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BLUE FUEL April 2013 | Vol. 6 | Issue 2

BLUE FUEL

Gazprom Export Global Newsletter April 2013 | Vol. 6 | Issue 2

How Gazprom Export Proved it is Worth its Salt Page 5

Natural Gas—The Future Leader in Road Transportation? Page 16

Discussion Paper: How the Third Energy Package is Changing the Way Gas Business is Done in Europe Page 19

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BLUE FUEL Gazprom Export Global Newsletter

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In this issue April 2013 | Vol. 6 | Issue 2 To Our Readers: Alexander Medvedev: “Maturity is an asset in its own right for Gazprom Export”..... Pg.4 How Gazprom Export Proved it is Worth its Salt History Revisited: 45 Years of Russian Gas Supplies to Austria.......... Pg.5 Air Products Signs MOU with Gazprom for Russian Helium Project....................................... Pg.8 Sakhalin Energy: Excellent Achievements and Vast Perspectives........................ Pg.9 South Corridor, Pipelines of Discord and Repositioning of Italy........................................ Pg.11 CNG Stronghold in the Czech Republic: Industries and Services Report Success............................... Pg.13 “Blue Corridor” 2012: A Successful Tool for Marketing Natural Gas as a Fuel.............................. Pg.14 Natural Gas—The Future Leader in Road Transportation?............................................ Pg.16 Discussion Paper: How the Third Energy Package is Changing the Way Gas Business is Done in Europe............. Pg.19 Next Comes Competition Between Gas Consumption Regions.................................................... Pg.22 Photo Wheel: 39 Authors and 177 Compositions................. Pg.24

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To Our Readers:

Alexander Medvedev: “Maturity is an asset in its own right for Gazprom Export” main markets—the EU and Turkey—are the Urengoy-Pomary-Uzhgorod pipeline, the Yamal-Europe pipeline, the Blue Stream pipeline, the Nord Stream pipeline and the future South Stream pipeline. The South Stream pipeline, together with the Nord Stream pipeline that was commissioned in 2011, will further enhance the reliability and flexibility of gas supplies to Europe, as our partners, customers and we, as the shippers, are looking to diversify our transit routes. This April, Gazprom Export will be in existence 40 years and this round number is a good occasion to not only look back at our history, but also towards our future. Our company is globally known as the largest supplier of natural gas. The demand for gas in the modern world is predetermined by many unique properties of the “blue fuel,” especially its environmental friendliness when compared with other hydrocarbons. Natural gas is the main energy source of the 21st century, a phenomenon that is becoming increasingly obvious by the day. Established four decades ago in the former Soviet Union, Gazprom Export became a 100% subsidiary of Gazprom—the world’s largest natural gas producer—in 1991. In the 40 years since Gazprom Export was established, about 4 Tcm of “blue fuel” have been supplied under long-term contracts to multiple partners. On average, almost a trillion cubic meters were supplied each decade! All these years, no matter the political events, economic and trade environment, or natural disasters, our clients uninterruptedly received the required gas volumes for industrial and domestic use at prices agreed in advance. Russian gas exports have been so highly reliable thanks to our access to the large resource base in Russia and the extensive network of existing and new powerful pipelines using the most advanced technologies. Among the major gas pipelines routed to our 4

Gazprom Group is investing in export routes diversification to minimize the impact of political risks, technical failures, natural disasters and terrorist attacks on the reliability of our supplies. Gazprom Export is also making all efforts towards expanding and creating gas storage facilities in Europe, particularly in Germany, Austria, Serbia, the Netherlands, and the Czech Republic, which will help optimize gas flow and increase energy security. The gas industry witnessed major changes over the past four decades—“blue fuel” markets grew and brought in new players and new products, especially liquefied natural gas (LNG). Gazprom’s strategy has been focused on expanding into new overseas markets. The launch of the Sakhalin-2 project facilitated the increased supply of LNG particularly to the Asia-Pacific region. Our planned LNG facility in Vladivostok with a capacity of 15 million tons by 2020 will further increase our production and exports to the growing and dynamic markets of Asia. As a global energy company we operate in sync with an environment in which customers need flexible yet stable energy supplies. In Europe, spot markets play a balancing role, since the prices at hubs are derived from the prices of long-term contracts. However, they do not duly reflect supply and demand. We strongly believe that it is inappropriate to reject time-tested long-term contracts that are


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April 2013 | Vol. 6 | Issue 2

based on a pricing formula, as this mechanism has proven to offer the best guarantees of maintaining a balance between the interests of both producers and consumers. We always look for a mutually beneficial compromise with our partners, allowing us to preserve supply stability and security for our clients, develop infrastructure projects, and support the industry’s pivotal investment cycle. Shale gas is gathering much attention today. Its production has become a catalyst for the active use of the “blue fuel” in the U.S., sending a positive signal to the global energy industry and the environment. This unconventional gas offers opportunities, but it does not threaten Gazprom Group’s business as some claim. We have experience in the development of unconventional gas resources ourselves, but for us it is much more profitable to produce conventional gas, which is abundant in Russia. As for Europe, there are good reasons to believe that local shale production will be limited and unable to solve the continent’s energy security issues. The cost of shale gas production is simply too high.

Looking into the future, we believe that gas pipelines will long serve as the vital arteries for reliable and secure energy supplies, primarily to Europe and China. The fact that despite increasing competition our company was able to enter into preliminary contracts worth more than 4 Tcm of gas is indisputable evidence. Natural gas is also increasingly replacing oil as a raw material in the chemical industry. Furthermore, the inevitable shift to gas as a fuel for global road and sea transportation will open up new opportunities. The world needs more efficient and environmentally friendly types of fuel and the demand for natural gas as a greener fuel than coal and oil will therefore continue to grow. Providing cleaner energy will contribute significantly to the safeguarding of the environment for future generations. In light of these many objective trends, we are able to maintain our leadership positions in existing markets, while entering new geographies and securing new business opportunities along the entire gas value chain. Ensuring stable and reliable energy supplies is our company’s main priority for the coming years and decades. We are looking forward with confidence.

How Gazprom Export Proved it is Worth its Salt History Revisited: 45 Years of Russian Gas Supplies to Austria By Yuri Zaytsev, councilor to Director General of OOO Gazprom Export

Yuri Zaytsev was previously Deputy Director General and Head of company’s representative office in Vienna; he was both witness and participant of landmark events related to Austria. Since the initial delivery in 1968, Gazprom has delivered roughly 181.0 bcm of Russian natural gas to Austria, as of 1 January 2013 including 5.22 bcm in 2012. and then-Prime Minister Alexey Kosygin had supported this initiative. Although negotiations with Italian ENI, French Gaz de France, German Ruhrgas and Austrian OMV started vaguely around the same time, Austria eventually was the first ever Western European country to receive Soviet gas. In 1967, the “Brotherhood” pipeline to Czechoslovakia had been built and commissioned, and in 1968, its branch started to deliver gas to Austria.

The idea of selling pipeline gas to Western Europe originated in 1966. Alexey Kortunov, Minister of gas industry of the USSR, had suggested the study of potential projects,

Evaluating the scope and essence of this development objectively may be an understatement: it was not “simply” a breakthrough of Soviet gas capturing a new market. Delivering new energy and commercial models to a western country, accompanied by mutually beneficial incentives to Continues on page 6

