Port of Sabetta, Yamal peninsula, December 2017: the world’s first icebreaking LNG tanker, Christophe de Margerie, begins loading its first cargo of liquefied natural gas in the presence of Russian president Vladimir Putin. Despite temperatures touching 30 degrees Celsius and, above all, Western sanctions, Russia’s first large-scale LNG project in Arctic waters began operations on time and within budget. It is expected to produce 16.5 tons of LNG per year by 2019, with access to both Europe and East Asia via the Arctic Sea route. Yamal LNG was a big success for the USD 27 billion joint venture of commercial stakeholders, including Russian operator Novatek (owner of 50.1 percent), French Total (20 percent), China National Petroleum Corporation (20 percent) and the Silk Road Fund (9.9 percent). The project seemed to be facing a major financial challenge in 2014 when the United States imposed sanctions on Novatek. However, the challenge was surmounted by switching the financing from dollars to euros and, significantly, through the acquisition of USD 12 billion from Chinese lenders to replace Western investment.
Russian leadership and the new role of China
For Russia, the world’s largest gas exporter, the project is a significant step towards becoming a major actor in the field of LNG. Russian gas exports, which mostly flow to Europe, have traditionally relied on a thick network of pipelines. However, they potentially face growing competition from LNG producers such as Qatar, Australia and the United States. This prompted Russian actors to seek a role as an exporter of LNG, a role which would also give Russia greater access to lucrative Asian markets. Hence, the Russian government ended the monopoly of state-owned Gazprom on LNG exports, and exempted these new exports from taxes, whereas the taxation on pipeline exports, where Gazprom retains a monopoly, is at 30 percent. Yamal LNG could be just a first step: Russia now aims to build more LNG plants, from the Baltic region to the Pacific coast.
The Yamal project highlighted the role of China, and is significant for its energy security. As seen, following western sanctions, Chinese actors provided the lion’s share of the necessary loans for the project. Significantly, the first cargo in December 2017 was sold to China in recognition of its support of the project. For half a year, gas exports from Yamal LNG can reach China in approximately 15 days through the Arctic route, half the time of the standard route via Europe and the Suez canal. From the perspective of Chinese energy security, this is also a step towards diversification of import routes, which are presently over-dependent on the Malacca Straits and the South China Sea. For Russian LNG, the Chinese market is a promising one: in 2017 it surpassed South Korea and became the world’s largest LNG importer after Japan.
The role of the European market
Yamal LNG was also a success for a European company, the French firm Total. While Western sanctions have hindered other Russia-based joint ventures with Western participation, such as the one between Exxon Mobil and Rosneft, Total has managed to preserve its stakes and will now buy four million tons of gas annually from Yamal LNG. In a symbolic act, the first of the 15 LNG vessels that will serve the project was named after Christophe de Margerie, the Total CEO who died in a plane crash in Russia in 2014.
While Asian buyers have reportedly bought 54 percent of Yamal’s contracted output, the rest can be sold on European and Western markets. It can therefore provide a Russian alternative to Gazprom-owned gas, thereby contributing to competitiveness in the EU market. At the same time, Gazprom’s pipeline gas remains the largest source of imports for Europe, and will likely stay so for the foreseeable future–particularly as domestic production in the EU decreases. In 2017, Gazprom supplied a record total of 193.9 billion cubic meters (bcm) of gas to Europe and Turkey, beating the previous record that it had set in 2016 by 8.1 percent. Germany was the largest customer, having bought 53.4 bcm. Austria recorded the largest percentage increase in gas bought from Gazprom compared to 2016 (+40 percent, for a total 8.5 bcm), followed by the Czech Republic (+28 percent and 5.8 bcm), Slovakia (+24.5 percent and 4.6 bcm), the Netherlands (+9.7 percent and 4.6 bcm) and France (+6.8 percent and 12.3 bcm). The record high sales are linked to several factors, including the cold winter, decreasing production in the European Union and rising demand due to the economic recovery in Europe. Gazprom sells its gas to Europe mostly through long-term contracts. Contracts with its two main customers in the European Union, Germany and Italy, run until the mid-2030s.
