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Market Oracle FREE Newsletter


Natural Gas Pipeline Macrame Game In Ukraine

Commodities / Natural Gas May 09, 2014 - 01:27 PM GMT

By: Andrew_McKillop


An Unglorious Mess
Usually away from the microphone, natural gas experts say that “pipeline corridor country” Ukraine in fact heavily needs a pipeline rationalization program. The country is oversupplied with a patchwork accumulation of lines built up over decades, which are under-used (and badly maintained). And as we and the IMF know, Ukraine cannot pay for the gas it takes from Russia.

Gas experts, using unreliable Gazprom data, roughly estimate pipeline gas losses in Ukraine as into the range of about 5 – 8 billion cubic metres per year. This is apart from and before gas thefts, which is a key bone of contention between previous Ukrainian governments, and the present “interim self-elected government”, and Russia - as well as with downstream buyers of gas. The attribution of “missing gas” between lost gas, and stolen gas, currently has a major political significance because it enters into the constantly changing estimates, by Gazprom, of how much Ukraine owes it for gas.

IMF-The Gas Man Cometh
The IMF approved a $17 billion loan to Ukraine started with a first $3.2 billion tranche which arrived in Kiev, Wednesday 7 May. Conditions attached to this “loan” feature gas. The “regime changers” in Kiev have complied, launching an inevitable austerity package – which includes an immediate 50-percent-plus increase of gas prices. According to IMF press releases, Gazprom is owed, and will be paid about $2.7 billion for gas arrears. Another $5 billion or nearly a third of the total will be paid – to the IMF – for amounts owed to the IMF by Ukraine on previous loans. As can easily be suspected, considerable amounts of the inflow of funds to Kiev will disappear into the pockets of Kiev's own “New Oligarchs”.
Already disclosed and published by the IMF, another condition of the loan is that Kiev “reasserts control over the whole territory”, specifically meaning the east, in particular the areas where key factories and mines are located, mostly in the Donetsk region. These are also the biggest gas-using regions of Ukraine. Already, we can note, the potential exists for Russia easily supplying gas to these regions near its border, and “cutting off” the Kiev-ruled part of the country.

Using Gazprom not IMF or European Commisssion estimates, Ukraine's monthly gas bill will likely increase – despite decreasing volumes – from around $1 - $1.5 billion per month to $2 billion or more. To be sure, potential total cut-off and certain reductions in volumes will affect this, but the IMF loan, after payments to the IMF and Gazprom, and “Oligarch losses”, will only represent a net inflow of funds to Ukraine of about $9 billion. That is, about 5 months of gas imports.

For reasons that are hard to understand, Ukraine's dependence on Russian oil imports – with a monthly value and cost to Ukraine of at least $1 billion – never figure in media coverage. As we can see, the IMF loan net of repayments to the IMF, gas arrears to Gazprom and inevitable losses, can easily be swallowed whole by combined gas and oil import costs, in a very short period. Exactly as for gas, Russia has already increased Ukraine's oil import costs by charging the world price.

The Bigger Picture
Geopolitical leanings and desires out of Washington and out of Brussels make for a simple conclusion that Ukraine is “between a rock and a hard place”.  To be sure, and concentrating on gas – as Washington and Brussels do – Ukraine has plenty of the blame for its predicament. It however is caught up in a three-way gas war. Washington claims it wants the whole EU to “reduce dependence on Russian energy”.  The EU wants the under-construction South Stream gas pipeline, which avoids Ukraine like the completed North Stream line to Germany, to be a “European” gas line, not a Russian majority owned line. The Commission insists that the agreements already struck between Russia and seven EU countries for the South Stream route infringe the competition laws of the EU.

What we can call the realpolitk of energy impacts these fine flowerings of “free market competition” due to several eastern EU member countries, like the Baltic States, depending on Gazprom for 100% of their gas.  Günther Oettinger, the EC’s energy commissioner has hammered the “message” of the Commission's Third Energy Package, requiring Gazprom to allow and enable “other suppliers' to also fill the South Stream when it is completed, and we might have to add, if it is completed. Moscow has already reacted with a complaint to the World Trade Organization (WTO).