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How Gazprom Export Proved it is Worth its Salt History Revisited: 45 Years of Russian gas Supplies to Austria Continued from page 5

develop and implement new technologies preordained breaking through the “iron curtain.” Prior to this time old Europe had never witnessed investment projects on a scale like this. In the beginning Western European partners-to-be were suspicious about the prospect of receiving gas from the Soviet Union. Politics wasn’t the only reason for skepticism. Technical and commercial challenges were also causes for concern. Our offer was subject to transporting large gas volumes thousands of kilometers from the West Siberian field — a distance hardly conceivable within the European gas industry of that time. However, thorough computations and duediligence, Gazprom was able to convince commercial entities and governments of participating countries. Beyond receiving the “blue fuel” in and by itself, European companies now had an opportunity to contribute their own equipment, materials and transportation technologies, which turned out positively for domestic European industries as well as for the Soviet economy. A great number of pipes and equipment acquired under projects in that era are still serving to produce and transport gas inside and outside Russia to this day. In 1968, the very first signed contract with OMV literally broke the ice of mistrust and triggered a chain reaction of new contracts. The year 1969 marked the gas supply contract with Italy, and in 1970 and 1971 Germany and France respectively followed suit. Another contract with Austrian OMV was signed later, all contributing to the successful legal framework which still serves as a basis for secure gas supplies to this day. The contracts formed 45 years ago have had a profound effect on the whole region. As a result of the ensuing growth 6

of gas consumption transmission systems have been ever expanding. The unique 4500-km-long and 30-bcm productive “Urengoy-Pomary-Uzhgorod” pipeline was constructed to bring additional gas to the western borders of the Soviet Union. Long-term gas supply contracts to western countries also stimulated the development of the Czech gas transportation system, enabling it to transit up to 105 bcm in various directions— just one of many such examples. Finally, the transport system of Austria itself received a strong impetus. The trunk pipelines TAG (Trans-Austria-Gasleitung) and WAG (West-Austria-Gasleitung) were constructed to transit “blue fuel” further on to Italy, Slovenia, Croatia and France. In my position as Head of Gazprom Export’s representative office in Austria in 19831985, I witnessed how this system was created. I am certain that these crucial events would not have happened, or would have happened in another form and within a different time frame, were it not for the pioneering contracts of 1968. Equal credit goes to our partners. The events of this era demonstrated without a shadow of doubt that we could supply gas anywhere in Europe. Furthermore, the production, transportation and commercial models that we developed in collaboration with our European partners remain sound and have been effective for decades. In the aforementioned time frame, modestly-sized Austria grew into a major junction, or hub on the continental gas map. Today, the country provides supplies and transportation of 58 bcm of gas annually for domestic consumers, as well as transit for Italy, Germany, France, Hungary, Slovenia and Croatia. Austria possesses the Baumgarten gas hub, the first hub in Central Europe ever; and the nation also operates large gas storage capacity. For example, we operate the Haidach gas


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storage in Austria in collaboration with Austrian RAG and German WINGAS. I am glad I had a chance to share my memories of the very origins of this historical event. When I graduated from high school in 1959, it was rather odd to enter a career in the gas industry. It seemed most anybody dreamed of either exploring outer space or constructing submarines. And here I was exploring a more opaque but challenging field of gas turbines for the trunk gas pipelines. My first years working in the industry coincided with a hardly visible but extremely important industrial revolution in our single branch: compressor stations on the pipeline from Stavropol to Moscow were upgraded from piston compressors to the first Soviet-made gas turbines— a cornerstone to current capacity and productivity of the export systems. Three famous transportation projects endure to this day: including the “Urengoy-PomaryUzhgorod,” the “Orenburg-Western border,” and the “Yamburg-Western border” projects. I was also privileged to witness first-hand other significant historical events, such as the trade liberalization in the Austrian gas market and opening of the market for third party suppliers. This period culminated in the establishment

BLUE FUEL of our joint trading firm. In October 2003, the country’s gas market was liberalized under the GWG-2 Federal Law. No gas supplier could pass on this tremendous opportunity. The establishment of joint ventures and trading firms by Gazprom Export and Gazprom in European countries was another important step for European consumers resulting from series of complicated negotiations. It should be noted that all these events date back to 1990s, a period when on the one hand new trade models emerged, while on the other hand there remained an overarching suspicion about how the former-Soviet-now-Russian exporter would behave under new market conditions. I participated in the initial set up of several trade companies, beginning with GWH, which together with OMV was established in Austria in 1993, followed by a number of companies in Italy, France, and other European nations. Today I am not shy to point out that we have passed the test. Markets participants were waiting to see what we can bring to the table and we delivered. We were able to demonstrate that we can trade gas demanded by Europe and keep our long-term competitive advantage. Despite all the turbulences that shake the gas markets today, I am confident about our common interests in sustainable gas for the future.

The first natural gas supply contract between Austria and the USSR, 1st June 1968, Vienna

Deputy Minister for Foreign Trade of USSR Sergey Osipov (on the left), Director General of OMV AG Ludwig Bauer (in the middle), Director General of Gazexport Yuri Baranovsky (on far right).

Start of Russian gas supplies to Austria in 1968. Gas Industry Minister of the USSR Alexey Kortunov (turning the valve), Austria’s Federal Minister for transport Ludwig Weiss (on the left), Director General of OMV AG Ludwig Bauer (in the middle) commission the first compressor station at Baumgarten.

Another contract for gas supplies between Gazexport and OMV AG signed in the presence of Austrian and Soviet officials in 1984.

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Air Products Signs MOU with Gazprom for Russian Helium Project Alexander Medvedev, Deputy Chairman of the Management Committee of Gazprom JSC and Director General of Gazprom Export LLC, and John Van Sloun, General Manager of Worldwide Helium at Air Products, recently signed a Memorandum of Understanding (MOU) to purchase helium from Gazprom Group. The agreement was signed on 25 March 2013. Gazprom intends to start developing its major natural gas resources in Eastern Siberia and plans to implement large-scale helium production from the helium-rich gas feedstock in the Blagoveshchensk region beginning in 2018. Beyond the purchase of helium, the MOU also indicates the interest of Air Product in working with Gazprom on logistical, technical and production facets of the overall project. “The careful planning of the extraction, transport and storage facilities for the East Siberian helium production should primarily ensure it supports effective helium technologies and exports, while preserving the valuable gas by means of creating an operative and strategic storage. We hope that our partnership with Air Products will help Gazprom Group in developing these vast resources in view of helium global demand growth,” Medvedev said upon signing the agreement. “Our focus on reliable helium supply to our customers is priority one for Air Products and working with Gazprom would further diversify our helium source portfolio. This MOU is the latest in a series of actions we have taken to better

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position ourselves in meeting increasing customer helium demand. We will continue to look for other helium source opportunities where we can participate as a buyer, an investor, and operator,” remarked Van Sloun. Air Products’ new, jointly-owned liquid helium production plant near Big Piney, Wyoming, is scheduled to be on stream in 2013. The facility will process natural gas from the Riley Ridge Field in Wyoming, one of the largest heliumrich natural gas fields in the United States. The Riley Ridge field is believed to contain sufficient helium reserves to support production for decades. Air Products has pioneered many of the helium extraction, production, distribution and storage technologies used in the industry today. Air Products maintains the world’s largest helium production and distribution system and operates numerous facilities around the world. Helium is used in many unique and valued applications including: magnetic resonance imaging (MRI); lifting scientific research balloons, blimps and party balloons to high altitudes; fiber optics and semi-conductor manufacturing; metallurgy; breathing atmospheres for deep diving or unique blood-gas medical mixtures; analytical chemistry; pressurizing and purging pipes, vessels and other critical equipment; leak detection; and other advanced applications.


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Sakhalin Energy: Excellent Achievements and Vast Perspectives In the year of 2012 alone, Sakhalin Energy paid USD 1813.6 million to the Russian budgets of all levels. This is USD 671 million (or 59%) more than in 2011 and more than one third of the total Russian Party take from the Sakhalin-2 Project which amounted to almost USD 5.0 billion. This result was due to successful overall performance and excellent teamwork. For Sakhalin Energy, 2012 was the third year of fullscale operations involving its comprehensive oil and gas infrastructure. Despite many challenges, it was a successful year. Sakhalin Energy has achieved excellent results in a number of areas — first and foremost, in health, safety, and environment, as well as in the LNG plant performance. In the area of industrial safety, Sakhalin Energy is at the top of the world oil and gas industry. The company has been operating its oil, natural gas, and LNG assets in compliance with strict environmental standards and strives to ensure serviceability and operational safety of its industrial facilities. Sakhalin Energy’s safety philosophy is based on prevention of incidents. As of today, the rate of oil leaked to oil produced is less than one-millionth of one percent. This is an outstanding result within the global oil and gas industry. The company has also achieved excellent performance of its LNG plant. This plant was inaugurated in 2009, and it is the first and still the only LNG plant in Russia. It has two trains, each with a nameplate capacity of 4.8 million tonnes of LNG per year. Due to successful debottlenecking and equipment adjustment, the Sakhalin Energy LNG plant has exceeded its design output by producing 10.9 million tonnes of liquefied natural gas. In 2012, a total of 168 LNG tankers (145,000 cubic metres per cargo) were shipped to Japan (76.3%), Korea (20.1%) and China (3.6%). Most of the gas is produced from the Lunskoye-A (LUN-A) platform. This platform is installed in the Lunskoye gas field and is the first-in-Russia gas production platform. As of the end of 2012, the platform’s average daily production rate was 44 million cubic metres. Gas is produced from wells with the largest diameter ever drilled in Russia. In 2012 the Lunskoye-A platform continued stable and reliable production from its 8 existing gas wells. One new big bore gas well was drilled in 2012. Although most of the Sakhalin Energy’s revenues are generated from the LNG sales, the oil sales also constitute an important part of the company’s proceeds. Last year, Sakhalin Energy produced and exported 5.5 million tonnes (about 43 million

