You are here: Parliament home page > Parliamentary business > Publications and Records > Committee Publications > All Select Committee Publications > Commons Select Committees > Trade and Industry > Trade and Industry

UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 1123-i

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

Trade and Industry Committee

 

 

UK dependence on gas imports

 

 

Tuesday 16 May 2006

PROFESSOR JONATHAN STERN

Evidence heard in Public Questions 1 - 41

 

 

USE OF THE TRANSCRIPT

1.

This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.

 

2.

Any public use of, or reference to, the contents should make clear that neither witnesses nor Members have had the opportunity to correct the record. The transcript is not yet an approved formal record of these proceedings.

 

3.

Members who receive this for the purpose of correcting questions addressed by them to witnesses are asked to send corrections to the Committee Assistant.

 

4.

Prospective witnesses may receive this in preparation for any written or oral evidence they may in due course give to the Committee.

Oral Evidence

Taken before the Trade and Industry Committee

on Tuesday 16 May 2006

Members present

Peter Luff, in the Chair

Roger Berry

Mr Brian Binley

Judy Mallaber

Mr Mike Weir

________________

Memorandum submitted by Professor Jonathan Stern

 

Examination of Witness

 

Witness: Professor Jonathan Stern, Director of Gas Research, Oxford Institute for Energy Studies, Honorary Professor, Centre for Energy Mineral Law and Policy, University of Dundee, gave evidence.

Q1 Chairman: Professor Stern, welcome to this first eminent 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 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 on page 4 of the memorandum 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 what actual security incidents had taken place in the world and so I created these categories of 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 being problems through transit countries which had cut off gas and facilities simply being technical problems or accidents which prevented gas being physically delivered and what was very interesting was that the main general concern about gas security, which is what I call the nasty and unreliable foreigners' concern is actually responsible for very, very few gas security incidents and 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 irritating 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, and I should just say that the UK is just one of the countries, 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 actually further afield, what is very interesting about the UK is that as the infrastructure is getting older we are having an increased incidence of facility failure. You do not want to be too dramatic about this, it is mostly only the odd pipeline, a field, an onshore pipeline, and it usually is 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 when the Russian Ukraine crisis was on almost solidly in TV and radio studios being asked what are the consequences of this incident for the UK of which the answer was, well nothing very much. I think when Rough happened I probably had about two 'phone calls in the period since Rough went down. It 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 about, 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. I say "should" because you can point to certain circumstances where brand new infrastructure has not been reliable, but they should be more reliable, they should be more diverse and the way they are being built in the UK they will be from diverse sources and 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. 1973/1974 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 thing that people really have not paid attention to, of which we have done quite a lot of work at our Institute, which is we do not think that demand is going to increase as fast as people think because we do not think people are going to build lots of new gas fired power stations and run them at high/low factors, so actually we think that, insofar as we have a corporate view which we really do not, but 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 probably import dependence will be less extreme than the conventional wisdom of 50 to 60 per cent by the early 2010s and 80 per cent 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 we have got left in terms of time.

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 Republic 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 investment is going in, I am not clear that it is enough in order to maintain an infrastructure which is getting very old very quickly, but this winter in 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 - if you told me they would be able to do that I would have said it was impossible. I mean 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 and the part of the infrastructure that I am most concerned about is actually the Ukrainian network and that was a very large 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 over the next 15 years and the problem they have is to decide how to replace that. 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 for them 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 and the concern that has been expressed in a lot of different places is that, well, 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 Asia. 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, 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 they do provide for Gazprom well over 50 per cent, probably around 55 per cent, of their total revenues and roughly 15 to 20 per cent of Russian foreign currency earnings, so I do not expect them to put that at risk. The issue of China and Asia is a different one, because when exports finally start to Asia and the United States, 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 an established transportation route with established customer bases, it just does not make any sense. 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 other markets, it just will not get produced, so what makes absolute sense for them is to develop that gas for the Asian and the American market and keep western Siberia for the European and the western Russian market.

