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Gazprom Gas Supplies May Fall Short of European Demand By 2015 - Warns IEA

Posted on: Thursday, 5 June 2008, 15:00 CDT

The International Energy Agency has warned that Europe may face gas shortages by 2015, largely due to Gazprom's inability to meet growing demand. While this presents short term problems for European supply, Russia also has much to worry about in terms of bringing new fields online as the EU attempts to diversify its supplies beyond its eastern borders.

The International Energy Agency's (IEA) warnings about potential shortfalls in European gas supplies are not new. The growth of Gazprom's production rate dropped to a mere 0.5% in 2005 and to almost zero in 2006, underlining the energy watchdog's forecasts that, without major development of new reserves, Gazprom could be unable to fulfil European supply demands. Even the Russian Statistics State Committee has admitted that gas production in 2007 was down 0.8% on the previous year.

Although Gazprom has claimed that it will not only be able to fulfill contracts but markedly increase output, the task ahead is considerable. Russia's main domestic reserves are believed to be over 50% exhausted, making it increasingly critical for Gazprom to develop new sites in technically challenging areas such as Eastern Siberia, the Yamal Penninsular and the Barents Sea. Should such reserves fail to come online, Russian gas production is expected to fall below 2006 levels by 2020. Even the most conservative estimates suggest that a $200 billion investment in the Russian gas sector will be required by 2020 if it is to meet international demand.

Ironically, reforming domestic prices so that they are closer to European rates would help to stabilize Gazprom's balance sheet and make a number of sites more financially viable (some 65% of gas produced is still used on a domestic basis). Russian President Dmitry Medvedev has indicated that prices will be examined towards 2011, but this will remain a piecemeal process that still falls well below prevailing competitive European rates. This is a problem that the IEA has highlighted in numerous other markets where political, rather than market, pricing is failing to reduce hydrocarbon demand. The fact that Gazprom also 'props up' transmission and distribution networks across Russia serves as an additional drain on resources relative to upstream assets.

Indeed, Gazprom's overall upstream expenditure remains modest compared to its investments in the downstream sector and export pipelines. Estimates from the Institute for Energy Policy suggest that Gazprom's expenditure on acquired investments has outstripped spending on the production and transportation of gas by a factor of two to one over the past few years.

While it is hard to deny that securing downstream assets is a prudent strategy in the short-term in order to boost profits in more valuable parts of the supply chain (while creating further resource dependencies with third parties), Gazprom is arguably putting the cart in front of the horse by forging long-term contracts without moving to ensure that the pipes, or indeed LNG tankers, will be filled.

Similar accusations have been made in relation to Gazprom's upstream internationalization strategy, which ranges from long-standing contracts with Central Asia, to more 'far flung' locations in Africa, the Middle East, Latin America and Asia. While many consider these initiatives to be a costly distraction from Gazprom's need to develop domestic reserves, they still have material relevance for Europe in terms of trying to diversify supplies away from Russia.

Indeed, the EU's commissioner for external relations, Benita Ferrero-Waldner, has claimed that the EU has signed, or is in the process of negotiating, agreements with Azerbaijan, Ukraine, Kazakhstan, Turkmenistan, Algeria, Egypt, Morocco, Jordan and Iraq, alongside a number of GCC states, to secure new gas contracts. Europe is even looking at Iran as a potential supplier to feed the Nabucco pipeline, which would prevent the need to fall back on re-exported Russian supplies from Central Asia, should the project ever come to fruition.

While this looks impressive, the problem is that the availability of gas resources, the possibility to develop them, and the political and commercial feasibility of the transport infrastructure, remains highly limited. The EU would, therefore, be well advised to focus on developing an integrated internal market in order to reduce the bilateral pressures that Gazprom puts on Eastern and Western Europe, and the pressure that Sonatrach puts on southern Europe, by forging greater European solidarity, rather than 'chasing shadows' in its external energy policy.

An increase in LNG offers another potential exit route from European dependence on Russian supplies. While this will be far from risk free if Moscow perfects arbitrage capabilities across multiple markets, given that European gas imports are expected to increase by 150% by 2030, even under the most optimistic estimates of Russian export capabilities, greater diversification away from Russian supplies will be required towards other LNG players in the Middle East and Africa.

This should partially break the close dependence between Russian supply and European demand, while still giving the EU both pipeline and LNG options, but Europe still faces major supply constraint problems in the short to medium term to 2015. Unless political risk recedes in Russia to ensure investment in supplies on the one hand, and Europe wakes up to the reality of needing a single integrated gas market on the other, gas will be hard, but by no means impossible to come by for the foreseeable future.

Source: Datamonitor

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