Changes in Eastern Europe’s Natural Gas Relations with Russia

In a guest post for the Russia Foundation website, Radu Dudau from  the University of Bucharest & Romania Energy Center discusses changes in Europe's gas market and the impact on Russian supplies.

Unlike Western Europe, the new EU member states to the East are overly dependent on Russian gas imports. Their region has an oligopolistic market structure, dominated by Gazprom. These countries pay roughly 20 percent more for Russian gas supplies than their Western counterparts. The high prices are often levered by Russia in order to extract political and economic concessions – such as control of downstream energy assets – against temporary price discounts.

Brussels’ response to this vulnerability of one of EU’s corners has been the Southern Gas Corridor (SGC), of which the Nabucco pipeline project, planned to transport Caspian gas to Europe, was the flagship. That is, it was until the European Commission (EC) obviously turned neutral between Nabucco and its rival within SGC, the Trans-Adriatic Pipeline (TAP) – meant to ship Azeri gas to south Italy. Indeed, at the end of June, the Shah Deniz consortium announced TAP as the chosen route to Europe. Consequently, on the one hand, Gazprom’s structural dominance upon the East and South-East European gas trade has remained virtually unscathed. On the other hand, the EC has fallen back on its “unified gas market” notion of energy security, according to which any EU entry point of diversified imports is as good as any other point for the energy security of every member state. But this, of course, is just an idealization that discounts the still significant viscosity of that internal market.

In any event, Eastern Europe has its options: major gas finds in the Romanian Black Sea offshore, by the Exxon Mobil - OMV Petrom joint venture; potential shale gas production in Ukraine, Poland, and Romania; on the longer term, pending adequate gasification and transport capacity, tapping into the increasing LNG global trade via Lithuania, Ukraine, Poland, Croatia, and Greece. The increased market liquidity and grid interconnectivity will allow for much more hub-based trading than possible under the heretofore Gazprom-driven long-term contracts (LTCs), with onerous clauses – oil-indexation of gas prices, destination conditions (i.e. forbidden re-exports), take-or-pay requirements etc.

To be sure, Gazprom understands perfectly well that it must adjust to the new realities. In terms of large-scale pipelines, the Kremlin seems to stick to the South Stream proposal, planned to carry gas underneath the Black Sea to Central Europe and to south Italy. For all of that project’s preeminently political nature and lack of economic sense, Gazprom may nonetheless go ahead with at least the project’s first leg of 15.75 billion cubic meters, due to be done by 2016. This would undoubtedly fortify Gazprom’s dominance in the Black Sea region and Eastern Europe, albeit at a very high price. Indeed, if fully implemented, Gazprom’s planned pipeline extensions to Europe, along with the existent pipes, would add up three times as much transport capacity as Russia’s overall gas exports to the EU. It will thus be exceedingly difficult for Gazprom to match the price level offered by American LNG exports to Europe and to other markets.

It is hence likely that the coming “battles” will be less about politically promoting or preempting this or that particular pipeline, than about substantive downstream presence and domination of trading hubs. For their part, backed by the liberalization directives of the EU, by increasing interconnectivity and market liquidity, the East European countries will probably be less and less interested in the physical origins of gas supplies than in their price levels and contractual conditions. A liberalized Gazprom competing in a liquid market would be just as reliable a provider as any other, and it would also do justice to Russia’s incontrovertible role as European energy provider. But at the same time it would effectively abolish Gazprom’s dimension as a foreign policy tool, something that the Kremlin is unlikely to resign to.