Technological advances in the area of natural gas liquefaction and hydraulic fracturing that unleashed the shale revolution in the United States have irrevocably changed the rules of the natural gas market. From a regional resource, natural gas is on the way to become a global commodity. The ongoing transformation has been particularly consequential but also distinctive for the Central and Eastern European region, where new market entrants have challenged Russian dominance.
Natural gas has been increasingly popular, especially in power generation. Compared to coal or fuel oil, natural gas is much cleaner—emitting considerably less carbon dioxide and local pollutants. This advantage is coupled with comparable, if not superior, performance and efficiency.
But in its gaseous, low-density form, natural gas is difficult and expensive to transport. Pipeline transportation has been a traditional go-to method to move the fuel. Given the prohibitively high cost of liquefaction, liquefied natural gas (LNG) has been used only where pipeline infrastructure could not be built. This resulted in markets that are regional in nature—established by long-term investment in pipeline infrastructure and followed by long-term contracts. In areas where one or few regional suppliers exist, this creates dependency, and the commodity then becomes subject to potential political risk and interference.
Over the last decade or so, however, two relatively recent developments have been markedly changing these natural gas market dynamics. First, natural gas liquefaction (LNG) technology advanced to become efficient and cheap enough to provide a viable alternative to piped gas. Second, new supplies of natural gas have been unlocked around the world, including in Qatar, Australia, and the U.S., where new horizontal drilling technology initiated the “shale revolution.” As a result LNG trade tripled over the last 17 years, rendering a more global, liquid, and deep gas market. In this market, there are many new points of supply and demand as well as an increasing share of trades that are either short-term or spot-based. In addition, the geopolitical value of the resource has diminished for traditionally dominant regional providers—potentially allowing more geopolitical sway to non-traditional gas suppliers such as the U.S. or Australia.
These trends challenge in particular the traditional dependency of Central and Eastern European (CEE) countries on Russian gas.
Following the fall of the Iron Curtain and having lost the ability to politically influence countries in the region directly, Russia has used its natural gas resources to achieve geopolitical ends and profited economically from its dominance. But the advent of a more fungible LNG market and the end of many long-term contracts with Russia (expiring in the early to mid-2020s), change the region’s bargaining position vis-à-vis Russia. And at least some CEE countries are ready to take advantage of this opportunity.
Poland and Lithuania have already made the first steps—building and operating new LNG import terminals. Additional terminals to support the CEE region are planned in Croatia, Estonia, and Greece. New long-term contracts have also been signed. Most recently, this included 20-year contracts that Poland’s PGNiG signed for 5.4 billion cubic feet (bcm) of natural gas to be delivered starting 2023. Importantly, the contracts are FOB (free on board) allowing PGNiG freedom when it comes to the gas destination after purchasing the contracted volumes. The company can either deliver those volumes to Poland or decide to sell it elsewhere, if Poland’s demand is not high enough to absorb it or if there is a cheaper source of gas that can be accessed at that time.
This arbitrage opportunity underlies a distinctive wrinkle in LNG trade in Europe. Considering higher costs associated with unconventional gas extraction, liquefaction, and transportation, LNG prices will likely be higher than conventional Russian gas transported via an existing and extensive network of pipelines. As such, LNG is unlikely to replace Russian gas. But it can diversify the supply, provide a price floor and balance the market. And, importantly, the ability to import and distribute LNG by countries in the CEE provides a “credible threat” to current Russian geopolitical and pricing practices. In that role, LNG offers greater energy security not only by diversifying the supply source but also by changing the nature of Russian gas deliveries—allowing CEE to take advantage of cheaper Russian gas on more competitive terms.