Podcast host Alexander Gabuev is joined by Katja Yafimava, a senior research fellow at the Oxford Institute for Energy Studies, and Sergei Kapitonov, a gas analyst at the energy center of the Skolkovo School of Management, to discuss the European gas crisis and Russia’s role in it.
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This podcast is part of the Russia-EU: Promoting Informed Dialogue project, supported by the EU Delegation to Russia. More info: http://eu-russia-expertnetwork.eu/
Gabuev Welcome, everyone, to the Carnegie Moscow Center podcast. My name is Alexander Gabuev. I’m a senior fellow and the host, and today—in a pretty freezing day in Moscow, and it’s starting to get cold—we’re going to talk about a really hot topic, which is the European energy crunch. And what’s Gazprom and the Kremlin up to in these very dramatic circumstances in the European energy markets? I’m happy to be joined by two leading experts on the issue, whom the readers of Carnegie.ru are very familiar with because they are really prolific, and we really enjoy their analysis. Today with us is Katja Yafimava, who is a senior research fellow with the Oxford Energy Institute. Welcome, Katja.
Yafimava Hello.
Gabuev And we are happy to have Sergei Kapitonov, actually, having him back—because he was one of the guests previously—who is a gas analyst at the Energy Center with the Skolkovo Management School. Welcome, Sergei. Let’s start with the kind of hottest, probably, topic. I opened the FT today, and I see that the decision of the German energy regulator, the Bundesnetzagentur, to suspend the technical certification process for Nord Stream 2 has made the prices for natural gas in UK and in some European hubs, again, climb by steep 15 percent. Katja, what’s going on? Like, you’ve written one of the best explainers on the approval process. So is that a technicality? Is it political? And how impactful is the decision of the German regulator?
Yafimava Yeah, thank you. Well, that’s true. That’s big news, yesterday, about the German regulator, BNetzA [Bundesnetzagentur], suspending [the] certification process, that’s regulatory certification process, which was meant to confirm that the operator of North Stream 2 pipeline complies with European gas directive requirements. So, that was a big surprise for a lot of people, and as you said, prices are up very sharply. So clearly, the market is disappointed about it, and that really shows just how important perception of Nord Stream 2 coming online is. And, you know, if you look back at a few, you know, weeks and months, any kind of positive news about Nord Stream 2 potentially going ahead, always come to market, all the negative news, which spell more delays, they have the opposite impact, they just cause prices up. Whether it’s just a technical issue, procedural issue, or political—I mean, the suspension of the process—I think it’s a little bit of both. That’s my kind of very first-day assessment of that. So, what the regulator really said is, under law, it had four months to consider the application. And that four months were supposed to be counted from the eighth of September; early January was supposed to be draft certification decision; and the commission would have two, and potentially another two or four, months all together for opinion. And then BNetzA would have two more months to issue a final certification decision, just to give you a timeline that was expected. So BNetzA actually sort of broke that timeline. It put a suspense on this. It has already used about two and a half months considering that process, and now what it has required, effectively, Nord Stream 2 to do, it basically said that in order to be certified, an operator would have to be a company registered under German laws. So, it has to be. At present, Nord Stream 2 is registered under Swiss laws. And once that process is completed, once Nord Stream 2 sets up this German subsidiary, etcetera, then that suspension would be lifted and BNetzA will resume the process and it will, it’s allowed to use the remainder of the four-months period. So, it’s about nearly two months. So, in my view, from what I understand, it takes about a couple of months to establish this new subsidiary. So, you could expect potentially the process to slip by a couple of months. And all in all, we would look into final certification decisions sort of around summer. And if you believe that no Nord Stream 2 flows will be allowed via Nord Stream 2 while this process is ongoing, that really spells, you know, there is no extra gas, at least via Nord Stream 2, and no extra Russian gas, via Nord Stream 2, into Europe, which spells sort of a winter, a whole winter of high prices. So, it’s no real surprise the market reacted the way it did. So, on one way, on one front, it’s a technicality, because BNetzA clearly interprets the law in such a way that it’s got to be a German subsidiary. And, you know, on the other hand, if that’s the case, it’s a good question why BNetzA accepted Nord Stream 2 certification request in September, it said all the documents were received, if it knew that the subsidiary would have to be German-based rather than Swiss-based. And, you know, it kind of looks as if, you know, BNetzA has started this process, but it also sort of allowed itself an inbuilt option to suspend this process anytime at its convenience, effectively. And what of the timing when it decided to suspend it, whether it’s coincidental, whether it’s partly political, that is really a big open question. But, ultimately, what it means for us people looking at gas markets, what it means for gas, that sort of means more uncertainty about, about you know, how tight, just how tight the gas balance is going to be in Europe.
