Europe’s requirement for additional gas supplies

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On paper, Europe is setting its policies on energy security but is finding many obstacles in its path for developing new transit links, particularly between neighbouring and CIS countries.

In practice, the obstacles are diverse and include local geopolitical issues, spiralling project costs, increases in oil and steel prices and access to proven fuel resources.

These obstacles are adding to the difficulties in establishing new energy links and supplies particularly with CIS producers. However, the question is whether EU policies and action is sufficient to alleviate these issues and deliver new supplies to Europe or whether its dependency on existing suppliers such as Russia and North Africa will persist?

The EU currently imports approximately 57 percent of its gas with imports expected to increase to 84 percent over the next 25 years. During this period, imports from Russia are expected to exceed 30 percent. During a summit in Brussels in 2007, the EU discussed plans for energy security of supply. It was outlined that the EU first needs to diversify its energy sources and promote feasible transport routes with better operational and management systems to respond to supply crises more effectively. It was also clear that new gas supplies needed to be secured. In addition, the European energy grid needed to be reinforced to ensure reliability of new supplies.

Diversifying gas supply
The key driver for these initiatives is that European energy consumption and import dependency is increasing significantly. Additionally, domestic energy production has steadily decreased particularly for hydrocarbons, solid fuels and nuclear resulting in Europe becoming further dependant on its neighbours for fossil fuels. In particular, natural gas demand is expected to rise with an additional 200 billion cubic meters (bcm) being required over the next 20 years. Compounding this, we understand that long term contracts with current suppliers are reaching an end and for new supply contracts Europe is competing with the world market. Thus, several critical issues have been highlighted:

Firstly, in some producing countries, operations of existing gas fields are not optimal meaning additional throughput capacities can not be realised. Also, maintenance practices are not consistent or implemented effectively meaning many pipelines and facilities are degrading. Finally, due to lack of investment, upgrading and development of existing fields has not been possible resulting in production being stifled rather than increased. For example, output for Gazprom’s three major fields in West Siberia, which amounts for 75 percent of its production, is declining by approximately six to seven percent per annum. Although Gazprom has now decided to commence production of the giant Shtokman field and in the Yamal Peninsula, it may take some years before the fields start producing at full output. A further factor is that the producing countries themselves are increasingly consuming gas, for example, Russia’s own demand for gas is increasing by over three percent per annum. Consequently, the EU gas deficit is expected to increase six fold in the next 20 years unless new production projects and transport routes can be generated.

In addition, as most of the EU’s imports are highly concentrated, disruptions for whatever reason can place Europe’s gas consumers at risk. For example, before 1999, approximately 95 percent of Russian natural gas exports outside the former Soviet Republics transited through the territory of Ukraine. Since then, Russia has initiated a number of projects aimed at diversifying its gas transmission routes effectively reducing dependency on Ukraine’s system to 80%, and will probably reduce this further. So although developments have been made, some effort is still required to diversify Europe’s dependence on Russian gas.

Although the EU policy makers are making progress in developing new supply initiatives, progress has been slow. Consequently, available gas quantities are dwindling as producers commit supplies elsewhere. For example, the Caspian Basin has an estimated seven trillion cubic meters of proven gas reserves with current production at 90bcm per annum. However, China and Russia have already secured 30bcm each, limiting the potential volumes available for Europe.

The issue for supply is further troubled by the current oil and metal prices, which have reached all time highs. Oil prices recently hit US$135/bbl and are expected to increase to beyond US$150/bbl later this year. Similarly, European gas prices have almost doubled from 2000 to 2007 and steel prices have increased by approximately 65 percent over the last three years. Availability of resources to design and construct projects is also critical at present. So what does this mean to the establishment of inter-regional gas markets?

On one side, the high oil price attracts suppliers where large returns on investment can be made. However, on the flip side, the rapidly rising cost of executing projects has made it difficult to fund projects without larger volumes of committed gas. Therefore, project developers are considering new technologies and advancements in construction techniques to improve project costs for the volumes available. These developments include advances in LNG, CNG and new sub-sea pipeline technologies. In doing so, new markets and sources for supply can be established with technologies available to transport these supplies to EU markets.

