European gas buyers unwilling to pay for security of supply

Even as we've been going through years of hand-wringing about security of supply, and about how Russia was an unreliable gas supplier, it comes out the European gas buyers are themselves increasingly refusing to pay the price that underpins the security of their Russian supplies, and are breaking their contractual obligations towards Gazprom, making Europe, erm, a less reliable customer... something that's likely to come and bite us in the near future:

European Energy Firms Fall Short in Gazprom Purchases

European energy companies, faced with weakening demand and plentiful lower-cost fuel supplies, have bought far less natural gas from Russia's OAO Gazprom this year than they are obliged to under long-term contracts -- setting the scene for a potentially damaging showdown with Moscow.

The reason for this is that long term gas supply contracts have their prices linked to that of oil, and the price of oil is now significantly higher than the price for the equivalent volume of gas on the spot markets, thanks mainly to currently very weak demand for gas in Europe, courtesy of the economic crash.

But the whole point of these long term contracts is to guarantee both supply for the buyers, and demand for the sellers. In fact, their very name ("take-or-pay," ie buyers have to pay even if they don't take delivery of the gas) suggests that it is security of demand which is the more important of the two. European buyers apparently unwilling that price is a major new development, and a very worrying one.

Of course, they will argue that they are in a competitive market, and cannot let their competitors undercut them with cheap gas procured on the spot market. In the goold old days, when they were domestic monopolies, the higher cost of supply could be passed on, in coordination with national authorities, to customers via regulated tariffs, but these don't exist. It is not unreasonable for the now deregulated players that entered into these contracts for national security reasons to be compensated for that effort. But of course there are no mechanisms to do so.

Take-or-pay contracts are a vestige of the early days of the gas industry when liquid spot markets didn't exist and producers needed long-term deals with stable prices to underpin vast investments in new gas fields.

The WSJ article blithely suggests that such long term contracts are no longer necessary, and that private markets and spot prices will spur the requisite upfront investment by companies like Gazprom. They might want to take a look at how ExxonMobil, Shell and others developed the Qatari gas industry: on the back of long term take-or-pay contracts for significant portions of the production. Even if Russia were somehow to authorize foreign investment in its gas fields, and exports of that gas by Western oil majors, the contracts would still look very similar to those currently signed with Gazprom.

The issue here is the short term gap between oil-based and gas-based spot prices, which make the Russian (and Algerian, and Norwegian) contracts uncompetitive today. But the European buyers did not complain too loudly when oil price increases in 2002-2008 were passed on to them only with a lag of several months, ie when the differential was in their favor.

So we bump against the intrinsic short termist behavior required of private firms in a deregulated market, which makes a joke of the supposed preoccupations of our governments with security of supply. Long term contracts ARE the best answer to security of supply worries, and they have worked in this industry for 40 years - and they are being trashed by the industry today, because it damages their profits this quarter.

It doesn't seem to matter that we get demonstration after demonstration that deregulated markets do not fulfill the most basic objectives of a sane energy policy (unless you count the profits of energy companies, traders and the banks supporting their speculative endeavors as the only such objectives) - the only lesson our pundits and propagandists "get" from such crises is to call for yet more deregulation.

Go figure.

Jerome, can you comment a report that Gazprom is to sell 13bn cu m of gas on European spot market in 2009, out of total 131bn cu m of export. The source (Russian business newspaper Kommersant) implies that Gazprom bids against its own long-term contracts to artificially create a situation where it can impose fines on European companies. If true, Gazprom successfully exploits deregulated markets, effectively selling the same amount of gas twice.

Gazprom has long been ambivalent about the spot market, feeling that they would be undermining their own long term contracts (given that there are no real alternatives, for significant volumes).

They've also created sub-contracts in their main contracts, which sell the gas not to the buyer but to joint ventures in variosu European markets between that buyer and Gazprom, and such JVs sell on the local market under different formats (contracts to large local clients, some spot).

They're probably also selling to new entrants and traders.

But I'm not sure they could game their contracts that way - don't forget that their big buyers can also play with several sources and have no qualms doing so.

Right now, the big issue is simply much lower demand, altogether.