Gabuev Just to clarify, Katja, without the certification process completed, and then the approval of the European Commission, and probably the court cases that might be brought up by Naftogaz, no flows on Nord Stream 2 will happen, or is there a way to ensure that the gas is flowing while the regulatory process is still ongoing?
Yafimava Well, normally, certification is considered complete and effective once all the stages have been passed, such as BNetzA’s draft, commission’s opinion, and BNetzA’s final decision, commission only has a consultative role, really, it can’t really tell BNetzA in that case what to do. And normally no flows would go via pipeline, as long as it’s not certified fully. And if flows just start going via the pipeline, BNetzA has a right to impose fines in that case, that’s, as I understand it, administrative offense under German law. And in my view, you know, if you imagine a scenario when it’s a particularly cold winter, unusually cold winter, if the storages are running low, and they are low, they’ve been filled up at a low state, at the low phase, then you can envisage a scenario when, at a certain point, an energy balance, the gas balance is going to look so precarious in Europe that the regulator, on balance of weighing different risks, may allow flows via the pipeline, because the important point to stress here that, actually, from a technical point of view, the pipeline is absolutely fine. It has been certified from a technical point of view, from the point of view of pipeline integrity. So, to put it simply, if you start flowing the gas via the pipeline, there’s not going to be any kind of technical disaster, you know, it can flow gas safely towards Europe. And there you have this brand new kit, with two pipelines sort of ready to start flowing gas. And if you see the situation in Europe very, very precarious later in winter, you may think that it’s possible to give such a permission. But that’s, again, that’s a lot of ifs and buts, etcetera.
Gabuev So, Sergei, let me turn to you to just briefly explain the logic of Gazprom. If I remember correctly, in October, Vladimir Putin said no-no-no, Russia doesn’t use energy as a weapon. We’re not trying to put pressure on the Europeans to get North Stream 2 approval. But, by the way, if Nord Stream 2 is approved today, the gas will flow tomorrow. If it is approved yesterday, we are ready to pump gas today. So, it shows that there is additional volume of gas that Gazprom is ready to pump, Gazprom has justified its meeting contractual obligation but not shipping extra volumes by the need to fill storages at home, which sounds like legitimate reason to delay the additional shipments. But now we started to see, like, some small inflow of additional gas for, like, a week back around November 8, November 9. So, is it a strategy? Is it coincidence of various factors? What is Gazprom trying to achieve?
Kapitonov Thank you so much, Alexander. Well, that’s how I call it. Gazprom has, personally, kind of a risky game this year. But this risky game hasn’t been specifically designed by Gazprom. I see that Gazprom was a lucky person out of the combination of factors that led to these skyrocketing gas prices in Europe. And amid this, this market situation, Gazprom has simply decided not to provide more gas to Europe, beyond their contractual obligations. And their meetings them that you have already mentioned in this situation is different, for example, to the situation in 2014 and 2015, when Gazprom was somehow trying to fight the Ukrainian reverse flows, and was not meeting contractual obligations. This year, from the legal perspective, Gazprom is absolutely secured. On the other hand, Gazprom can possibly play a role of a good cop, providing more and more volumes to Europe, but they definitely can’t do it on the spot. They can do it the other day after the decision is taken, because they probably do have enough resources, not only on the Yamal Peninsula, when they have, the Bovanenkovo gas field has reached its plateau level this year, but they know that in Bovanenkovo they can also extract more by 15 BCM, more than 115 BCM from the deeper layers, and they are now moving north from Bovanenkovo to the Kruzenshtern... to the Kharasavey and then to the Kruzenshtern gas fields. On the other hand, their legacy gas fields in Nadym-Pur-Taz, reducing their production volumes from what Mr. Miller has said, Gazprom has some 100 BCM of extra capacity. But that doesn’t necessarily mean that this capacity can be used tomorrow, when, when they see that the demand is growing in Europe. What I see [is] that Gazprom does need some predictable and long-term relations with their European consumers. For example, when the first Nord Stream project was implemented, Gazprom assigned new contracts for some 20 BCM of new Russian gas to Western Europe. These days, so with the Nord Stream 2 saga, they haven’t signed any new contracts, they probably do need some long-term guarantees that their investment, that their time they spent to utilize these idle production capacities, and this idle infrastructure, has been spent properly, and that they can repay their investment into, into this new capacity. So, in my view, if, if there is a need from Europe for new long-term contracts, we can see more Russian gas in Europe. But this is a long-term game. From the tactics of this year, I don’t think that Gazprom will somehow change its behavior, we see a minor, minor increase in Gazprom’s flows to Europe, primarily to inject into their storage in Germany and in Austria. But this minor increase isn’t the thing that can somehow completely change the whole picture, and the prices are at the historically high levels at the moment. So, I don’t think that Gazprom is going to somehow ease the tension on the market, just from their goodwill.
