NEW EUROPEAN REALITIES

Over the past few months, a gas rush has covered the European countries, having reached its climax in early October. The exchange price of gas in Europe set a new record on October 6 amid low reserves in storage facilities, growth in fuel demand before the heating season and limited supply and now exceeds $1,950 per thousand cubic meters. First Vice President of the European Commission, Frans Timmermans, said on the same day that the demand for energy resources in the EU had reached a maximum in 25 (!) years, having caused such a sharp jump in prices.

Who to blame?

Gas reserves in European underground storage facilities (USF) are at a ten-year low - 75% against 94% last year. Although European Energy Commissioner Kadri Simson assures that this volume will be enough for Europe to survive the winter, according to experts, the duration of the price frenzy in the market will largely depend on natural factors. If the winter turns out to be relatively warm, we can expect that the level of stocks and prices normalise. Otherwise, the cost of gas in Europe will remain high over the next year.

In Russia, they believe that it is possible to stabilise the situation on the EU market thanks to the full-fledged launch of Nord Stream 2. But the pipeline is still going through the test injection stage to be followed by a certification process. Another possible option for the Kremlin is to increase the volume of gas supplies through the existing pipelines. However, this is possible if only the EU or individual EU countries request Russia for gas volumes by concluding contracts. Incidentally, Hungary has already signed a new agreement with Russia amid the rising gas prices. Perhaps other European consumers of Russian pipeline gas will follow suit.

Meanwhile, a number of European politicians openly accuse Moscow of deliberate suspension of gas supply to European consumers in order to create a rush in the market. While Europe's largest gas companies say Gazprom remains committed to its long-term contracts, the Russian energy giant remains a focal point of debates over whether it can boost exports or not.

Finance ministers of France, Spain, Greece, the Czech Republic and Romania asked the EU to develop tools “for an immediate response to a significant rise in prices” and to investigate the situation on the gas market. They also noted that the EU should coordinate the supply chain.

In mid-September, a group of MEPs asked the European Commission to investigate the role of Gazprom in the current market situation. They argue that the company may be to blame for the record price jumps to speed up the approval of the Nord Stream 2 gas pipeline.

US Energy Secretary Jennifer Granholm said that Washington was closely watching Russia's role in the European gas crisis. She added that the US was trying to find ways to help resolve the crisis, including the assessment of Gazprom’s involvement in it and manipulations in the market.

Russia is ready for new contracts

Meanwhile, exchange price for gas in Europe dropped noticeably (less than $1,000 per 1,000 cubic metres) on October 7. Experts believe that one of the reasons was the promises of Russian President Vladimir Putin to help Europe stabilise prices, which he made at the inter-cabinet meeting for the development of energy sector.

Previously, however, Mr. Putin criticised the EC decision to curtail long-term contracts for gas supplies and reorient fuel trading to exchange stocks. “It turned out that this policy was completely mistaken,” Vladimir Putin said.

He explained that this policy does not take into account the specifics of the gas market due to a large number of uncertainties, such as the rapid post-crisis economic recovery, which has warmed up the demand for energy, as well as the decline in natural gas reserves in USFs due to the cold winter. Another factor, according to Mr. Putin, was the reduction in wind generation due to the heat and calm weather. “Please note that over the past ten years, the energy balance in Europe has changed dramatically. Many countries in the region have dumped coal and nuclear power plants in favour of weather-dependent wind power,” he said.

At the same meeting, Mr. Putin supported the initiative to increase the supply of gas to the world market through the St. Petersburg Stock Exchange.

Experts believe that over time such actions will help stabilise the situation with prices for energy in Europe. However, analysts do not expect gas prices in the region to drop to last year's values and an instant effect, since even the increase in exports is a gradual process.

Russian Vice-Premier Alexander Novak said that the current level of gas prices in the market was unhealthy; not only the current situation is a result of fundamental factors, but it also formed because of market speculations. It is necessary to quickly stabilise the situation: immediate benefits for suppliers will not outweigh the potential long-term damage from price differences.

“Under such circumstances, many production facilities, especially chemical companies working with natural gas, shut down. This is already happening, for example in Britain, in European and other countries. We observe a more intense transition to renewable energy sources at current prices. Obviously, this leads to investments in more inefficient extraction projects. Therefore, the market should be stabilised as soon as possible, ” Mr. Novak said.

British crisis

Meanwhile, in the UK, as the Russian minister pointed out above, things are even worse than in the EU. Due to high gas prices over the past 1.5 months, five energy companies have already suspended operations, four more companies may announce their bankruptcy soon. Analysts believe that by the end of the year, only ten energy companies may remain in the country, while 70 of them were working at the beginning of 2021.

Britain is one of the largest consumers of gas in Europe. The British electric power industry and thus the entire economy is very highly dependent on gas. In 1Q2021, according to the British Association of Oil and Gas Companies (OGUK), 35% of the country's electricity was produced using gas.