I think it's turning this issue on it's head. Gazprom might be willing to sell additional gas, but it's up to buyers to decide if they are willing and need to get that gas in addition (that part is very important) to the signed contracts. If buyer decide that that can cheat by buying cheaper spot gas and ignore the contract, well.. that simply breaking the contract. And it does not matter who they buy the spot gas from. Whether they'll buy it from Gazprom or not. First they must buy contracted gas at contracted prices and then buy spot gas. And Gazprom of course must follow it's part of the contract and first sell gas at contracted price and then sell what else it has available at spot prices (as it has done when prices favored buyers). Both sides must follow the contract, not only one side.

there are short term and long term considerations. In the short term, you are right, of course. But if buyers see Gazprom supplying a lot more gas on the spot market, they might be tempted to not renew their long term contracts when the opportunity comes, or only for smaller volumes.

But what if gas companies can't sell the gas to end users because end users buy cheaper spot gas from Gazprom? The companies can't compete with Gazprom, they can't lower the price. And Gazprom can always say "you don't buy enough gas, so we have to sell it on spot market".

Funnily enough I was wondering whether in a crisis Australia should renege on LNG supply deals to China. To give credit to many TOD commenters they forsaw this when our political and business leaders didn't.

I think plug-in cars will be too expensive and have too short electric range for many people. If CNG vehicles, initially buses and trucks then cars become popular then gas will be as crucial as oil. Then there is nitrogen fertiliser, process heat (eg baking) and backup for lulls in wind power. Therefore gas should be restricted to vital applications. IMO at least half the grid electrical input should be nuclear. Australia and Canada are not going to withhold that particular fuel. Home heating of well insulated rooms should be done with smart metered air source heat pumps. That is, remove the gas heating. Use the cap-and-trade revenue to pay for most of this.

A bare-bones amount of gas generation should be allocated as wind power backup, depending upon transmission alternatives. The starting ratio should be 1:1. That is no more than 1 kwh of gas fired for every 1 kwh of wind. Baseload gas generators and excessive amounts of gas standby should be mothballed. Voila, we need less gas or at least the priorities are altered.

Im a little surprised that no one here seems to saying anything Turkmenistan? Or is it that everyone who knows is too busy running around screaming as if their hair was on fire?
On October 12, two separate sources -- Russian journalist Arkady Dubnov, writing for the Russian newspaper Vremya Novostei, and a Germany-based non-governmental organization called the Eurasian Transition Group (ETG) -- alleged that the Turkmen government misled the independent auditors by providing them with inaccurate, hyped data. The end result was that Turkmenistan’s actual reserves are probably far lower than the estimate contained in the 2008 Gaffney Cline report.

I found these articles, suggesting that the overstatement may be real.

Turkmenistan’s Eastern Promises

There is trouble in Turkmenistan. Revelations that reports on natural gas reserves in the former Soviet republic were overstated could reawaken concerns about Ashgabat’s ability to meet all its ambitious export promises. if it wasn’t bad enough, Turkmen President Gurbanguly Berdymukhammedov fired almost all the country’s top oil and gas officials on 13 October in a humiliating televised scolding, citing their “irresponsible approach” and accusing them of unspecified deficiencies and negligence.

Experts have been wondering that for years - can Turkmenistan meet its promises or not? “That has always been an open question – could they meet their commitments, even to Russia for that matter,” Ron Smith, chief strategist at Mos cow‘s Alfa Bank, told New Europe on 15 October, adding that Turkmenistan has remained closed to the outside world.

Turkmen President Fires Officials For Overstating Gas Reserves

Turkmenistan's President Gurbangeldy Berdymukhammedov has dismissed gas officials for allegedly overstating the country's reserves. reported Berdymukhammedov acted after receiving reports that officials had doubled or even tripled data on extractable gas reserves at the country's Iolotan-Yashlarsk group of deposits.

Although I don't know the details of different markets, it is hard to think of other markets where there is such a disconnect between spot prices and long term supply prices. For example, in North America, long term natural gas prices seem to follow spot prices. My impression has been that with other types of energy products (uranium, coal, LNG), long term prices and spot prices don't stray terribly far from each other.

