Monday, 29 May 2017

Why do consumer expectations of a higher competition between LNG and pipeline gas in Europe now perceive as even more problematic than before?

A year ago, forecasts for development of the European gas market suggested that expansion of a global gas glut would tend to increase competition between LNG especially the first American shale LNG to arrive in Europe as well as conventional LNG on the one hand, and pipeline gas on the other hand. However, these hopes have not materialized yet. In 2016, there were only four shale LNG cargoes delivered to the EU market from the US, including Portugal, Spain, Italy and Scotland. In the latter case, ethane from US shale gas was shipped to company INEOS' petrochemical plant at Grangemouth. Two more LNG shipments from the US were made to Turkey. In total, the volume of American LNG delivered to Europe in 2016 was about 500 mcm. For comparison, that is approximately 40 times less than the increase in gas imports to Europe via pipelines from Russia reaching almost 20 bcm in 2016.

Despite overall natural gas demand growth in Europe in 2016, in the majority of the European countries LNG had been driven out by the competition of pipeline gas and many of them saw a decline in LNG imports as most of this fuel went to better-priced markets in Asia and the Middle East. As a result, utilization of the total installed capacity at the European LNG import terminals had been declining during 2016 to a very low level. According to the LNG World News, the average rate of LNG terminal utilization in Europe has decreased significantly since 2010 to below 20% of the total send-out capacity last year.
This trend seems to be continuing. For example, LNG FSRU in Lithuania has a particularly low rate of utilization. During the first four months of this year LNG FSRU Independence located in the port of Klaipeda regasified 2,977,000 MWh of LNG, 54% down compared to 6,478,000 MWh for the same period of 2016. It has to be admitted that since the beginning of this LNG project the fundamental rules of market competition and economic feasibility have not played their usual role. Lithuanian company Klaipėdos Naptha has a 10-year lease with Norway’s Hӧegh LNG for use of an old LNG tanker as FSRU at an annual cost of 61.45 million Euros. Installation of the terminal in the port of Klaipeda, and its connection to the gas transportation system cost 101 million Euros. It is not hard to calculate that lease payments for 10 years including other costs will exceed 710 million Euros, which indeed is a heavy burden for the country since, as a comparison, in 2016 the State budget revenue of Lithuania accounted for 9.3 billion Euros only. Thus, regrettably, the Lithuanian LNG project is not fulfilling its mission efficiently, nor did it represent the best use of funds for energy development aimed at competitive retail pricing in the gas market.

Retail prices - an attribute of the "game" on several playgrounds for price formation but common principles of market competition do not apply to all of them.

The formation of prices can be compared with the sports game that reveals an important distinction - this "game" is going on three playgrounds each with different rules to settle the score. Three playgrounds correspond to the three components of the diagram of different colors below. There are those playing on blue color game site that determine cost of the energy component, thereafter, toffee color – cost of the gas network component, and the last one, green color – cost of the taxes and levies component.

It should be clear to everyone that competition occurs just on blue playground. Only there competition is exercising direct influence on formation of the energy component within a retail price in gas market. According to Report on Energy prices and costs in Europe, published by the European Commission on 30 November 2016, due to competition the share of the energy component in the total price decreased by 5 percentage points from 59% to 54% for the period from 2008 to 2015. The average energy component accounted for 3.54 Eurocent per kWh in 2015.

Unlike the above-mentioned, the competition is absent, by definition, on toffee color and green color playgrounds. In this case, the formation of retail price components is governed by state regulations. The share of the network component marginally increased from 21% to 22% and amounted to 1.49 Eurocent per kWh in 2015. The biggest increase by 4 percentage points occurred with the taxes and levies component from 20% to 24% and accounted for 1.56 Eurocent per kWh in 2015. According to the recent Eurostat data, the EU-28 average price of natural gas for household consumers during the second semester of 2016 amounted to 6.4 Eurocent per kWh.

Thus, owing to competition in the gas market the share of the energy component declined although gas consumers could hardly benefit from it because both of the other price components related to the network cost as well as taxes and levies still make up half of retail price for household consumers in the majority of the EU member states.

On these last two price components, it is commonly believed that only they are regulation objects. Meanwhile, non-market administrative and regulatory forces actually interfere in the formation of the energy component, in particular influencing competition through selective imposing certain import barriers and conditionalities on the routes of gas supplies to the market. However, fundamental analysis of commodity markets claims that the greater the supply, the lower the price tends to fall benefiting gas consumers.

In practice the arguments in favour of "concerns about potential disruption of gas supplies" to Europe because of the ongoing conflict in Ukraine, which still remains a major transit route for Russian gas, do not seem convincing any more. Attempts to limit natural gas imports from Russia, for example via pipeline OPAL can negatively affect the supply-demand balance and leads to undesirable changes in competitive prices. Quantitative restrictions imposed on gas supplies are known to contradict the core principles of the WTO, although it seems as if Brussels does not care about it. What is more, for the European Commission it seems to be the normal thing to consider initiatives of some EU member states, particularly Poland, which are standing for limiting of gas supplies from Russia, while European companies fulfilling the Russian gas imports recognize its ability to compete in the European gas market.

"Europe is "dependent on Russia" in terms of a secure and affordable gas supply," Chief Executive of Germany’s largest crude oil and natural gas producer Wintershall, Mario Mehren, said in an interview with Handelsblatt in April, explaining that Europe needs additional gas imports and Russian gas can withstand any competition.

According to Reuters, in 2016 the average gas price was expected to be 167-171 USD per 1,000 cubic meters (1.60 – 1.64 Eurocent per kWh). By way of contrast, Lithuania, for example, was purchasing imported LNG at the price of 2.19 Eurocent per kWh in the first quarter of 2016. Such a high price obviously did not resulted from the market competition but was politically motivated. During a presentation for investors in Singapore in February Gazprom announced that following the trends in the world oil market prices of export gas contracts to Europe would rise in 2017 to 180 -190 USD per 1,000 cubic meters (1.72 -1.80 Eurocent per kWh) remaining competitive.

So why not start considering competition at gas market not only within business environment but also at the policymaking level of the EU member states entirely as means to reduce costs and improve energy services rather than a tool for advancing narrow political interests?