Europe, Russia and Ukraine: From "ménage à trois" to divorce

"Can LNG ride to the rescue of the European gas market?" was the question posed at Flame in Amsterdam, the Netherlands by Thierry Bros, Senior Analyst, European Gas & LNG Markets, SOCIETE GENERALE. But it was Mr. Bros' description of gas relations between Russia, Europe and Ukraine that stole the show, when he termed it a "ménage à trois."

He offered: "We are going to have more LNG coming into Europe, because there won't be any re-export as we've seen back in 2013-14." Back then, he said, re-export had made sense, because of lower gas prices as well as the higher volume index in Asia. "This means," he explained, "this LNG will stay here."

While new LNG volumes are more diverse and an increase of supply, he said LNG will not save Europe in case of the huge drop in volumes like for replacing the Netherlands' Groningen gas field.

Now, explained Mr. Bros, Europe, Russia and Ukraine are facing an unstable ménage à trois, because of their completely different perspectives on gas. For Russia, it means a long-term strategy for avoiding Ukraine as a gas transit country. He reported that while in 2004 Gazprom had transited 120 bcm of gas across Ukraine, in 2014 that number had gone down to 60 in total: 44 bcm for Europe and 15 bcm for Turkey.

"Gazprom wants to avoid any Ukrainian gas transit in 2020 and may not renew the transit contract that will expire on 31 December 2019," he said. "So the question for Europe is, where are we going to find those 44 bcm if we need them."

The ménage à trois, he said, is headed for a divorce. Meanwhile, any growth in Europe's natural gas demand, according to him, has only been due to increases from low winter temperatures.

Of the prospect of LNG filling the gap, he explained: "Of the LNG world, until now it used to be a very simple case of supply setting demand - when a cargo was not needed somewhere they were unloaded somewhere else." But now, new US LNG is coming onstream, he said.

"And this is going to change the risk-reward of this industry."

Still, Mr. Bros reminded the audience that Russia is still the lowest priced gas producer for Europe and will continue to be, and Russia and Norway control about 50% of demand, meaning that they set the floor and ceiling for prices, the latter being around $9.50/MMBtu, which was equivalent to, for example, gas coming from Shah Deniz II. Anything above such a price made it difficult to take final investment decisions, contended Mr. Bros.

"So, therefore, the other new suppliers can be US LNG, which in our model is Henry Hub plus $6/MMBtu - the cost of producing the LNG, shipping and regas."

However, at any higher price, then US LNG will not arrive to Europe. "Maybe we are not going to see any US LNG," he remarked, "maybe not have the 40 bcm of gas we are missing." But his two caveats were that LNG is a global industry, and the over investment in liquefaction in the US: 45 million tons worth of investment so far.

With Australian LNG also set to come online by 2019, Mr. Bros said that Russia could be tempted into a price war, but it is still a question at what price US LNG would stop producing. It could go down to the Henry Hub price plus $2/MMBtu, he said.

In closing, Mr. Bros raised the question of whether US LNG is an expensive bet or a rational hedge against Ukrainian transit risk and the stopping of gas deliveries through the country by 2020.

-Drew Leifheit