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Moscow May Use ‘Nuclear Option’ In European Gas Race

Vanand Meliksetian

The competition for a stake in the European gas market is heating up in 2019, which promises to be an important year. The outcome of this contest will have a long-lasting effect. Two interconnected but separate developments are having a substantial impact on Europe’s energy imports. On the one hand,  the shale revolution in the U.S. is producing massive amounts of natural gas, which is supercooled as LNG and shipped overseas. On the other hand, Europe's long-time supplier, Gazprom is working on additional pipeline infrastructure such as Nord Stream 2 and Turk Stream to secure its market share in the wake of increased competition.

The American natural gas industry developed itself into a significant exporter and has increased the stakes for Russia’s state-owned energy giant Gazprom. Russian officials, for a long period, were in denial of the negative consequences as a result of American LNG exports. However, Sergei Komlev, the head of contract structuring & price formation for Gazprom Export, recently acknowledged the new situation in Gazprom’s magazine: “it is obvious that LNG will be the main rival in the battle for the European consumer”. Therefore, the construction of both pipelines is of paramount importance for the Russian energy giant. 

The missing gas problem

Despite increased competition, Gazprom is still doing good business in Europe. The energy giant managed to export 202 bcm in 2018 and doubled its profit despite efforts to reduce dependency on Russia.

Analysts expect Europe’s dependence on imported natural gas to increase even further due to the depletion of domestic gas fields. Until 2025 a ‘gap’ of approximately 100 bcm will arise which needs to be imported from abroad. There are two options to fulfil the extra demand based on existing or ‘under construction’ infrastructure: LNG or additional supplies from Russia.

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According to most analysts, Gazprom’s motivation to construct Nord Stream 2 and Turk Stream is more political than economic due to Moscow’s desire to circumvent Ukraine and punish her for its pro-European stance. However, the fact remains that Gazprom is still mostly dependent on Ukraine’s infrastructure for the majority of its gas sales to European customers. It is in Kiev’s interest to maintain its status as a transit country which provides her significant strategic value and generates $3 billion in annual transit fees for the state’s coffers.

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Source: S&P Global Platts

Moscow’s European gas strategy

Gazprom has a gas transit contract with Ukraine’s Naftogaz until January 1st 2020. To put maximum pressure on Kiev, Moscow intends to complete both Nord Stream 2 and Turk Stream before the end of 2019. Depriving Ukraine of its strategic value and income from transit fees would seriously erode its bargaining position vis-à-vis Gazprom for the import of Russian gas and most likely plunge the country into a recession.

However, Denmark delayed the approval to use its EEZ for Nord Stream 2, which is a setback that could postpone the pipeline’s completion. Interfax news agency quoted Nord Stream AG, the company responsible for construction activities, that the project is suffering delays and will go into production in 2020 instead of the end of 2019.

Gazprom could be preparing for what some analysts call the ‘nuclear option’ which will seriously damage Russia’s position as Europe’s most important energy supplier. The intention, however, is to put maximum pressure on Ukraine and remove it permanently from the gas delivery business. To achieve its goal, Gazprom has been filling storages across Europe, including the leasing of additional locations. This way, the energy giant would be able to meet its minimum contractual deliveries to European customers while bypassing Ukraine’s pipeline system.

A difficult decision ahead

The cancellation of deliveries through Naftogaz’ infrastructure would dramatically increase gas prices on the continent due to scarcity and most likely push Ukraine into a recession. In such a situation Kiev would also be unable to buy gas from its European neighbours through reverse flows leading to a disastrous first year in office for Ukraine’s new president Zelensky. Moscow would be betting on the besieged Zelensky to cave in and adhere to the Kremlin’s demands.

Despite the possibility, it remains highly unlikely for Russia to choose this option because it would also significantly damage its reputation as a reliable supplier.

By Vanand Meliksetian for Oilprice.com

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