Oil and Gas in the Capitals

	Vol. 231 No. 4
ØYSTEIN NORENG, CONTRIBUTING EDITOR, NORTH SEA

Natural gas for Europe: How much? From where? At what price?

The outlook for the European gas market is changing quickly. The conventional demand outlook was that, because of diminishing domestic output and rising consumption, Europe would be forced to increase imports and consequently lose leverage with a limited number of suppliers, with an upside price risk. With more emphasis on energy conservation, renewable energy and eventually nuclear power, Europe’s gas import needs might be much more moderate than, until recently, anticipated. As for supplies, worries about scarcity dissipate as the availability of seaborne supplies is realized, and especially as the potential for shale gas dawns. Moreover, new pipeline supplies seem to be available from the Caspian region and even Central Asia. The diversification enhances supply security and strengthens the buyers’ bargaining position, leading to a downside price risk for producers.

The development of shale gas in the US has triggered a chain of changes in the global gas market. Only five years ago, the consensus was that North America was destined to become a major LNG importer. Prospects for US sales spurred investment in gas fields, LNG export terminals and tankers. The Shtokman project in the Russian Barents Sea explicitly targeted the US market, as did LNG projects in Angola, Qatar and other countries. Consensus was also that rising US imports would pull gas prices up, so that, in the longer run, both LNG and pipeline gas would be more costly.

Such prospects caused concerns in Europe; the outlook was for both gas import dependence and gas prices to rise quickly. Repeated disruptions of Russian gas supplies through Ukraine were a reminder of the precarious security of supply for pipeline gas transiting third countries. Sudden leaps in gas prices, partly due to indexation to oil prices, demonstrated the cost of depending on a small number of external suppliers.

Against this backdrop, the European Commission designed an ambitious program called “20-20 by 2020”—meaning a 20% reduction in the energy intensity of the EU economy and a 20% share for renewable energy. Policy instruments are regulations and subsidies; for example, utilities in Germany are compelled to have a certain share of renewable energy in their portfolio, and governments pay for investment in wind and solar power.

As the economic context changes, policies change. The most immediate impact is that LNG projects once destined for the US are seeking ports elsewhere, essentially in Europe and China. Next is the potential impact of pipelines from new gas suppliers such as Libya and Azerbaijan. Even if the Nabucco project to bring Caspian gas to Europe is costly and may initially be difficult to fill and finance, there is supply potential beyond Turkey. Relations with Iran might improve, and Qatar has the world’s second-largest proved gas reserves. Consequently, Europe is potentially facing a much larger choice of gas suppliers.

Such prospects evidently enhance the attractiveness of natural gas for Europe’s energy investors and national energy planners. Developing a European shale gas industry would likely take at least a decade, given the need for investment in infrastructure and environmental problems. But there are resources there, and such prospects also enhance the attractiveness of natural gas. Dependence on fuel imports looks less threatening with a plethora of suppliers.

The financial crisis, the European recession and the high debt burden of many governments undermine “20-20 by 2020.” Stagnant economies, unemployment and budget deficits reduce governments’ appetite for costly energy programs, and there is not much private capital available for energy projects that are only viable with handouts from governments that need to cut budgets.  Against this backdrop, policies are likely to converge on the most cost-effective solutions, which probably will mean considerable gas volumes for heating and electricity.

The structure of the European gas market is likely to change markedly. Supplier diversification and competition provide strong arguments for open access to infrastructure and clients, and against import monopolies and political control of gas trade. The historical monopolies in European gas trade were justified by the need to invest in infrastructure and to bargain with a small number of sellers. This is no longer the case; infrastructure has been developed and sellers are many.

Gas suppliers to Europe, whether by LNG or by pipeline, may experience volume growth in the market, but much stronger competition is likely to keep prices down for a long time. Spot trading is likely to replace long-term take-or-pay contracts, and indexation to oil prices will be unsustainable. The Shtokman project seems far off, and Nabucco seems rather uncertain. Deferring major investment projects has little or no impact on the immediate market balance, but compromises the long-term predictability of the gas market, whose balance ultimately depends on heavy capital investment with long lead times. Thus, short-term and medium-term consumer gains may lead to a long-term predicament.

To sum up, changing circumstances enhance the competitiveness of natural gas in the European market, but the incumbent suppliers need to rethink their strategies. Norwegian gas exporters will continue to benefit from geographical proximity and a reputation of reliability, but will have to comply with lower margins and a more volatile market. Russian exporters will have to prove their reliability. Russia’s major advantage is that it is a huge market for European goods and services, with potential for further growth. In the immediate future, Russia may lose from supplier diversification, but, in the longer run, Russia may be a winner, insofar as its gas resources are available for incremental exports to Europe and have not been committed to the Chinese market. Against this backdrop, Europe has an interest in maintaining a major share for Russia in the gas market and not uncritically diversifying away from Russian gas imports. WO