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 memoranda I have 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. I mean what they pointed out was that they were 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 as 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, they certainly do not have the capability 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", and it is a complete non-story. It arose from an analyst's telephone conversation 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 just because the British market is just too far away from Russia but, be that as it may, our press, and certainly some of our political establishments throughout Europe and the United States, is anxious to see a threat involved in Russian energy supplies and 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 CIS countries, including Russia and Europe, and going in the other direction China and going 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 Transcaspian 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 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 actually 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 sort of 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 get to do that itself. In general what you are finding in central Asia is in the case of Kazakhstan people 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 and 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: We are publishing a paper on this not before very long. What we have tried to do is chart this thing from its start in 2001 and it is a forum where the membership is somewhat fluid. At times there have been as many as 18 country representatives and sometimes as few as 11. Some countries do not attend all the meetings, others do. I think to try and summarise this, the forum has repeatedly denied that it intends to become an OPEC type, in other words, a price setting group of cartel, in other words it has attempted to distance itself from the raison d'être of OPEC in terms of oil. What has happened in reality is that the forum has tried to get some agreement between national governance on how gas commerce should be conducted and largely it has failed. It has become more of an information organisation, such that they get together and they talk about the problems they have had, the issues they have on their agendas and it has become, over the past two years, more of an LNG exporting organisation than a gas exporting organisation. The pipeline countries, the Netherlands is not there at all, Canada is not there at all, Norway is there 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, Gaza, Iran and Trinidad and 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 meeting of the forum, which is always held in April, which 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 we are certainly in limbo with the forum, they did not have their meeting, we do not know if they are going to have their meeting. If they do not have their meeting we do not know what the future holds. 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 way: you cannot rule out the fact that the forum could become something like a gas OPEC in the next ten to 20 years and I mean it did take OPEC about 20 years before it became a serious cohesive organisation, but we do not see 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 I think this kind of arithmetic is something that is very fashionable at the moment. Unfortunately it does not really tell you anything you want to know which is well, if they did come together 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 and their aims are very moderate in terms of getting together and talking about future gas exports and, as I say, they specifically disavow they want to become a gas OPEC.

Q16 Roger Berry: Your argument 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 census, 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 had our own supply? And the usual answer is, well, what can happen to you is that when you become dependent these nasty unreliable exporting countries 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 doing this foreign policy thing that you are doing or do something else we are going to cut your gas off". My situation 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 and my 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 these $30 billion any longer and so it does not matter if we put them at risk. We basically 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. 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 are creating, we will probably have diverse sources of LNG imports, we will have 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 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, the economics make it profitable for them to deliver to us, but our relationship with these countries has deteriorated so badly that we no longer can develop this type of commerce and that would be a different threat to one that we had faced before.

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 and the numbers here are somewhat false because everything was bartered and therefore the absolute numbers are misleading, 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, tried to find anywhere else in the world where gas was being sold, even to domestic customers, and even in Bangladesh, which is a significantly poor country, domestic customers pay a higher price than that for gas and this is a legacy of the soviet period and a problem because of the transit versus supply dependency and in the book I kind of chart the last 15 years of this and in an article which is on our website at the Institute I try and demonstrate how this relationship deteriorated with the election of President Yushenko in the Ukraine and so the conclusion I draw is that this incident was political in that had the orange revolution not happened, had President Yushenko 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 when a few hundred kilometres further west you are 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, however you want to define Europe, and, secondly, it has agreed, as the others, and particularly the Ukraine have not, to share the export infrastructure that crosses its territory, so the Yamal pipeline belongs to Russia, belongs to Gazprom, the land on which it sits belongs to Gazprom, but interestingly even the Belarussians from the beginning of next year are under pressure 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 that people 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 and 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 what he meant by that - 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 accountable to that and I have to say I think he has got a very good point. Incidentally I am not totally despondent that they will ratify it in the future, but this has been a very, very unfortunate example for them.

Q20 Roger Berry: Another criticism of Gazprom is, of course, its monopoly power, as the sole gas exporter. This raises several issues and one is does this provide a disincentive to other companies exploiting Russia's gas reserves and is this of any significance in the future in terms of Russian exports? There seems a nervousness in some quarters in part because of one company. This may not be a rational concern, but it is a concern I want to raise with you.

