OREANDA-NEWS. July 27, 2012. The Moscow School of Management SKOLKOVO Energy Centre has prepared a new study analysing challenges faced by Russian gas supplies to Europe within the context of current trends in the European gas market. The study highlights the current “phase transition” of the market involving all the fundamentals: demand, supply, pricing and regulation.

The trend, in the Centre’s expert opinion, will result in increased competition and stagnant demand for Russian gas. In the next three years, the threat to the Russian position is not that great – there are no real alternatives or new sources of supply, while Gazprom’s deliveries are protected by the long-term contracts. However, after 2015, the market may face a radical change both concerning demand (its slowdown may take place in response to high oil-indexed prices for gas), as well as due to the rapid expansion of supply from other sources.

According to the experts of the Energy Centre, it is highly likely that the stagnation of demand in Europe is a long-term trend associated with the market oversupply and decrease in the attractiveness of gas for power generation. Low demand for electricity, the growth of alternative power generation and the relatively high price of gas as compared to coal restrain the growth of gas consumption: it decreased by 9% in 2011.

On the other hand, the volumes of gas supply is increasing, which is a result of launching the next wave of LNG projects - from 2015 and on, LNG suppliers from Australia, North America and East Africa will enter into the competition with Russian gas in the European markets. Additionally, Europe may rely on gas coming from the Caspian region. “At the same time, there will not be room for additional supply in the European market until 2017: all gas demand is fully covered by existing long-term contracts. By 2020, the market niche will amount to 50 bcm, and it will be only after 2025, when it will start to expand rapidly. But by 2020, this market niche will be claimed by uncontracted volumes of gas from around the world totalling to more than 270 bcm. In this situation, the competitiveness of Russian gas will be crucial,” notes Tatiana Mitrova, Head of Global Energy at SKOLKOVO business school Energy Centre and one of the authors of the study.

Another important trend taking place in the European gas market is a significantly increasing role of the spot market in gas pricing. To date, when spot pricing has already expanded to more than half of the gas volumes supplied to the market, it is unlikely to reverse this process. In fact, the transition to spot prices as a benchmark has become inevitable - the only question here is the pace of this transition.

However, Gazprom's policy pertaining to the revision of contracts is yet based on the principle of the provision of minimally acceptable discounts for customers, which are deferred for a maximum period of time within the framework of the “special” bilateral relations with various countries, while preserving the oil-indexed prices. According to the estimates of the SKOLKOVO business school Energy Centre, Gazprom’s strategy, which ensures the revenue growth even at lower exports and existing high prices, may be beneficial only in the mid-term perspective, while it is reasonable to form the long-term strategy on a gradual transition to spot pricing. At the same time, Russia may negotiate with buyers on the “buy-out” of the long-term contracts and then, within the framework of spot pricing, perform a simultaneous optimization of prices and volumes, depending on the current market conditions. In this case, in order to preserve its market position, Gazprom would have to agree on prices ensuring the competitiveness of gas in the power sector (which should not to exceed USD 9-10/MBtu) and provide greater flexibility of gas supplies. And the main efforts of the gas industry strategy should be focused on the control over the costs of production and transportation, and, considering the potential high risks, which may occur during the implementation of expensive new projects, it should also rely on the state stimulation and support. It might be reasonable to abandon some of the projects that would not pay off at the given price level. “If Gazprom's export strategy will be still prioritized on maintaining high prices, the Russian export volumes are unlikely to exceed 150-180 bcm by 2025, and, then, it seems appropriate to update the investment program and the General Scheme of the gas industry development,” according to the research of the SKOLKOVO business school Energy Centre.