Ukraine should decrease its transit fees if it wants to undercut the business case for the Nord Stream 2 pipeline bringing Russian gas directly to Germany, says Thierry Bros.

A French national, Thierry Bros is a Senior Research Fellow at the Oxford Institute for Energy Studies where he is in charge of the Quarterly Gas Review. He is also a visiting professor at SciencesPo Paris and a senior expert at Energy Delta Institute. Thierry also provides research to Tellurian, a company planning to build low-cost LNG from the US.

He was interviewed by EURACTIV.sk’s Senior Editor Pavol Szalai on 22 August 2018.

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Donald Trump and Jean-Claude Juncker agreed to increase imports of US liquefied natural gas (LNG) to Europe despite the market reality. What is your perspective on this?

We have seen a very small amount of US LNG coming to Europe in 2017 and in 2018. Interesting enough, we are seeing more reloads, which means some LNG may come, but it’s going to be reloaded and sent away.

This is in fact showing us that in Europe, we have a functional gas market. It is a huge achievement of the European Commission we should all be very proud of. It took more than 20 years, but at least we are here. We have a gas price in Europe, at the TTF (virtual trading point operated in the Netherlands), and everybody can compete.

Comparing those suppliers of gas is very simple. Russian pipeline gas is the cheapest, followed by Russian LNG. They are making profits. All the others are more expensive, including Norwegian gas which is either more expensive or on the same level as Russian gas.

Can US LNG ever compete with Russian gas?

Our research shows US LNG can profitably come to Europe. When you have a spread of 5 or 6 USD per MBTU for an LNG free-on-board in the US (as compared to the Henry Hub trading point prices), it is profitable to send it to Europe.

But it’s not coming to Europe, because US LNG has an optionality: It is sold to China, Mexico and South Korea for a higher profit. Whereas Russian pipe gas has to come to Europe, it has no optionality. Tomorrow it will go to China, but the Russians cannot easily switch between Europe and China. It will take decades.

How can we explain the Trump-Juncker agreement against the odds of the market?

It’s very strange. The markets will find the most secure and cheapest way of trading. We have regasification (import) terminals in Europe that are used at 25 percent. By the way, they are more used for reloading than for unloading and putting gas in the grid. But that’s not the major issue.

The major issue is that US LNG may come if we have higher prices. But why would we need them? They are quite high already. If China is prepared to overbid us, we don’t need the American gas. We can ask for more Russian gas.

Then comes the questions why two policymakers, who are supposed to be on the capitalist side and regulate market and not mismanage it, come with such a kind of declaration. When regulating markets, you have to make sure nobody has a huge market power in your market. Diversification of supplies is what the European Commission may be hinting on. US LNG is increasing our diversification of supplies and maybe we should have more LNG.

But more LNG doesn’t mean we will have more US LNG. LNG are tanks on the sea. You call anyone around: the Qatari, US, Algeria, or Russia.

Trump's plan for US LNG in Europe to face reality check President Donald Trump’s plan for “vast amounts” of US liquefied natural gas (LNG) to be sold to the European Union after trade talks with its top representative faces a reality test.

Can this deal translate into the EU competition policy on the internal market?

Today, Gazprom has a market share of 34% in the EU. It is perfectly fine. The question is how much can we accept this market share to grow? DG Competition says if a market share is below 40%, there is no competition issue. So, we can say that if it is above 40%, it starts to be a little bit of an issue.

The Herfindahl-Hirschmann Index, which is supposed to measure the competitiveness of the European market, should not be above 2,000. We are way above in many countries. I know this is not binding, but at the end of the day, we have to think about our security of supply and our diversification policy. I think this is what Juncker alluded to. He is in a powerful position to say: We have a market with this gas price, if you want, bring your cargo and you will be paid.

But it is very important to understand it has nothing to do with the cost of supply. US LNG is one of the most expensive, cost-wise. But if the price is below European prices, it’s fine.

A few years ago, I was one of the first to say the gas industry needs to go low-cost. And lots of people said it was not possible, there are extra costs. In the airline industry, it’s the low-cost companies that are most profitable. This is exactly what we are living right now in the gas industry: If you want to be a supplier, you need to go low-cost.

Low-cost in Europe means Russian gas.

True. Russia is profitable. The US needs to reduce the cost. They can do it and they are doing it. All cargoes that came to Europe made a profit.

In the meantime, Gazprom is preparing Nord Stream 2. It has all the building permits except for the Danish one. Plus, the project is under antimonopoly investigation in Poland. What are the chances the Baltic pipeline between Russia and Germany will be built next year as planned?

Half of the capital expenses of the 9.5-billion-euro project has been spent. But first, I want to clarify a couple of things. I was in charge of the security of supply of the French state and I was in favour of Nord Stream 1 and of its full usage. It was supposed to bring new gas to Europe, it was a new route and a new technology.

