European gas market: trends and prospects

Home / Analytics / European gas market: trends and prospects
Alexey Sharskiy, RTA Overall review The European Union is one of the largest importers of natural gas. According to popular belief, Europe is also completely dependent on Russian supplies of ‘blue fuel’, although this is not entirely true. Russian gas accounts for only 30-40% of European imports, another 25% is taken by Norway, and 12% by Algeria. Natural gas makes 14.4% in its own energy production in Europe. It is extracted by Norway (48% of European gas production in 2016), the Netherlands (19%), and Great Britain (17%).
 The European Union has 22 terminals of liquefied natural gas, which with a capacity of 216 billion cubic meters can cover 50% of its current import requirements, but are loaded only by 20%.
At the same time, the gas pipelines connecting the countries of Central and Eastern Europe can already deliver 147 billion cubic meters of gas per year from the West to the East, as a result even Ukrainian gas import requirements can be met through West-East interconnection. Gas consumption in Europe grew steadily in the previous decade, reaching its peak in 2010 (597.9 billion cubic meters), but subsequently the demand for this type of energy began to decline gradually. The main ‘culprit’ is the electric power industry with the level of gas consumption in 2013 dropped to the level of 2004.
For instance, Italy reduced use of natural gas for the electric power industry from 33.4 billion cubic meters in 2008 to 16.8 billion cubic meters in 2014 (– 49.7%), Great Britain – from 24.8 to 14.2 billion cubic meters (– 42.7%), Spain – from 16 to 4.4 billion cubic meters (–72.5%).
At the same time, production of natural gas in Europe is declining, mainly due to the depletion. So, from 2004 to 2014, gas production in Europe fell by 42%. The largest producer of gas in the EU – the Netherlands – has become a net importer (they import more gas than they export). British deposits in the North Sea are gradually depleted, and Norway has no potential to increase exports to the EU. All this led to an increase in European imports, as a result the volume of Russian gas to the EU countries has increased in recent years.
In 2016 and 2017 total export of Russian natural gas (including liquefied natural gas) increased by 6.8% and 0.9%, respectively, as against the previous year and in both cases reached its record values of 214 billion cubic meters in 2016 and 216 billion cubic meters in 2017.
 But these figures cover exports to all regions, including Asia, which have recently increased in supply, while demand for Russian natural gas is steadily declining in Europe alone. The deliveries increased to some European countries, for example, to Great Britain (+ 39%) and Germany (+ 12%) in 2016 (compared to 2015) and France (+ 5.1%) and Germany (+ 3.7%) in 2017 (compared to 2016). EU energy policy plays a significant role in reducing the demand for natural gas in Europe, in particular, gradual elimination of fossil fuel (coal, natural gas), withdrawal of energy-intensive industries, growth of energy use from renewable sources in industry and households, measures on energy efficiency. Thus, the EU energy strategy sets a goal of achieving energy savings by 20% in 2020 and by 27% by 2030. At the same time, according to Eurostat and the Energy Research Institute of the Russian Academy of Sciences, the level of practically achieved energy efficiency will be 18-19% by 2020, so the goals set in the energy strategy are quite realistic.   Gas transportation to Europe After collapse of the USSR, Ukraine became a monopoly on transit of Russian gas to Europe. So, in the 90’s more than 90% of gas exports to the European region were carried out through gas pipelines created in Soviet times on the territory of Ukraine.
Capacity of the gas transmission system (GTS) of Ukraine at the entrance (on the border with the Russian Federation) is 288 billion cubic meters, at the output – 178.5 billion, while in the European direction it is possible to pump 142.5 billion cubic meters of gas.
 Natural gas comes through Ukraine through 22 pipes, while 15 of them are for transit. The main gas pipelines through which gas is transported to Europe are Soyuz, Progress, Urengoy-Pomary-Uzhhorod, Kursk-Kiev, continued with Kyiv-Zapadnaia Granitsa and Dolina-Uzhhorod. Natural gas goes through them further along the routes Slovakia-Czechia-Germany, Slovakia-Austria-Italy, Ukraine-Hungary-Serbia. The Balkans are supplied through Ananiev-Tiraspol-Izmail gas pipeline with a capacity of 20 billion cubic meters a year through the territory of Moldova and the unrecognized Transdniestria and Shebelinka-Izmail pipeline consisting of three strings with a total capacity of 17 billion cubic meters. One of them provides gas to the Transdniestrian republic and continues on the territory of Moldova. The other two together with the Ananiev-Tiraspol-Izmail pipeline forms the so-called Trans Balkan gas pipeline, which goes further to Romania, Bulgaria, Greece, Turkey, Macedonia. In 1994, construction of the Yamal-Europe gas pipeline began, which passed through Belarus, Poland and Germany and began operating in 1999 (at full capacity in 2006).