Gabuev But wouldn’t the additional volumes bring additional cash into Gazprom coffers? It’s, if it’s time to earn money on the European gas market, it’s probably now, or the share of the spot in the formula is just too low. Or there’s probably a technical lag of a couple of months. So, the current spike in the prices will be reflected in the money that Gazprom is actually getting from the customers sometime later. And that’s why Gazprom is not willing to pump more gas now. What’s, what’s the logic here? Because I think that that’s the argument I hear a lot, saying, hey, if Gazprom is a commercial animal, it should be earning money like crazy, when there is so much demand and the prices are so high. Why is Gazprom not doing that?
Kapitonov Is the question to me or to Katja?
Gabuev I think we can start with you and then go to Katja.
Kapitonov Okay. Okay, great. First, I do agree with you that this is a high time to earn money in Europe. On the other hand, I do think that Gazprom can sacrifice that kind of upside in the revenues this year to, let’s say, a more stable future for the years to come, because the whole gas game is a long game. And the, all these pipelines, the TurkStream and the Nord Stream 2 pipelines, designed for decades and the repayment of investments is planned also, it’s no less than seven years or eight years. So, probably, Gazprom is not specifically pursuing this strategy of pressure. Gazprom was a lucky one to be in such a situation. But I don’t think that the company is somehow interested now to, let’s say, to decrease, decrease this degree of pressure on the market, not in the pressing terms, but also in terms of the thirst for new gas, and this new gas, especially why the long-term contracts may be Russia’s gas, and what we have, what we have seen from this, what we have learned, from this gas crisis [is] that fully depending, fully relying on the spot market is a, is not a good strategy. The…LNG hasn’t come to Europe, amid, amid the skyrocketing prices. LNG flows mostly to Asia these days, and what does it mean that in, despite the huge capacity of regasification terminals in Europe, Europe can’t rely on the spot market. Europe does need a new long-term relationship, be it Russia or be it the United States. And in this game, as I already said, Gazprom, might be in advantage making Europe to sign something, something new with Russia.
Gabuev Katja, do we know how much spot price is reflected in Gazprom’s European contract? Is that the public information, or it varies from country to country and from customer to customer?
Yafimava Well, the information that’s been presented in various Gazprom’s reports, in public disclosure, that is a very significant share of Gazprom’s European contract is hub price. It’s not just spot, but also, you know, prompt and prices for, for the period of months, for example. So, it is also a lag. So, there is a high share of hub prices, which is why Gazprom has also been making good money this year, because the prices, these hub prices, they fit through into the contracts as well. And that, of course, compared to the previous year, which wasn’t a very good year for Gazprom, to put it mildly. So, it’s kind of compensating now isn’t it. But I agree with Sergei that, really, Gazprom has found itself in that situation where it’s, it’s beneficial for it. And it’s benefiting from its gas sales, but, you know, it has not, you know, abused anything, it has not manipulated anything, in my view, it just found itself in a good situation. And it has enjoyed it, you know, from a financial point of view, but also in terms of adding extra gas. I think the crucial point here, at least it has been so far, is that actually if you look at Gazprom’s production, it’s been very high. And the reason, in my view, why until recently we haven’t seen additional flows into Europe was just Gazprom was really pumping into domestic storages at high rate, and I understand this season has just been finished by the seventh or eighth of November. So, to me, what we saw is reduced outflows in late August and September that was actually due to the lack of available surplus gas to send into Europe to refill storages, Gazprom storages in Europe, because Gazprom had to do it first at home, so to speak, in Russia. It’s like, you know, it’s like airline principle, you know, fit your own mask and then help others, really. So, it’s kind of sensible, pragmatic behavior. And if that theory is correct, and I think it’s sort of starting to be evident that it is, because, as you’ve mentioned earlier on, as of eighth and ninth of November, we see sort of, you know, increasing, slowly increasing flows into Europe to feed storages, so I would interpret it, it’s as the gas which has now been freed up, so Gazprom no longer needs it for domestic storages, and that’s finding its way into Europe. The question about infrastructure is really, you know, if gas could come via existing routes, which is, you know, Nord Stream 1, TurkStream, Yamal, Europe, and Ukraine. But, also, if at a certain point there is sufficient amount of gas to flow also via Nord Stream 2, once you know, if and when it is cleared, then of course, that would pacify the market because it would be on a daily basis. But it also would create a perception within the market that, you know, there’s now those new gas fields, they’re connected by the new gas pipelines, and everyone feels a lot more relaxed that gas will come in, when and if, as needed into winter. With this kind of suspense now, again, that’s a big question mark.
