’t be revised unilaterally and should be diligently followed by the Parties.

Third Energy Package

What is the outlook for the Third Energy Package implementation in the EU?

As we know, the EU Member States were to implement the Third Energy Package obligations into their national legislations by March 3, 2011, but a number of states haven’t completed the procedure so far.

This fact bears witness to the heterogeneity of the EU Member States’ attitudes to the Third Energy Package itself, as well as the uncertainty of regulation induced by new energy rules. There is no doubt that it affects not only the activities of European energy companies, but also the activities of third country corporations operating in the EU, such as Gazprom.

Moreover, it is obvious that there is no common understanding of how a number of important provisions of the Third Energy Package correspond to the international law, first of all to the international obligations of the EU Member States on investments protection and encouragement.

At the same time, we certainly welcome the opportunities the Third Energy Package offers to energy companies regarding work with ultimate consumers, and we will actively seize them. However, we are strongly convinced that new rules shouldn’t affect us as investors allotting our internal funds for the development of the European energy network.

For example, right now we are witnessing a paradoxical situation with OPAL and NEL gas pipelines receiving gas from Nord Stream. The German energy legislation, amended in compliance with the norms of the Third Energy Package, demands that third parties be given access to gas transmission facilities in the Federal Republic of Germany, OPAL and NEL gas pipelines included. But physically the third parties will simply be unable to use these facilities, because gas is delivered to them from Russia via Nord Stream which falls outside the scope of the EU. This is a spectacular example of how any idea may be reduced to an absurdity and how the prospective development of the European gas transmission system may be put in question, as nobody will want to invest into the pipelines destined to stay half-empty due to the regulation.

What is your attitude to the EU Gas Target Model?

At the moment, the documents related to the EU Gas Target Model are being elaborated. The Target Model in its present state suggests the European gas market division into zones. Inside each zone, which will be organized on the entry-exit principle, it is planned to secure unhampered and competitive gas trade in liquid trading floors.

Right now, the EU Gas Target Model is not a binding document but rather a scenario prototype which the EU Member States should take into account while developing both national and European gas market. After the final consolidation in 2014–2015 of the Third Energy Package obligations in legal systems of European countries, the principal provisions of the Gas Target Model may serve as the basis for future European Union justice initiatives in the energy sector.

Only the existence of system-wide components in the European gas transmission system may secure uninterrupted gas supplies across Europe and ensure the appropriate level of energy security

It should be mentioned that to really create a single European gas market, as is provided by the Target Model, considerable funds should be invested into the development of additional gas transmission networks, laying of interconnectors and creating capacities for reverse gas flows. Quite often such investments are system-wide and serve as an additional load to the economics of business networks. A more than 60 year-long history of the integrated Unified Gas Supply System of Russia confirms the fact that only the existence of system-wide components in the European gas transmission system may secure uninterrupted gas supplies across Europe and ensure the appropriate level of energy security. Is Europe ready to invest such large-scale funds by itself? There is no exact answer to this question yet.

Russian gas outlooks

What are the outlooks for the Russian gas in the European market?

The European market finds itself in a difficult situation now. In 2011 gas consumption in Europe declined drastically (by 9.6 per cent) and hit the level of ten years ago. Gas consumption in the current year continues to decline: following the results of half a year it decreased by 7 per cent in comparison with the corresponding period of the last year.

We anticipated that weather conditions and market environment wouldn’t considerably support our export business in the current year. Though, on the other hand, their negative impact might be less intense than in 2011. Moreover, this Balanced Scenario of the course of events was considered by the Gazprom Board of Directors as the most probable one. Calculations in accordance with this scenario showed the decrease in sales volumes while obtaining the optimal balance between sales volumes and foreign currency earnings.

As for the long-term outlooks, much depends on how realistic would be the scenarios of the EU economies ‘decarbonization’, elaborated by the European Commission in the end of last year as part of the Energy Roadmap 2050. Today all the Roadmap scenarios provide for the reduction of the natural gas share in the EU energy balance by the middle of the century. Even in the most optimistic scenario the EU experts do not expect an increase in natural gas consumption: they think that the rates will remain at the same level only if restrictions are imposed on nuclear power or if additional taxes are levied upon CO2 emissions.

If we are a success in realizing our potential, by 2030 the Gazprom share in the European market may increase from current one-fourth to one-third of the total European consumption.