barrels) of Vityaz Blend oil from the Prigorodnoye terminal. The Vityaz Blend is a new oil grade introduced by Sakhalin Energy to the Asia-Pacific Region. It is a light, low-sulphur oil blend, similar in quality and composition to the light oil produced in Oman. In total, 12 companies from seven countries purchased Vityaz oil blend in 2012. Products were delivered through 15 transit and destination ports in Japan, China, Korea, Philippines, Indonesia, Taiwan and USA. Most of the oil is shipped to China (39.36%), Japan (24.29%) and Korea (25.37%). China’s shares in purchasing the Company’s products increased considerably (by 39%) as compared to 2011. Along with exporting oil and LNG, Sakhalin Energy, as of 2011, has been supplying natural gas to the gas trunk-line system of Gazprom to pay royalties payable in kind to the Russian Party of the Production Sharing Agreement (PSA). The gas is transferred via two terminals in the Northern and Southern parts of the Sakhalin Island. Since the commencement of natural gas delivery via the Southern Gas Transfer Terminal to the Yuzhno-Sakhalinsk Heat and Power Plant-1 and other Sakhalin infrastructure facilities, 393 million cubic metres of natural gas have been delivered. In 2012, 798 million cubic metres of natural gas were delivered via the Northern Gas Transfer Terminal to the Sakhalin-KhabarovskVladivostok gas trunk-line for further usage as part of the Far East and Primorye fuel and energy sector development programmes. In total, 1105 million cubic metres of gas was supplied to the Russian Party in 2012, and the amount of royalty obligations totaled USD 619 million. Production sharing between the company and the state forms the basis for the Sakhalin Energy project development and is triggered by full recovery of the investor’s costs. Due to the Company’s focus on production optimization, Sakhalin Energy reached the important milestone of cost recovery in March 2012, with production sharing started earlier than expected. In the 2012, the Russian Party share amounted to USD 676 million.

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Sakhalin Energy: Excellent Achievements and Vast Perspectives Continued from page 9

The Sakhalin-2 PSA also stipulates that the Company should pay a profit tax at the rate of 32%; this rate is higher than the profit tax rate charged from the non-PSA tax payers. The financial year 2012 profit tax owed by the Company totaled USD 598 million.

a unique access to international best practices, global business opportunities and management skills. They have also become higher competitive bidders in other project operators’ tenders, both in Sakhalin and worldwide.

With production sharing started, the Russian Party take from the Sakhalin-2 Project has reached since 1995 almost USD 5 billion, while in 2012 alone Sakhalin Energy paid USD 1813.6 million (provided for payment in kind and cash) to the Russian budgets of all levels. This is USD 671 million (or 59%) more than in 2011.

Sakhalin Energy is always looking for opportunities to increase the Sakhalin-2 project profitability and to extend the operational life of the fields being developed. The company’s objectives for 2013 are determined by its priorities: safety, reliability, production, cost efficiency and development. Growth and development are the main drivers of its way forward. As ever, safety is the main priority for the Company’s business.

It is of the utmost importance for the sustainable development of the Sakhalin Island, which is the region where the company operates, that taxes and other mandatory payments by Sakhalin Energy form a substantial part of the budget revenue for a vast majority of the municipalities. In 2012, the Company paid USD 391 million in taxes and other mandatory payments to the Sakhalin regional and local municipalities, exceeding the 2011 figure by USD 331 million (more than a fivefold increase). For the Sakhalin Island it means a new housing construction, investment in social sphere, including upgrades in medical care, education, etc. The Sakhalin Energy project has contributed to a wide-ranging revitalization of the economy on the Sakhalin Island. It has boosted the development of many Sakhalin and other Russian enterprises, generating more employment and ensuring higher salaries, increasing retail trade, extending social programmes and increasing tax revenues. The total value of contracts awarded to Russian companies, since the Project had been launched through the beginning of 2013, has exceeded USD 17 billion. In 2012, the value of new contracts and amendments to existing contracts with Russian companies totaled USD 804.4 million, or 61% of the total value of all contracts. In addition, Sakhalin and other Russian companies involved in the project have gained 10

The main production projects for 2013 involve active works at three offshore platforms including optimization of drilling and keeping up of consistently high performance of both hydrocarbon and LNG production. They also include development of design documentation and other preliminary works under the onshore processing facility compression project. The main development plans up to 2017 include: • Optimization of production of oil and of LNG and gas to be supplied to the internal market, as well as improvement of the facilities’ operation; • Increase of the production capacity; and • Definition and optimization of the concept of development of the South Piltun area in the Piltun-Astokhskoye field. Besides, the company and its shareholders will continue to explore a possible Project expansion by increasing gas liquefaction capacities at the additional LNG Train 3.

Sakhalin-2 Project: profile Sakhalin Energy Investment Company Ltd is the operator of the Sakhalin-2 Project. The Project comprises the development of two oil and gas fields in northeastern Sakhalin offshore, approximately 15 km off the coast Sakhalin Island. The sea depth in the area ranges from 28 to 48 meters.


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The shareholders in Sakhalin Energy are major global companies which have acquired and are successfully using their vast knowledge and expertise in construction and operation of oil and gas infrastructure, production and transportation of hydrocarbons. The Company’s current shareholders are Gazprom, OAO (50% + 1 share), Royal Dutch Shell plc. (27.5% - 1 share), Mitsui and Co. Ltd. (12.5%) and Mitsubishi Corporation (10%). Sakhalin offshore fields were discovered in the 1980s. Development started at the Astokh area of the Piltun-Astokhskoye field in 1996. In 1999, Sakhalin Energy began producing oil at the field from the first offshore platform in Russia. In 2003, Sakhalin Energy launched Phase 2 of the Project which resulted in building one of the largest oil and gas infrastructures in the world, designed for extraction of hydrocarbons and transportation, and also production and marketing of LNG.

BLUE FUEL were designed and constructed within a short time, the PiltunAstokhskoye-B platform (PA-B) and the Lunskoye-A platform (Lun-A), the first offshore gas production platform in Russia; trans-Sakhalin pipeline system was put into operation that includes 300 km offshore and 1,600 km onshore oil and gas pipelines; the Onshore Processing Facility was built, the Booster Station, the Oil Export Terminal, with a Tanker Loading Unit installed in Aniva bay 5 km from the shore; the first and still only in Russia liquefied natural gas plant. The LNG plant with the LNG export terminal and the Tanker Loading Unit are part of the Prigorodnoye facility complex, the first-in-Russia specialized marine port for shipping oil and gas. All Company facilities are certified as being compliant with requirements of the Environmental Management Systems standard ISO 14001:200.

