Supplementary memorandum submitted by
Peter Kaznacheev, Managing Partner of Khaznah Strategies Ltd
Following the Evidence Session which was held by
the Energy and Climate Change Committee of the House of Commons
on 5 July 2011, I would like to submit the following answers to
questions that were raised. In this brief overview I tried to
summarize my responses during the Session as well as address those
questions which were not covered in the allocated time.
Three revolutions in global energy.
The latest World Energy Outlook published by the International
Energy (IEA) in June 2011 is referring to the current era as the
"golden age of gas". Over the recent years, the world
has benefited from two major technological breakthroughs, and
one more is just in the making. All three of them are revolutionizing
the production and transportation of gas.
Liquefied natural gas.
The first one is the growth of LNG production which has allowed
to detach gas transportation from pipelines and consequentially
ignited the process of delinking gas prices from oil prices. According
to the IEA, trade in LNG between major regions will double to
over 1 tcm by 2035 and overall gas liquefaction capacity will
increase by 40%. Regasification capacity is expected to increase
even faster.
Shale gas. The second
one is the shale gas revolution which turned the US from an importer
to an exporter of gas and is leading to the emergence of new and
unexpected centers of gas production. Shale gas reserves are very
large and widely distributed: US, China, Europe, Latin America,
the Middle East etc. Other unconventional resources will play
a role too: in Australia coal-bed methane is already being liquefied
and exported to China.
Arctic gas. And the third
revolution in hydrocarbon production is just starting. According
to Wood Mackenzie, the Arctic's combined gas potential represents
29% of global gas resources, three quarters of which are in the
Russian territory. The Russian Kara Sea alone accounts for 45
billion boe of yet-to-find oil and gas. For context, Wood Mackenzie
estimates yet-to-find volumes in Brazil's Santos Basin—currently
the world's hottest exploration play—at around 32 billion
boe.
The "gasification" of global energy.
All three breakthroughs are not simply influencing hydrocarbon
production but redefining the entire energy landscape. The IEA
predicts that by 2035 gas will cover one quarter of global energy
demand. In Europe the trend of "gasification" is much
more significant: gas already covers 40% of energy needs and over
the next two decades its share may raise up to 90%. Given the
leap in gas reserves due to the shale gas revolution (and the
development of the Arctic in the future) and the increased flexibility
of gas markets due to LNG, the prevalence of gas in the European
energy mix increases the overall energy security of Europe.
For those policy-makers concerned with reducing CO2 emissions,
the "gasification" of Europe has the extra benefit of
reducing the carbon-intensity of energy at no extra cost.
UK energy interests. The
UK's energy landscape appears to be even more secure than that
of Europe in general. On top of all the positive developments
described above which make global energy more secure, more diverse
and more affordable, the UK benefits from two major characteristics
of its energy market. First of all, it has significant (by Western
standards) remaining indigenous hydrocarbon resources. Over 80%
of UK gas demand is met by domestic production. This makes the
UK market less dependant on imports and more secure in terms of
physical supply. Secondly, unlike most other European countries,
the UK does not depend on long-term contracts as it has a developed
gas market where prices are set by competing producers and consumers—not
bilateral negotiations which is still mostly the case in continental
Europe. In addition, the UK has a developed infrastructure of
LNG terminals (in South Wales, Kent, Essex and Middlesbrough)
which is expected to grow and therefore increase overall market
flexibility by allowing to switch suppliers or change their shares
of imported gas.
Policy implications of "gasification"
for the UK. All in all, from that point
of view energy supply the UK is in a very strong position. There
are no major energy-related issues which would potentially undermine
the country's security. Realistically, major disruptions of imported
hydrocarbons are very unlikely. The main issue of concern for
the UK appears to be the future price of each source of energy.
Given the global dynamic described above, it is expected that
gas will become even cheaper relative to oil as new gas reserves
(unconventional and then Arctic) will come on stream. A major
shift to gas as an alternative to other fossil fuels would therefore
benefit the UK economy. Such a shift is already taking place and
should be welcome by policy-makers. The only policy suggestion
which could further strengthen UK's position would be to moderately
invest in some additional gas storage capacity. That may help
to mitigate potential short-term price hikes and also further
secure physical supply.
Eastern Europe's energy situation.
Like the rest of Europe, Eastern Europe will generally benefit
from the emergence of new major sources of gas, as the increased
supply is pushing the price down. The key difference between Eastern
Europe and the rest of the continent is the former's strong reliance
on imported gas from Russia. Bilateral long-term contracts between
Gazprom and respective companies in Eastern Europe are mostly
pegged to oil prices which means that as global gas prices continue
to decrease relative to oil, Eastern Europe and all other major
Gazprom customers will be paying a higher price. This is the major
risk that Eastern Europe faces as risks of physical shortages
or supply disruptions are minimal. Europe continues to be Gazprom's
only external gas market and therefore any major disruptions in
supply would seriously harm Russia's position. The two short episodes
of the "gas war" between Russia and Ukraine are highly
unlikely to repeat again.
Price risks mitigation.
The real price risk could be mitigated by two key policies. First,
European countries should continue to insist on the price peg
to the gas spot price instead of oil in Gazprom's contracts. On
average, about 15% of the price formula is already tied to spot
prices. If Gazprom's customers manage to increase this share or
replace the oil peg altogether that will be a major improvement
for European consumers.
Gas interconnectors. The
other major step forward is to build interconnectors (short and
relatively inexpensive pipelines), which could bring gas from
LNG regas terminals and various sources other than Gazprom's gas,
into the pipeline system of Central and Eastern Europe. Projects
such as ITGI and TAP are capable to achieve exactly that. Other
projects, such as Nabucco or South Stream which were designed
in the era before the "three gas revolutions", are not
relevant and hardly affordable. Both of them continue to enjoy
some support for purely political reasons (from European and Russian
politicians respectively). Neither of them appears to be commercial
and Nabucco is almost certainly out of the question as it does
not have a major sponsor.
Russia's overreliance on the European market.
Overall, Russia's position appears to be less secure than that
of her customers. European countries have various sources of gas,
and those which still mostly rely on Russia are likely to diversify
fairly easily. Russia, to the contrary, depends on its only external
customer—Europe. Overreliance on the European market turned
out to be a short-sighted policy as the fastest growing gas importers
are not in the West but in the East. Current infrastructure is
designed to serve the European market and the gas pipeline from
Russia to China is only at the earliest stages of development.
Russia's challenges. Even
more importantly, Gazprom is visibly lagging in LNG which is expected
to become the major means of gas transportation. In addition,
despite the largest gas resources in the world, gas production
in Russia is stagnant, as Gazprom has not sufficiently invested
in the development of major deposits or is far behind schedule
(Stockman, Yamal, Kovykta etc). And on top of that, as a the number
one exporter of gas Russia is very concerned about the gradual
gas price delinking from oil. All of that is a major challenge
to Russia and its future economic development. However, it is
unlikely to pose any major risk to Europe as Russia will continue
to depend on the European market and therefore would not jeopardize
its export obligations. In brief, Russia's economic dependence
on Europe is greater than Europe's dependence on Russia.
September 2011
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