Professor Stern: The Gazprom monopoly is a de facto monopoly, in other words there is nothing in Russian law that says that other people cannot export gas. It is perhaps not as well known as it might be that there are a significant number and a significant amount of gas being produced in Russia not by Gazprom. I estimate it at about 15 per cent of total production and I think it will go up to about 20 per cent, which is not dramatic, but on the other hand is significant particularly in volume terms. What Gazprom has said, and the Russian government has intimated is that rather as in the case of oil, and it is the case of Russian oil that you are not allowed to just produce oil in Russia and export it, you have to deliver to the domestic market and it seems likely that when companies start delivering on a large scale to the domestic market, the issue of exports will be re-visited, but the real nightmare that neither Gazprom nor the government is prepared to countenance is where Russian gas finds itself competing with other Russian gas in Europe and that is, if you like, what the logical conclusion of a competitive market would be, that you would have a lot of different companies exporting gas and that they would be competing with each other and I think what you see in Moscow is an irritation that people are so keen to see Gazprom doing this and see Gazprom's monopoly broken up that nobody really complains about Sonatrach's monopoly of Algerian gas exports, nobody complains that much that the Norwegian gas exports are relatively carefully orchestrated so they do not compete with each other and Gazprom feels, rightly or wrongly, that it is being singled out for behaviour in gas commerce that is not expected from anyone else who supplies the European market.

Q21 Roger Berry: A final question on Gazprom. You have suggested that Gazprom's monopoly over gas exports to Europe will decline during this decade, whereas many commentators feel that will not happen. Do you really believe, clearly you do, why do you believe that ----

Professor Stern: I do not think necessarily it will decline during this decade. I think that Gazprom will not have the monopoly on gas exports to Europe for ever, but my sense of this is that actually what you need to look at is how the European market as a whole will develop. What Gazprom perceives, and I think a lot of other people perceive, is this market far from becoming more liberalised and competitive, is becoming more monopolised and structured, in other words it seems now likely that the European gas market will be controlled, at least in the downstream, largely by half a dozen utilities and as such what Gazprom is saying is, "Well, since there is not going to be much liberalisation and competition downstream in Europe, there is no particular reason to see a lot of liberalisation and competition upstream". I actually believe that if it turns out that against all of our expectations we see a lot of competition in the European gas market, we will per force see Gazprom's monopoly weakened, I would not put it any stronger than that. If you ask me in 2020 what proportion of Russian gas will still be sold by Gazprom, I would say, "Well, well over half". But I think it would be wrong to see this completely set in stone and I think Gazprom will, to some extent, take its cue from what is happening in the downstream.

Q22 Mr Binley: In fact you lead in nicely to the subject I want to talk about which is quite involved with liberalisation and particularly European liberalisation of the market, because our predecessors had suggested to them in the last parliament that one of the reasons for growing tension between the European Union and Russia over gas was the demand amongst supporters of market liberalisation for the end to the traditional long term gas supply contracts and indeed in your paper of 2002 I think you suggested ways in which long term contracts could remain without some of the restrictive elements that hinder the functioning of the market. Can I ask what sort of contracts could give security to suppliers who often have to make a long term investment in infrastructure to deliver gas, whilst also encouraging liquidity and real competition in the European market, there seems to be a bit of a conflict there?

Professor Stern: I think the key thing about long term contracts is that they have already moved to be less long, in other words they are mostly no longer 20 to 25 years, they are mostly eight to 15 years which is, as it were, long enough, but the key thing really that most people are talking about is the price conditions within the contract and the price conditions within the contract have got to be kept competitive, in other words, for as long as oil and oil products are the competing fuels then everything remains roughly the same. Should we move to gas-on-gas competition in Europe then prices have got to move towards something like a spot price, however defined in each country, but if I can just move to the second part of your question which is really about liquidity and the development of a competitive market. I think it is really quite difficult to be optimistic about this in the short term, to the extent that the markets in Europe are already dominated by national champion companies, one or more in each country, and appear in 2006 to be consolidating further, with the Gaz de France-Suez merger with whoever in DESA is going to merge with and with the recent Austrian merger. National champion companies and constant market concentration seems to be accelerating, this is the enemy of liquidity and competition.

