Russia and Europe: “Can’t Live With ‘Em, Can’t Live Without ‘Em”

Europe’s natural gas relations with Russia are kind of like an old marriage that’s hit a rough patch, but in reality the two sides can’t live without each other: Europe needs the gas supplies and Russia needs the income from selling them.

But that doesn’t mean that Brussels has not been publicly speaking about diversifying its natural gas supplies in light of the crisis in Ukraine.

And that crisis looks very touch and go: just on Thursday, pro-Russian forces shot down a Ukrainian army helicopter, resulting in 12 casualties.

Meanwhile, negotiations over the price Ukraine is paying for Russian gas and its unpaid bills to Gazprom were set to continue this week.

In consideration of all of that, Natural Gas Europe had the pleasure of speaking with Ms. Tatiana Mitrova, Head of Oil and Gas Department, Energy Research Institute, Russian Academy of Sciences, who offered her insights on the dynamics affecting the Russian-European gas relationship at Flame in Amsterdam, the Netherlands.

Considering the Ukraine crisis and how it is affecting relations between the West and Russia, how would you describe the present situation in broad terms?

TM: It reminds me of a vicious circle when each announcement and statement from one side, being badly interpreted and received by another side, leads to another unfavorable statement on the situation just aggravates the situation every day, and I think it’s not a zero-sum game, so everyone involved is losing in this interaction and it’s definitely a destructive process. Many of the gains which we achieved in the post Soviet period are lost already and I’m afraid that there will be further losses if the process doesn’t stop, if we don’t calm down and try to find a more constructive way of cooperation.

What is at stake in terms of our energy relationship?

TM: There was a question at today’s conference, who is more dependent: Russia or Europe, and who will lose more. I don’t have a clear answer, but in my understanding both sides are extremely dependent on each other. It has quite different implications for Europe, which is mainly dependent upon Russian gas, while Russia is mainly dependent on oil exports to Europe, so there is an assymetrical spread but, nevertheless, if the relationship were to deteriorate further and if the 3^rd, 4^th, 5^th wave of sanctions is applied, I think that it will result in a very significant economic slowdown, both in Russia and in Europe.

We’ve calculated a scenario of Europe completely trying to stop, as much as possible, gas supplies from Russia – it would drive European gas prices towards double, and still many countries in Central & Eastern Europe are facing a deficit, black-outs and other very unpleasant things which are not acceptable at all; for Russia, it means a huge loss in budget revenues, which means lower spending’s available for healthcare, education, research, military – everything.

So I think it’s not acceptable for anybody and all these sanctions dealing with advanced technologies make it mutually painful, because not only Russia will lose access to new technologies but Europe will also lose quite a significant market for services, for technological transfer. Sanctions are definitely not the way forward to deal with this situation, which is a political situation that needs to be solved on a political level not on the economic.

It really feels like we’re in some sort of standoff in which neither side can make any real moves.

TM: Yes, I think that’s true and to some extent all the sides have made statements that were too tough and announced very serious threats to each other, so I don’t know if we’ve passed the point of no return; I’m hoping it hasn’t been, but the situation is by no means rosy.

How do you think this effects business decisions for Europe’s largest gas supplier, Gazprom. Is it possible for them to remain agnostic in the context of this scenario?

TM: Here I think there should be a very important message that, unless there is very strong resistance and direct sanctions from the European Union prohibiting Russian gas supplies to Europe, Russia wants to increase its gas export, so there’s absolutely no intention to decrease these exports or restrict them somehow – it’s a very good, attractive market for us, we do not want to lose it. In this respect, I don’t think that any political developments could drive the Russian government and Gazprom to decide to refuse the European market – I just can’t imagine such a situation, so in this respect I don’t think that it can somehow affect Gazprom’s behavior in Europe.

You mentioned in your presentation at Flame that there’s a lot of gas sitting in the ground in Russia and things would be better if there were stronger domestic demand. How is that excess of gas affective decision-making?