In addition to the first offshore platform Molikpaq (PA-A), installed in Russia in 1998, two other production platforms

South Corridor, Pipelines of Discord and Repositioning of Italy By Demostenes Floros, economic and geopolitical analyst (Italy) Russian Federation could be in a position to keep the European Union under constant political blackmail through the weapon of energy security. In such a context, Washington would see Italy as the weak link in Moscow’s hands. This assessment, without being at all unfounded, needs to be verified, but not before it is made clear that it was the U.S. that has made its national energy industry one of the pillars of its foreign policy, as the Unocal and Knight affairs demonstrate. South Stream has one key goal: diversifying natural gas transit routes towards southern and central European consumers by crossing the Black Sea. By bypassing the Ukrainian territory, the transport of energy would directly pass from the producing country to the consumer market, preventing disputes with the intersected countries from jeopardizing European energy security while ensuring greater stability of demand. However, the United States does not seem to appreciate the South Stream pipeline, and they prefer to support a rival project, Nabucco. Behind these two opposing energy supply solutions hide several geopolitical orientations that do not always appear clear to the eyes of the uninitiated. We will try to present the most significant aspects of an issue that is vital for both Italy and the whole of Europe. The U.S. seeks to deter the South Stream project for various reasons, the most important of which involves the idea that the

Here are some considerations in contrast with the American argument: • Russia is the main energy producer in the world—in 2011, the Russian share of worldwide oil production grew to 13%, while that of gas increased to 15%—so it is quite logical that the European countries receive some of their energy from Russia. • During the Cold War period, the two border countries par excellence—the Federal Republic of Germany and Italy —imported oil and gas from the Soviet Union. The first agreements stipulated by Enrico Mattei date back to as far as 1958. • The EU represents the main final market of raw materials for Russia, as it absorbs the largest part of its oil, gas and coal exports. More generally, Germany, Italy and

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South Corridor, Pipelines of Discord and Repositioning of Italy Continued from page 11

France seem to be linked by a relation of effective interdependence with the Russian Federation that is more than mere subordination, both for the dimensions of their final markets and for financial and technical capabilities (upstream) of the related national energy companies. • The entrance of French and German shareholders in South Stream capital changes the nature of the project from a bilateral joint-venture to a continental plan. • Compared with the total consumption of primary energy, the level of dependency of Russian gas was 11% for Italy in 2010, 9% for Germany and 5% for France. On the other hand, there are some valid arguments in favor of the American thesis: • From a strictly financial point of view, Eni could use the capital committed to South Stream for more profitable investments, including those in Africa. • The progressive decrease of European domestic gas production will make many countries more dependent from the outside. • In the following years, the link between the EU and the Russian Federation—to date, definable as a kind of “reciprocal constraint”—may give way due to rapid growth of energy demand coming in Asia which, in spite of itself, could allow Moscow to move within a new Eurasian energy context definable as “the market of the two ovens.” Europe could face the issue of its own energy security, as well as the political risks connected to it, laying the groundwork for a strategic relationship with the Russian Federation. This is something that only Germany—clearly and in full autonomy— seems to be doing through Nord Stream. A second political issue of primary importance is the conflict between the South Stream project and Nabucco. The goal of the latter, sponsored by the U.S. and EU, is to diversify the source of European supply to reduce 12

dependence on Russian gas imports by working around its territory.

What are the limits of this project? Supply represents the main limit of Nabucco. In fact, supplies from Azerbaijan (Shah Deniz II) are insufficient to make the project commercially sustainable (10/15 bcm per year). In addition, part of these supplies could take the direction of Moscow and Ankara, as long as Tehran is not involved. Since the war started by Georgia in 2008, Moscow’s influence in the Caucasus has increased. Baku is certainly aware of the pressures that the Kremlin could apply on Jerevan regarding possible contractual concessions in the territory of Nagorno-Karabach. If Nabucco or Nabucco West transported methane gas towards Eastern Europe and Austria, it would almost certainly rule out the alternative pipeline TAP (Trans Adriatic Pipeline) at which Italy is aiming in order to create the so-called South Corridor. A third fundamental political issue is the attempt at an external breakthrough by the EU. In fact, the main limit of Nabucco—the amount of supplies—could only be overcome if the EU constructed the missing building block that is the TCP (Trans Caspian Pipeline), a pipeline across the Caspian Sea that should allow central and southern Europe to receive gas from all the countries around this basin.

What would the consequences be? Since the definition of the pending legal status of the Caspian Sea would need the unanimous consensus of all five coastal States - including the Russian Federation and Iran - Russian Foundation for Energy Security Director Kostantin Simonov said, “the construction of this pipeline would mean to spit in the face of Russia and the real risk may be that of a military conflict, in front of which Russia will not pull back.”


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The possible repositioning of Italy The balance of power existing among the great powers are no longer the same as in the aftermath of the fall of the Berlin Wall. The Cold War, as we have known it from Hiroshima until the dissolution of the Soviet Union, has ended. However, this does not mean that it is not occurring in a different way. Italy urgently needs to build a new industrial system to redefine its role through 2050, within the new international division of labor. To this end, it raises questions about through which resources (assets) and in which new sectors (new economy) does the country intend to develop its productive potential, without disregarding cornerstones born during the Industrial Revolution (old economy)?

The issue of energy strongly emerges, starting with the choices made in foreign policy, aimed at outlining a new balance between Washington and Moscow as well as the U.S. and EU. The governments that have followed one another since the midnineties have not always appeared to have been able to pursue a more balanced policy which could take into account the Italian national interests within an international framework, which is clearly now more polycentric in nature. Author’s summary of his article that appeared in I Classici di Limes – Quel Che Resta Della Terra”, n°2 2012.

CNG Stronghold in the Czech Republic: Industries and Services Report Success Czech Vemex, which currently operates eight compressed natural gas (CNG) fueling stations in the Czech Republic, has received initial feedback from different industrial and commercial clients that switched their fleets to this eco-friendly fuel. Richard Slavík, director of the Energy purchase section at Wienerberger brickworks, lauded the cost savings provided by CNG. “The corporate CNG filling station at the brick production premises of Wienerberger in Jezernice on Morava was commissioned on 30th August 2012. After six months of operation, this project, combined with a fleet of four Linde forklifts, brought back an average monthly fuel cost economy of cca 85 000 Kč (3,400 Euro) compared to diesel. Crucial for this success is a combination of the quality of TVAJA CNG fueling unit, performance of the Linde trucks, and the support of Vemex which has been providing attractive solutions for purchase of gas to be used for CNG.” For the period mentioned, total gas consumption reached cca 30,000 m3, and the fleet of four CNG vehicles drove 5.500 mth (engine working hours). Jan Kubásek, head of the Transportation Division, Transportation Section, Czech Post/Česká Pošta, said the fuel met his expectations, adding, “The fuel costs went almost 30% down, and we expect the overall fuel consumption to be lower too.

He continued by noting that “our fleet counts 230 FIAT Ducatos, 182 FIAT Doblos, 60 VW Passats and 10 IVECO Daily trucks. The drivers’ reports are positive on all of these models. We did experience small problems with fueling in the few days after the launch of operations, but these were soon settled. After several repetitions of the fueling process, the drivers became quite comfortable with the procedure.” Kubásek added, “as for the available capacity, we experienced minor conflicts with local taxi drivers in Olomouc. However, these were settled by Vemex together with the station operator. Now everything runs smoothly. He also said that the driving performance, service specifics and the driving range of the CNG fleet meet their expectations, noting “we also had positive feedback from our Head of Internal Audit, who can drive up to 500 km with her VW Passat with only 21 kg of CNG.” He concluded by mentioning plans to expand their fleet this year and that they have already announced a tender on 150 heavier and 50 lighter vans, as well as 10 trucks; he said they expect these vehicles to arrive by October. Vemex also welcomes a new corporate vehicle: a FIAT Fiorino. Branded with the slogan “Drive full natural gas!” and the Vemex logo, it is now advertising the new gas fuel across Prague.