The Committee suspended from 5.30 pm to 5.40 pm for a division in the House

Q23 Chairman: It is useful to hear you express doubts about the possibility of energy market liberalisation in Europe because it is the great white hope of the sector, and I am becoming increasingly sceptical about its likelihood in a reasonable timeframe. That is clearly your view too.

Professor Stern: I am a 20-year veteran of this. I was there pretty much close to the beginning in 1988; in 1990 and 1991 I worked in Brussels with the Commission on what was then the failed Directive, and the position in most of the major continental European countries has never really changed which is this is not an important initiative for us to become involved in. Competitiveness and energy pricing is something that continental European politicians talk about, but not with any enthusiasm. National champion companies have always been at the very top of their agenda. It is almost a non partisan issue in most continental European countries that governments should decide the strategic direction of these utilities, and we in the UK have never wanted to listen to this. We have tried to ram our experiment down their throats because we are so absolutely convinced we are right about this and what we have done is wonderful; we have not wanted to listen when they have not been impressed by it; we have taken the view that in time they would be forced to adapt their systems in the same way that we have adapted ours, and I simply feel that we have acted like real Brits, we have talked rather than listened, and when we have listened we have simply tried to shout them down. I am not trying to defend or say that I think that what France and Germany and many other countries have done in the utility sector is a good thing, in many ways I do not think it is, but the problem is that they hold their policy as dear as we hold ours. They really believe that the way they have organised and pursued the utility business is correct, and the way that we have done it is wrong.

Q24 Chairman: And of course their behaviour is more like Russian behaviour.

Professor Stern: It is very much a corporate stated-type model of the utility sector and, after all, that was pretty much the model we had with the CEGB and the old British Gas Corporation prior to the 1980s. So it is really that they have not changed, whereas we did; they have held to their model except they have introduced a larger degree of privatisation, but that has not led to, in their minds at least, the idea that just because the company is privatised it should be the company itself that makes the decisions. They still do not have any problem with government making those strategic decisions.

Q25 Mr Binley: I am still concerned about what I see as a bit of a dichotomy here, quite frankly, about control at one level being changed into a freer market at a level lower down the chain, if you see what I mean. In order to be able to create that I still am concerned about security, particularly when you talk about the part of the world where political stability is not uppermost in people's minds.

Professor Stern: What I suppose I need you to define more closely is what is it you are concerned about. Are you concerned about the fact that if there are no longer term contracts suddenly there is no security of supply? Is that the principal concern you have?

Q26 Mr Binley: I have that concern and I see a threat to those longer term contracts coming from a possibility of political instability that I talked about, and we have already seen the way that political instability can degrade a country quite dramatically and quite quickly, but for a very long time.

Professor Stern: I think myself that long-term contracts have shown the ability to move through different phases and become more flexible. I am not trying to say they are not needed any longer. Clearly, for some of the greenfield projects they are needed, but what I see now being signed by Centrica and other companies are 5-8 year contracts which are clearly sufficient to underpin infrastructure. What I think is more problematic and actually applies in this country rather than in continental Europe is substantial price volatility, and I think that is a problem in this sense: that some British commentators like to say that price volatility is market signals being passed through to users. I personally think that is not correct. I think that what is happening is that our market model is producing more price volatility and that is not a good thing for investments. On the other hand, what Ofgem is undoubtedly correct in, and I say this because not everything Ofgem says I personally agree with, is that our model in this country has not in any way held back major investments being put in. As you see from our huge amount of import infrastructure. Not all of that investment is underpinned by long-term contracts. In fact, if you look at the Langeled pipeline, some of the major investors in that pipeline have not signed long-term contracts - or, indeed, any contracts - for their supply, so confident are they that in a liquid market they will be able to find customers. So if we have political instability I think we will have instability whatever type of contracts we have. In other words, I do not put together stability and contracts. I think contracts are about risk and about willingness to invest, and nothing I see in European markets at the moment makes me feel nervous about willingness to invest. Some things that I see on the political front make me nervous about the ability to mobilise gas resources, but that is mainly in the Middle East where we see instability for other reasons.