Europe and Russia, a historical relationship
The energy partnership between Moscow and European countries was built over several decades, often defying severe political tensions. The gas trade between Russia and Western Europe dates back to the Cold War period. In the late 1960s, a relaxation of Cold War tensions induced Austria, West Germany, Italy, Finland and France to sign the first gas import contracts with the Soviet Union. For Western European countries, incentives to strengthen their energy relationship with Moscow grew as a result of the 1973 oil crisis, when the Organization of Arab Petroleum Exporting Countries imposed an embargo on oil sales to Western countries that supported Israel in the Yom Kippur war. The event called into question the security of energy supplies from the Middle East. Meanwhile, new gas field discoveries in the Soviet Union turned the country into the world’s largest gas producer by 1984. In this context, and despite the opposition of the Reagan administration in the United States, Western European countries deepened their energy relationship with the Soviet Union and successfully insulated it from the political tensions of the Cold War. It is paradigmatic that the large Urengoy-Uzhgorod pipeline, shipping Siberian gas to Central Europe, became operational in 1983 during a new peak of tensions between the Western and Eastern blocs in Europe. East-West energy trade boomed as the Cold War drew to an end: the volume of Soviet gas exports to Europe rose from 29 bcm in 1983 to 40 bcm in 1987 and 60 bcm in 1989. After the collapse of the Soviet Union, energy trade became the cornerstone of EU-Russia economic interdependence. In order to accommodate the growing trade flows, new transport infrastructure was built, most notably the Yamal pipeline (across Belarus and Poland) in the 1990s and the Nord Stream pipeline (connecting Russia and Germany via the Baltic Sea) in the early 2010s.
The late 2000s, however, also saw occasional disruptions in the flows of Russian gas to the European Union linked mostly to disagreements between Russia’s Gazprom and Ukraine’s Naftogaz regarding the price of Russian gas and the transit fees paid by Gazprom to Ukraine to channel gas westwards to the EU Political disagreements between the two countries also contributed to the disagreements. In both 2006 and 2009, these factors led to temporary disruptions in the flow of Russian gas to Europe. Although the disruptions were limited to a few weeks, the fact that they occurred in January and that European countries were highly reliant on immediate gas supplies from Russia meant that they had a large resonance in the Western media.
In the early 2010s, increased gas storage capacity in Europe and the construction of the Nord Stream pipeline decreased risks for the EU related to new potential disputes between Russia and Ukraine. Even so, around 50 percent of Gazprom’s exports to Europe continued to be channeled via Ukraine. Unsurprisingly, concerns mounted in 2014, when Russia annexed Crimea and tensions between Moscow and Kiev reached an unprecedented peak. As the European Union sided with Ukraine during the crisis, many politicians and analysts feared that Russia would weaponize its energy exports and cut supplies to Europe. In fact, the ‘energy weapon’ did not materialize and Russian gas continued to flow to Europe, even across Ukrainian territory. Indeed, despite tense relations between Moscow and Kiev, the transit of Russian gas through Ukraine’s pipelines increased by 13 percent in 2017, totalling 93 bcm–the highest level since 2011. These data highlight how energy trade between Russia and the European Union continues to defy political tensions and disagreements and mostly responds to market logic.