Nord Stream 2 is a slightly different story. Germany is already dependent on 55% on gas from Russia. With Nord Stream 2, the biggest gas market in Europe is going to be dependent on Gazprom on 80%.

Then there is the issue of the European legislation. We have a legislation on security of supply binding us to act collectively. If a country is exclusively dependent on one supplier, does it meet the N-1 regulation (readiness for action in case of the disruption of a major gas source)? What if there is a problem? It doesn’t have to be the Russians, it can be a technical problem.

According to the legislation, in case there is a problem in Germany, we will have to switch off the French, the Polish, the Hungarians, the Italians to provide gas to the Germans. Germany is not following all those EU rules.

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Germany said Nord Stream 2 will be built only if gas transit through Ukraine continues. Are both possible at the same time?

Let’s make some very simple math. Seventy-seven BCM of gas for the EU were transited via Ukraine last year. We can add 16 BCM for Turkey, but they are lost as they will be transited by Turk Stream. If you deduce the capacity of Nord Stream 2, 55 BCM, you are left with 22 BCM. I am not sure 22 BCM will get enough revenues for Ukraine with its transit network of 146 BCM per year.

The problem is that – contrary to what Angela Merkel and Vladimir Putin stated at their August meeting – Nord Stream 2 is a political project, not only commercial. Merkel does not have a very good track record of providing an EU energy policy. Germany is going to miss the 2020 target for CO2 emissions. I don’t think it will ever meet the N-1 target. It doesn’t meet the gas target model.

Do we leave it to Germany or does the EU have to look into it? To be a bit blunt, when Greece has a huge deficit problem, it loses sovereignty over the management of its budget.

Are you suggesting that Germany should lose its sovereignty over its energy policy?

No. But there is a parallel. Germany is still running coal power plants and we all feel the drawbacks. It is fighting against a CO2 floor price proposed by Emmanuel Macron and successfully implemented by the UK.

Given the negative circumstances, will Nord Stream 2 be built next year as planned?

It won’t. It is not going to happen as it is designed now. How could the European Commission kill South Stream and let Nord Stream 2, which is exactly the same, go ahead?

Nord Stream 2 is going through less countries, it is less complicated from the regulatory point of view, isn’t it?

The question for Nord Stream 2 is exactly the same as that for South Stream: When you enter the waters of Germany or Bulgaria, do you have to be unbundled? This killed South Stream in 2014. People think it’s different because Germany will have the power to impose itself on Brussels. If it had a very good track record in energy policy, maybe it could.

Will Nord Stream 2 not be built because the EU will overrule Germany?

Brussels has tried to stop Nord Stream 2 in different ways, because it wants some Ukrainian transit. A WTO ruling is generally in favour of Brussels’ decisions. The Commission now knows it can push for more unbundling. The power of Brussels is a bit stronger. Germany shows absolutely no sign of willingness of entering into a decent, fair bargaining.

Germany is, indeed, blocking the legislation against Nord Stream 2 in the EU Council.

True. The Italian Prime Minister should absolutely not be happy that South Stream has been stopped and an Italian company, Eni, suffered, while Nord Stream 2 will go ahead.

Angela Merkel eventually had to admit after many, many months that Nord Stream 2 is not only commercial, but also a political project. And if it’s political, it has to be discussed with the other EU Member States.

Merkel was one of the leading figures at the European level when France had a weak government. That’s over. France is back on track, Greece, Portugal and Spain are back on track. There is a unity. Germany could impose fiscal policy on Greece, because it had a good track record itself. But that’s not the case for energy policy.

Lignite has a stable share in the German power production. But the shares of renewables and gas are rising, while those of nuclear and black coal are decreasing.

If you invest 500 billion euros into renewables and at the end of the day you fail to achieve your climate target, it is a failed policy. I know people never want to say Germany has a failed policy. In energy, it is failed. And therefore, Merkel’s power on this subject is fading.

Germany is not going to meet its 2020 climate target. If we are to meet the common European 2020 target, all the others must be better. Incidentally, the UK which is the good student, is going to leave us. It means that the 26 others will have to perform way better.

It is a German policy that I don’t understand, it is a non-EU and non-climate-friendly policy.

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So what about Nord Stream 2?

There is still the Polish case pending. This brings me back to the market share issue. Capitalism is all about market share. It was built and designed on the splitting of the Rockefeller Group in the US

Nord Stream 2 could increase Gazprom’s market share on the European market to 40%. I am absolutely fine with Gazprom having a higher share. But if we allow them to build the pipeline and then say, oh, by the way, you have to reduce market share – which is what we have done with Nord Stream 1 – it is not going to work this time.

In those conditions, my prediction is that Nord Stream 2 is not going to be built as planned today and with those companies investing behind. There are many other options, it can be built differently.

What should Ukraine do?