Q27 Mr Binley: Can I go on to another question, and my final point? You did note in 2002 the difficulty of obtaining finance for multibillion dollar infrastructure investments when the investing companies were selling gas into liberalised and competitive markets, which is partly what you have just said in truth, so you clearly hold to that here. We understand the European Commissioner for Competition is holding an investigation into the German Government's underwriting of Gazprom's investment into the new gas pipeline to Germany. Would the pipeline be beneficial to the European market as a whole, or would it simply lead to preferential treatment for Germany and its large "national champion" gas companies, and to what extent will the European Commission have to temper its desire to promote competition in order to encourage the building of important infrastructure?

Professor Stern: If I can deal with this question about the DG Comp investigation, there may have been some impropriety about the offer to guarantee that billion euro loan. However, the world has dramatically changed in the last ten years for Gazprom and for Russia. While Gazprom could not build infrastructure without that kind of guarantee during the Soviet and immediate post-Soviet period, now Gazprom does not have a need for anyone to guarantee its loans, and it said rather disdainfully that it did not need the loan, it did not need the guarantee, if anybody wanted to investigate it that was fine but basically it was irrelevant. My sense for the North European pipeline is that Gazprom feels that the January/February incidents with Ukraine have completely vindicated its strategy of building the North European pipeline. I personally think they are wrong and I tried to say this several times in Moscow, in this sense: that if you export 150 billion cubic metres of gas to Europe, of which something like 120 goes through Ukraine, you might be able to re-orient 20 bcm or 50 bcm through some other route but you still have a lot of gas going through the Ukraine and that is not going to change, and foreign policy and diplomacy teaches us that we have to be able to get along with countries on our borders despite the fact we have difficulty with them, and I think this is a problem that Russia has to get to grips with and is having huge difficulties in so doing, but that does not surprise me in the sense that, although the Soviet Union is already 15 years ago, that is not a very long time to change that situation. So I would say that the North European pipeline is beneficial to Europe in that it gives Europe an additional route for Russian gas supplies. It does not solve the Ukrainian problem. What is so, for me, very disappointing is how little role European, particularly Brussels institutions, have played in trying to mediate between Russia and Ukraine, and in fact they have antagonised Russia by simply criticising it as if everything that happened was just Russia's fault, which is, I think, terribly unfortunate. What I would say in terms of who is the pipeline of benefit to is that obviously it will benefit Germany but it will benefit every country in north west Europe that imports Russian gas in that it will be a more secure route than the route through Ukraine, but in a sense it gives us a false sense of security because, for as long as there is no resolution of the Russian/Ukraine dispute we remain vulnerable to the kinds of events we saw earlier this year, and there is no getting away from that.

Mr Binley: Thank you.

Q28 Judy Mallaber: To what extent are the problems with supply from Russia a reflection of struggles over the control of infrastructure and the commercial conditions of transit across countries?

Professor Stern: Can I just ask you to expand a little bit on that? I am not quite sure I have understood the meaning of that question.

Q29 Judy Mallaber: Well, if it is being suggested that part of the dispute about gas prices between Ukraine and Russia was concerned with control of where transportation pipelines go, and you did say to us that it was about trying to get a decent price from the Ukraine for gas but there is clearly an issue about where the pipelines go and who controls them and who has ownership of them, how much is that a key factor and a battle over who controls the commercial rates of transit?