I am wondering if with the recession, people are enough poorer that this is starting to cause the system of a high long-term natural gas price tied to the price of oil and a much lower spot price to start coming apart. Buyers simply can't afford the higher long-term prices, and this is putting pressure for Russia to sell its gas at a price closer to the spot price. One might expect with this scenario that the long term prices charged by Russia would need to come down, to be more in line with the short term prices, even if Russia would prefer to charge more (and could afford to pump more gas if higher prices were available).

If this price collapse does occur, it seems to me it could have a very negative impact on supply, since with natural gas, the amount a company can afford to pump depends very much on price. If prices are low, there is no point in developing the more difficult gas supplies.

Don't forget that the differential can work both ways - during most of the past decade, as oil prices were going up, gas prices in Europe followed only with a lag, to the advantage of the buyers.

Should we dump a system that has worked well for 40 years because of an unprecedented drop in gas demand in the past few months?

And, more to the point, what's the right price for "security of supply"

I doubt that enough people are already poor enough to not be able to pay their gas bills to make a difference. Recession did not cause too many people to loose their jobs. Besides that, in most European countries there is a social network supporting those without an income. There won't be hordes of people in the cold soon. The majority of the people might not have gotten a raise last year, but almost everyone is able to continue their life comfortably.

And even if gas prices continue to be very high, then that might have the positive side effect that more people start thinking about investing in conservation or alternatives. The extreme would be a big increase in use of solar collectors for LT heating or PV panels in combination with heatpumps and conservation. This results in less polution, CO2 and less vulnerability of energy supply on foreign countries.

It seems that an escape forward (to sustainability) now might be wise as there is still enough money flowing to be able to implement these alternatives, instead of waiting until expense on energy diminishes the liquidity to do so (downward spiral).

While your point is not directly about fungibility of the commodity, it of course plays a good part in NatGas.

If natgas was like oil, we'd not have this problem to a same degree, but pipeline delivery means longer contractual agreements for both parties.

Like Jerome has well pointed out, this has advantages in terms of security for both parties.

Now, as you clearly point out, removal of this security on the producer side kills investment incentives over the long term, esp in times of volatility.

What would be the most obvious move from Russia in this case?

Use some of those national reserves to build delivery capacity to India, China, etc, which could in the future buy up all the Russia can produce and more. Less volatility, more buyers, easier to pit them against each other, higher prices.

Now, if it were as simple as dropping ready made pipes from a plane, Russian companies along with some help from the government would have already done this. Currently the cost is the prohibitive factor, but I bet it will come, in due time. It's just a matter of time.

European would be silly, imho, to hasten this process with their own short-sighted profit-taking. After all, we are in Europe fairly tightly wedded to Russian gas, esp. if we are going to start phasing out coal due to GHG emissions. Nuclear capacity won't be built in fast enough time-frame to replace it and if we'd lose gas in the same rough time-frame? Well, not a good idea, to put it shortly.

Like Jerome said, security has a price. Nobody can just value it perfectly and in times like these, many are looking keenly on expenses.

Apologies for a somewhat off-topic comment, but it is directed at people based in the UK so I thought a TOD:Europe thread would be the best place to post.

If you are a citizen or resident of the UK, please sign this petition to the Government to read and respond to the recent UKERC report on oil depletion:

I don't know how useful it will be, but it only takes 30sec to sign. Cheers all.

Sure thing, why not. But do you really expect the PM to take any notice of these petitions? Tens of thousands signed the one to strip Fred Goodwin of his knighthood and stop his pension. Did it do any good? The political 'elite' don't care what you and I think!

No, I don't expect it to do much good per se, but I think that there is a value in low-level agitation of this kind, if only so that you can then work upwards. I went to see my own MP a couple of weeks ago about this - unfortunately she is Conservative, but relatively receptive so I asked her to find out her own party's stance on preparation for the peak. If we can get them to come out with any sort of official position, then that gives some starting point for a debate, and given that they may well be in Government themselves this time next year it could be more useful. If they can be encouraged to express a view while still in opposition, it may be a more helpful one.

