Gas Crisis Not Looming - as Long as Russia-Ukraine Deal Holds

Natural Gas Europe had the pleasure to discuss a variety of important European natural gas sector themes with political and energy affairs expert Mathieu Boulegue.  Mr. Boulegue is a partner at the risk management consulting firm AESMA based in Paris, France & Washington D.C. and Eurasian expert at the Institute for European Perspective & Security in Europe (IPSE) in Paris.

The ongoing crisis in Ukraine and its ramifications both for Kiev, EU-Russian relations, as well as the developments occurring with the South Stream Pipeline project, the Southern Corridor route from Azerbaijan and the likely outcomes for the aforementioned.

It seems that we are at a crossroads of important events for the above and the situation can be summarized as being in flux, since all players are competing and collaborating with each other at the same time.

The most pressing and sensitive issue that will affect the European gas sector is the Ukrainian situation which may spill into a wider European energy crisis if the bad scenarios are materialized. For the moment there is a "tense stability" unfolding, atleast for the upcoming winter season that may be a great opportunity for all stakeholders to try to strike an all-inclusive agreement. 

As the winter approaches it seems that Ukraine lacks adequate natural gas reserves, while at the same time, is running a coal deficit. How do you assess the situation unfolding with its relationship between Gazprom and Russia?

I’m glad you mention coal, as this is a worrisome issue!

As you know, most of the coal extraction capabilities have been “nationalized” by the DPR/LPR authorities and they will not ship the production to mainland Ukraine anymore.

70% of the nation’s 83 mines were shut down and many of them are now under the territorial control of the separatist authorities.

Coal will therefore become a problem for Kyiv in the coming months and will leave the country in dire need for coal to feed its thermal power plants in order to avoid any shortages in the dead of winter.
The situation is critical to a point where Kyiv only has 1.7 million tons of reserves but will need to import at least 4 million tons of coal by the end of 2014 to meet heat and power generation needs.

Even worse, on November 11, Steel Mont Trading canceled its contract to supply thermal coal to Ukraine to “avoid reputation risks”, as the company reports it does not want to delve in the domestic political situation in Ukraine and Donbass. Back in August, Steel Mont and Ukrinterenergo had agreed to a 1 million ton of South African coal supply contract.

The only solution now, as agreed by Energy Minister Yury Prodan is to “buy coal from Russia, or we will have to buy coal from the area controlled by Russian groups”. So it is either Kyiv buys from a more “reasonable” provider, say Poland, or from Russia – and Moscow might be tempted to increase the prices.

This is the same for gas and the relationship with Gazprom. The deal brokered on October 30 between Ukraine and Gazprom is a very bad deal for Kyiv. Let me explain: 

1/ Ukraine managed to ensure gas deliveries from Russia but is forced to make prepayments for future deliveries and pay the 1.5 billion dollars in arrears. This means that Kyiv will have to transfer a big chunk of its IMF/EU financial assistance to pay for Russian gas. This money could have been used for structural reforms but is now earmarked for Gazprom.

2/ The gas price agreed on until March 2015 remains higher than the EU average (around $375/378 per 1,000 cm instead of $300 on average in Europe). Once again, Kyiv is losing money on gas.

To sum up, we have a no coal (or expensive Russian coal) and expensive gas situation for Ukraine. Gazprom has virtually won the negotiations on gas and Russia might get a sizeable coal contract form Ukraine (if the EU does not wake up first).

In the end, we have a clear win-lose situation at the benefice, once again, of Russia.

Is a gas crisis looming ahead for the EU based on the Ukrainian situation?

I don’t believe a gas crisis is looming any time soon as long as the Russia/Ukraine gas deal holds on (at least until Q1 2015). We’ll be safe for winter that is!

Yet coal will become an issue for Ukraine if EU countries do not provide Kyiv with enough thermal coal to cover winter.

This is where European countries might start being fed up of “paying” for Ukraine: the money given by the IMF/EU package for reforms will be wolfed down to repay Gazprom. This means a new package will have to be created to implement the reforms.

