Russia holds the largest proven reserves of natural gas and is the world’s top natural gas exporter. These exports have not only been a dependable stream of revenues but also have allowed Russia to use geopolitical tools, mostly to influence countries in Central and Eastern Europe where traditional dependence on Russian gas has been particularly strong. But Russia is also dependent on Europe for most of its natural gas demand. The interdependency has been facilitated by an extensive network of pipelines, long-term contracts, and a lack of alternative supply/demand sources.
But as today’s natural gas market becomes increasingly globalized, the relationship seems bound to change—and both Russian revenues as well as geopolitical influence may suffer. How extensive the impact will not only depend on Russia’s actions but also on whether countries that rely on Russian gas recognize the stronger bargaining power they can wield against Russia if they effectively use the opportunities a more global and more liquid natural gas market offers.
To begin, the global gas market is becoming increasingly competitive as new supplies of natural gas are being made available from countries such as Australia, Qatar, Russia, Mozambique, and possibly even Iran. In fact, the global gas market has deepened significantly since 2000 as total trade has more than doubled and the total number of importing and exporting countries has expanded considerably. This has been made possible by a massive expansion in liquid natural gas (LNG) production. Unprecedented growth in short-term and spot LNG trading (from 5% in 2000 to 30% in 2017) made the prices more responsive to market conditions and increased its competitiveness relative to bilateral, take-or-pay contract terms that used to dominate the global LNG market.
Meanwhile, Russian deliveries of contracted piped gas became less reliable as conflict with Ukraine led to several breaks in European supply. Also other instances of Russia using natural gas as an “energy weapon” have given Europe a reason to reconsider the long-standing relationship. In an effort to increase its energy security, the EU turned to diversification. The resolve has been particularly visible in the CEE region where the dependence on Russian gas has led to higher prices and allowed Russia to use natural gas deliveries to further its political agenda.
Lithuania and Poland’s LNG import terminals became operational in 2014 and 2015, respectively. First deliveries of non-Russian gas to those terminals not only have decreased the share of Russian gas but also have lowered the price of Russian gas delivered to the region. In addition, alternative piped natural gas may become available soon from Azerbaijan via the TANAP pipeline; scheduled to be completed in 2018 and potentially able to deliver gas to Europe in 2020.
Of course, Russia also took note. Given that its supplies are generally more competitive than LNG, especially if undisturbed flow via new pipelines is ensured, Russia decided to embark on new pipeline projects: Nord Stream 1 and 2 (NS1 & NS2) that will bring Russian gas under the Baltic Sea directly to Germany, and Turkish Stream that will bring gas to Turkey for distribution in the EU.
To diversify its demand markets, Russia has pivoted to Asia, seeing special opportunity for gas exports to China. In May 2014 the two countries signed an agreement for construction of the Power of Siberia pipeline. In addition, Russia has also looked at the possibility of liquefying its gas and making it available to other countries in Asia and beyond.
But all these efforts are facing strong headwinds. First, the EU has consistently pushed for liberalization of its market and most recently extended the provisions of ownership unbundling, tariff regulation, and transparency to natural gas pipelines (existing and future) to and from third countries. The amendment has important implications for the new pipeline projects to the EU given that the only Russian company allowed to export gas via pipelines—Gazprom—is vertically integrated.
The conditions for construction of the Power of Siberia (PoS) pipeline have been skewed toward China who, also sensing Russia’s vulnerability, withdrew from its initial commitment to provide $25 billion pre-payment for the investment. Thus, it is not surprising that, in the era of low oil and natural gas prices, this ultra expensive project that requires development of new fields and new infrastructure has not been progressing as planned. Additionally, once completed PoS will not improve Russia’s bargaining position against Europe as it dips into gas reserves in the Russian East, generally considered a stranded asset save for delivery to China.
In addition, sanctions that Western Europe and the United States imposed on Russian oil and gas and financial industries after the country invaded Ukraine and annexed Crimea have made the ability to gather necessary capital and provide the newest technologies extremely difficult.
The sanctions also curtailed Russian ambitions to expand its LNG sector. Currently, only two terminals are operational—Sakhalin and the newly opened Yamal LNG. Also, since Yamal LNG is a project of Novatek and not Gazprom, its natural gas deliveries may actually compete with Gazprom’s gas piped to Europe. Additional LNG terminals have been planned but would require enormous investment and involvement of foreign companies to provide expertise and technology, all of which are negatively impacted by current sanctions.
All in all, Russia’s market and bargaining position in natural gas trade has become visibly weaker in Europe and beyond. While Russian gas will likely remain a large component of the European energy mix (given its low price and ease of delivery) it will have to compete with other sources of natural gas, most importantly LNG. This will most likely have a negative effect on the excessive prices Gazprom has been able to charge in the CEE. More competition should also limit Russia’s ability to use natural gas as a geopolitical tool. That is, if Europe recognizes the opportunity and pushes for true diversification and free access of natural gas suppliers to its market.