And no, in the main I think they don't care or don't know enough to care, but it is clearly better to try to do something than nothing, especially small things which take very little effort. (Email your own MP)

EricaT - the problem with all MPs and all main parties is that they will nod politely as you explain the situation. They might even understand it. They might even genuinely share our concern. But then they will trot out some BS about "building a sustainable green economy, which will power future GDP growth yada yada yada". Not one politician will acknowledge that it is the unsustainability of consumptive exponential GDP growth and expanding populations which will do for us in the end. They are all, frankly, duplicitous morons.

The exception to the above being the Green party, but they hide their lamp under a bushel: too afraid to speak the truth or they would get even fewer votes than they currently do. And as far as I am aware the Greens are in favour of ever larger world government/EUSSR and have no intention to limit immigration - which means that how ever noble they may be on issues of the environment and resource depletion they will never get my vote. (If someone can put me right on these issues then I would be happy to vote Green at the next election.)

It is a telling state of British politics that the only two parties to acknowledge peak oil (and other resource depletions) are the Greens (good), and the BNP (less good..). Michael Meacher (Labour MP) is quoted as being Peak Oil aware, but is not taken seriously by the government anymore as he doesn't fit their narrow agenda.

With ALL due respect: I would strongly request that you watch what Jimmy Carter told the American people in 1977. When America "peaked". He was a man of GREAT courage, and that courage cost him re-election. And today's leaders have learned from this.

OF COURSE Governments are aware of the problem/s. [Iraq/Nabucco/ect] All over the world, governments are moving geopolitically to sure up assets. And are investing record amounts in "green tech" in some capacity. Are they moving fast enough? No. But, they ARE moving. And "we" all know why.

It is incredibly naive for anyone to suggest that it is GOOD for -ANY- politician to stand up, and proclaim, LOUDLY that the "age of oil is ending", and that "Every car everyone owns, might not have affordable petroleum after 2020, if not sooner."

Wile we all would HOPE that this news would encourage the unenlightened populations among us to support massive and major investment in "green tech"... I would encourage you to consider it might -NOT-.It might just cause chaos at the WORST possible time.

Let alone in the UK where GB/Labour is in a near impossible situation as it is. Or, in Eastern Europe+Eurasia where the Economic crisis is STILL raging, and ethnic/nationalist populations are making a LOT of dangerous noise.

A time WILL come when everyone is aware. The problem, and the solution WILL reveal themselves! Let us debate "when" Governments need to speak about it, what to say, and what to do.

Not "if" governments are even aware.

done , "every little helps" to qoute one company...


I put a notice up on Drumbeat as well, since it gets more readership.

It appears to be down for maintenance.

I would be deligted to but seeing as the gov totaly ignored the petitions demonstrations regarding ilegal Iraq war then proceeded to made Blair a peace commisioner and now want to make him EU president. I dont think there is a blind bit of hope that they will pay any attention.

Oh dear oh dear.
One solution, surely, would be to change the oil linkage. The problem being that oil, like gas, appears to be plentiful at the moment, but that its price does not reflect this (or, if we believe the conspiracy-theorist faction at this site, oil is in fact scarce, and gas isn't.)

Hence the disconnect between contract and spot prices. Substitutability between oil and gas clearly isn't great enough to justify such a tight linkage.

On the other hand, I certainly hope the Euro clients won't be stupid enough to renege on their contracts. As I understand it, the current oversupply of gas is likely to be temporary, with Russian fields likely to decline soon.

And an unreliable European market will tend to push the central Asian producers towards China, where the buyers have strategic vision... so the pipelines will go east, not west...

Question - I've been trying to find a study of how people and utlities coped in 2008 during the gas embargo. I had thought that the electricity grid would collapse due to over demand but it didn't as far as I know.
Was this down to any or all of the following ?
1. people didn't have enough resistance heaters on hand or in the shops to overload the grid given their low prevalence these days
2. people obeyed the public call for restraint in their use

Also I had heard that re-starting domestic supply was tricky due to the need to purge the system of air. However I didn't hear of this as a serious matter after this crisis.

Just trying to figure out what would happen in the UK if this happened ?

Remember that the gas embargo happened in January, at the beginning of the winter, ie when storage was close to full, so utilities did not need to cut off deliveries quite yet. Even in countries that receive all their supplies from Russia, I suspect that any cuts that took place were "managed" by local authorities to blame Russia rather than caused by actual physical shortages.

