Examination of Witnesses (Questions 1-19)
PROFESSOR JONATHAN
STERN
16 MAY 2006
Q1 Chairman: Professor Stern, welcome
to this first evidence session we are having on the UK dependency
on gas imports. I am really grateful to you for the trouble to
which you have gone both in coming and accepting the short delay
caused by the reading of a Statement in the House which a number
of us are interested in and some of us were successful and some
of us were not, but thank you for that. Thank you particularly
for what I found a fascinating paper you prepared for the Committee
on the Security of supply consequences of growing UK gas import
dependence which I have read with interest. Perhaps I can
just ask you to explain for the record who you are?
Professor Stern: I am Jonathan
Stern, I am Director of Gas Research at the Oxford Institute for
Energy Studies and Professor of the Centre for Energy Mineral
Law and Policy at the University of Dundee.
Q2 Chairman: I wonder if I could
just begin by asking you to explain something about risk in the
context of this discussion this afternoon. I was struck by your
comment in the memorandum, specifically headed "Security
and Import Dependence: some empirical observations", where
you talk about the nature of gas security incidents since 1980
three times: source, transit and facility and perhaps you could
explain the nature of the risk attaching to these three different
sources of instability and what concern this Committee should
have on each of them and indeed the country?
Professor Stern: Yes. Let me just
explain that the work that I did arose from a question I was asked
by the International Energy Agency back in 2001 to explore types
of actual security incidents which had taken place in the world
and so I created three categories: source risk, transit risk and
facility risk. Source risk being the likelihood of political or
other instability which actually cut off gas at the source; transit
risk being problems within transit countries which cut off gas;
and facility risk being technical problems or accidents which
prevented gas being physically delivered. What was very interesting
was that the main general concern about gas security, which is
source risk of what I call the "nasty and unreliable foreigners"
problem is actually responsible for very few gas security incidents.
Most of the gas security incidents which have been very serious
and deprived customers of gas for long periods of time, have been
caused by technical problems of a very boring nature, usually
to pipelines or processing plants, in other words, some facility
like a processing plant that you cannot fix very quickly. My view
of the UK gas security, and I should just say that the UK is just
one of the countries which I study, I deal with gas all over the
world, and so I am not particularly centred on the UK. But when
I came to look again at the UK after many years of looking further
afield, what is very interesting is that as the infrastructure
is getting older we are seeing increased incidence of facility
failure. You do not want to be too dramatic about this, it is
mostly only the odd pipeline, a field, a sub-terminal, and it
is usually only for a day or even a few hours within a day. But
what I think we are seeing is the consequence of an ageing infrastructure
and so my principal concern about UK gas security is because of
the facilities getting older we have a less reliable infrastructure
and we are going to get increased security incidents as a result
of that.
Q3 Chairman: You, for example, in
your paper, drew the Committee's attention to the great importance
of the Rough storage facility fire. which had almost no exposure
from the media whatsoever while you were worried about Gazprom,
"we always get our priorities right" is what you are
saying?
Professor Stern: This had a big
impact on my life and I spent the first four days of this year
during the Russian Ukraine crisis almost solidly in TV and radio
studios being asked: "what are the consequences of this incident
for the UK", to which my answer was, "well nothing very
much". I think that since Rough happened in February I have
probably had about two phone calls. There is something magic about
unreliable and nasty foreigners that catches the journalists'
imaginations and they can then see Hollywood film scripts in their
mind about nasty people turning off gas and holding Europe to
ransom. Fires on platforms due to unreliable chillers are just
not that interesting for most of the world.
Q4 Chairman: Can I just ask: those
unreliable and nasty foreigners of whom you speak are also scrambling
for energy supplies around the globe at present, so should we
be more concerned than we were, forgetting the details and the
issues, about our dependence on imports in that new rather more
competitive world?