For comparison, in Germany, which is the largest European consumer of gas and the most significant export market of Gazprom, this indicator in the same period was twice as less (16%), while in France the share of gas in electricity production does not even reach 6%, because the second largest EU economy relies mainly on nuclear energy. On average, the share of gas in the EU’s electric power industry was 20% in 2020.

In Britain, 85% of houses are heated with gas, while in Germany and France this indicator is 48% and 39%, respectively.

Such a high dependence of the UK on gas is a direct consequence of more than half a century of active oil and gas production on the continental shelf, primarily in the North Sea. Thanks to the exploitation of large fields off their shores, the British did not build an extensive system of underground storage facilities for gas. Thus, the total capacity of gas storage facilities in the EU is approximately 80 times the capacity of British ones.

The increased vulnerability of the UK gas market can also be explained by its strong dependence on short-term purchases of the required volumes, that is – on spot prices.

But spot prices have skyrocketed to what seemed quite simply impossible recently: from $200 per 1,000 cubic meters at the end of 2020 to almost $1,180 on September 30, 2021.

In this situation, German and other continental energy companies, which, as a rule, conclude long-term contracts with a stable price formula with Gazprom and other suppliers, have found themselves in a significantly more advantageous position than British importers, which are now struggling with difficult problems.

Meanwhile, the EU countries are preparing for the next waves of inflation. According to analysts, this is a likely scenario in the European gas and electricity market in 2022.

Plans of Azerbaijan

In fact, gas shortage in Europe increased the volume of gas exports from Azerbaijan. At the same time, thanks to an OPEC+ decision effective since August, Azerbaijan may increase the monthly oil production by 7,000 bpd. Therefore, the overall effect of the growing volumes of mineral exports, coupled with high prices for oil and gas on world markets, will definitely benefit the national economy of Azerbaijan. According to FitchSolutions (part of FitchGroup), the GDP growth in Azerbaijan in 2021 is at 2.5%, and will raise to 3.3.% in 2023. This growth will stimulate strong external demand, including a steady demand for oil and gas.

Although Azerbaijan supplies gas to Europe mainly on the basis of long-term contracts, one cannot exclude the spot component of these contracts. Vitaly Beylarbayov, Deputy Vice President of SOCAR for Marketing and Investments, indirectly confirmed this as well. In his interview with Independent Commodity Intelligence Services, Mr. Beylarbayov did not comment on the price of gas, but said that Azerbaijan sold spot gas on the Italian market, while SOCAR sought to provide buyers with “flexibility in accordance with market conditions”.

The pipeline company TAP AG reported that during December 31, 2020-September 16, 2021, Azerbaijan supplied 5 bcm of gas were to Europe (Italy, Greece, and Bulgaria) via the Trans-Adriatic gas pipeline. But this is actually the volume that, according to the Ministry of Energy of Azerbaijan, Azerbaijan planned for export this year.

Meanwhile, Baku has already announced its readiness to increase export volumes to Europe. But, as noted by the President of Azerbaijan Ilham Aliyev, it will be necessary to conclude new contracts.

“On December 31, 2020, we started the reliable export of gas to Europe. Our gas is cheaper than the gas supplied [to Europe] from other sources. We supply gas to Europe on the basis of contracts. That’s why, if European consumers need additional volumes, then we need to start negotiations, because we need to determine where the gas will be sold and then produce it. This is how the gas business operates,” Ilham Aliyev said in his interview with the Spanish news agency EFE.

He added that due to technical and commercial reasons, it is impossible to increase the volume of export supplies of Azerbaijani gas to Europe this winter. “However, if we start [negotiations] now, then I think that by next winter we will be ready. There is a potential for increasing the volume of supplies,” Mr. Aliyev said.

President Aliyev also recalled that Azerbaijan’s gas reserves were estimated at 2.6 trillion cubic meters. “This volume will be enough to meet both domestic and export needs for at least 100 years. In addition, we are currently developing new fields. We can increase production volumes, but we need to start negotiations and conclude new contracts for this,” he said.

By the way, the authorities also have plans to expand the geography of gas exports thanks to the Balkan and Eastern European countries. “We can supply gas to other European countries. We plan to work with the EU to expand the geography of gas supplies,” Mr. Aliyev said.

OPEC experts believe that gas demand will grow in the next 25 years. According to the OPEC forecasts, the share of gas in the global energy balance in 2045 will grow from the current 23.3% to 24.4%, and it will take second place among all types of energy (in 2020, coal was the second after oil).

Cartel also believes that record gas prices could push the use of hydrocarbon products as an alternative fuel in power generation if the winter of 2021-2022 turns out to be cold.

Considering these forecasts and the potential of Azerbaijan, we can assume that Azerbaijani gas will easily find new buyers. As for the technical side of the issue, doubling the throughput capacity of the Southern Gas Corridor (SGC), no problems are expected for now. Given the recent energy crisis, the value of the SGC and Azerbaijani gas increases significantly.