As it is, South Stream on current trends will cost Russia about 16 billion euros or over $20 billion, and Gazprom is heavily engaged in trying to find ways to finance it. To date this year, it has signed up new supply deals with companies in Germany, Italy, Austria, Hungary and Switzerland and its main project partners, Italy’s ENI and France’s EDF, have also increased their efforts to find additional funding. Making things a whole lot more complicated, the EU, partly to appease or please Washington, is actively developing gas-supply ties with Azerbaijan and possibly also with Kazakhstan, which will need their own expensive pipeline infrastructures. When or if the Iran nuclear issue is ever resolved, Iranian gas may also be added to the mix – one day.

Washington’s rhetoric about “isolating” Russia is dismissed by many in Europe as a form of juvenile delinquency, but the EU also has its own delinquants! The net result, unfortunately, is the Empire of Gas Chaos, made worse by the political elites either being unable, or unwilling to look at a map (see below)

Missing from this map are firstly the local gas line networks – which are vast. Secondly it also excludes Europe's LNG port terminals and local gas lines. In several countries these are increasing at such a fast clip that by 2020, in some cases, if LNG supplies and prices were adequate and acceptable, no pipeline gas imports of any kind would be needed. LNG supply could cover the entire national needs!

Macrame Game
To be sure there are excuses and reasons for Europe being saturated with gas lines, and boasting (if that is the right word) as many total kilometres of these lines as the much bigger 48-continental States of the USA have. One reason is historical. Another is changing technology in European gas-supply, from coal-based, through pipeline, to LNG.  Another is the realpolitik of Gazprom's gas being very cheap for a long time, and reliably supplied. Another are new and emerging pipeline-gas source countries, such as Azerbaijan, Iran and Kazakhstan. The trans-Mediterranean pipelines (not shown in the above map) bringing Algerian and Libyan gas to Europe are more gas transport infrastructures that – like the others – have to be paid for and used.

This brings us to the basic – but almost totally ignored – subject of why Gazprom and Russia started “cracking down” on the Ukraine. This was not only politics.

Gazprom is a fragile giant, financially, when account is taken of its total costs for exploring, developing and producing gas, and building and maintaining supply infrastructures.  It can no longer afford to give away gas to Ukrainians or anybody else. New competition is coming at a key moment when ever-bigger projects have to be funded, to maintain rather than increase production.

Scenarios of a death cross for Gazprom are possible.

While Washington's ability to export US shale gas to Europe as LNG will remain “homeopathic and symbolic” for at least 5 years – and maybe 10 years – the global gas picture is of very possibly burgeoning supply. Both stranded gas and shale gas discoveries and development have radically changed the potential supply picture.

Potential is however the keyword, because this all has to be funded and then built.

Depending only on that factor, not unrealistic scenarios paint a picture of Gazprom's supply declining alongside gas supply from Norway and Algeria, as domestic European gas production also continues to shrink. This of course is the LNG breakout scenario, because it will be LNG suppliers who profit – again depending on price. In other words we have a price constrained scenario of gas shortage in Europe, which already has typical gas prices around $12 per million BTU, equivalent to about $70 per barrel of oil energy. Continuing with that scenario, European gas prices would need to reach current Asian buyer prices, around $16 per million BTU and sometimes higher, to assure supply.

No rocket scientist is needed to predict a dire financial future for the pipeline consortia needing tens of billion of dollars (up to $40 - $50 bn, possibly more) for completing and operating current projects to supply Europe.  Alternately, Europe will have to pay higher prices for gas, with an inevitably knock-on impact on Europe's already declining gas consumption.

Ukraine's gas crisis is therefore only a subset of a much bigger picture. The country has its own, almost undeveloped but large gas resources, mostly in the east of the country. It also has large coal reserves, located idem. For historical reasons – ultra cheap “friendship gas” from Russia - its consumption was extreme, but has already significantly declined.  Europe in fact will not be particularly affected by the Ukraine in the longer term, because of both continental and global gas outlooks and factors, stripping away a key part of the rhetoric surrounding the present political crisis.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2014 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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