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*crisis looming?The gas supply from Russia has been making the news in recent weeks, and, as E&T explains, Europe is taking a big chance by relying on Russia.

The media is awash with stories of the dispute between Russia, Ukraine and the European Union (EU) for the provision and payment of the supply of natural gas to Eastern European states.

What Europe has recently experienced, with Russia turning off its supplies in January 2009, could be an early preparation for a more serious supply problem when Russia simply will not have enough gas to go around. This could mean parts of Europe being cut off for months at a time.

Such a prospect must be seen as surprising, given that Russia has the world's largest proven gas reserves 1,576 trillion cubic metres, according to the BP World Energy Review for 2008.

Marina Tsygankova, energy markets economist at Statistics Norway, predicts that the gas supply situation will remain tight at least until 2011, while Alex Alexiev, senior analyst at RAND Corporation, contends that Gazprom has a shortfall now and imports gas from Turkmenistan to satisfy domestic needs. Dr Nazrin Mehdiyeva, Russian gas expert at Pöyry Energy Consulting, Europe's leading enegy consultancy, argues that supply shortages will become increasingly pronounced around 2012 if Gazprom misses the key deadline in launching the first field at Yamal. 

Real shortages will appear in a few years when Gazprom has to fill two more pipelines (Nord and South Stream), yet it is unable to develop new fields due to lack of current investment.

This is supported by Vladimir Milov, head of Moscow's Institute of Energy Studies, who predicts that there could be a supply gap in the next decade of 120 billion cubic metres; while Alan Riley, associate research felow at the Centre for European Policy Studies, suggests it could be double that.

Analysts observe that Russia has failed to invest sufficiently in upstream infrastructure to expand production and meet future demands. The Russian government hopes that part of this problem can be dealt with by switching industry away from gas dependency, but industrialists are struggling to find the capital required.

Political barriers

This situation exists primarily due to the geopolitics in Russia. Former Russian President Vladimir Putin has created a business climate - including putting domestic price controls on gas, which has discouraged investment in energy.

The Russian hierarchy has been accused of using Gazprom as a tool to further his political ambitions, at home and abroad, including using company finances to nationalise large sectors of the economy and thus diverting investment away from core areas.

In comparison to its Western rivals, Gazprom, like much of the Russian economy, is overmanned, uncompetitive and inefficient. It has 436,000 employees while ExxonMobil, manages with 100,000 staff, despite having a four times greater turnover.

As a result of Putin's policies, Gazprom CEO Aleksei Miller has focused on making the firm the world's largest by market value. In January 2008 it was placed third behind ExxonMobil and General Electric.

For years analysts had warned that the high world energy prices had overvalued the company and so, when prices fell, Gazprom's valuation plummeted to 35th place.

Given the current state of the Russian economy and the increased demands placed on Gazprom by the government to support the economy, it is doubtful that the company will be able to develop sufficient, market-ready gas to plug its energy crunch.

Already Gazprom is $60bn in debt, has been losing $100m a day from the Ukrainian dispute, and is facing "demand destruction, falling prices, and huge challenges to finance its ambitious investments and manage its debt burden", says Douglas Busvine, an analyst at Medley Global Advisors.

Jonathan Stern from Oxford's Institute of Energy Studies says: "The reality of the situation has begun to bite." To put it simply, you could say that Gazprom has not produced enough gas.

In fact, Russian gas production fell from 612 billion cubic metres in 2006 to 607 billion cubic metres in 2007, says the BP World Energy Review 2008.

Part of the problem for Gazprom is that it has already developed the relatively easy and cheap mega fields discovered in Russia - the Urengoi, Yamburg and Medvezhye located in the Nadym-Pur-Taz area of Western Siberia and with reserves of 16 trillion cubic meters of natural gas among them, accounting for about 70 per cent of Gazprom's natural gas production.

Stratfor.com analysts describe Gazprom's efforts to counteract this serious decline as disappointing, with only one mega field - neighbouring 3.3 trillion cubic metres Zapolyarnoye field, whose production is continuing to climb - brought online in 2001. Though, Dr Mehdiyeva observes that Gazprom's existing plans to bring relatively small fields in the traditional Nadym-Pur-Taz area online will be insufficient to offset the continued decline in production from these super-giant fields.

Analysts observe that little effort has been made by Gazprom to reverse the current decline in production. In 2007, the International Energy Agency (IEA) forecast that, unless there was a substantial immediate increase in investment, total Russian output would continue to decline and the Russian domestic market will increasingly be dependent on imports from Central Asia.

Apart from these fields, the only significant increase in Gazprom's production is not expected to be from investing in major new fields, but from shares Gazprom has bought in a number of independent gas producers operating the Sakhalin gas fields off the Russian/Far East coast. 