EU/US financial markets have been supporting the Ukrainian economy for the past 6 months to save the country from default. Which means that out taxes pay to keep Ukraine virtually afloat (at least until the situation stabilizes and Kyiv is able to take over its own economy).
Add a “cheap” coal contract to the mix, where EU will provide coal top Ukraine at advantageous prices.
This is starting to be quite expensive for Europe.

More than an energy crisis, I’d be inclined to fear a financial quagmire between the EU and Ukraine.

There has been a lot of talk over the past period, regarding the prospects of the South Stream project. What trends and challenges lie ahead both from an institutional EU level and the states involved in the pipeline?

Moscow has been pushing its dual Stream project for quite some time but has not been that successful lately. Due to the events in Ukraine and the bad relations between Russia and EU, the South Stream project has been over-politicized and is now a major point of disagreement between both parties. The problem is not the project itself, the issue is that it is Russia-led.

José Manuel Barroso said in June that South Stream was “not a priority” anymore for the EU, as alternative projects were present (cf. TANAP/Nabucco West). Last June, Bulgaria also gave a major blow to the project by announcing that the country suspended the construction of the pipeline – this is especially important as the Varna terminal on the Bulgarian coast is the first point of entry for the South Stream gas.

Now only Serbia and Hungary still push for the construction of the project. Their lobbying capabilities in the EU Commission amount to nothing compared to, say, Poland’s. Which means that the project is losing ground and will probably not be built for the time being.

The Ukrainian crisis considerably affected what was already a controversial project: back in 2013, I remember the Commission opened an anti-monopoly investigation on the South Stream as it reportedly did not follow the rules of the EU's Third Energy Package.

Legally speaking, the question is also difficult to apprehend as Russia and Bulgaria now share a maritime border in the wake of Moscow’s land grab in Crimea and this whole new scenario somewhat changes the equation!

Now the issue is simply political and the Commission is blocking the project to “punish” Moscow. In the end, the South Stream project is not a question of energy security (or “transit risk” as Russia puts it) but rather mere political considerations.

Is the so-called Southern Corridor project (TANAP&TAP) a viable, long-term and significant diversification route for the EU?

The new EU pet-project for a Southern Corridor (TANAP + TAP/Nabucco West) was created on the ashes of the stillborn Nabucco pipeline, which means that we use the same principles, try to learn from our mistakes, and hope for the best.

To analyze your question:

- Is it viable? Technically yes, at least on paper. Reality is another problem: everybody was sure, 10 years ago, that Nabucco would save Europe from the Russian gas dependency. Nabucco is dead today and the alternative route builds on the same principles. Furthermore, it will require some heavy courting in Baku to talk Azerbaijan into becoming a huge gas transit country (and not simply an oil producer).

- Is it a long-term solution? I’d say mid-term: Azerbaijan does not have the resources to sustain 30 years of massive gas production for now (Shah Deniz is not enough). The key is the construction of the TransCaspian pipe and the connection to Iran, which leads to the 3rd point

- Significant diversification for EU? The Southern Corridor, to me, will only make sense if we connect it further to the TransCaspian project (which is technically feasible now that a legal status for the Caspian has been virtually found) and use Iran as a bulk provider for the EU. Otherwise, Gazprom’s monopoly should not be too overshadowed by the mere 10 billion m3 per year of gas initially planned for Europe through the TANAP.

One thing is sure: once constructed, the TANAP will considerably increase Azerbaijan’s milestone position on the European gas strategic chessboard, hence Baku would be sure to become a long-term key partner with European countries.

In the end, the viability of a real Southern Corridor depends mainly on:

- Discussions with Turkmenistan, Iran, and Azerbaijan on the creation of the TransCaspian and connection with existing pipelines and

- The opening of Iran in terms of energy diversification for the EU. This will take some time, as no one seems ready to discuss with Iran on other things than nuclear.

If a TransCaspian – Iran + TANAP – TAP + Nabucco West corridor is built, then we will talk about a viable, long-term, diversified solution for Europe. Otherwise, dependency on Russian gas and Ukraine’s gas storage capabilities will remain.

Lastly I would like to ask you if the East Mediterranean gas reserves could be of any significance for the EU's future energy architecture both in terms of security of supply and diversification?

It’s a good point! To me, the key to energy diversification is more diversification!

Technically, the more projects the EU will be able to sustain, the better for our energy security.