Capacity of the gas pipeline is 32.9 billion cubic meters per year. After its commissioning, the ratio of exports of Russian gas changed by 10% (80% through Ukraine’s gas transportation system, 20% through Belarus).
In 2003, the Blue Stream pipeline was launched, directly transferring natural gas from Russia to Turkey, which reduced Ankara’s dependence on the Trans Balkan pipeline, one branch of which transited natural gas through Ukraine, Moldova and Transdniestria, Romania and Bulgaria, increasing cost of the product for the end user. In 2012, construction of Nord Stream was completed, bypassing Ukraine, consisting of two lines with a capacity of 27.5 billion cubic meters per year. The pipeline directly connects Russia and Germany on the bottom of the Baltic Sea and allows to significantly reduce the cost of Russian natural gas for Germany and other European countries. Nord Stream for the first time allowed to enter the UK market. On the territory of the Federal Republic of Germany, Nord Stream continues through the OPAL and NEL gas pipelines, which carry out further transit of Russian gas to Europe.
As a result, the share of Russian gas supplied to Europe via Ukraine, by the results of 2015, has already fallen to 39-40%.
 It is important to note that until 2009, Ukraine and Russia did not have a particular contract for the transit of natural gas to Europe; until 2006 Ukraine was paid for transit in kind, and the price of gas for Ukraine was related to the stability of transit. In 2009, Russia and Ukraine signed two contracts for the supply and transit of gas for 10 years and transferred their relations in the gas field to a fully commercial basis. The formula for the tariff for the transit of Russian gas through Ukraine to Europe in the contract was now related to the price of gas, which in turn was linked to the price of fuel oil and gasoil on the Italian market and was determined by a simple linear dependence, not setting the limits of increase or fall in prices. Consequently, the import of Russian gas became much more expensive, and the level of its consumption in Ukraine decreased noticeably. The economic recession that began in 2014 led to a further reduction in gas consumption in Ukraine, and after the conflict with Russia, Ukraine switched to reverse gas supplies from Europe, refusing direct purchases from the Russian Federation. In this regard, after Ukraine announced its intention to increase the price for the transit of Russian gas after 2019, the transit risks for Russia also doubled. For European consumers and for Gazprom itself, transportation of natural gas from Russia bypassing Ukraine is becoming more profitable. So, before getting to the countries of Europe, Russian gas overcomes 3678 km just in Ukraine.
If we calculate the cost of transit at a tariff of 2.5 dollars per 100 km, then the total amount per pumping of 1 thousand cubic meters will be $ 91.95, and at a tariff of 4.5 dollars, which Ukraine insists after contract expiry in 2019, the cost of gas pumping for European consumers will be 165.5 dollars for 1 thousand cubic meters. Length of the Nord Stream is only 1224 km, so the cost of transit at the same rate of 2.5 dollars per 100 km will be 30.6 dollars.
 In addition, the GTS of Ukraine, which has been used since Soviet times, objectively requires modernization, and therefore the transit risks increase not only for the Russian Federation, but also for the countries of Europe themselves. In the summer of 2012, the German company Ferrstaal evaluated the deep modernization of the Ukrainian GTS at 5.3 billion dollars. The service life of 85% of the equipment of the GTS of Ukraine at the time was 20 years or more. The Ukrainian government was negotiating for a loan with the IMF, the EBRD, there were discussions about creation of a consortium of Ukraine-EU-Russia, but until February 2014 this issue was not resolved. At the same time, with each year the cost of modernization and related risks increase; at the moment according to different estimates, the total repair of the Ukrainian gas transport system can cost from 9 to 10 billion dollars. The situation is complicated by the fact that decrease in the transit volume through the Ukrainian GTS below the level of 30 billion cubic meters per year will make the use of the system uneconomic, and already in 2014 the transit volume through Ukraine collapsed to 59.4 billion cubic meters (although later the situation stabilized slightly and by the end of 2017 this figure was 90.8 billion cubic meters).   South and Turkish Streams In the 2000s, the so-called concept of the fourth gas corridor emerged, implying supply of Central and Southern Europe with natural gas from the Caspian region and the Middle East through a system of surface pipelines. The European Union viewed this concept as an instrument to ensure energy security of the region and to reduce Europe’s dependence on Russian gas. The main project of the second half of the 2000s was the Nabucco gas pipeline, which was supposed to supply gas from such potential sources as Azerbaijan, Egypt, Iran and Iraq through Turkey to the European Union (through Bulgaria, Romania, Hungary). Due to the lack of guarantees from the main gas suppliers, the project was not implemented. Russia’s response to Nabucco in June 2007 was an attempt to enter the fourth gas corridor with its South Stream project, which was provided with Russian gas resources and allowed Gazprom to simultaneously bypass Ukraine and Turkey as transit countries and exit directly to the European Union, almost to the same geographical market as the Nabucco project.