Moscow's strategies to avoid Ukraine
Much has been written in recent years about Russia’s attempts to bypass the Ukrainian transit corridor through the construction of new pipelines. The Nord Stream 2 and Turkish Stream project are largely intended to fulfill this goal. Nord Stream-2 would double the capacity of the Nord Stream energy corridor, bringing it to 110 bcm/year. Turkish Stream would carry 31.5 bcm/year from Russia to Turkey under the Black Sea. Part of this gas would then be channeled to the European Union from the Turkish-Greek border. If both projects are implemented, Ukraine will probably see a reduction in the flow of gas bound for the EU through its territory. From a commercial perspective, this could make sense, as Ukrainian transit pipelines are aging and will require extensive maintenance in coming years. Shifting gas flows to other routes would also help depoliticize debates on EU-Russia gas trade by greatly diminishing the possibility of transit crises such as those of 2006 and 2009 with their potential for supply disruptions. However, even the construction of both Nord Stream-2 and Turkish Stream would not automatically end Ukraine’s role as a transit country for gas. If the Ukrainian pipeline network is kept in a good operational state, and the cost of channeling gas through it remains competitive, European buyers will continue to be interested in this import corridor. Significantly, in April 2017 the Italian company Snam and Slovakia’s Eustream signed a memorandum of understanding that highlighted their interest in making the Ukrainian gas transport system more efficient, modern and competitive. The memorandum was signed while Gazprom and its European corporate partners were going ahead with plans to build Nord Stream 2 (construction is planned to start in the summer of 2018). This suggests that market competition will play a decisive role regarding the future infrastructure through which Russian gas will be exported to Europe.
How important is Russian gas to Europe's energy mix?
While the geography of import pipelines is likely to change and become more diversified in the near future, there is little doubt that Russian gas will remain an essential component of Europe’s energy mix. This is due to its economic competitiveness, the extensive infrastructure that is already in place and the long-term contracts between Gazprom and European companies. The decrease in the EU’s domestic gas production, the phase-out of nuclear power plants in large energy consumers such as Germany and, importantly, the role of gas as a less polluting fuel than oil and coal in Europe’s energy transition also point to the prospective importance of Russian supplies.
Therefore, both Russia and the European Union have an interest in managing their gas trade according to a commercial and mutually beneficial logic. First and foremost this requires agreement on the rules that regulate the functioning of the EU energy market. In the spring of 2017, Gazprom’s commitments to address the European Commission’s concerns about anticompetitive practices in East-Central Europe were an important step in this direction. The commitments were made following the European Commission’s launch of an antitrust investigation concerning Gazprom’s market practices in 2012. The Commission suspected Gazprom of having abused its dominant market position in East-Central Europe by imposing territorial restrictions in its supply agreements, thus preventing the cross-border flow of gas. This allowed the company to impose higher prices in fragmented regional markets. Gazprom was also accused of making supplies to Bulgaria and Poland conditional upon obtaining commitments regarding the access to, or control of, pipeline infrastructure.
Following years of investigations and negotiations between the Commission and the Russian company, Gazprom agreed to remove all contractual barriers to the free flow of gas in East-Central Europe. It also committed to enabling a better integration of regional markets in the Baltic states and the Balkans. Moreover, Gazprom agreed to revise contractual clauses in order to ensure competitive gas prices linked to those paid at Western European hubs.
As the European gas market becomes increasingly diversified in terms of suppliers and import routes, there will be less room for monopolistic or politically-motivated practices by exporters. Suppliers will compete for shares in the lucrative European market through pricing and relationships of trust with buyers. Gazprom’s current strategy seems geared to facing the growing competition of new LNG suppliers through a combination of more flexible pricing and the building of new infrastructure to provide more reliable and abundant supplies. For the first time since its creation, Gazprom will also face competition from other Russian gas in its traditional European market: with the start of sales from Yamal LNG, Novatek and its partners have opened the era of Russia’s LNG business in the Arctic and Europe.
Rising demand in East Asia and the growing energy partnership between Russia and China highlight that Europe will no longer be the only significant market for Russian energy exports. However, even while Gazprom and other Russian suppliers increasingly look at the Far East as a promising avenue for their future commercial operations, the European market will remain a fundamental source of revenue for Moscow’s energy exports. Following the pattern initiated in the 1960s and 1970s, when East-West energy trade constituted–according to some analysts–a hidden form of pan-European integration, the EU-Russia energy relationship will continue to be the main constituent of their economic interdependence.