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“Blue Corridor” 2012: A Successful Tool for Marketing Natural Gas as a Fuel By Andre Schumann, Head of Department for Technical Cooperation and Project Support, E.ON Ruhrgas AG and Detlef Wessling, Head of Cooperation and Business Development for Gas, E.ON Ruhrgas AG The involvement of E.ON Ruhrgas in this event follows many years of productive collaboration with Gazprom on scientific and technical projects. Today, this collaboration can look back on 20 years of history and currently encompasses some 40 different topics in 7 technical fields— one of them being the use of natural gas as a fuel. It’s no secret that vehicles fueled by diesel and petrol remain the biggest polluters of our atmosphere. Yet this burden on the environment can be eased significantly by switching to compressed or liquefied natural gas as a fuel source. Using natural gas reduces carbon dioxide (C02) emissions by almost 25% compared with petrol, while smog-forming nitrous oxide (NOx) emissions are 95% lower in comparison to diesel. And there is one further advantage for the customer— natural gas is significantly cheaper than petroleum. This has special relevance for Europe in these times of austerity. Gazprom and E.ON have been working together for many years in an effort to establish these answers, to research the markets and to bring the issue to public attention. One aspect of this collaboration is the road rallies with natural gas-powered vehicles (NGVs), which have been held since 2008 and are now a regular tradition. Gazprom’s management has recognized that campaigns of this nature are ideal for raising the necessary public awareness and for popularizing the use of compressed natural gas (CNG) for transport in Russia. The route from St. Petersburg to Moscow was chosen for the first rally in 2008, while the 2009 rally ran from Moscow to Sochi on the Black Sea. In 2010 the rally took participants to leading Russian motor vehicle plants, and a team from E.ON Ruhrgas driving a VW Passat became the first foreign team to take part in the tour. 14

A rally is much more than just a trip with standard OEM gas-powered cars running from one natural gas refueling station to another. Exhibitions are held to present modern gas vehicle technology to visitors, while roundtable discussions and meetings are held with interested parties in major towns and cities along the rally route, inviting entrepreneurs and representatives of businesses and local councils, regional governments, public transport operators, logistics firms, fleet operators and agricultural companies to get involved. The rallies were naturally given a (brand) name —in this case “Blue Corridor” in an echo of the Russian Vernadsky Foundation initiative to support the launch of environmentally— friendly fuels. Following the positive experience of 2010, E.ON Ruhrgas and Gazprom decided to organize a joint tour outside Russia. In June 2011, the route took participants from Prague via Leipzig and the Volkswagen plant in Wolfsburg to Berlin, finishing at the point where the Nord Stream Pipeline comes ashore in Lubmin near Greifswald. Apart from the organizers, teams were fielded by Kamaz, Vemex from Czech Republic, Gasum from Finland and Beltransgaz from Belarus. The same year also saw a 4,000 km natural gas rally run through Russia—the longest ever up to that time. The route ran from Yekaterinburg via Chelyabinsk, Ufa, Orenburg, Samara, Saratov, Volgograd, Tambov, Voronezh, and Tula to Moscow.


April 2013 | Vol. 6 | Issue 2

“Team E.ON Ruhrgas” of course competed with its now legendary VW Passat. The sustained success of these rallies prompted the creation in 2012 of a new “Blue Corridor” project, this time taking teams all the way from Moscow to Western Europe. This was the longest route to date, taking participants over 6,700 km and through seven European capitals, from Moscow through Minsk, Warsaw, Prague and Paris to Brussels and Berlin. The 2012 rally combined the efforts of major European gas companies, vehicle manufacturers and national natural gas fuel associations including NGV Russia, NGVA Europe, and NGV Polska, the German ERDGAS mobil, Dena, E.ON Gas Mobil, the Czech E.ON Česka and Vemex, the FrancoBelgian GNVERT, and, of course, the team from Gazprom: Belarussian Beltransgaz, Gazprom Marketing & Trading SAS France, Gazprom Germania, Vemex and Gazprom Export. Direct participants included teams from energy companies such as GDF SUEZ, E.ON Ruhrgas, Verbundnetz Gas, Gazprom Germania, Vemex and motor manufacturers LiAZ, KAMAZ, MAN, Mercedes-Benz, Volkswagen, SOLBUS and IVECO. Four natural gas vehicles started the rally in Moscow, with more vehicles joining as each new country was reached. 10 cars took part on average, with each car carrying two to three team members representing the participating organizations. The rallies aimed to show that it is possible to journey the well-travelled route between Yekaterinburg-Moscow and Western Europe with NGVs, and therefore the potential to reduce the pollutant emissions from the huge volumes of traffic passing between Western and Eastern Europe. This is, of course, only possible with Blue Corridors to provide the necessary refueling infrastructure along these routes. The infrastructures supporting natural gas vary widely in standard from country to country. In Germany there are now more than 900 multi-fuel service stations where motorists can choose to fill up with petrol, diesel or CNG, and these types of stations are available broadly to the public. The picture in France is different—here, natural gas refueling points are not only separate from conventional service stations, most are on company premises to which the motoring public has no access. If we want to motivate people to switch to natural gas then we must offer them the same level of refueling convenience across the whole of Europe. In order to market natural gas as a fuel, market players have joined forces to create a consortium and set up a company (natural gas mobil) with the task of expanding the network of outlets. An expansion program in Germany has cost 200 million euros, with all of the money coming from private investors.

BLUE FUEL In Europe, all leading motor manufacturers include NGVs in their fleet as standard options. VW, for example, offers the Passat, Touran and Caddy; Mercedes Benz its E Class and B Class; while FIAT has the Multipla and Kombi. KAMAZ offers a range of 15 different purpose communal vehicles that run on CNG and LNG. Other models of natural gas vehicles, including commercial vehicles and buses, are also available. Incentives of the kind offered by firms such as Wintershall, E.ON Ruhrgas, Gazprom Germania, Vemex and Gazprom Export are also important. A range of concessions are available to assist with the purchase of NGVs, although much depends on the market strategy of the companies operating in a country’s gas market. Government policy too has a role to play— fiscal policy in particular. In Germany the tax on natural gas as a fuel is lower than in many other countries, so prices are correspondingly lower and there are also cheap loans available to small and medium enterprises looking to acquire natural gas technology, including vehicles. These programs are supported by the German government. There are a number of pathways that might be taken to establish natural gas successfully in the fuel market. As well as CNG, for example, liquefied natural gas (LNG) can also be used as a fuel. This sector may not yet be so well developed as the use of CNG, but the potential here is substantially greater. Today we can already say that LNG as a fuel is very economical. Greater distances can be covered with a tankful of LNG than with compressed natural gas. LNG does not require large gas tanks that take up a lot of space on the vehicle. A change in engine technology compared with the technology for CNG is not necessary, as a compact regasification unit is perfectly adequate and manufacturers like Iveco, Mercedes or Kamaz already have such developments. A combination of CNG and LNG at the same ‘gas station’ is also possible, so both types of fuel could easily be offered side by side. Natural gas can be liquefied or converted from LNG to CNG with the right equipment. Natural gas as a fuel can only look forward to a successful future if businesses and government agencies act in concert and take the necessary steps, internationally as well as domestically. The objective of the rally from Russia to Europe was to highlight the need for international action. Motorists, road transport companies, local authority agencies, motor manufacturers, gas equipment producers and gas companies —each of these interest groups represents a different aspect of one overarching issue of international importance which deserves to be resolved jointly.

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Natural Gas—The Future Leader in Road Transportation? By PD Dr. Christian Growitsch, Director of Applied Research and Member of the Management Board of the Institute of Energy Economics at the University of Cologne and Hannah Schwind, Research Associate at the Institute of Energy Economics at the University of Cologne In early 2013, the Commissioner for Transport and European Commission Vice President Siim Kallas presented the European Union’s Clean Fuel Strategy, which includes goals for the future of Europe’s road transportation sector. Compressed natural gas (CNG), a fuel that is currently only used by about 0.5% of the total fleet, is aimed to increase ten-fold by 2020. Moreover, the maximum distance between publicly accessible CNG refueling points is set to be reduced to 150 km in the future. Whereas some countries have already achieved the second milestone (regarding distance between CNG fueling stations), the market for natural gas vehicles (NGVs) is not yet well developed. However, increasing Europe’s NGV stock bears a high potential to accomplish the EU’s 2009 car regulation, which sets a target of 95g CO2/km as the average emissions for the new car fleet by 2020. This article is meant to provide a short overview of the myriad of economic and environmental reasons that speak in favor of an enhanced market for NGVs and, in particular, CNG.

Current market conditions keep NGVs from reaching their potentials The Clean Fuel Strategy encourages a way out of the vicious circle that has been characterizing the European NGV sector. On the one hand, it is not profitable for additional stations to offer natural gas as long as the filling-station-to-vehicle-ratio

remains as low as it is at present.1 On the other hand, the insufficient number of refueling stations (from a customer perspective), as well as relatively higher purchase costs for NGVs, prevent the market from developing. Furthermore, similar to energy efficiency investments in the residential sector, consumers often do not take into account future savings when they make the investment decision to buy a new car. In 2011, the monetary fuel efficiency for NGVs in Germany greatly exceeded the efficiency of petrol and diesel. For a EUR20 filling, the NGV cruising range amounted to 468 km, compared to 297 km for diesel and 179 km for petrol.2 Yet, consumers are confronted with confusing pricing information, since conventional fuel and natural gas are reported in different units that ignore their different energy content. As a result, perceived infrastructure barriers, in combination with opaque pricing communication and relatively higher purchase costs, impede the proliferation of natural gas-fuelled light-duty vehicles (LDVs). Unlike the LDV segment, natural gas has already won recognition as a beneficial fuel alternative for truck as well as bus fleets—both being vehicle types that tend to drive the same routes on a regular basis. In Germany, 18% of all NGVs sold in 2011 were busses and utility vehicles3, which consumed 55% of the natural gas provided as motor fuel.4 In addition to the more economical fuel efficiency, NGVs also surpass conventional

1.

