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All Eyes on Russia as the European Energy Balance Shifts

by | published November 30th, 2012

A massive shift is underway in the energy balance in Europe.

And my meetings in Frankfurt and Warsaw last week only further convinced me that this is coming along faster than anyone expected.

Domestic movements are accelerating to secure additional unconventional natural gas volume at home (in places like Poland). Other European countries are increasing their liquefied natural gas (LNG) imports from Qatar and North Africa. And import volumes will likely increase in 2014 as North American terminals receive their final approvals to export LNG.

The developing environment will favor a European economy where the cost of gas for end users ranks among the highest in the world. The loser will likely be the largest current provider of gas to the continent as new flows undercut its prices.

The provider is Russia.

This ongoing shift makes the meetings I am off to this morning critical for the energy balance spanning two continents.

And, in the process, something else is developing that will have a direct impact on energy investors everywhere.

As you are reading this, Marina and I are back on an airplane flying across the Atlantic, this time bound for Moscow. In front of me are meetings, both formal and informal, surrounding the annual planning sessions of the Russian Ministry of Energy (Minenergo).

Most of the sessions will revolve around the rapidly changing energy mix in Europe and Asia. Given the dependence Moscow has on securing export revenues for its oil and gas going to both continents, the subject matter is of decisive interest to policy makers.

This is because for all of its massive size and industrial base, the budget of the vast Russian nation remains dependent upon those export revenues. The decreasing reliance of either continent on Russian energy, therefore, comprises a direct threat to the economic well-being of the nation.

There is little public discussion about this in Russian policy making circles, although it is emerging in newspaper and media commentary. Nonetheless, it is certainly on everybody’s mind in private conversations. Thought it best, therefore, that I simply confront the matter head on.

My formal publicly presented advisory is entitled “LNG Spot Markets and the Future of Long-Term Take or Pay Pipeline Contracts,” and it is intended to hit the problem square in the middle. As in my experience in the past, Russian officials also would prefer that a foreigner kick the hornet’s nest in these meetings.

I am always happy to oblige.

Here’s the problem in a nutshell.

Editor’s note: Kent doesn’t just provide insight to European politicians and big oil firms. For a year, Kent’s been doing the same for a select group of investors on ways to exploit the smallest yet most explosive companies in the energy market. And today, he’s extending to you a chance to join this exclusive list. But act fast. There are only 400 seats at this table.

To view your official invitation, click here.

From Russia with Love

Russia currently provides nearly 40% of the natural gas moving into Europe, although that percentage is declining. The competition is coming from rising LNG consignments and, ultimately if the reserves are substantial enough, from the new shale gas finds across Europe.

The Russian volume comes in via pipeline under long-term (20-year or more) contracts with prices based on a basket of crude oil and oil-product prices. When oil prices rise, so does the price of gas to Europe.

In addition, the Russian contracts have another element adding to the cost. The agreements include a “take-or-pay” provision. These oblige parties to take a minimum amount of the contracted volume on a monthly basis (usually 80%) or pay Gazprom (the Russian gas giant) as if they had.

Moscow has always argued that this is a necessary ingredient to allow Gazprom to commit a certain volume over a multi-decade period. European end-users, on the other hand, have considered such contract provisions expensive. They also limit more efficient acquisitions of energy during warm periods or those of lowered consumer usage.

Until recently, Europeans had few alternatives. In fact, with the competition of the Nord Stream pipeline under the Baltic to Germany and progress on the South Stream pipeline under the Black Sea to Southeastern Europe, it looked like even greater reliance on Russian sourcing was in the cards.

This is until the rise of LNG.

The shipment of liquefied gas via tanker to terminals where is it regasified and injected into existing pipeline networks has become a game changer. The major locations of entry are being transformed into local hubs for the setting of spot prices.

That’s where this becomes interesting for Europe, and the opportunities begin for investors.

Normally, local spot markets in gas only emerge at primary intersections of pipeline systems -Henry Hub in Louisiana, for example, or Baumgarten in Austria. That is because, unlike crude oil, conventional gas is not shipped except by pipeline. LNG changes that fundamentally by providing for gas moving via tanker as a liquid.

A local spot market, therefore, can now emerge at places like the Rotterdam Gate in Holland, the newly opened and largest-volume LNG terminal in Europe. Spot markets provide consignments on very short-term contracts, with the entire period for completing the contracts usually taking three days.