Professor Stern: My feeling about
imports is that they have great advantages, they come through
brand new infrastructure which should be more reliable can point
to certain circumstances where brand new infrastructure has not
been reliable, but they should be more reliable also because in
the UK they will be from diverse sources via diverse routes and,
as I say, although there is a great desire to portray producers
and exporters of all types of energy as people who are just waiting
to make you dependent and then cut you off, there really is not
any empirical basis; 1973-74 still remains very vivid in people's
memories, despite the fact there really has not been another comparable
incident in the last 30 years and in fact there have been a number
of circumstances where we, as a group of importing countries,
have embargoed exporters rather than the other way round.
Q5 Chairman: Do you have a view of
the extent to which we will be depending on importing gas and
there is a conventional wisdom out there, what do you make of
the rundown in the UK Continental Shelf supply?
Professor Stern: My sense of this,
but I confess I have not studied this myself, my sense of this
is that supply may well run down less quickly than we think. But
the aspect that people really have not paid attention to, on which
we have done quite a lot of work at our Institute, is that we
do not think that demand is going to increase very quickly because
we do not think companies will build lots of new gas fired power
stations and run them at high. load factors. So insofar as we
have a "corporate view" which we really do not, we think
that on the balance of likelihoods domestic supply will not run
down as fast as we think and demand will not grow as quickly as
we think, and therefore import dependence will probably be less
than the conventional wisdom of 50 to 60% by the early 2010s and
80% by 2020.
Q6 Chairman: You are sceptical about
the second dash for gas?
Professor Stern: I am sceptical
that it is going to happen as soon as the end of this decade.
I think once we get to the middle of the next decade it will depend
on whether other power generation options have been taken up enthusiastically,
particularly coal, or whether in fact gas is all that can be built
given the lead times needed for other technologies.
Q7 Mr Weir: I want to follow with
the question, you made a very good point about the state of the
infrastructure within the UK, but often we hear about the state
of infrastructure in Russia and the former Soviet Republic. Is
there any danger of relying on imported gas from Russia or former
Soviet Republics running through aged infrastructure, is investment
going into renewing that infrastructure to supply western Europe?
Professor Stern: It is a difficult
question to make a brash generalisation about. If I could put
it to you like this: if I had to generalise I would say that I
am not clear that investment is enough to maintain reliability
of an infrastructure which is getting very old very quickly. But
this winter during the January and February cold spell, the Russians
delivered a volume of gas—and I speak as someone who has
been studying this for 30 years—that if you told me they
would be able to do that I would have said it was impossible.
Their performance in terms of delivery and holding the gas and
the electricity infrastructure together when the temperature was
minus 30 for ten straight days in Moscow was quite remarkable.
The part of the gas infrastructure that I am most concerned about
is actually the Ukrainian network and that was a major factor
in the dispute between Russia and the Ukraine which led to the
episode in the first four days of the year, so I do not think
we should be complacent about the state of the infrastructure,
but when put to the test this winter it did extremely well.
Mr Binley: I was particularly
concerned about that period actually and you have obviously covered
it.
Q8 Mr Weir: Obviously we hear a lot
about the vast reserves of gas that Russia has, but some comments
have suggested that the western Siberia fields are running down
and the new field would be further to the east which makes it
easier for Russia to supply, say, China, Japan and the United
States. How long will Russia be able to supply Europe from easily
accessible reserves?
Professor Stern: That is a very
tough question to answer quickly. I have actually just written
a book about this which takes about six chapters to try and get
through this.
Q9 Chairman: If you want to give
us a headline answer and either refer us to the book or give us
a note afterwards, that would be very welcome?
Professor Stern: Basically the
situation with Russia, and particularly with Gazprom, is that
fields that have sustained the Russian gas industry for the last
20 years are now in decline, with the exception of one super giant
field that they brought into production earlier this decade, and
they will lose round about two-fifths of their total production
from fields currently in production and planned to start production
soon over the next 15 years. The problem they have to resolve
is how to replace that production. They already have identified
the reserves and the fields from which that will be replaced,
so it is not a question of finding more gas. It is an issue of
when they decide to put the investment in, which in turn depends
on a judgment of when Russian domestic gas prices will increase
fast enough and far enough to make that investment worthwhile.