Gabuev But we’re probably not talking this winter, for the reasons we discussed with the Nord Stream 2 approval process. So, the additional gas might flow through Ukraine, beyond the 40 BCM a year capacity that is envisaged in the contract. I don’t know how much spare capacity there is in Yamal pipeline, particularly given the threat of President Alexander Lukashenko of Belarus to cut the transit. I think that one interesting question here is the share of hub price reflected in the price formula. I remember that was a hot button issue just a couple of years back with Polish gas company pushing to have more hub price reflected. And I think that this time around, they wanted to go back to the price tied to the oil product, is that correct? So do we have an understanding and the feeling in the market of whether the market is okay to say, yeah, hub prices are nice when they’re low. But sometimes they are high because of these circumstances that are created by various market conditions like this year. And we had to bear with that, because that’s how this pricing mechanism works? Or is there a debate to go to kind of more oil-connected pricing formula to have a more balanced solution? What do you think, Katja?
Yafimava Well, I think that if you look at European gas market, and you kind of tracked balance of how much Europeans benefited from the period when the hub prices resulted in lower, actually were lower than prices that had been connected to oil for many years. And if you compare it with this, here, that on balance the European market has benefited a lot from hub-based prices. That’s one point. So, I don’t think they will likely sort of rush back to ask for predominant oil indexation. And also, just sort of an economic, you know, point is, hub prices, they effectively reflect supply and demand of gas as a commodity. So, it’s logical that the price of gas as a commodity is established by supply and demand for gas rather than supply and demand for oil. And that, of course, that’s a long argument. And that goes back. You know, when, oil and gas were sort of replaceable, because oil was a lot used for power generation in the past. It’s no longer the case in most of European countries, but also to note, about in particular Central and Eastern European countries, which for a long time, you know, they had contracts predominantly indexed to oil, and they were paying more than they would be paying had it been hub-based and they fought for years. But then, you know, you have this inquiry and [competition] investigation into Gazprom, which concluded peacefully with commitments, you know, Gazprom made certain commitments, etcetera. So now it’s impossible for Gazprom to sell gas anywhere in the European Union, pretty much, at a price which would be, you know, diverging from, from whatever level is on, on the hub. And, you know, so that’s, that’s really what it is now, it’s just so happened this season, it’s pretty much unprecedented, unprecedented, that, you know, oil prices, oil indexation, that would have been resulted in a lot lower prices. But having said that, of course, countries, particularly countries with weaker economies, they might want to have, you know, certain degree, you know, of both, and we witnessed that within Moldova contract, which understood to have 70 percent oil indexation, 30 percent gas indexation. And now, what’s upcoming is negotiation over the Serbian gas contract and how that will go. And it’s also supposed to be on a longer-term basis. And Moldova is for five years, Serbians talk about ten years, I think, and then there will be, there’s also been news of negotiations between Gazprom and Germans, on, on a new supply. But, I mean, so another point actually to add here is with the energy transition, green transition, and for European countries, which, you know, now prioritize these green transitions very much. The question is, you know, how willing they will be to conclude long-term contracts? And, again, what do you think long term? Is it five years? Is it ten years? Because in the old days, there were, like, twenty-plus-year contracts. And for countries which, you know, put less priority on this green transition and high priority on physical security, like, for example, Turkey, that might be more, you know, palatable to have a, preferable in fact, to have a longer-term deal. And, of course, the final point, you know, the current energy crunch, it’s kind of pushing people to, you know, revisit and revalue their priorities about physical security, price security, green transition, etcetera. And they put different values on, on those things. And I think, depending on how long the energy crisis is ongoing, or how severe it’s going to be next winter, will potentially have very significant implications for gas in European, particularly European, balances. And it’s not just about Gazprom, it’s not just about Russian gas, it’s for, for gas in Europe and globally.