In the present situation, the possibilities of expanding the Gazprom Group market share are primarily connected not to the increase in consumption, but to cutting down its indigenous natural gas production in the EU Member States, which results in a gap between current production volumes and gas import on the one hand, and forecast consumption volumes – on the other. According to the consensus forecast, this gap will reach 100 billion cubic meters by 2020 and will increase to 140 billion cubic meters by 2030.

One of the ways to push up gas sales further is to enter the market segments new to us, for example, gas-fired power generation and gas use as a motor fuel. If we are a success in realizing our potential, by 2030 the Gazprom share in the European market may increase from current one-fourth to one-third of the total European consumption.

Will Gazprom increase gas sales in Europe at spot prices?

European gas market restructuring based on the liberal model principles became a kind of a durability test for our long-term contract relations with the major partners. During the last year and a half, the EU’s stake on the development of gas exchange trade in the conditions of oversupply has led to the Russian gas purchasers’ spree of rearrangements of basic contract conditions, including fixed pricing principles and a basic price level.

First of all, we face the demands for the price level reduction, and one of the mechanisms offered for it consists in pegging a substantial part of contract volumes to price quotations of trading platforms (spot prices), while preserving long-term contracts which have a considerable cost of yearly and daily flexibility. It should be mentioned, however, that there may emerge a situation when spot prices will exceed the oil ones, thus forcing the customers to U-turn their demands.

At present, to support the competitiveness of Russian gas, Gazprom makes efforts to adapt the existing contracts offering the counterparties compromise solutions. The model of basic price level correction in long-term contracts without changing the oil product pegging formula is currently regarded as a possible way of adaptation. In a number of cases, direct pegging to gas indexes was used for a part of volumes. These adaptation measures are applied gradually, to a limited extent not to provoke the self-induced price adjustment cycle in the direction of their further decrease.

Power

What are Gazprom’s plans with regard to the European power market?

Right now, Gazprom continues operating in the European power market through the offices of its subsidiary company Gazprom Marketing & Trading. The company’s activities include both power trading and supplies to ultimate consumers in the German and UK markets. The latter have increased almost twofold in comparison with the last year (1.52 terawatts-hour in the first three quarters of 2012 versus 0.86 terawatts-hour in the corresponding period of 2011).

Gazprom Group is considering a number of power generation projects in the UK, Germany and Benelux, Turkey and the Balkan region.

The Company is planning to increase supply volumes to ultimate customers to 20 terawatt-hour by 2020 along with substantially expanding the geography of supplies. Meanwhile, Gazprom Group is considering a number of power generation projects in the UK, Germany and Benelux, Turkey and the Balkan region. Right now, talks are held with several European companies on asset purchasing or cooperation in the power generation sector.

Were talks with Bavaria a success?

Last December, Gazprom and the Federal State of Bavaria signed a Roadmap for cooperation in power generation and gas supply. In the course of the past year, consultations with Bavarian authorities and Bavarian electricity producers allowed Gazprom to substantially advance in implementing the Roadmap provisions.

At the same time, I’d like to stress that to make a final decision on investing into power generation projects in Bavaria we need to be more sure in the gas-fired power generation demand. The most promising option of improving the investment attractiveness of gas-fired power generation in Bavaria and Germany as a whole is represented by the capacity payment mechanism, which stipulates collection of extra payments by power stations owners from system operators for reserving generating capacities in the periods of insufficient power in the system.

Gazprom is expecting that its German partners will make active efforts to make the capacity payment mechanism work in the German power market as soon as possible. Moreover, currently Gazprom is looking into the possibility of implementing a pilot project of using gas as a motor fuel in Bavaria.

America

What is your attitude to prospective LNG supplies from the USA?

At the moment, there is only one operating LNG plant in North America situated in Alaska (with the annual capacity of some 1.4 million tons of LNG), which has been on stream for 40 years now. It has recently been announced that 22 LNG export projects were to be constructed in North America (15 – in the USA, 7 – in Canada) with the total capacity of about 265 billion cubic meters of gas or 195 million tons of LNG a year.