The question that has been widely asked is that, if they choose
not to put that investment in, where will they get the gas from?
They have, to some extent, answered that by saying that it will
come from two sources:, firstly, independent gas producers, that
is the Russian oil companies and Russian gas independents and,
secondly, Central Asian countries. The difficult thing, and this
is where I have spent a lot of pages in the book trying to lay
this out, is how they will phase the decline in their own production
with the increase in supply from those other two sources, and
at what point they will decide to put in the investment which
will restore their own production and that is the kind of a puzzle
that they have to resolve and it is difficult to say how they
will choose to do it. But the one thing I do not expect is that
they will be unable to service their legally binding European
contracts, and I do not expect that partly because they are legally
binding and last year they provided Gazprom witharound 55% of
their total revenues and roughly 15 to 20% of Russian foreign
currency earnings, which I do not expect them to put that at risk.
The issue of supplies to China and the United States is a different
one, because when exports finally start to those markets, and
I do not expect that to happen for about ten years, at least not
in meaningful quantities, it makes no sense for Gazprom to use
the same fields through which it can deliver to Europe and Russian
customers where it already has established transportation routes
and established customer bases.They have enormous stranded gas
fields, one in the Barents Sea, many in eastern Siberia and the
Far East, where, if that gas does not get delivered to foreign
markets, it will not be produced, so what makes absolute sense
for them is to develop those fields for the Asian and the American
markets and keep western Siberia for the European and the western
Russian markets.
Q10 Mr Weir: At the same time Gazprom,
if I recall, when there was some question about their initial
approaches to Centrica had suggested a veiled threat almost that
there was other markets that they could develop in the United
States and China. Gazprom perhaps is not a totally independent
company as we would recognise it in the UK; do you think that
that could have a bearing on how they approach this situation?
Professor Stern: I think in the
paper I submitted I tried to set out at some length the actual
language that was used in the press release and the way this was
interpreted in the west and particularly, I have to say, in the
Financial Times, and I found this very extraordinary because when
I read through the press release I could not see what the veiled
threat was. What Gazprom pointed out was that it was developing
other markets; well this we knew, but they did not say, "But
actually we will not be exporting anything to these other markets
for ten years". The press reporting made it seem that Gazprom
was saying to Europe: "well if you are nasty to us we will
take the gas that we are exporting to you now and export it to
somebody else tomorrow". Well, that is not going to happen,
they do not have the capability to do that and I personally do
not think they have got the desire to do it. Centrica, in my view,
was a complete non-story and when I said this to a couple of journalists
they said, "Yes, but it is such a good story".It arose
from a telephone conference with financial analysts where Gazprom
was asked straight out, "Are you interested in buying Centrica?"
To which the person, who incidentally was not responsible for
asset purchase within Gazprom, said, "Yes, but", and
then he went on to explain they were interested in buying a lot
of other properties in both Europe and the US. Our press seized
on this and made a story out of it which, I believe, was simply
not a story. Personally I think Centrica would be a disastrous
purchase for Gazprom because the British market is just too far
away from Russia for large scale, profitable gas sales but, be
that as it may, our press, and certainly some of the political
establishment throughout Europe and the United States, is anxious
to play up a threat involved in Russian energy supplies. Although
it is impossible to deny that there is that possibility, from
the way they express themselves, I personally cannot see it and
I feel if you actually read the original sources, you can see
that it is very much a matter of interpretation as to how you
read their words.
Q11 Mr Weir: As well as Russia, and
obviously there is quite a supply of gas in the central Asian
republics, what is the potential for gas supplies to western Europe
and central Asia?
