EUROPEAN PRICE CEILING REVISITED

Is not it strange to see the interstate underwater pipelines in the Baltic region damaged again with the onset of autumn in the past two years? In September 2022, the Nord Stream-1 and Nord Stream-2 pipelines connecting Russia and Germany under the Baltic Sea were disrupted by explosions, causing Russia to suspend gas exports to Europe. The perpetrators of the incident, as well as its causes, have yet to be identified, with no repair works underway.

On October 8, 2023, a leak was detected on the Finnish-Estonian Balticconnector gas pipeline. This time the damage was minimal, as the Balticconnector is used to transport gas between Estonia and Finland. Nevertheless, gas prices in Europe jumped by 14% on October 10. It will take several months to fix the problem. Eventually, the situation has a negative effect on the gas market. Politicians are afraid that winter supplies this year can be jeopardised by the conflict between Israel and the Palestinian group Hamas, as well as possible sabotage of gas infrastructure.

Baltic syndrome

After the Balticconnector incident, gas prices in Europe exceeded $500 per 1,000 cubic metres for the first time since August 22, 2023. Then the price jumped to $600, although Europe still enjoys warm weather and underground storage facilities are full.

Now the gas is traded at above $500 per 1,000 cubic metres, fluctuating between $530 and $540.

Balticconnector has been in operation since January 2020 and was initially used for exports from Latvian gas storage facilities to Finland via Estonia. When the Exemplar floating liquefied natural gas (FLNG) terminal in Inkoo was commissioned at the beginning of 2023, the load on the pipeline has been reduced.

The pipeline was damaged on the night of October 8 in the eastern Baltic Sea. It is assumed that the backup communication cable between Estonia and Sweden was also damaged during the incident.

Finnish President Sauli Niinistö did not rule out that it could be the result of "external influence". During the preliminary investigation, the Finnish police found that the Chinese Hong Kong-flagged vessel Newnew Polar Bear was at the location during the incident. The vessel's involvement in the incident is being investigated.

According to experts, the gas pipeline may be put into operation after repair not earlier than April next year.

The forced shutdown of the Balticconnector affected about one third of Finnish consumers. Although the condition of the Finnish gas system is assessed as stable, the gas supply via the Inkoo LNG terminal is now also secured.

Estonia plans to compensate for the losses with supplies from Latvia, through the Incukalns underground storage facility (UGF). At the same time, Estonian energy company Eesti Gaas announced that additional volumes of LNG will be delivered from the US to the Inkoo terminal in the second half of November.

Gas attack on prices

Apparently, the shutdown of the Baltic interconnector is not the only cause affecting the gas prices. The situation is much more influenced by the escalation in the Middle East. Thus, the Israeli authorities decided to temporarily stop gas production at the offshore field Tamar. This reduced gas exports to Egypt, eventually increasing the prices for gas. Also, two Egyptian LNG terminals transport part of the Israeli gas to Europe, which is trying to replace Russian imports with purchases from other countries. The market reaction did not take long—on October 20, futures for Dutch gas, which is the European benchmark, jumped by 35%.

There are fears that production at Israel's other major gas field, Leviathan, near Lebanon, can also stop if the conflict in the Middle East escalates.

Gas prices also went up due to the threat of new strikes at two Chevron LNG plants in Australia. They collectively account for about 7 per cent of global LNG supplies and their shutdown can lead to lower imports to Asia and intensify competition between European and Asian buyers.

Last time, protests at Australia's Wheatstone Downstream and Gorgon LNG plants took place on September 8, leading to an 8% jump in gas prices throughout Europe.

Overall, all these changes hit the market that has been volatile since the start of the conflict in Ukraine. In addition to even short negative influences on prices, the failure of the Balticconnector due to a possible sabotage following the explosions at NS1 and NS2 pipelines means there are serious security problems in the key European energy infrastructures.

The market's reaction to protests at Australian plants shows the increasing global reliance on LNG, while the conflict in the Middle East demonstrates how sensitive the gas market is to the global geopolitical situation.

Despite the increase, the gas prices in Europe are much lower than they have been since the war between Russia and Ukraine. Nevertheless, it is an alarming signal that the EU needs to react to. Amid fears of a new energy crisis in the coming winter, European countries are considering the extension of price ceiling for the natural gas introduced in February 2023.

