All Eyes on Russia as the European Energy Balance Shifts
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.
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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.