Gabuev That’s a perfect summary for the potential impact of the energy crunch for the European gas market going forward. Sergei, finally, I’m turning over to you to ask, what would be Gazprom’s likely reaction to the transition that’s visible because the energy crunch is partially a result of the energy transition globally, and it’s not only Europe, but it’s, it’s China and many factors here are interrelated. So, higher demand for gas born out of post-COVID recovery, and some weather elements, and others sending the prices to the trajectory where they are. That’s definitely having the repercussions for the European market. But what would be Gazprom’s response to these very serious dynamics in the European gas market in, like, ten years’ timeframe? What’s the Gazprom options available? Is it more gas to China? Is it hydrogen? What are the options on the table?
Kapitonov Thank you so much, Alexander. Great question. Well, I will divide this question into two parts. First, what is Russia’s take on the whole future of natural gas? And in my view, the answer is clear. It’s LNG that is flexible, that can move to every part of the world, primarily to Asia’s markets. And the LNG that the history of the last couple of years shows can be green—in accounting terms, of course—but the carbon footprint of LNG can be compensated using different trading schemes, the carbon credits can be bought on the market terms and the consumers that are willing to pay more to show that they are buying clean LNG with no, in accounting terms, carbon, they, they do it and there are a lot of carbon-free cargoes traded at the moment on the markets, and free cargoes have already been exported from Russia’s projects. So, LNG and, in the future, these so-called “carbon-free LNG” with, the, as it can be compensated or real measures to, to reduce the carbon footprint of LNG can be used, and this LNG can be also in demand in Europe, especially in the markets like Spain, or Portugal. What Gazprom will be doing is a bit more complicated thing because Gazprom, of course, is more conservative, Gazprom for—a couple of years ago Gazprom has demonstrated in, in their strategy, that their strategy will be based on three chains...of three new chains, this is first natural gas, then methane-hydrogen mixtures, for the next five years, and in the future of 2030 they can supply pure hydrogen to Europe. But the problem here is in the acceptance of this blue hydrogen, or Turkish hydrogen, which Gazprom is promoting, the hydrogen which is, which can be produced using the methane pyrolysis technology, with no co2 emissions, but with only, with carbon black as a side product. This is a technology that Gazprom is now testing in a lab. But while this is a lab technology, and there are no commercial practices of using this technology; so far, Gazprom has invited German partners to further elaborate on this technology, but there are no real pilot projects yet. And the thing is on the acceptance of this hydrogen in Europe, because the current European discussion is based on the green hydrogen, on their own domestic renewable capacities that can produce this green hydrogen, let’s say in twenty years’ perspective. But, well, what I see now is that both Europe and Gazprom can be in the same boat because, well, this energy, this gas crisis, has shown a lot, has taught us a lot of lessons from, from the necessity of long-term predictable relations to inability of renewables to save Europe in times of the energy crunches. And it all means that the period, that this transition period may be a bit longer than was previously expected. And that gas, and gas also from Russia, can be in demand in Europe for, for a bit longer than it was expected because, before, most analysts said that after 2030 the reduction of Russia’s gas flows to Europe will be dramatic. This is now not that vivid.
Gabuev This is really fascinating. As I sit here in Moscow, in mid-November, I’m happy that Gazprom has put the mask on its face first. Probably, I know that it doesn’t make life in Europe easier. But I hope that this crunch will be resumed sooner rather than later. And the dynamics and the changes that it brings to the market are extraordinary, with a lot of implications for both the gas industry, the energy market, and Russian politics. So, we definitely should reconvene once the madness is over sometime next year. I thank you very much, Katja and Sergei, and looking forward to host you again and to read your stuff. Thanks.
Kapitonov Thank you so much.
Yafimava My pleasure.