Other factors in the production equation are the output provided by domestic independent producers and central Asian imports.

Independent gas providers

Russia has a few independents that produce gas for the domestic market, usually as a by-product of oil production. But it appears that their efforts to expand are hindered by a hostile attitude from both the government and Gazprom, and the independents' inability to deliver gas outside their region without using the Gazprom-owned national gas grid, as only Gazprom is permitted to export Russian gas.

Despite all these obstacles, the IEA reports that independents managed to double their production of gas to supply the domestic markets between 2000 and 2007, while Gazprom only managed 2 per cent.

In the government's latest Energy Strategy for 2020, it is predicted that independent producers will double market share to 20 per cent but, unfortunately, the current world economic situation, and the failure of the government to fully open up the gas sector to competition, means that there is little incentive for independent producers to boost production

The other alternative source is gas imports from central Asia. Central Asia supplied an estimated 47 billion cubic metres of gas in 2006. As Russia has failed to invest sufficiently in home production, it has been increasingly dependent on cheap Asian production to top up its domestic supply since 2001. Gazprom needs cheap gas to supply the domestic market, thanks to the government setting domestic gas prices at well below market prices.

However, because central Asian gas is used to supply the unprofitable home market, it has enabled Gazprom to export Russian gas to the profitable markets abroad. Consequently, it is not surprising that the government plays such an active interest in restricting efforts by the EU to gain direct access to these supplies.

Gazprom has at last shown some efforts to seriously tackle this problem and, in December 2008, it announced an investment program, which calls for capital spending of US$24.67bn in 2009, a 32 per cent increase in capital expenditures, in order to increase output.

In addition, there are reports that there are plans to plug the supply gap in the next decade by bringing on stream two mega fields - Shtokman in the Barents Sea and Bovanenkovskoe field on the Yamal Peninsula. Gazprom had announced that both fields would be developed at the same time. However, even before the credit crunch, doubts were being expressed about the scheduled dates for bringing these fields on stream.

The Shtokman field is one of the world's largest natural gas fields, and Gazprom has little experience of developing such an offshore field. The company will have to depend on its foreign partners and lenders for the necessary resources and expertise. These fields are due on stream by 2013, but already analysts are suggesting Shtokman will be delayed until financial conditions improve.

The Yamal scheme is more advanced than the Shtokman project, and Gazprom predicts that Bovanenkovskoe will produce 115 billion cubic metres per annum. Analysts expect the Bovanenkovskoe field to come online in 2015 rather than 2013.Gazprom has already, announced a neighbouring field the Yuzhno-Tambeyskoe gas field on the Yamal Peninsula, has been put on hold until at least 2024.

Another important factor lies in the pipeline situation. Dr Mehdiyeva says: "The construction of new pipelines, such as Nord Stream and South Stream, will create significant excess pipeline capacity in supplying gas to Europe, which, from the economic perspective, may appear meaningless.

"However, having more pipelines transporting gas will create 'manoeuvring space' for Moscow and virtually wipe out leverage that Ukraine and Belarus currently hold over Russia by controlling transit routes for gas. Europe will consequently be able to prioritise among its foreign customers, with West European consumers generally benefiting from this situation and former Soviet states, notably Ukraine, losing out."

Central Asia will become increasingly vital to meeting Gazprom's consumer's demands. Al Breach, country head for Russia at UBS Investment Research contends that "central Asia will become more crucial in the Russian gas balance going forward".

He projects that imports will amount to 93.2 billion cubic metres by 2014, or 10 per cent of all the gas that Russia consumes, exports or transits.

But there is uncertainty over whether Gazprom will be able to gain access to sufficient supplies from this region for fields in the Yamal region to come online. Though, as alternative routes out of the region develop, Gazprom's suppliers will increasingly demand that the Russian giant pays world market prices for gas.

Damaged distribution

Distribution plays an important part in the supply problem. Some analysts estimate that 12 per cent of all gas produced is lost through leakages and insufficient investment in the distribution network. 

Currently, 20 per cent of Russia's gas pipelines are more than 33 years old, and a further 40 per cent range between 21 and 33 years old, estimates Dr Mehdiyeva. Gazprom has announced a $7.3bn programme of investment to tackle this, though there are doubts it will be fully implemented.

Vladimir Inozemtsev, director at the Independent Centre for Post Industrial Research says: "Russia currently consumes more gas than seven of the world's biggest economies combined." This is because there has been no economic or political incentive to save energy or invest in energy saving technology, despite the Russian government being one of the first countries to sign up to the Kyoto Protocol.