The South Stream gas pipeline with a total capacity of up to 63 billion cubic meters was not only to finally solve the problem of Ukrainian transit, but also to open new niches for Russian gas in South-Eastern Europe and the Balkans.
Construction of the gas pipeline began on December 7, 2012 and was scheduled to end in 2015. But, due to the pressure by the US and EU on the Government of Bulgaria (the pipeline on the bottom of the Black Sea directly connected the Russian Federation and Bulgaria, and from there the pipeline continued to other EU countries), and the project’s inconsistencies with the requirements of the Third Energy Package of the EU, the Stream construction was frozen. It was replaced by the Turkish Stream as an attempt to achieve the same goals. The gas pipeline will consist of two strings and will be able to transport natural gas to 15.75 billion cubic meters per year (per pipe). At the same time, the gas supplied by the first string is destined for the Turkish market, and the second string will pass towards the border of Turkey with the EU for consumers in South and South-Eastern Europe. The first gas supplies are planned for the end of 2019.
As of March 6 this year 50% of the undersea pipeline has been laid, but construction is progressing mainly on the first string (for the Turkish market), while there is no clear certainty on the second string, which countries will pass the route, which company will implement the European part of the project.
Most likely, there are concerns that the Turkish Stream can suffer the same fate as the South Stream. With Turkey itself, the situation is more or less clear – this is the second largest export market of Gazprom; in 2017 a record 29 billion cubic meters of gas was exported to the country. The first string of the Turkish Stream in the future can replace the supplies that are currently being carried through transit through Ukraine, Romania and Bulgaria via the Trans Balkan gas pipeline. Instead of the Nabucco project, the so-called Trans-Anatolian gas pipeline (TANAP) is being successfully implemented, which bypasses Russia, passes through the territory of Azerbaijan (the Shah Deniz field), Georgia and Turkey to the border with Greece. Its capacity is 16 billion cubic meters – 6 billion of which should be consumed by Turkey, and 10 billion by Europe. However, the Trans-Adriatic Pipeline (TAP: Greece, Albania, Adriatic Sea, Italy) must continue along the territory of the EU, construction of which should begin only in 2019. Therefore, if the future for gas supply to Europe along this route is still rather uncertain, then the TANAP, which is completed and to be launched on June 12 this year, may lead to an additional reduction in Turkey’s natural gas demand and further reduce demand for the Trans Balkan gas pipeline. In addition, Bulgaria has recently made numerous statements on possible resumption of the South Stream project, especially after the meeting of the Presidents of Bulgaria and the Russian Federation in Sochi on May 22 this year, which, however, have not yet been backed up.   Nord Stream 2 According to Gazprom’s calculations, the level of natural gas production in Europe will fall year by year and by 2030 will be halved, while the needs in this resource will remain at the same level in the next 20 years. As a result, the company’s representatives forecast growth of imports of European countries in the coming years to meet increasing demand. The success of the Nord Stream and its noticeable advantage over the transit through Ukraine led to the decision to build two more gas pipeline strings, conventionally called Nord Stream 2. Their capacity will also be 27.5 billion cubic meters on each pipe. The gas pipeline construction is planned to be fully completed by the end of 2019. It should be noted that implementation of the Nord Stream 2 project, just as the South Stream at the time, is subject to the political influence of the EU countries in connection with the issue of preserving transit through Ukraine. Thus, at the joint press conference of the President of Ukraine P. Poroshenko and the Chancellor of the Federal Republic of Germany A. Merkel, on April 10 in Berlin, the latter stated that the question of whether the norms of the third energy package of the EU will be applied to North Stream 2 will depend on whether Gazprom will continue to transit through Ukraine.