The major economic prerequisites for the growing interest in American LNG projects are as follows: the unsatisfied global LNG demand in the medium term, the relatively low cost of shale gas production in North America and the possibility of reducing capital expenditures on the projects, many of which are to be constructed on the basis of existing regasification terminals with operating sea infrastructure facilities, interconnectors and LNG storage facilities.

However, it is unlikely than all the projects mentioned above will be implemented in the medium term. The main reasons for that include: the time-consuming procedure of obtaining permits for the export of a strategic resource, namely natural gas, to the countries which didn’t sign a Free Trade Agreement with the USA; public discontent caused by the construction of LNG plants, which are high-risk facilities, in heavily populated areas of the US East Coast and the Gulf of Mexico; the absence of an indispensable fleet of expensive LNG carriers.

Moreover, the US authorities are in no rush to support new export gas projects, as their implementation will lead to the increase in domestic gas prices, which will considerably reduce competitive advantages of other sectors of the American economy: petrochemistry, metallurgy, heavy engineering. Today only the Sabine Pass LNG project (with the annual design capacity of 17 million tons, commissioning scheduled for 2017) has all the permits for construction and LNG export.

The issue of American LNG prospects, especially in the European market, has another important aspect, which is the price. Many people think the US gas which costs USD 2 to 3 for one million British thermal units will be exported to Europe at similar prices. This is a serious misapprehension. The export price should be evaluated in the following way: the calculation of the gas prime cost at the field plus the cost of its transmission to the LNG plant, the cost of liquefaction (gas technical losses included), cost of ocean freight, as well as regasification at the port of destination. And to crown it all – suppliers’ margins, possible taxes, excise duties, etc. The roughest estimated totals equal USD 13 and up for a million BTUs. As a result, this gas in Europe will cost more than Russian or Norwegian one. Maybe, LNG supplies to the premium Asian market will yield more profit, especially in Japan where prices amount to USD 16 for a million BTUs. As for the Europeans, they will not pay such prices.

Africa and Asia

Have Gazprom’s plans related to the countries of North Africa changed?

Since 2008 Gazprom together with the Algerian state-owned company Sonatrach have been implementing the El Assel joint project in Algerian Sakhara through the Gazprom International project operator. The geological exploration stage is to be completed in 2014. In the frame of the forthcoming changes to the Algerian hydrocarbon legislation we expect that the government status of our companies will allow to expand our activities not only on the basis of regular tenders but in a bilateral format as well. We also keep track of regional energy projects outlooks and the surge in activities of European countries in the sphere of Mediterranean integration in the power industry with Algeria and Morocco being given key positions of future generating capacities.

A difficult situation in the field of security hampers Gazprom Group from resuming operations in Libya. Moreover, other foreign companies, having partially resumed their oil and gas production activities, still haven’t started geological exploration because of the existing risks. Nevertheless, now Gazprom Group is elaborating the opportunities for resuming work in Libya, in the first place with due account to the further pace of developments in the country. One should bear in mind that political dislocations in a number of African states in 2011–2012 accompanied by the interruption of hydrocarbons export once again demonstrated the significance of Gazprom as one of the most reliable suppliers of energy resources.

What are Gazprom’s plans regarding the expansion of its presence in the LNG market?

The LNG share in the global gas trade amounted to almost 25 per cent by 2011 and continues to increase. The growth of LNG production was caused by the emergence of new importing countries and creation of new liquefied natural gas markets. In 1996 LNG was imported by 9 countries, whereas in 2011 there already were 25; moreover, the total import volume increased from 74.6 to 239.1 million tons. Now there is a gap in the LNG market, but in three years supply volumes will grow due to the commissioning of new capacities, first of all in Australia.

The Gazprom Group strategy is in keeping with this global trend, we are working on building up the LNG share in our export supplies with the crucial role to be fulfilled by the corresponding Russian projects. An important step taken in this direction in 2007 was Gazprom’s joining Sakhalin II, the first Russian liquefied natural gas production project, which allowed us to enter the market with the LNG of our own. Now we are conducting a feasibility study of expanding the LNG plant in Sakhalin, particularly construction of the LNG plant train 3 to produce up to 5 million tons a year.

A promising project in the Far East is the construction of the Vladivostok LNG plant with annual throughput exceeding 10 million tons. LNG projects in other countries are also being looked into in cooperation with foreign partners.

Finally, another promising direction is developing markets for LNG use in marine vessel bunkering and in motor vehicles.