Professor Stern: It is a key factor, and what Gazprom has said to the Ukrainians on numerous occasions - and incidentally not just the Ukrainians but all CIS countries - is: "If you allow us to own or at least co-own your infrastructure we will give you a better deal on gas sales", and they have done that for a very practical reason, which is that if they co-own and therefore control the infrastructure they can control whether gas is being syphoned out of the infrastructure, and what the Ukrainians have said repeatedly is that they will not allow Gazprom, and sometimes they have said they will not allow any other country, to co-own the Ukrainian infrastructure. This is partly, I think, a commercial issue in that they feel quite rightly that they can command very high transit fees out of the infrastructure and partly a pride issue in the sense that they feel this is such a valuable national asset that they do not want to give it up to any other country. But what the Russians are saying is that in part they are concerned at the deterioration of the infrastructure in that every year it is capable of transiting less gas than the year before because not enough money is being spent on it and, secondly, and very much in our minds as a result of January/February, they cannot control that gas being taken out of the infrastructure as it transits through the country. Their position is the only way they can guarantee security of transit is if they are co-owners of the infrastructure.

Q30 Judy Mallaber: So should we be more concerned about that issue and about that control over transit charges when we talk about whether Russia is willing to supply Europe with gas? Is that first point more important?

Professor Stern: I think it is. I have said repeatedly in the work I have published that security of transit is the basic problem for security of Russian gas supply, and that Gazprom's post-Soviet strategy of simply taking pipelines across water in order to avoid transit countries does not address the basic issue, which is they have to find a meeting of minds, both commercially and politically, with the transit countries.

Q31 Judy Mallaber: So where does that leave us and the EU? How should we respond to that?

Professor Stern: How we should respond is, through the institutions which have been created, principally the EU-Russia dialogue and the EU-Ukrainian summit, we have a role to play here in terms of persuading both sides that their behaviour, their bilateral relationship cannot jeopardise our security of supply, and we need to do this in an even-handed way, and a way in which, in a sense, nobody feels they are being discriminated against. At present, and I felt the full fours of this in Moscow three weeks ago, the Russians feel that anything that happens they are held responsible for and nobody says anything to the transit countries, and we have to be much more even-handed than that.

Q32 Judy Mallaber: So what does that mean we should be saying to either side? What should we be saying we want from Russia, and what should we be saying we want from the transit countries?

Professor Stern: We should be saying that we want them to institute the Energy Charter Treaty Transit Protocol conditions which is that, whatever their bilateral disputes are, they cannot be allow to affect the transit of energy, and that is almost the first principle of the Transit Protocol. That nobody, for whatever reason, is entitled to take energy in transit to a third country.

Q33 Judy Mallaber: What are the sanctions on that? They can sign up to it but --

Professor Stern: The sanctions are international dispute resolution procedures which then impose penalties for violating the transit of energy, so it is like liquidated damages.

Q34 Judy Mallaber: And is anybody taking any action to do that? Or are the Russians right, that everybody is having a go at them and not being even-handed?

Professor Stern: I understand that at least in private letters have been sent to the Ukrainian Government by the Energy Charter Treaty, but whatever has been done has been done extremely privately which contrasts the extremely public rebuke of Russia for its behaviour by almost all parties in the EU. The key for me about the Energy Charter Treaty and its transit protocol is that, although it has not been ratified, its rules exist and can be referred to and are a guide to behaviour that should be adhered to and, therefore, especially for those who have ratified, they could be asked to live up to those rules and should be publicly required to do so.

Chairman: Thank you.

Q35 Mr Weir: I wanted briefly to go back to the question of the supply infrastructure to the Ukraine. I was interested in what you were saying that the problem appeared to be that they wanted some co-ownership presumably to invest in and upgrade the infrastructure but, given that Russia has constructed a North European pipeline and presumably that is a much more moderate infrastructure project, what is the incentive to invest a lot in the Ukraine now? Is it not, from Russia's point of view, more sensible to invest in the North European pipeline?

Professor Stern: The North European pipeline has not yet started construction, or at least not the water part of it; some of the land parts have. But upgrading the Ukrainian infrastructure would cost a fraction of any of these new pipelines that Russia is thinking of building. The two North European pipelines, to give you an idea, would probably cost, if we take both the sea and the land parts, upwards of $10 billion to construct. Now, upgrading the Ukrainian network, which would provide almost as much capacity on a firm basis, would probably require not much more than $2 billion, so it is a question of confidence in the transit infrastructure. What the Russians have said is they have no confidence in the transit infrastructure. What some of us have tried to say to them is: "We know that and we understand why you do not have any confidence, but you cannot turn your back on the geography of the pipeline network and the economics of building an alternative pipeline network", and that is what they appear to be attempting to do, to say: "Well, we cannot deal with the Ukrainians so we simply have to give up and start building pipelines around them". And many of us have said: "No, look, do not do that because it does not solve your problem. You have not got $50-$100 billion to build an alternative network around the Ukraine; you have to come to terms with them."

