Photo Gallery: Gazprom's Ambitions

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Europe's Failed Natural Gas Strategy Gazprom Hopes to Build Second Baltic Sea Pipeline

With the planned Nabucco natural gas pipeline in southern Europe hitting snag after snag, Russian natural gas giant Gazprom is considering the construction of a second Baltic Sea pipeline to go with the just-finished Nord Stream. With unconventional natural gas from the US flooding the market, however, the strategy is not without risk.

Seven years later, it is now clear who won the duel. When the government of Social Democratic Chancellor Gerhard Schröder came to an end in 2005, both he and his foreign minister, Green Party éminence grise Joschka Fischer, embarked on second careers as energy lobbyists.

Schröder is in the service of Russian energy giant Gazprom -- as chairman of the board of the Nord Stream natural gas pipeline on the Baltic Sea floor. The pipeline went into operation six months ago and now natural gas from Siberia flows through the 1,200 kilometers (745 miles) of pipe to the German city of Greifswald.

Fischer is an advisor to Nabucco, the consortium favored by the European Union, which also includes German electric power company RWE. The Nabucco pipeline is intended to transport gas from the Caspian Sea region, along a 3,900-kilometer southern route to Baumgarten in Austria, bypassing Russia in the process. But not a single meter of the pipeline has yet been laid, and that will likely remain the case. The Nabucco project will not be implemented as planned.

Three weeks ago, Hungary's MOL Group voiced significant doubts about the project, and now another consortium member is thinking of pulling out. RWE executives have already prepared politicians in Brussels and Berlin for the worst case in recent weeks. They haven't made a final decision yet, but the chances that the company will remain committed to Nabucco are not good.

One reason is that the estimated total cost of over €15 billion ($19 billion) is more than twice as high as the original projection. Another is that potential suppliers Azerbaijan and Turkmenistan have not yet provided definitive commitments to supply natural gas to the pipeline.

Turmoil in the European Natural Gas Market

Indeed, it is beginning to look as though the erstwhile competition between the two pipelines has been overwhelmingly won by Nord Stream. Schröder's team has just decided to expand the Baltic Sea pipeline's capacity.

The owners, Gazprom, E.on-Ruhrgas, Wintershall, Gaz de France and the Dutch firm Gasunie, are investigating the construction of a second pipeline through the Baltic Sea, which is likely to be built close to the existing line. The end result would be a dual pipeline that could begin transporting additional billions of cubic meters of gas from Siberia directly to northern Europe in seven to eight years.

The scenario that seems to be unfolding -- an expansion of northern supply lines and a downsizing of southern routes -- will bring turmoil to the entire natural gas market in Europe. The European Union had conceived Nabucco as a way to broaden its source of supply. Instead, however, the apparent failure of Nabucco and the expansion of the Baltic route threatens to make the EU more dependent than ever on Russian sources.

Europe already buys about a quarter of its natural gas from Russia with Germany relying on the country for 35 percent of its needs. This makes Germany vulnerable.

So far, Moscow has consistently proven to be a reliable supplier. Officials at Gazprom say that a pipeline "is a delivery promise cast in steel," and they insist that no company is going to invest billions in a pipeline and then choose not to use it.

But with each additional cubic meter of gas, the concerns are growing that the Russians will use their natural resources as a means of applying pressure, and that natural gas will become a political weapon. "There is no national security without energy security," says European Energy Commissioner and Nabucco advocate Günther Oettinger. And Gazprom has wielded its immense power in the past -- by, for example, shutting off Ukraine's gas supply for several days in January 2006, cutting supplies to Europe in the process.

Truncated Nabucco

The construction of Nabucco was intended to rule out such a frosty scenario. Shareholders from Germany, Austria, Hungary, Romania, Bulgaria and Turkey, flanked by their national governments and EU representatives, formed the consortium nine years ago in Vienna. A visit to the State Opera gave the participants the peculiar idea to name the project after the Verdi opera, famous for its prisoners' chorus.

It was clear from the start that the fate of the project depended on whether the operators of the Shah Deniz 2 field would supply the pipeline with gas. The giant field is in the Caspian Sea, about 70 kilometers south of the Azerbaijani capital Baku, and the drilling rights are owned by the State Oil Company of Azerbaijan (SOCAR) and two energy companies, BP and Statoil. The negotiations have dragged on for years and have yet to reach a resolution.

As a result, Nabucco shareholders now believe that only a smaller version of the pipeline is realistic, if at all. "Nabucco West," as this version is informally known, would be a mere 1,300 kilometers long and would only establish the connection from the Turkish-Bulgarian border to Austria. Farther east, the gas would be transported through the Trans-Anatolian Pipeline (TANAP), a project that is being spearheaded by SOCAR and is also still in the planning stages.

Even if this version is implemented, Europe will have failed to meet its goal of having control over its own supply route.

Instead, the Russians are now pushing ahead with the expansion of the northern route. In recent weeks, they have informed political leaders in all the affected countries, including Poland, Finland and Germany, about the plan. According to one participant, no one has yet raised any major concerns or objections. After all, the construction of the first pipeline has proceeded without a hitch thus far, despite the many misgivings voiced ahead of the project.

Gazprom's Risky Strategy

It was British Prime Minister David Cameron who initiated the unexpected expansion, after traveling to Moscow late last year to discuss possible cooperation in the energy sector. The United Kingdom meets most of its needs with its own gas, but North Sea reserves are gradually running out, unlike Siberian reserves. The talks triggered the idea of a second Baltic pipeline at Gazprom.