Professor Stern: I would say that
central Asia has the potential to develop an export capacity of
over 150 billion cubic metres a year, in other words, roughly
what Russia exports today. How those exports are divided between
Commonwealth of Independent States countries, including Russia
and Europe, and markets in the other regions: China and further
south, possibly Pakistan and India and as Vice President Cheney
pointed out when he was in Kazakhstan a couple of weeks ago, the
possibility of a Trans-caspian pipeline taking central Asian exports
to Europe through Azerbaijan and Turkey will, I think, depend
somewhat on politics and somewhat on economics. The one thing
I would say is that, and this I fear this is an unpopular view,
in my view it is absolutely incontrovertible that the most profitable
way for those countries to export gas is via Russia. Now, this
is unfortunate, because everyone is very keen and understandably
so, that those countries move away from Russia's grasp in the
export of their energy products. But I think if you take a look
at a map and you look at what the alternative customers in China,
in Pakistan and India would pay for central Asian gas, and the
sheer distance that has to be travelled between those countries
and the pipeline routes that have to be established, I think you
can see quite easily without doing very much calculation that
to deliver that gas to Europe through an established pipeline
network, albeit one that needs a bit of work done on it, is going
to be far more profitable for those countries. The question really,
and this is a fascinating geo-political question particularly
for Kazakhstan, is that if you sit between two huge countries,
China and Russia, and you are being courted by both those countries
for your energy supplies, it is probably wise to balance your
export markets and I think that is what we are seeing particularly
in Kazakhstan; Turkmenistan I am less certain about, despite the
contract that was signed a couple of months ago with the Chinese.
Q12 Mr Weir: You said earlier that
one of the concerns about the supply pipeline was the state of
the Ukrainian section of it. How able is a country like Kazakhstan,
Turkmenistan, to invest in the infrastructure required to exploit
and export the gas that they have?
Professor Stern: In the case of
Kazakhstan they have a number of foreign partners who are capable
and happy to develop those fields for them and would develop pipelines
for them, although I think that the national company is well capable
in terms of financial ability and hiring of contractors to do
that itself. In the case of Kazakhstan, companies are falling
over themselves to try and become involved. Turkmenistan is more
problematic both in terms of the politics and the state of the
infrastructure. It is an environment that foreign companies have
found it difficult to operate in for a variety of reasons, principally
related to governance and some very difficult politics with the
regime there.
Q13 Judy Mallaber: Can you tell us
something about the gas exporting countries forum, how many countries
belong to it, how significant is it in supply terms and, following
on our Chairman's introduction, is it going to become another
OPEC?
Professor Stern: My Institute
is publishing a paper on this very soon. What we have tried to
do is chart the Forum from its beginnings in 2001 and it is a
Forum where the membership is somewhat fluid. At times there have
been as many as 15 country representatives and sometimes as few
as 11. Some countries do not attend all the meetings, others do.
The Forum has repeatedly denied that it intends to become an OPEC-type,
in other words, a price setting cartel. In other words it has
attempted to distance itself from the raison d'e®tre of OPEC
in terms of oil. What has happened in reality is that the Forum
has tried to get some agreement between national governments on
how gas commerce should be conducted, and so far it has largely
failed. It has become more of an information organisation where
governments meet and talk about the problems on their agendas.
It has also become, over the past two years, more of a Liquified
Natural Gas exporting organisation than a gas exporting organisation.