Currently, there are 2741 CNG stations throughout Europe (http://cngeurope.com.)

2.

https://www.swrag.de/privatkunden/erdgas/erdgas-ein-kraftstoff/reichweitenvergleich.html

3.

Initiative Erdgasmobilität, Zwischenbericht 2012

4.

Ibid.

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April 2013 | Vol. 6 | Issue 2

cars with respect to environmental efficiency. Given that almost one third of the final energy consumed in the EU occurred in the transport sector in 2010, energy savings in this sector play a crucial role in mitigating climate change: total greenhouse gas emissions from transport in the EU amounted to 1,225 million tons (mt) of CO2-eq. in 2009, more than 70% of which can be attributed to road transportation.5 In its 2011 Transport White Paper target, the EC set the reduction of GHG emissions by 2050 to 60%, relative to 1990 levels. With regard to the achievement of environmental goals, NGVs provide a promising alternative to conventional vehicles since natural gas is a relatively clean-burning fuel. Compared to a petrol engine, a natural gas engine emits 25% less CO2 during combustion.6 Furthermore, CO2-eq. emission factors, which include the emissions released along the value chain as well as the actual consumption in the vehicle, speak in favor of natural gas (“well-to-wheel,” WTW, emissions). With well-to-wheel emissions between 67 and 80 grams of CO2-eq./MJ (depending on the remoteness of the production site), natural gas generates 11% to 25% fewer emissions per unit of energy than diesel. Overall, emissions are a little smaller for petrol.7 A paper recently published by the Institute of Energy Economics at the University of Cologne demonstrated that natural gas-based road transportation in Germany can accumulate up to 464 mt of CO2-eq.WTW emission reductions by 2030 (-26%, assuming maximum diffusion). Yet, it should be noted that the diffusion of NGVs is a slow process and a realistic replacement rate would only amount to a reduction of 10% in WTW emissions from road transportation for the period to 2030.

BLUE FUEL Even when taking the relatively higher purchase costs into account, NGVs are more profitable than conventional vehicles in the long run. Referring to the fuel efficiency values outlined above and assuming 17,000 km of annual driving per car, a rough back-of-the-envelope calculation on cost amortization can be made. As a result, the additional average cost of 2,000 euros associated with purchasing a natural gas-fueled LDV is paid back within two years when compared to a petrol-fuelled car. To facilitate the economic advantage of natural gas in transportation, however, additional infrastructure is necessary. This need therefore raises the question of the welfare potential of NGVs for the economy as a whole. A sound cost analysis, although not yet performed, would have to account for life-cycle costs for an NGV (purchase, fuelling), as well as for necessary fuelling infrastructure, especially pipelines. Infrastructure is the key determinant for market penetration of NGVs. The better the existing infrastructure for natural gas is, the more cost-efficient the alignment of the road transportation to the “new” fuel will be. Overall, the development of a market for NGVs corresponds to an ‘incremental system innovation,’ which is characterized by a smooth transformation process rather than by abrupt changes in the market environment. At first glance, Germany could be predestined to use the unutilized pipeline capacity of its closely meshed pipeline grid. It goes without saying that the amount of unutilized capacity highly depends on future developments in the heat and power markets. Whereas the first is said to experience a declining demand in the near future due to energy-efficiency improvements, forecasts about the latter Continues on page 18

5.

„EU Transport in Figures“, Statistical Pocketbook 2012

6.

http://www.erdgas-mobil.de/tankstellenbetreiber/erdgas-als-kraftstoff/

7.

Lochner & Wang-Helmreich (2011), EWI Working Paper: http://www.ewi.uni-koeln.de/fileadmin/user_upload/Publikationen/Working_Paper/EWI_WP_11-14_ Natural_gas_road_transportation.pdf

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Natural Gas—The Future Leader in Road Transportation? Continued from page 17

are difficult to make, as the importance of natural gas in electricity generation heavily depends on the relative price of gas to coal. If, however, a transformation of the German transport sector could actually rely on its existing infrastructure, the economic potential rooted in the existing infrastructure could be considered to be a real option. Indeed, Germany may take the lead in NGV infrastructure development in the next years. 100 out of the 264 CNG stations planned to be added in Europe are to be constructed in Germany.8

Possible and actual policy responses Overcoming the obstacles of systemic nature, Italy has proven to be a good example of a country able to quickly increase the share of NGVs in the total car stock. During 2005 and 2011, the number has doubled, now representing close to 2% of all vehicles (785,000 vehicles). A favorable business structure with the national energy company ENI, active in both the filling sector and the gas trade, made it possible to overcome coordination issues between station owners and gas suppliers. Moreover, Italy has introduced a variety of public measures that favor investments in NGVs, e.g. the coupling of a scrap bonus with an NGV purchase subsidy.9 Hence, Italy is a good example to illustrate how policy makers can stimulate a market to correct market externalities that are induced by pollution and credit barriers. At a European level, the recently introduced European emission standard Euro 6 is likely

to indirectly favor the economic viability of NGVs in the future through cost increases for diesel and petrol engines via stricter requirements for nitrogen oxide emissions.10 In addition to having lower fuel costs, the difference in relative purchase prices with respect to conventional cars is then expected to decrease as well. In light of the quantitative and qualitative information presented, it is clear that NGVs benefit from environmental and economic efficiency gains. Given the aforementioned obstacles that prevent the NGV market from developing, however, policy makers are needed to foster market growth. The inclusion of the transportation sector into the Emission Trading Scheme (ETS) seems to be a promising remedy to properly display the environmental advantages of natural gas. In multiple regards, promoting a lowcarbon technology could help to reach the EU’s environmental policy goals. The more sectors that fall under the ETS, the higher the overall investment protection will be for the technologies with the lowest CO2 avoidance costs. As a result, the establishment of a market mechanism would make the permanent enacting of new standards and regulations obsolete. Contrary to the commodity price relationship in the power sector, in which price differentials between coal and gas are too high for the ETS to promote gas as the cleaner fuel, the current gas-to-oil relationship in the transport sector would induce the desired effects if the trading scheme were to be extended.

8.

http://www.ngvaeurope.eu/european-ngv-statistics

9.

http://www.ngvaeurope.eu/ngv-market-growth-in-italy-1973-2008

10. http://ec.europa.eu/enterprise/sectors/automotive/environment/eurovi/index_en.htm

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April 2013 | Vol. 6 | Issue 2

BLUE FUEL

Discussion Paper:

How the Third Energy Package is Changing the Way Gas Business is Done in Europe By Alex Barnes, Head of Regulatory Affairs, Gazprom Marketing & Trading Limited This year marks the twentieth anniversary of Gazprom, but the relationship between Russia and Europe for the supply of gas dates back to 1969, when Gazprom’s predecessor signed a gas supply contract with Italy. Since then we have seen two oil shocks, three Gulf Wars and the fall of the Iron Curtain in Europe. Yet gas has continued to flow to meet European gas demand with only one notable interruption by a transit country in 2009. This record is, in itself, a testament to the enduring commercial relationships between Gazprom and its customers; indeed, Gazprom and its predecessors helped build and establish the natural gas industry in Europe. Gas is a significant primary energy source in Europe. Growth in gas-fired power generation has been a significant contributor to reducing carbon emissions. This gas success has been achieved despite a high degree of import dependence. The commercial model that enabled this was relatively straightforward: gas exporters such as Russia, Norway and Algeria signed long-term contracts to supply gas to importing companies such as Gaz de France, ENI, RWE and E.On Ruhrgas, which were often monopolies. Under this system, the exporters guaranteed gas supply with the flexibility needed to cope with changes in demand (due to weather for example), whilst the importers guaranteed demand. Long-term transportation capacity bookings underpinned the supply contracts and the financing of the pipelines to move the gas to and within Europe. During the 1980s and 1990s, however, economic theory changed, as a new consensus emerged around the view that the gas industry did not need to be monopolistic to be commercially viable. The thinking was that only one part of the gas business was a true “natural monopoly,” a business where it was not economically viable to have competing business—namely the transportation part of the chain, including the ownership and operatorship of the pipelines. If you think about it, it would make no sense at all for two competing gas companies to build duplicate pipelines to supply the same street or factory. The thinking is that, so long as all companies have an equal opportunity to use the pipelines in return for payment of a fee, you can have competing gas suppliers both upstream (gas producers) and downstream (gas supply companies who sell to end users). The concept