In recent years, gas demand has risen at 4 per cent per annum, reports the Russian State Statistics Service Rosstat. The IEA reports that the main users of gas are the Metallurgy sector at 22 per cent and user and power generation at 36 per cent. A Russian smelter needs 6.2 times more gas to make a tonne of aluminium as a French one.

For future growth in demand to decline, the government plans to fully liberate prices by 2011, but this is seen as increasingly political unlikely. Further pressure on demand is the extensive program of urban and rural gasification which means Gazprom will find it harder to protect supplies, and this will make it harder for the company to manage supplies.

Russian MP Anatoly Chubais predicts gas demand will continue to increase now that industrialists have the freedom to build or buy their own power stations. This, of course, relies on adequate investment.

Stern, of the Insitute of Energy Studies, points out: "If the recent announcements to invest heavily are implemented to tackle the future production deficits, shortages are unlikely."

Others doubt Gazprom has the investment to deliver the required capacity on time.

Russia's gas future

In the short-term, if Russia is to ensure there is enough gas for the market, Gazprom must buy every drop of gas available from central Asia. The company should also focus on implementing the measures it agreed to overcome the predicted gas crunch, including focusing on investment, expertise and resources on the schemes that will deliver substantial improvements in exploration, domestic production and delivery of gas to the market.

The government should open up access to enable independent gas producers like Lukoil and Novatek to distribute their gas output via Gazprom's pipeline monopoly. This also means having direct access to the profitable foreign markets.

As for Putin, he has to admit that Gazprom is in urgent need of reform. Such reform would require Russia seriously implementing its ambitious Energy Strategy policy for 2020 of reducing domestic demand for gas at home by at least 225 billion cubic metres.

The government needs to participate in sufficient funding in the development of new coal, hydro and nuclear facilities, and the upgrading of the electric grid networks. Given Russia's history of development of such projects, this will mean overcoming domestic political concerns and inviting foreign expertise and investment to participate.

In the medium-term, Putin should start the process of reforming the gas sector, following a similar model that was implemented for the electricity and railway industry which have broken these industries into competing component parts. This means creating more favourable tax, market and investment environment for investors in the Russian gas sector.

Gazprom should work in partnership with investors to explore and develop new fields on a turnkey fixed-cost basis. This would enable it to gain access to new technology, skills, experience and capital.

Lastly, Russia needs to actively encourage energy efficiency and conservation, which means moving forward faster on plans to liberalise the domestic market pricing structure so there are economic incentives for users to either switch away from gas or be more economical with gas.

The country may consider inviting EU expertise in implementing such a policy.

Growing gas demand

Between 2000 and 2030, gas demand in Europe is expected to double, reaching 4.3Gtoe (Gigaton of oil equivalent).

During this period, growth in the use of gas for power generation is likely to contribute 50 per cent of this increase, while European gas production is expected to decrease by half. This could mean that Europe will need to double its present gas imports from its current 300 billion cubic metres, reports Eurogas.

The recent events in the Ukraine have demonstrated that Europe still does not have a truly integrated gas super grid that enables countries to switch supplies. Because of this, large parts of south-east Europe were without gas in the depths of winter, because they could not get supplies from elsewhere.

In fact, recent events suggest Europe should act quickly in implementing the Community Gas Ring, which is part of the proposed power super-grid plan announced by the European Commission recently. This would enable countries to share gas if Gazprom disrupts supplies again.

Europe also needs to continue to develop its links to new sources of supply; this includes backing for such schemes as the Nabucco pipeline project, which plans to link the Iranian and central Asian gas fields with Europe, as well as looking further afield with more investment in liquefied natural gas facilities to import gas from Australia and Nigeria.

Unless the EU manages to further liberalise the European gas market, current legal and political restrictions will make it very difficult to switch gas across the continent using the proposed Community Gas Ring. However, if Europe is really serious in developing new links it will need to be more proactive. This means that, given the current economic downturn, EU states will have to shoulder more of the burden in financing such projects as part of there fiscal stimulus to save the economy.

In addition, project developers should be encouraged to make use of new technologies and construction techniques, so as to improve the viability of such schemes.

Europe must also continue with its policies of cutting demand for gas, promoting energy efficiency and investing in alternative sources of energy including coal and nuclear, in order to reduce certain EU states', like Bulgaria's, total dependency on Russia.

Inozemtsev suggests that the EU should take a proactive part in implementing energy saving and efficiency programme in Russia. It is likely that the share of gas consumption for power generation will increase from 28 per cent, which is was in 2005, to 38 per cent of total gas demand in 2030.

Like Russia, the EU must reduce its demand for gas by switching away from gas to fuel its power stations, and invest in alternative sources of fuel.

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