In its recent presentation to European diplomats, the European Commission stated that the price ceiling has not yet had a negative impact on the market.

The EC is expected to present a proposal on the energy sector in November. It will, among other things, recommend a price ceiling, measures to approve new energy projects, and regulation of gas distribution. Voluntary commitments to reduce gas consumption by 15 per cent have already been extended until March 2024.

Towards expansion

As for the supply of Azerbaijani gas to Europe, everything is stable, with the volume of exports growing. In 2022, Azerbaijan managed to increase exports to Europe by 40% to 11.4 billion cubic metres (bcm). This year it is expected to reach 12-12.5bcm.

According to Eurostat data published in September, Azerbaijan was among the top five pipeline gas suppliers to Europe in the first quarter of 2023. Norway, North Africa, Russia and the UK were also among the top five exporters from January to March.

According to the recent nine-month report published by the Azerbaijani Ministry of Energy, the volume of exports to Europe reached 8.6bcm, or 48% of all supplies. It is expected that the demand for Azerbaijani gas will increase in Europe. "Europe needs Azerbaijani gas more than ever due to the recent geopolitical changes," President Ilham Aliyev said at the opening of the Garadagh solar power plant.

He emphasised that Azerbaijan's economic mission now was to continue diversifying the economy in order to reduce dependence on fossil fuels. "At the same time, we realise that the international market will need our oil and gas for many years to come. Thanks to the established system of oil and gas pipelines, we can export our oil and gas to different destinations," Aliyev noted.

The current buyers of Azerbaijani gas in Europe are Italy, Greece, Bulgaria and Romania (since March 2023). By the end of the year, supplies to Hungary and Slovakia should start. Serbia is next in line, already in 2024.

The Shahdeniz consortium is working to increase production and annual exports to the EU from 10bcm to 20bcm by 2027. At the same time, the process of commissioning new fields is underway. In July, the production started at the Absheron offshore field, while deep-gas production will start next year at the Azeri-Chirag-Guneshli block of fields.

"The total annual demand of more than ten European countries for Azerbaijani gas reaches 30bcm. Therefore, the gas projects implemented by Azerbaijan are an important source of supplying additional volumes," Azerbaijani Energy Minister Parviz Shahbazov said.

It is also planned to expand the Southern Gas Corridor to deliver additional gas volumes from Azerbaijan to Europe through all the pipeline components of the Corridor, including the South Caucasus Pipeline, TANAP, and TAP.

Turkish Energy Minister Alparslan Bayraktar confirmed that his ministry had instructed the TANAP operator to prepare for an expansion to 31bcm annually.

In order to increase the capacity of the Trans Adriatic Pipeline (up to 20bcm), the TAP consortium and the gas network operators of transit countries are carrying out a market assessment. The results will be made public at the beginning of 2024.

In total, all these works will require significant investments and guarantees to secure buyers for the additional volumes of gas. A point of contention here, as Azerbaijani and Turkish officials point out, is the reluctance of European buyers to enter into long-term contracts, favouring short-term or so-called spot contracts.

"I am not quite sure whether the European market is ready to receive more gas on a long-term basis via TANAP. Without this commitment, I don't think expansion is possible," Bayraktar believes.

SOCAR Vice President Elshad Nasirov told reporters that long-term agreements on gas purchase and sale guarantee the return of investments made in the export infrastructure

"Any gas producer involved with pipeline transport needs long-term purchase guarantees spanning ten years or more. For example, in 2013 we concluded agreements to sell gas for 25 years in advance on a take-or-pay basis. Naturally, this provides guarantees of capital repayment. But now companies are not ready to conclude contracts for more than ten years, and basically everyone wants to finish taking gas by the time when it cannot be used [according to the EU climate goals)," Nasirov explained.

Also, European banks are not enthusiastic about financing hydrocarbon projects.

If we consider all these short-term issues, Azerbaijan needs to sell gas at very high prices in order to pay off in ten years. But it is impossible to sell at prices higher than those provided by the European liquidity market, Nasirov said.

According to Nasirov, there are also issues associated with the expansion of the pipeline system in Italy; we need guarantees that there will be one available.

Perhaps the time will tell whether the recent events shaking up the gas market influence the position of European buyers, and the process of attracting investments for the expansion of the South Gas Corridor accelerates.