Last Friday, Nord Stream shareholders agreed on final details in Frankfurt. The plan calls for a second double line. "By the end of the year," says Nord Stream Managing Director Matthias Warnig, "we want to present a feasibility study in which all the key issues, such as environmental aspects, cost effectiveness and the route are discussed." If auditors don't discover any major obstacles, Warnig adds, there will be no reason not to expect a construction decision by early 2013.

New companies are expected to join the existing partners, including financial investors, as well as energy companies like British oil and gas giant BP. The company has already signaled its clear interest, which will only worsen Nabucco's prospects, given BP's key position as a gas supplier in that arrangement.

The construction of the second Baltic pipeline would be a triumph for Russian President Vladimir Putin. At the same time, though, the strategy being pursued is nothing short of audacious. Indeed, Gazprom is seeking to expand its infrastructure at a time when the natural gas business is undergoing radical change worldwide. The market for the fuel is losing what has long been its most salient feature: scarcity.

America's Growing Role in the Natural Gas Market

With the help of a technology known as hydraulic fracturing, or fracking, energy companies are able to tap into gas reserves that were considered unattainable until now. The environmentally controversial method is widely in use in the United States. In the southern states of Louisiana and Texas, for example, so-called frack trucks travel from well to well, forcing a liquid mixture of water, sand and chemicals into the ground under high pressure. This fractures rock formations, allowing gas to escape that would otherwise have remained trapped in the ground. In the US market, some 60 percent of natural gas is now being produced by unconventional means.

The use of fracking has enabled the United States to become the world's largest producer, even larger than Russia. What is currently happening in the United States "represents a potentially decisive shift in the history of energy," says ExxonMobile CEO Rex Tillerson.

The excess supply of gas has caused prices to plunge in the United States. Only four years ago, the price for one million BTU (British Thermal Units), the standard energy unit in the industry, briefly rose to $14. Today the price has dropped to only about $2.

US trucking companies have long since begun converting their fleets from diesel to natural gas. Coal producers are having trouble selling their product, because it's become cheaper to operate power plants with natural gas. It's also better for the environment, given that natural gas emits only half as much CO2 as coal. On the whole, the low price of natural gas in the United States has given the country a significant advantage and attracted foreign investment. After all, prices for natural gas elsewhere are much higher. In Asia, consumers pay up to $16 for a million BTU. In Europe, they range between $6 and $8.

But this price differential between the US and the rest of the world will probably not be sustainable for long, now that energy companies are transporting more and more of the fuel by ship in the form of Liquefied Natural Gas (LNG), making natural gas a global commodity.

Risks for the Russian Business Model

Many ports are building new terminals for LNG tankers. On the Louisiana coast, for example, Houston-based Cheniere Energy has built a transshipment station that was originally intended for importation. Now the company plans to use it as a launch pad to export cheap American natural gas worldwide.

This new competition threatens the Russians' traditional business model. They are accustomed to pegging the price of gas to oil prices. Delivery contracts sometimes run into the decades, and if customers need less, they have to pay the full contract price anyway. The principle, called "take or pay," has been extremely profitable for the Russians.

As old contracts begin to expire, customers are becoming more self-confident in new negotiations, because they can now buy natural gas on the spot markets. On the European Energy Exchange (EEX) in the eastern German city of Leipzig, for example, trading volume increased by more than 50 percent last year.

Being part of a competitive environment is a new experience for the Russians. Nevertheless, Nord Stream Managing Director Warnig is convinced that a new pipeline through the Baltic Sea will pay off. "Shale gas," he says, "will not acquire the same importance in Europe as it has in the United States, if only because of the much smaller areas where drilling can take place. In fact, we are even likely to see a substantial shortfall in Europe in the next 20 years."

He believes that demand for natural gas in northwestern Europe will remain relatively constant, at about 300 billion cubic meters a year, until 2030. During the same time period, however, supplies from natural gas producers such as Great Britain and the Netherlands are likely to decline, Warnig believes -- from 150 billion cubic meters annually today to just 50 billion each year in 2030.

Competition in Europe

Also working in Gazprom's favor is the fact that Germany's shift away from nuclear power has made natural gas that much more important. Modern gas-fired power plants are extremely well suited to offsetting the strong fluctuations in the power grid that result from renewable energy sources' growing share of the energy mix. If the wind isn't blowing or the sun isn't shining, operators can fire up the power plants within minutes, much less time than for any coal-fired power plant, and thus keep the grid stable.

According to energy industry estimates, Germany will need at least a dozen more gas-fired power plants in the coming years. The Russians would like to not only supply the gas, but also operate the power plants, as Gazprom CEO Alexey Miller recently announced. Then they could earn money in two ways, by selling both the gas and the electricity.

But that is still a long way off. Whether things will go according to plan for the Russians depends mainly on how the flood of gas triggered by the United States will affect Europe. If it puts pressure on prices, the Russians will be forced to make concessions when negotiating future contracts.

All of which means that the natural gas market in Europe is seeing the kind of competition that hasn't existed thus far. In the end, this development could have a greater impact on energy security than the decision over how long the Nabucco pipeline will be -- or whether it will be built at all.

Translated from the German by Christopher Sultan
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