Actually not all Eastern European countries have enough natural gas storage to cope with such a supply problem. While my information about the topic comes only from media coverage, I watched the natural gas problems of January 2009 quite closely. The situation in the north (Poland, Czech Rep.) was manageable – there were high storage levels, and some nat. gas was still coming from Russia with the pipes going through Belarus. AFAIR only some big industrial customers (using above 1 mln m3 gas daily) felt any kind of problems – the local population was rather unaffected.

In the south (Serbia, Bulgaria) the situation was much different. First, these countries rely much more on the natural gas transit through Ukraine. Second, they have close to no storage. All the nat. gas was gone in the first or, the latest, second week of January. Since then some people had to freeze in the dark – there were not enough heaters for them to buy, and there were local blackouts due to increased electricity demand (no total collapse of the grid however). Some city utilities switched to other fuels (I remember reading the complaints of people from Sofia about air pollution caused by burning diesel instead of nat. gas), some needed to shut down.

Coming from Eastern Europe myself, I cannot remember any large-scale blackout in the last 20 years. The biggest one that happened would shut down a large city, but region-wide or country-wide blackouts just didn’t happen. I don’t know the reason for that though.

I have no idea about the issues with re-starting the natural gas transit system. However, I think the people there know how to do it since the Russians provide them with regular exercise :)

I don't know where you read this, but noone had to "freeze in the dark" in Bulgaria. First it's not true there is no storage - there is a huge storage near the village of Chiren capable of meeting about half of the country's normal winter demand for several weeks - which allowed most essential usage to be left uninterrupted. Second the majority of people already do have resistive heating devices in their homes, and the electricity supply in the country is quite reliable.

What really happened is that some factories suffered losses because they were the first to be disconnected. Second, central heating utilities had to switch between natural gas to heating oil and this technologically takes about a couple of days - during which there was no service. Yes, some schools had to miss classes for a day or two, there was even a case for a hospital which lost heating, but nothing extreme. Overall it was more of a media fuss than being a real problem; in reality the situation was brought under control relatively quickly.

Yes, there is the question what would be if the crisis had continued a month or two, but in my opinion both sides participating in this showdown knew they had to resolve their issues promptly otherwise their reputation would be damaged way too much (which of course was the source of pressure from both of them).

I remember reading in January 2009 some alarmist articles about the situation in Bulgaria and Serbia. It is well possible that the media just wanted to exaggerate and found the most extreme cases. As I said, I am not an expert on this and I just repeated what I have read before - you seem to be much better informed here.

I personally know that there were no big problems in Poland and Czech Republic at that time - only some big industry companies had reduced supplies. District heating is based mostly on coal there so it was also no problem. However people were aware that the supply situation might get worse should the pipelines be cut off for a longer time (which means until the spring comes, or longer). You say mostly the same about situation in Bulgaria – this means that Jerome's comment was fully correct in this matter.

I also bet that the two disputing sides didn't want to wait until the other indirectly involved countries really suffer.
China Pays Premium for Qatari Gas
OCTOBER 28, 2009

Reuters reports that Qatar is diverting some 10% of its natural gas exports to China from the U.S. because China’s paying more.

“We will not go to a low price market. There is a lot of demand for our gas elsewhere,” said Ibrahim al-Ibrahim, adviser to the ruler of the tiny Arab Gulf state, according to Reuters.

What Qatar says matters. While it’s not the biggest oil producer, it’s the world’s biggest LNG exporter. China uses much more coal than natural gas, which accounts for only about 3% of its total energy use. But gas imports are rising fast. Last month in September, China imported a record volume of liquefied natural gas.

It is implied in the post and comments that failing to meet the annual take requirement is some kind of breach of contract. That is probably not correct; the contracts seem to provide for a liquidated payment in the event of the buyer's failure to meet the annual contractual take level, which is what I think is being discussed between Gazprom and the affected utilities. There may even be a way to roll the deficiency over into the next year.

Therefore it is false to link this situation with a failure by governments/private firms to provide for security of supply; the long term contracts do not appear to be at risk of being breached. (Now if the utilities fail to make any required payment, it would be a different matter altogether).