It’s quite a recent situation. So far, gas demand was booming for many years and the government had a special headache dealing with the gas deficit, therefore it’s been quite difficult to switch over to the exact opposite situation when you have a potential abundance of gas – of course, nobody’s producing this gas, it’s staying in the ground, but I think it has started to drive decisions and might, in the longer term, change the governmental perspective because it is posing a choice: either you simply postpone the most expensive projects and leave part of this gas in the ground for future generations, which is an acceptable solution, or you’re expanding exports through lower prices, more flexible policy, and so on, through reaching new markets. Gazprom and Novatek are both looking to Asian markets which are conventional, but also to such unconventional markets like South America, Middle East, India. There are many emerging markets where Russian LNG wouldn’t theoretically face as many political constraints as in Europe and where cooperation could develop – why not?

Having an abundance of gas could be a good driving force for Russian companies to try and find new, creative solutions, new ways of marketing, new markets. Novatek’s Yamal LNG is quite an innovative project – many components of it are unique and you can’t find those anywhere else in the world – imposing some additional risks, but also showing that when people want to monetize their gas, they find very sophisticated solutions. In several years Russia might go for more such solutions and the role of independent explorers will be important, but Gazprom’s role will still prove decisive.

Given the economic slowdown in Europe, coupled with the stories we’ve been hearing about industry moving to North America because of the cheaper price of natural gas and feedstock, how do you see the prospects for Russia selling more of its gas to Europe at a lower margin?

TM: I think it’s a matter of time. Currently, the European gas balance is becoming more and more a deficit. Sergei Komlev’s presentation showed how Russia has increased its share of European gas exports and all the other producers supplies have declined is a very good illustration of this thesis.

Right now there is not enough gas available for Europe, except for Russian gas. Europe doesn’t have significant options because all LNG is diverted to Asia, which is providing much higher margins. All the new projects under discussion, like East Africa, North America, Iran, Iraq – they will not come to fruition in this decade, they will likely be postponed even further. So right now Europe doesn’t have many options and normal behavior, in economic terms, would be for the dominant supplier to use this situation and to try to gain as high a margin as possible – absolutely rational behavior.

Stepping back and decreasing prices would be economically very generous, but economically it’s not justified. When, by the end of this decade, newcomers will enter the market – US LNG, maybe some gas from the Middle East, and so on – I think Russia will have to review its strategy and adjust to the new situation and start to compete. Definitely, part of this competition will be changing pricing conditions. By that time, I think it’s reasonable to expect a more flexible approach, probably with a higher share of spot indexation, or maybe just further review of the oil-indexed contracts to make them more competitive.

They will definitely go for a more flexible policy, but probably in 5-6 years’ time – not before that.

The campaign to build the South Stream pipeline appeared to have some thrust before the tensions over Ukraine emerged. In light of what’s happening, how possible will it be to implement it?

TM: It’s amazing that the first reaction of the European Commission was, “Hmm, we don’t like what is happening in Ukraine, therefore we will try to not allow South Stream to be built.” From a rational point of view, I would assume the normal reaction would be the opposite, because, frankly speaking, the whole situation which is evolving in Ukraine is not inspiring at all, and I don’t see any way that it could be settled swiftly in a political way, which means that it will be an area of instability at least for the next few years, and I hope that it will not imply more victims but definitely it will be very unstable.

In this situation, when it is imposing a direct threat to transit supplies, South Stream, which is finance by Russia and its counterparties, and which is providing a bypass route that provides more security of supply than Ukrainian transit, looks like a good blessing for Europe – at least you don’t have to worry about long-term supplies because Russia will take care of that. So this first, very politicized reaction that “this is a Russian project, therefore we don’t like it” will change in some time when the European Commission will see that the Ukrainian story is not simply an accident, but a temporary event which will take quite a long time to be settled, and most likely there will be a change in the attitude because South Stream in this case becomes the single reliable option; no other sources will be available to Europe in the next 4-7 years, and the only source of additional gas is Russia – there are no options to replace it, so for this period of time Russian gas is absolutely critical, and if Ukraine doesn’t provide reliable transit, South Stream becomes a must, just to guarantee normal supplies to Europe, so I think this attitude will be reviewed. Regarding commercial viability for Russia is a different question. If were in the Europeans’ shoes I would definitely support this project, at least now in this situation with Ukraine as it is becoming critically important in terms of physical security of supplies.

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