Development for gas transport routes
Over the last decade, a number of new transport routes have been proposed particularly for delivering gas from Russian and Middle Eastern and Central Asian producers. Indeed, some of the new developments have generated media coverage and interest. For example, the Southern Europe Gas Ring Project has been constructed to transfer gas sources from the Caspian Basin, Russian Federation, Middle East, Southern Mediterranean countries, and other international sources through Turkey and Greece. The pipeline is approximately 300km long and includes an offshore section for 17km across the Marmara Sea. The International Agreement between Turkey and Greece was signed in February 2003 to deliver 13Bcm per annum, of which 3.6Bcm per annum will be transported to Greece and rest to Italy.

Meanwhile, Russia has been developing its own alternative routes into Europe. Most notably, the Nord Stream pipeline project, initiated in 2003 by German Chancellor Gerhard Schroeder and President Putin, is planned to transport up to 55 BCM per annum for gas into Germany, bypassing the Polish infrastructure. Construction of the Russia sections began late 2005 and is estimated for completion in 2010. Other projects planned by Russia’s Gazprom also include the South Stream and Blue Stream projects which aim to deliver a combined 46bcm of gas to European and Turkey shorelines.

Europe has been supporting the Nabucco project, a 56” pipeline capable of delivering up to 31Bcm of gas from potential sources in the Middle East and Central Asia. Other transit options to deliver Caspian gas to complement Nabucco are also being considered. These studies are at an early stage of development. Although these projects will go someway towards alleviating Europe’s gas deficit, they do not deliver the additional 200Bcm required by 2030. As such, further development in the transit countries will need to continue and committed supplies secured from alternative producers.

European co-operation
From our experience in the region, many of the transit pipelines are old and in poor condition, due to lack of investment. Therefore, rehabilitation of the existing lines and modernisation of facilities will be required. However many current pipeline capacities are already at a maximum and some infrastructure obsolete, therefore new facilities will be required.

The system is further complicated in that a series of different design and construction standards are used in the transit countries. Therefore, initiatives to harmonise standards and best practices, improving operations and maintenance procedures, maintenance rehabilitation of current infrastructure, reducing losses and developing new infrastructure are being developed. In particular, programmes such as the INOGATE Programme, which was founded by the EU’s TACIS Regional Co-operation Programme, are acting as a catalyst for attracting international investment to the region thus improving safety and operation conditions.

The Energy Neighbourhood initiative also aids in facilitating round-table discussions to improve harmonisation practices between Russia and the EU states.

Challenges for developing European gas security
The developments aimed at increasing gas security to Europe go someway to address future gas supply shortfalls. However, several challenges still remain and several steps in the process still need to be established

Firstly, it is important that committed gas supplies are secured from producers. This issue is the most critical, and is an area to which the EU is applying considerable effort. For example, a Memorandum of Understanding on Energy Co-operation was recently signed between Turkmenistan and the EU. Similar discussions with other producers are also planned.

Secondly, it will be important that the political and regulatory enablers are in place. Some mechanisms are already being established such as the European Gas Directive, an enabler for developing stability and harmonisation in European Gas Markets by ‘Acceleration’ and market opening by legal unbundling of assets.

Lastly, developments in technical and legal options need to be established. As discussed earlier, these options have been conducted via INOGATE projects which have considered the technical, legal, financial and environmental options for establishing transit links between CIS regions and Europe.

Conclusions
Europe’s increasing gas demand will mean the continued importance of CIS producers to the EU’s energy mix. However, if the EU is not able to secure gas supplies from Caspian producers in the short-term then either there will be increasing dependence on Russia, or supplies will have to come from further afield, at higher cost. There is already transit infrastructure in place, although much of it will need to be upgraded or replaced, and efforts to harmonise standards and operations are underway. Through an integrated approach and with co-operation from the CIS producers, Europe can plan to ensure its future gas demands will be met.

Azfar Shaukat is Director of Oil & Gas Consulting at Mott MacDonald, one of the world's leading multi-disciplinary consultancies . HE IS A a Professional Engineer with over 24 years’ oil & gas experience with international consulting firms and major operating companies. He has completed high-profile assignments on all continents and has expertise in strategy, financial appraisal, design and operation of upstream and downstream petroleum facilities, including gas pipelines, refineries, LNG and other fuels terminals. For more information please contact azfar.shaukat@mottmac.com or visit www.mottmac.com.