underpinning this is known as regulated third party access (rTPA) and it is at the heart of all gas market liberalization. The U.S. and the U.K. introduced rTPA in the 1980s and 1990s, and by the end of the 1990s both had vibrant, liberalized and competitive gas markets. The European Union also wanted to liberalize its energy markets in order to benefit from competition between suppliers (whether upstream or downstream) and help improve its economic competitiveness. This eventually led to the Third Energy Package, which was passed in 2009 and has been in force since 2011. The package includes detailed a series of rules for the way the gas market is structured, which in turn will affect the way business is done. First, the way transportation capacity is booked is changing radically. Capacity will now be sold and allocated via auctions, and any capacity which is booked but not used will be made available to the market. This means that, so long as there is sufficient physical capacity to flow gas, there will be greater competition between different national markets as gas will be able to flow from low-priced markets to higher-priced markets. Pipeline companies have put in place a project called PRISMA, which will auction capacity at a number of locations from April this year. Second, there is likely to be surplus capacity available, at least some of the time. This stems from two main causes. Gas networks are usually built to meet “peak demand,” that is the amount of gas required to flow to meet demand on the highest demand day (e.g., the coldest day in winter). This peak is also usually set according to an expectation of the highest demand during a period of time—for example the coldest winter day within a 20year period. Of course most of the time, demand is below this level and there is spare capacity. In addition, EU security of supply legislation requires that countries build additional pipelines connecting them with neighboring markets to cope with the loss of a major source of supply. The idea is that this will make it easier for gas to flow from countries with plenty of gas to those who might otherwise have a gas emergency due to significant loss of supply. However, as the loss of a major source of supply does Continues on page 20

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Discussion Paper:

How the Third Energy Package is Changing the Way Gas Business is done in Europe Continued from page 19

not happen every day, this means that there will be plenty of capacity available to flow gas between national markets, and thereby encourage more competition. Third, the price at which pipeline companies sell the capacity will change. Partly this is as result of structural changes. Capacity is no longer sold on a point-to-point basis (e.g., from border to power station) but on an entry/ exit basis. Companies book entry capacity to enter a market zone, which means that they are at the trading hub, and exit capacity to leave the trading hub to go to the customer (e.g., power station, stadtwerke, large factory). Pipeline companies are regulated as to how much revenue they are allowed to earn, and then decide how to structure their capacity charges to earn their allowed revenue. So they can decide how much to earn from entry charges and how much to earn from exit charges. In addition, they face the problem that if they do not sell as much capacity as they expect, or network users pay less for capacity than they expect, TSOs do not earn their allowed revenue. Under proposed rules they will be allowed to raise their tariffs for the following year to make up the shortfall. However this will mean that companies who have booked capacity for more than one year will have much less certainty as to their future capacity costs. Finally, new rules will change the point at which upstream suppliers sell gas to downstream companies. In the future it will be possible to sell gas only at the Virtual Trading Points or hubs, as it will not be possible to book or nominate gas flows to delivery at the border between two national markets, as is currently the case. This will mean that a company which previously sold gas to its counterparty, for example at the border between Germany and Netherlands, will now have to choose to sell the gas either at the German hub or the Dutch hub. These changes, which are just the tip of a very complicated iceberg, will change the competitive dynamics of the European market, and hence require market participants to adapt their commercial strategies. This will inevitably mean that existing contractual structures will have to adapt. If we look at the changes to capacity booking first, we will see that the key determinant of a company’s booking strategy will be its expectation of physical congestion, or the likelihood that companies will wish to nominate to flow more gas than the system can physically support. 20

20

If there is plenty of capacity (i.e., the risk of physical congestion is low) the company will be more comfortable booking only the capacity it needs, for the period it needs it, when it knows for certain that it needs it. If there is the risk of physical congestion, the company will know that it will be able to book what it needs thanks to the use of auctions to allocate capacity so long as it is prepared to pay a high enough price. It may wish to book more in advance to avoid the risk of capacity selling out or only being available at a very high price in the shortterm auctions. However, as we have seen, it is likely that there will be enough capacity to meet physical flows because of the way systems are designed and the requirement for connecting pipelines for security of supply reasons. These factors will encourage companies only to “profile” capacity, that is, book less for periods of low demand than for those of high demand, since this way they minimize their capacity costs. They also mean that companies will usually pay the minimum price for capacity since the supply of capacity will usually exceed likely demand. Both these outcomes raise the likelihood that pipeline companies will suffer shortfalls in their revenue. This in turn will encourage pipeline companies to raise their tariffs for the following year, increasing costs for companies who have booked capacity and certainly increasing cost uncertainty for those companies. Of course the obvious way for companies to address these cost increases and uncertainty is to book as little capacity as possible for as short a time as possible. But this risks creating a vicious circle since such a strategy will increase the risk of a revenue shortfall and hence further tariff increases by the pipeline company. In the U.K., for example, revenue shortfalls have led to a high degree of capacity price volatility. Companies also face the risk of changes to the structure of tariffs as a result of moves to harmonize tariffs across Europe. Although the overall level of transportation charges will stay the same because the revenues that pipeline companies earn are regulated, tariffs for different companies could change substantially. Let’s look at the split between entry and exit charges. If a TSO is allowed to earn revenue of €100 million, for example, it can decide how much of its revenue it will earn from selling entry capacity, and how much from exit capacity. The split between entry and exit capacity


April 2013 | Vol. 6 | Issue 2 varies between countries—some opt for a 50:50 split, others are split 20% on entry and 80% on exit. Using our example of an allowed revenue of €100 million, a move from a 20:80 split to a 50:50 split would mean an increase in charges of €30 million for those shippers who deliver to the hub (buy entry capacity only) and a €30 million decrease for those shippers who buy at the hub and then deliver to end users. Some regulators have mistakenly said that because the cost of transportation is only a small part of the end consumer’s bill, changes to such charges should not have a big impact. However, as the example above shows, tariff design is a zero sum game for the gas companies themselves, and can have a significant effect on individual companies’ costs and profitability. Where companies have booked capacity, they will of course want to ensure that they can pass this cost to their customers. This depends on the willingness of the customer to bear the capacity risk, and this in turn is affected by the market structure. Where delivery of gas is at the hub, buyers of gas will naturally compare the price they pay to the hub price. As we have seen above, the intention is that gas is delivered at the hub rather than at the border as now. Hub price gas implicitly includes the cost of entry capacity, since entry capacity is what you need to get to the hub. However not all entry capacity costs the same. Hence it is possible (indeed likely) for entry capacity at point A to be more expensive than entry capacity at Point B, because the price of capacity is meant to reflect the cost of providing it, and this will differ between entry points. The hub price only includes the entry capacity costs of the marginal cost of gas supply to that hub. If the cost of supply (cost of gas plus cost of entry capacity) for a particular seller is greater than the hub price, either the seller will have to sell the gas to its customer at the hub without recovering its full entry capacity costs, or the customer will have to buy gas at a higher price than its competitors. Either way the supply contracts will need to be structured in such a way that both buyer and seller are happy with the risks they bear.