They are the remedy for being stuck with the long-term obligations required by Gazprom. One other factor of especial note – spot market prices are almost always well below pipeline contracted prices. This is because it is too expensive to stockpile volume of additional tankers are always depositing additional gas.

The very guarantee of continuous alternative LNG sourcing, therefore, is assuring Gazprom that its prices will be undercut. That, in turn, means customers will resist existing contracts and force the company to renegotiate.

That renegotiation means lower revenues and an adverse impact on the Russian national budget.

My presentation this week, therefore, is deliberately designed to open up the entire can of worms for public discussion.

After all, we are not visiting Moscow for the weather!

Prospects Rise for U.S. Gas Production

Here’s what this means for investors – there are new offsets emerging in the acquisition of energy that are going to impact how one profits from them. With regard to LNG, by 2014, North
American-based volume will begin deliveries to Europe (and Asia). The balance forming there will have a positive impact on monetizing excess shale gas extractions here.

Then again, if the Poles and others find sufficient shale gas on their own, even more tradeoffs in that balance will emerge.

Each one of these new wrinkles will provide additional investment opportunities. I’ll be sure to let you know more about them in the coming months.

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  1. Bob
    November 30th, 2012 at 15:20 | #1

    What’s your reaction to the recent Rosneft/BP-TDK buy-out deal?

  2. Charles
    November 30th, 2012 at 16:07 | #2

    Ken:
    How do the customers get out of/break the long term take-or-pay contracts? That would be a legal problem here in the US. Is it different in Europe?

  3. Al Bickerton
    November 30th, 2012 at 17:07 | #3

    With the physical size of China geographically, what are the chances of shale deposits of gas and/or oil being found there? Surely that would be a world price-changer. Someone please comment back to my email address at

  4. Bruce
    November 30th, 2012 at 19:39 | #4

    what about Turkmrnistan and the effect/contribution to Europe in terms of oil and natural gas it is producing? Dragon Oil was supposed to build a pipeline to China. Did Russia muscle them out of the way? What is the status of Dragon Oil going forward?

  5. Sergey
    December 1st, 2012 at 05:02 | #5

    Kent! I do really appreciate Your participation in these discussions with Russians. What ever is Your goal it would be very usefull to Russia as a nation to force Gazprom people to do something else than to make fortunes contracting the pipelenes.

  6. Dieter Hausammann
    December 2nd, 2012 at 16:55 | #6

    You make this sound as if this is going to happen in the next years.
    There are very few LNG terminals as of now in Europe and to build them in numbers, so that LNG by ship could start to make a dent into the russian contracts, is, at best, a vision.

    You seem to forget that the Russian pipeline system has been, with the exception of North- and south Stream, paid off long ago.
    Transporting gas by pipe costs a fraction of transporting it by ship.
    LNG from shale in the US, exported to Europe, will still be far more expensive then gas from conventional wells.

    Last but not least, natural gas has a reputation in Europe as beeing a very reliable energy because the pipe from every user is, “kind of directly” connected to the source. A ship transport cannot match that.

    So lets be realistic. The shale gas does a much more wonderful thing in the future. We all will not ship our money to the Sheiks, who do not know anymore what to do with it, but it will go to developed economies where it will help grow the economies for the good of everyone.

  7. Dieter Hausammann
    December 2nd, 2012 at 16:57 | #7

    @Charles
    It is the same legal problem in Europe. It will be a political thing to find a mutual agreement on any contract modification.

  8. Dieter Hausammann
    December 2nd, 2012 at 17:00 | #8

    @Bob
    BP needs the money to pay the fine to the US. The genious people who brokered that contract understood how to deal with the Russians. I guess they are all retired by now.

  9. Les Henderson
    December 4th, 2012 at 15:13 | #9

    I suppose the Russians are, and should be, concerned; however, this will have time to be absorbed by both the Russians and the Europeans. Indeed, the Russians are today shipping LNG to Japan across the Arctic ocean and, likely, in the near future be supplying other Asian countries via the same vehicle.

  10. Sumflow
    December 6th, 2012 at 23:24 | #10

    @Dieter Hausammann >You make this sound as if this is going to happen in the next years. North- and south Stream, paid off long ago.Transporting gas by pipe costs a fraction of transporting it by ship.LNG from.. the US, .. more expensive the pipe from every user is, “Kind of directly” connected to the source. A ship transport cannot match that.<

    Ships will release the LNG into the other end of the same pipe. The user will not know the difference, except in lower fuel costs.

  11. Sumflow
    December 6th, 2012 at 23:27 | #11

    Q. “You make this sound as if this is going to happen in the next years.”
    A. Permits are being considered now, it can’t happen sooner than that.