The prices in the long term contracts were established at a time when natural gas and fuel oil were substitutes. That is no longer the case. Indexing the price of natural gas (a commodity of one type) against the price of oil (a commodity of another type) is similar to pricing wheat against corn. When the supply and demand fundamentals of one commodity become completely different from those of another, it no longer makes sense for those prices to be linked.

If the annual purchase deficiency is rolled into the 2010 requirement, it would set up a massive oversupply situation in 2010 as the pipeline takes would conceptually have to increase over the 2009 level, even as LNG supply increases and demand is not projected to rebound significantly. Presuming that 2010 pipeline take levels are higher, this supply/demand imbalance is poised to become worse sooner than it will improve. The fundamental economic imbalance is going to have to be addressed, and the most likely situation is that the economic burden will fall on the pipeline suppliers to price their commodity in a way that more completely reflects supply and demand of that good.

If economic signals in the market are telling producers to slow down, then I can imagine no better reason for them to do so. It is difficult to construct an argument that has the consumer funding an unreasonable economic rent for a good she doesn't demand.

So right snook...the devil's in the details. Can't really judge such situations without all the aspects at hand. back in the energy crunch of the late 70's in the US "take or pay" clauses became very popular. A utility had to secure NG for its users but you can't force a utility to take deliveries if they can't sell due to low customer demand. The pipelines had to have such relief because they typically had to guarantee volumes/prices to producers. I don't recall if there was a carryover credit in such deals. How tough the individual terms are will generally mimic the supply/demand relationship: if User A doesn't like the terms but User B accepts them that's where the NG goes.

I hadn't thought about it but as PO becomes an ever more controlling issue such take or pay requires could become a factor in oil purchases: Yes...I'll sell you oil at the current market price but to get access to my supplies you have to contract X million bbls over Y months at a price of $Z/bbl. You might have to accept the deal because there are more buyers with the cash then there are supplies. Imagine if a refiner had cut such a deal last year when oil was $100/bbl and then had to keep buying at that price or, perhaps, pay some $ penalty per bbl not bought under the contract. Time will tell.

Perhaps the existence and condition of required infrastructure plays a role.
For example, if you have a solid network of pipelines, storage etc (and I am referring here to NG) which is paid for, or at least has managable periodic costs, one can participate in the shorter term markets because there is less of a need to accurately define future cashflows.
On the other hand, if you're building an LNG train which costs billions (of fresh capital) and high operating / variable costs you need to ber quite certain of your future income---> long term contracts.

Imagine if a refiner had cut such a deal last year when oil was $100/bbl and then had to keep buying at that price or, perhaps, pay some $ penalty per bbl not bought under the contract

I imagine that refiner would be out of business, and some other outfit would buy the refinery's remnants later after the shortage of refining capacity had driven up the prices. But I live in an odd world. The local refinery sits right on TAPS and has a sweetheart deal with it but none of the enron type outfits that bought the plant lately are really very interested in the refining part of the business. They were all playing some kind of book keeping game with the assets. We pay CA level fuel oil and gasoline prices even though the refinery sits right on the pipeline (no tanker loading, shipping or offloading required) and these guys still can't seem to make a profit. My view could be a little skewed.

Right. I posted a comment in the European Tribune version of this story which I forgot to include here:

The interesting question of course, is whether the European buyers will actually pay for the gas they chose not to have delivered this year, as their contracts require.

I expect that they will - they can deduct the funds paid this year for undelivered gas from payments in the coming years for volumes above their minimal obligations then.

So is this only about changing the price formulas (away from oil prices towards spot-based formulas), or is it some attempt to weaken the "take-or-pay" clauses? It's not clear to me yet, and I'm pretty sure that different players in this story (including those reporting it) have different agendas here.

I should have made that point clearer here too. But the noise is about the oil indexation, and if the "protest" takes the form of non-payment of amounts due, it could get nasty.

Russia sells natural gas for 40% the price of oil on a joule for joule basis. This is hardly unreasonable economic rent. It is an unjustified subsidy to a bunch of hypocrite whiners who have the freedom to shop elsewhere if they are so afraid for their "security". The current drop in gas demand is a meaningless blip that does not negate the real, long-term demand for natural gas in Europe. The contracts are there to address this market and not daily speculative nonsense. These contracts are quite generous to the customer.