BLUE FUEL Pulling this together, what does it mean for suppliers of gas to Europe? It means gas supply contractual terms will need to adjust to take account of the changes outlined above. Where buyers have considerable flexibility as to how much they nominate on a day, as is the case today, this will place an increasing burden on suppliers who will need to book this capacity in order to satisfy the nominations, and thereby expose themselves to the variable and likely increasing capacity charges described above. In addition, those who buy capacity will want to make sure they only book what they think they will use, as under new rules, companies which book capacity but do not use it risk having the capacity being taken away from them but still being liable to pay for it. Delivery at hubs will also mean that contractual structures will have to change to take account of the fact that suppliers will now have to buy entry capacity. If a supplier sells gas on a hub-related price, it will want to ensure that it has a means of managing its capacity cost exposure, whether by being able to pass the cost on, or by limiting the flexibility it provides to the buyer, or by having the flexibility to source from the cheapest source, and thereby minimize its capacity costs. Regulators have mistakenly expressed the view that changing the delivery point is “as simple as changing a train ticket,” but this fails to take account of the need to change the terms of supply contracts that determine how much capacity is required. It is no longer going to be a simple case of booking capacity for 20 years and then forgetting about it. And of course this is before one recognizes that to change a delivery point in a contract requires the consent of both parties, which in turn opens up the possibility of re-opening other aspects of the supply contracts. As gas market reform gathers pace, we are likely to see further pressure to change the nature of supply contracts to reflect the new market rules. How the industry meets these challenges will go a long way to determining the success of the gas industry in the next 20 years.

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Next Comes Competition Between Gas Consumption Regions Dominique Finon is a CNRS Senior research fellow, former Director of the Institute of Energy Policy and Economics (CNRS & Grenoble University), and former President of the French Association of Energy Economists. Here he answers questions from the editors of Blue Fuel. bargaining power and no transit issues. Perceptions started to change even more drastically with the 2004 EU enlargement.

BLUE FUEL: How have perceptions changed more recently?

BLUE FUEL: What, in your opinion, is the perception of Russian gas within European institutions? DOMINIQUE FINON: As an economist, I am

struck by several aspects of the European perception of Russian gas. The first is of a “Russian risk” rather than a transit risk. The three latest crises—Ukraine in 2006 and 2009 and Belarus in 2007—were by their nature transit crises. The second is the perception of Russia as an initiator of a gas OPEC. The third is the perception of danger surrounding Gazprom’s vertical integration, despite the company’s successful cooperation with Wintershall on Wingas since around 1990 and no market power abuse suspicions from German authorities. Conversely, Gazprom perceives European market liberalization as presenting a demand risk, leading to growing uncertainties around net revenues and sales. Before the 1990s, perceptions were quite different, with the existence of a club of buyers and sellers with clear balanced

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FINON: Gazprom is clearly seen as the most vehement defender of long-term contracts, particularly within the context of growing discrepancies between contract and spot prices. The company is also seen as being particularly reluctant to introduce a spot price component to its contracts. Other players such as Algeria, however, have also been reluctant to add spot price components to long-term contracts. Moreover, Gazprom has conceded substantial but temporary rebates in its contracts with a number of buyers. In light of this, the EU Commission’s antitrust probe is quite surprising since the organization has not attempted similar probes into Statoil or Sonatrach, which also have oil-indexed contracts with other countries. BLUE FUEL: How do these perceptions impact the objectives and tools of European energy policy? FINON: Article 194 of the Lisbon treaty establishes four aims of energy policy actions, which include ensuring security of supply and promoting the interconnection of energy networks. Interestingly enough, the EU’s foreign energy policy is primarily gas-oriented. As far as oil is concerned, member states have always preferred the IEA and global coordination. Two objectives seem to prevail in the gas sector. The first being the diversification of Western and Eastern European gas


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supplies to reduce the perceived geopolitical vulnerability of new member states. The second aim is to increase Europe’s overall ability to cope with supply disruptions, regardless of underlying causes.

the European partners in Nabucco because the “Nabucco coalition” had no economic foundation.

There are many obstacles, however. Article 194 also clearly states that individual member states have the right to maintain their own energy mixes which has resulted in growing differences between member state energy relations, contributing to the diversity of perceptions on geopolitical risk and dependence on Russia. Moreover, the High Representative of the Union for Foreign Affairs and Security Policy has little experience in energy policy, so the proposal of a single gas buyer or single negotiator is clearly a myth. Such a model would also run counter to the Commission’s market liberalization program.

FINON: Soft-power is always the best choice for the EU. Strict implementation of competition rules and gas market directives has been seen as a possible substitute for a foreign energy policy. Questioning the vertical integration of pipeline systems through unbundling rules may reduce the power of foreign suppliers while the probe against Gazprom could lead to a renegotiation of contracts with its main clients. However, current energy regulations are already weakening not only foreign but also European majors and the denunciation of oil-indexation through an EC probe could impact all long-term contracts in Europe, not only Gazprom’s.

BLUE FUEL: Besides institutional limits, what are the other obstacles to the implementation of this EU foreign energy policy? FINON: European energy companies do not need a European foreign energy policy. The size of most gas, electricity and oil companies means that they are able to negotiate directly with public gas exporting firms, often developing successful long-term relationships. These companies can also promote the development of transit infrastructure and LNG projects such as Nord Stream. Moreover, while European energy companies used to be efficient in negotiating long-term contracts when they were large midstream companies, they have been weakened by EU competition policy. In Germany for instance, the single negotiator has been forced to divest and unbundle. BLUE FUEL: You perceive the Southern corridor policy of the European Commission as a case-study on the limits of this foreign energy policy… FINON: There is indeed no better example of the structural tension between market norms and a voluntary policy, which spectacularly fails and tends to ridicule the European Commission’s voluntarism. The Commission is playing a “Great Geopolitical Game” to promote the diversification of supply through its aggressive Southern Corridor policy. The Nabucco project was designed as a “merchant pipeline” without ex-ante gas contracts between producers and European buyers and under the illusion of automatic gas supplies from Azeri, Turkmen, Iraqi, Iranian sources, etc. Gazprom was indeed in a position to react with its gas or even Turkmen gas and to form alliances with large western companies such as ENI, EDF and Wintershall. Eventually, South Stream attracted nearly all

BLUE FUEL: Is “soft power” the only way to implement EU foreign energy policy?

BLUE FUEL: What would you recommend to the European decision-makers then? FINON: First of all, stop mistaking transit risk for “Russian risk.” Diversification of sources is unlikely to occur through pipelines but the ongoing diversification of transit routes will have a strong impact on transit risk, which is inherently more significant. Moreover, dependence on Russia is already decreasing and will keep decreasing with LNG and possible shale gas developments. To handle possible supply disruptions, the EU should focus on forging interruptible contracts, increasing storage capacity, and promoting the development of interconnector and reverse flow equipment, particularly in Central European and Baltic member states. As far as economic theory is concerned, the contradiction between the liberal, pro-competition approach of the internal market and the voluntary, political approach of the foreign energy policy is unsustainable. The EU must be aware that building a well-functioning internal gas market is less prestigious but more efficient than any foreign energy policy. This does not reduce the political value of solidarity mechanisms built on each member state’s protection mechanisms against shortage crises. Last but not least, EU decision-makers should keep in mind the increasing pressure of Chinese demand. Beijing is able to finance pipelines directed towards Caspian or Central/Eastern Siberian sources and recently succeeded in gaining access to resources in Eastern Turkmenistan. Global energy competition fuelled by increasing integration and globalization will therefore be the most likely next major challenge facing energy markets.

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Photo Wheel: 39 Authors and 177 Compositions The Journalists Union Photocenter in Moscow hosted an exhibit entitled “Moods of Life” as part of the final stage of the Photo Wheel program, a photography course and contest for children from Gazprom Exportsponsored childcare centers.

children. The children were also treated to tours of RIA Novosti and discussions with leading press photographers, as well as a visit to the Golden Turtle exhibition at the Central House of Artists and the Moscow House of Photography.

Prior to the March exhibit, a group of wellknown Russian photographersm— including Vladimir Vyatkin, the leading photographer at RIA Novosti; Sergei Shakhidjanyan, the press photographer with the daily newspaper Komsomolskaya Pravda; and photojournalist Vasily Prudnikov, the head of the cultural project RUSS PRESS PHOTO — all held master classes for the

During the Photo Wheel contest, 177 photos from 39 children were submitted, and 53 of their best works chosen to be displayed at “Moods of Life.” At the exhibit, children were presented with awards for their work.

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The Photo Wheel program was developed at the cultural center RUSS PRESS PHOTO with the support of Gazprom Export.


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April 2013 | Vol. 6 | Issue 2

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Blue Fuel #19 | April 2013 | Vol. 6 | Issue 2