Of pipeline countries, the Netherlands and Canada are not there
at all, and Norway is as an observer, whatever that means. Russia
has attended every meeting but, as far as one can see, has played
very little part. The really big players in the forum are Algeria,
Qatar, Iran and Trinidad, Algeria and Iran are pipeline exporters,
but their big unifying factor is LNG exports. This is a particularly
uncertain time for the Forum because the presidency this year
was passed to Venezuela. It was an extraordinary thing to do since
Venezuela is not, and has no immediate likelihood of becoming,
a gas exporting country. The 2006 meeting of the Forum, which
is always held in April, and was to have been held in Caracas,
did not happen. We expected that they would come together at the
International Energy Forum meeting in Doha earlier this month,
they did not. So the Forum seems currently to be in limbo, they
did not have their meeting and we do not know if they are going
to have their meeting this year. If they do not have their meeting
we do not know what the future holds. The way I have tried to
summarise this in the paper, and in our paper that we are going
to be putting out in a few weeks' time, is in the following: you
cannot rule out the fact that the Forum could become something
like a "gas OPEC" in the next ten to 20 years, and it
did take OPEC about 20 years before it became a serious cohesive
organisation, but we do not see a respect of that today.
Q14 Judy Mallaber: What proportion
of the current supply is supplied by the countries involved, can
you estimate that at all?
Professor Stern: It is in the
paper. I do not hold it in my head, but the thing is that because
the forum involves Russia and Algeria, it is a substantial proportion.
Then if you include Norway as an observer, whatever that means,
it is a very substantial proportion. But although this kind of
arithmetic is very fashionable at the moment, unfortunately it
does not really tell you what you want to know which is: if they
did come together in a price setting cartel,what could it mean?.
What would be the likelihood of them coming together is the better
question.
Q15 Judy Mallaber: Do you have any
clear idea of what their aims are, or is it as we see from that?
Professor Stern: They have no
website, they have no publications, they have no press releases,
so it is only if you are on the margins of the meeting that you
can get anything out of them. Their aims are very moderate in
terms of getting together and talking about current and future
gas exports issues and, as I say, they specifically disavow they
want to become a gas OPEC.
Q16 Roger Berry: Your argument is
that at least in the short and medium term we should not worry
too much about growing import dependence in relation to gas supplies.
As you point out, your paper is contrary to the consensus, it
is contrary to one of the basic premises the Government has given
for having an energy review right now. Why have another energy
review? Because our dependence on gas imports is growing faster
than we anticipated three years ago. But you have also just said
in ten years' time the global gas market may be very different,
there could be a cartel. How confident are you that some are worrying
too much about growing dependence on gas imports?
Professor Stern: I try and ask
myself the following question: what is it that could happen to
us if we became dependent on gas imports as opposed to having
our own supply? And the usual answer is, well, what can happen
to you is that when you become dependent on nasty unreliable exporting
countries and they turn round and they say, "Unless you do
X we are going to cut you off", and then you have to ask
yourself, well, what are they going to ask for? Well, they could
ask for higher prices. In the case of Russia they could say, "Unless
you give up this foreign policy that you are pursuing we are going
to cut your gas off". My position is that I have been rehearsing
these type of scenarios for the last 30 years in my work, and
I have never come across any scenario that I have found really
very convincing. The conclusion from the work that I have done
is that there is one situation in which I would be much more concerned
about gas import dependence, and that is a situation where the
exporting country decided that it no longer needed the revenues
from the product it was exporting. So for example, if you can
construct a scenario where the Russians in 20 years' time will
say, "Well, actually we do not need $30 billion per year
any longer and so it does not matter if we put those earnings
at risk. We do not care that we have invested multiples of tens
of billions of dollars creating this infrastructure to deliver
gas to Europe, therefore it is not a problem for us if we make
some foreign policy move which shows that really we are prepared
to use this commodity as an instrument of blackmail". I just
have never managed to develop a credible scenario based on that
proposition. Nobody can say that it will not happen, it could
happen, but my sense of this is that the key to security is diversity
and that is what we are doing. We will have diverse sources of
LNG imports, and diverse sources of pipeline imports. The paper
that I am writing at the moment raises a slightly different concern
and that concern is that the most recent set of geopolitical developments
with Russia and with the Middle East countries may be such that,
in ten to 15 to 20 years' time, we could see a relationship with
these regions deteriorate so badly that we will not be able to
access their resources. In other words the resources exist and
the economics of production and transportation make it profitable
for them to deliver to us, but our relationship with these countries
has deteriorated so badly that we can no longer develop this type
of commerce, and that would be a different problem to those that
we have faced previously.