Besides, even if the project does not encounter any obstacles and will be completed in 2019, it will not be able to fully become an alternative to the Ukrainian route, because the corresponding infrastructure is not prepared in Europe. For example, the pipeline, which is to continue Nord Stream 2 on the territory of Germany – EUGAL – under the project should be fully completed only by 2021, while the term of the transit agreement with Ukraine expires as early as 2019.
To summarize, it should be noted that, despite the decline in natural gas production in Europe and the projected increase in demand for this energy resource over the next 20 years, there is a steady trend towards substitution of production based on natural gas with renewable energy and falling annual growth demand for natural gas. Even according to Gazprom’s calculations, the demand for natural gas will remain at the same level by 2030, but will not increase, as it was in the 2000s. The share of renewable energy in electricity production as of 2016 reaches 30.1% in Germany, 18.1% in France, 37.3% in Italy, 25.6% in the UK, 40.1% in Spain and 97.9% in Norway. These figures will only grow each decade.
Despite the rather close prospect of Russia’s refusal to transit gas through Ukraine, it will not be terminated from 2020.
 Even if we assume that construction of the Nord Stream 2 and Turkish Stream gas pipelines (including the second line for the EU) will be completed by the end of 2019, the corresponding infrastructure in Europe will not be ready by that time (the EUGAL gas pipeline is planned to be completed by the end of 2020, and continuation of the Turkish Stream has not yet been agreed). It is important to understand: although the transit agreement between Russia and Ukraine expires in 2019, many contracts of Gazprom for gas supply to European buyers have a significantly longer duration (for example, a contract with ENI, Italian company, for gas supply until 2035). Since Nord Stream 2 and Turkish Stream will not be able to operate by 2020, the current pipelines for delivering gas to European consumers bypassing Ukraine will not be able to cover capacity of the Ukrainian GTS.
Thus, through the Nord Stream it is possible to pump 55 billion cubic meters per year, through Yamal-Europe – 32.9 billion cubic meters, which in total amounts to 87.9 billion cubic meters per year, while the Ukrainian gas transit capacity in the European direction is 142.5 billion cubic meters of gas. This necessitates further use of the Ukrainian route.
The issue of completing construction of these gas pipelines is politicized by the EU countries and the US and is directly linked with the condition of preserving transit through Ukraine, as well as compliance with the norms of the Third Energy Package of the EU. So, in 2014-2015 the Yamal-Europe 2 gas pipeline project, which was to pass through Belorussia, Poland and to Slovakia (due to ‘pressure’ on Ukraine), and the South Stream were frozen. As a result, it became known, as expected, in April that negotiations had begun between Russian Gazprom and Ukrainian Naftogaz about new conditions for transit of Russian gas from 2020. The question would be how long a new contract would be concluded (for 10 years or less) and what will be the conditions and volume of transit through Ukraine. Gazprom CEO A. Miller said on April 3 that the launch of the Turkish Stream and Nord Stream 2 will not stop transit through Ukraine, but will reduce its volume to 10-15 billion a year. Most likely, Ukraine will insist on a ten-year period precisely to secure its own long-term guarantees, and the transit volume will be at least 30 billion a year (with a smaller figure, the use of the GTS becomes unprofitable). After launching the first string of the Turkish Stream in 2020 and the TANAP gas pipeline, there will be no need for one of the pipes of the Shebelinka-Izmail pipeline (transiting through the unrecognized Transdniestrian Moldavian Republic and Moldova to Istanbul) due to the fact that Turkish and Blue Streams completely cover Turkey’s gas needs and are more beneficial in terms of transit conditions. Moreover, capacity of these two pipes (15.75 and 16 billion cubic meters) completely covers capacity of the transit route through the territory of Moldova and Transdniestria. On the other hand, the European part of the Turkish Stream in terms of capacity and number of routes is less than each of the pipes of the Ukrainian GTS. In addition, Gazprom’s interest in implementing this part of the project is low due to new transit risks in many countries (unlike the bilateral Russian-Turkish and Russian-German agreements) and frustrated hopes for a serious increase in gas consumption in South-West Europe. Due to the uncertainty regarding further construction of the European part of the Turkish Stream and inability of this project to replace existing Ukrainian routes, a new agreement between Ukraine and Russia on gas transit will presumably also provide for gas transportation through Moldova and the Balkans. As for Nord Stream 2, it should be emphasized that, despite politicization of this project, the pipeline will be in demand due to a decrease in domestic gas production in the Netherlands and the UK, as well as the need to meet the EU’s gas needs. At the same time, the use of Nord Stream 2 will be much more reliable and more profitable compared to the Ukrainian route, which cannot be said about the Turkish Stream.