    Q.” North- and south Stream, paid off long ago.”
    A. Price is based on oil, not cost of pipeline.

    O.”Transporting gas by pipe costs a fraction of transporting it by ship.”
    A. This low cost is irrelevant, it is not passed on to the user.

    Q.”LNG from.. the US, .. more expensive”

    A. You don’t get it. Natgas fixed to oil will always be more expensive than natgas based on new discoveries. By providing an alternative our exports will give countries the power to renegotiate those fees with Russia and could mean cheaper energy for everyone.

    Q.” the pipe from every user is, “Kind of directly” connected to the source. A ship transport cannot match that.”

    A. Ships will release the LNG into the other end of the same pipe. The user will not know the difference, except in lower fuel costs.

  12. Sumflow
    December 6th, 2012 at 23:27 | #12

    @Dieter Hausammann
    Q. “You make this sound as if this is going to happen in the next years.”
    A. Permits are being considered now, it can’t happen sooner than that.

    Q.” North- and south Stream, paid off long ago.”
    A. Price is based on oil, not cost of pipeline.

    O.”Transporting gas by pipe costs a fraction of transporting it by ship.”
    A. This low cost is irrelevant, it is not passed on to the user.

    Q.”LNG from.. the US, .. more expensive”

    A. You don’t get it. Natgas fixed to oil will always be more expensive than natgas based on new discoveries. By providing an alternative our exports will give countries the power to renegotiate those fees with Russia and could mean cheaper energy for everyone.

    Q.” the pipe from every user is, “Kind of directly” connected to the source. A ship transport cannot match that.”

    A. Ships will release the LNG into the other end of the same pipe. The user will not know the difference, except in lower fuel costs.

  13. Sumflow
    December 6th, 2012 at 23:29 | #13

    Charles :
    Ken:
    How do the customers get out of/break the long term take-or-pay contracts?

    @Charles A. That is a legal problem that will be settled with money.

  14. Sumflow
    December 6th, 2012 at 23:33 | #14

    Al Bickerton :
    With the physical size of China geographically, what are the chances of shale deposits of gas and/or oil being found there? Surely that would be a world price-changer. Someone please comment back to my email address at

    A. That would be great. We supply whoever needs it temporarily, then we keep our own natgas as world discoveries increase. In any case, the price of natgas will come down for people currently basing the price of natgas on Oil.

  15. Sumflow
    December 6th, 2012 at 23:42 | #15

    Sergey :
    . What ever is Your goal it would be very useful to Russia as a nation to force Gazprom people to do something else than to make fortunes contracting the pipelines.

    A. Russia exploited the situation on there own terms because they were the first to provide a solution. The game is moving into another stage, they will adapt. Export nations will a add supply until alternative sources can be developed.

  16. Sumflow
    December 6th, 2012 at 23:46 | #16

    Les Henderson :
    Indeed, the Russians are today shipping LNG to Japan across the Arctic ocean.

    A. The key thing is at what price. If we can supply the same markets based on the price of natgas instead of oil. Gazprom will be forced to renegotiate to the current (lower) market price.

  17. Paul Van Hoesen
    December 7th, 2012 at 17:25 | #17

    @Dieiter: Another thought – The advantage that you aptly described may now be the weakness:
    The traditional pipeline system is connected to a single source: Russia. Single source = high risk

    The real advantage of LNG for Europe is the ability to create and control a virtual spot gas market in their own backyard sourced from not one country and a few pipes, but many countries and many terminals.
    It’s many to many rather than one to many.

    Rather than hoping Russian pipeline politics in the east continues to be amenable, Europe can now look to many source nations to deliver LNG to a number of convenient points in Europe. The transport cost difference erodes as previously faraway NG sources enter the market and driving the cost of goods lower. The fact that it costs alot to build the infrastructure should not hinder anyone. Europe is now merrily printing money like the Fed.

    Germany uses about 98bcm/yr of PNG (equals about 163Mcm of LNG). According to the GLE there is about 160Mcm/yr of LNG terminal receiving capacity, 9Mcm of LNG storage capacity, and 200bcm/yr of LNG regasification capacity in Europe at present. LNG import and production capacity is close to 200% of Germany’s requirements alone.

    The Dutch of course are way out in front. They build the biggest LNG terminal in a country that doesn’t need anyone’s natural gas! Add a GTL breakthrough and Rotterdam may be the next Houston – minus the hurricanes.

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