Q36 Mr Weir: Is it not also a question of politics and control and saying to the Ukraine "We have an alternative if you do not play ball"?

Professor Stern: Yes, it is absolutely is. The difficulty with that idea is that when the Russians began to do this with their first pipeline through Belarus and Poland their idea was that they would indicate to the Ukrainians: "Well, if you behave badly we will simply bypass you", but what the Ukrainians discovered is that when you have 120 billion cubic metres of capacity going through their country, yes, you can take 30 and put it somewhere else but that still leaves 90, and however much Gazprom takes out and puts somewhere else there is still a hefty dependence on Ukrainian transit which is only going to decrease to a limited extent, so it is I am afraid a classic diplomacy and interdependence issue. Yes, you can spend as much money as you like building new transportation infrastructure, but for the foreseeable future you depend on the Ukraine and you have to come to terms with it.

Q37 Chairman: Two concluding questions, if I may. I wanted to get a fix on to what extent we should regard Gazprom as a rational private sector company. I know it has a 51 per cent shareholding from the State but to what extent does it behave as a rational economic entity? Allied to that, and to paraphrase a rather tabloid approach in the Financial Times to the Russian issues which was followed by an article from Vladimir Milov on 24 April where he seemed to be agreeing with the Financial Times and disagreeing with your analysis, to what extent should we take notice of that point of view?

Professor Stern: I think Gazprom is a very rational company and now has a very commercial management, but we cannot ignore the fact that it is majority-owned by the State and the President did a lot of very complicated things to ensure that 51 per cent of the equity was owned by the State and that, rather as I tried to describe continental Europeans, the strategic direction of the company is determined by the State and to a not small extent by the President himself. That will mean that in issues such as should the Ukrainians be told to pay a higher price, the Russian Government and the Russian President will have a big say in the extent to which that happens, and for the big strategic decisions such as are there going to be LNG projects and which companies are going to be involved in them, are there going to be pipeline projects to Asia, at a high level of strategic management Government and the President will have to sign off on those plans, and some of those plans may not be the actions of a totally private sector company driven by commercial instincts. Some of them will be political.

Q38 Chairman: It will not be profit maximising in every situation?

Professor Stern: Absolutely. That is a good way of putting it. As to Vladimir Milov, a very bright guy. I was somewhat surprised by his outburst in the FT, but I have been somewhat surprised by his views on this. I can only say that I do not agree with them. He is a very bright guy, though, and he does serious work in this area. The one thing I will say, though, is that he is out of favour in Moscow politically and therefore that may have coloured some of his views, but I certainly would not want in any sense to say that he did not know what he was talking about. He is a very bright guy.

Q39 Chairman: Finally, we have spent most of this session discussing the Russian situation because that has been the one that has dominated the political and media agenda in recent months here, but should we have spent time talking about Norway, Tunisia, Algeria and Qatar for different reasons?

Professor Stern: I think probably we should have spent more time talking about Norway and gas coming from continental Europe from a range of sources. I would be amazed if, even if 15 years' time, Russian gas was more than 15 per cent of UK gas demand. It is possible but I think it is highly unlikely, and I think we are going to be dominated by Norwegian gas and a range of energy supplies for really a significant period of time.

Q40 Chairman: So the key phrase that we take away today is "The key to security is diversity"?

Professor Stern: Absolutely.

Q41 Chairman: Is there anything else you would like to add?

Professor Stern: I think I am finished. Thank you.

Chairman: We are most grateful, Professor. It has been a very informative and enjoyable, if slightly disrupted, evidence session. Thank you very much.