Q17 Roger Berry: Thinking of Russia
and Gazprom and you mentioned the Ukraine incident; what was that
all about?
Professor Stern: What that was
principally about was Gazprom's increased determination to withdraw
subsidies which had existed since the Soviet period. The numbers
here are somewhat misleading because this was a barter trade,
but if you take the absolute numbers at face value, Gazprom, until
the end of last year, was exporting gas to Ukraine for $50 a thousand
cubic metres. On January 1, just because I was asked by a journalist,
I tried to find anywhere else in the world where gas was being
sold, even to domestic customers, at $50/mcm and even in Bangladesh,
which is a significantly poorer country than the Ukraine, domestic
customers pay a higher price than that for gas. This is a legacy
of the Soviet period and a problem because of the transit dependency
of Russia, versus supply dependency of Ukraine. In the book I
chart the last 15 years of this relationship and in an article,
which is on our Institute's website, I try and demonstrate how
this relationship deteriorated with the election of President
Yushchenko in the Ukraine. The conclusion I draw is that this
incident was political in that had the Orange Revolution not happened,
had President Yushchenko not been elected, then almost certainly
this episode would have been avoided, but it was entirely clear,
even by the beginning of 2005, that Gazprom was determined to
phase out Soviet subsidies to CIS countries. The opportunity cost
of supplying these countries for $50 to $100 per thousand cubic
metres when a few hundred kilometres further west Gazprom is getting
$200 to $250 is just too great, and for me this is what it was
about. It was not, in my view, about political blackmail, despite
the fact that that is how it was represented.
Q18 Chairman: Belarus still gets
a very good deal, does it not?
Professor Stern: It still gets
a very good deal, but Belarus does two things. Firstly, it has
not strayed from the political path, in other words it is Russia's
remaining loyal ally in Europe. Secondly, it has agreed, as the
others, and particularly the Ukraine have not, share ownership
of the gas export infrastructure that crosses its territory, so
the Yamal pipeline belongs to Gazprom, and the land on which it
sits belongs to Gazprom. But interestingly even the Belarussians
from the beginning of next year are likely to have their prices
raised very considerably.
Q19 Roger Berry: Given, as you have
pointed out, the importance to Russia of gas exports to Europe
as elsewhere, given that you have argued that it is different
from your scenarios where Russia might cut off the gas supply,
as the media would put it, why then is Russia not ratifying the
Energy Charter Treaty, is it of any significance that they should
do so?
Professor Stern: It is significant
that they should do so and the principal reason that they have
refused to do so, and there is a long history of this, starting
with the problems that initially the US and Canada caused in the
Energy Charter Treaty ratification process and then the EU caused
in the process, which are far less well known than the problems
Russia has caused. but the principal reason that Russia has refused
to ratify is that they fear, and unfortunately they see January
2006 as vindication of their fears, that the Energy Charter Treaty
is a plot to discriminate against Russia. In other words they
believe that countries are waiting for Russia to ratify so that
Russia can be held accountable to the rules of the Energy Charter
Treaty but nobody else is going to be held accountable. That is
why you saw Alexander Medvedev, Deputy Chairman of Gazprom, in
London a couple of weeks ago saying, "The Energy Charter
Treaty is a stillborn document", and I think what he meant
by that was—and I was actually in Moscow while he was saying
that in London—what is the point of ratifying a treaty when
a country like Ukraine that has ratified the treaty violates the
first principle of energy transit and nobody, not the Charter
Secretariat, not the European Union, not a single European leader,
holds it publicly accountable for that; and I have to say I think
he has got a very good point. Incidentally I am not totally pessimistic
about the likelihood that they will ratify it in the future, but
this has been a very unfortunate example for them.
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