Putin was absolutely right when he stated at his meeting with Merkel that Ukrainian transit has to be economically acceptable. The Ukrainians are way too late in adapting. The transit fee in Ukraine will have to go down. I am not blaming anyone, but the Ukrainian position is also problematic.

By now, Ukraine should have been able to come up with a decent transit fee undercutting Nord Stream 2. If Ukraine had said the transit fees for using their pipe were lower than the fully disclosed cost of Nord Stream 2, it would have been very difficult for financial investors (i.e. the five European companies) to continue putting money in this project.

If Ukraine reduced the fee, it would make no sense to build Nord Stream 2.

Is really the transit fee the problem? Isn’t it the lack of basic trust between Russia and Ukraine?

First of all, Nord Stream 2 is both a political and commercial project. I can understand Putin’s political position on the project and also him discussing the economics of the project. I am European, so I fully understand the EU’s position. The Commission wants to maintain Ukrainian transit and some 2 billion USD in yearly transit fees to flow through Ukrainian economy to contribute to its sustainability.

But Ukrainians are doing things the other way around. They are thinking: Commission is going to help us, so let’s increase our fees to 4 billion USD. The transit grid in Ukraine is more than 40 years old, it is amortized. Therefore, the transit fee in Ukraine should be lower. It should be lower than Nord Stream 1 and 2.

Ukraine is not helping either on the political, or on the commercial side. Yes, there is a lack of trust. But if I was looking only on the economical level, Ukraine has a solution.

Unfortunately, Ukraine plays on both levels. It wants the help of the EU and US on the political level, but it is not smart enough to understand that in our low-cost energy world the winner has the low cost.

Russia and Ukraine in EU-backed talks to avoid fresh 'gas wars' Officials from Moscow and Kyiv were set to gather in Berlin on Tuesday (17 July) for EU-backed talks on the future of the transit of Russian gas through Ukraine in a bid to minimise disputes when the current contract expires next year.

What is the role of natural gas in EU’s future energy policy? Given the rising EU ETS prices, do you see a perspective of switching from coal to gas in Europe?

CO2 prices are now at a record level over a period of two years. Climate change is a real issue. There are only two leaders that are questioning climate change: US President Donald Trump and Australian Prime Minister Malcolm Turnbull (who resigned in August).

So, the question is: What do we do to mitigate climate change? One of the very simple things is moving away from coal power plants to the gas. If we replace in the EU all the coal power plants by gas, we have met today our COP21 target. The UK has proved it is possible to do this in two years. It’s very painful. But this is where Germany should lead a little bit more.

As the European Union, we can’t push Poland to go greener, if we haven’t pushed first Germany, the bigger and richer country. Policy-makers say, we are doing coal because of employment. A policy paper by Bruegel says it’s wrong. It is an employment issue in a very few constituencies, mostly in Poland, not in Germany.

The EU is a bargaining system. You can’t say: I am Germany, this is my position and you all have to sign the paper.

Aren’t renewables growing fast enough to replace coal?

Gas is not the only solution. It indeed be renewables or even nuclear energy,… But it is time for Germany to try to understand it has to close down a few coal power plants.

Germany should say: We are going to close more coal power plants, so we will need more gas and therefore we need Nord Stream 2. But Germany is saying: We need Nord Stream 2 – for whatever reason I can’t understand – and then we will continue to burn coal in our power plants.

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Would you advise investors today to put money into gas for electricity production or road transport?

Yes, absolutely. I am at the gas programme of the Oxford Institute for Energy Studies, so I still believe there is a future for gas. I went to a fair in Lausanne, Switzerland, where they showed a hybrid gas-powered car is the best option today.

Can gas-powered cars compete with battery electric vehicles?

Once you have an LNG regasification terminal, be it in Spain, Lithuania or Poland, your transportation fleet – buses or taxis – should go to gas. It’s better for the environment. The Barcelona regasification terminal is the oldest in Europe and there are still taxis operating on diesel in this tourist destination. It makes no sense.

The gas industry is not fighting enough. Gas in the form of LNG or compressed natural gas (CNG) is used in Italy. Why shouldn’t it be used in other places? The issue about the electric car is how to make the electricity for it. I am not a big fan of hydrogen. So, gas is the solution right now. It is not so expensive; therefore, it should be a smart solution for bigger cities. If you are Malta and have a regasification terminal, why not using it not only for big ships, but also for you own car fleet?

Not doing anything is not a solution anymore. You can’t say I am going to continue running my coal power plants because, otherwise my utilities won’t be profitable. It is not acceptable environmentally, financially, it is unacceptable on the private level and on the European level.

Every little helps. I am happy everything is going renewable. But we have issues with the quite costly batteries and extracting cobalt and lithium. The gas market in Europe works. We can get and use the gas. If you don’t want nuclear, it’s fine. We, the French are more pro-nuclear. But it makes absolutely no sense burning hard coal or lignite to generate electricity.