Bulgaria Analytica: US LNG has arrived to the region. First to Turkey, soon to other countries.

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The news of the arrival of the first LNG tanker from the US to the Turkish terminal Aliaga, and the arrival of another one in the bunkering port of Kalamata in Greece, stirred agitation among gas traders and major market players in Southeast Europe.

The long-expected entry of US shale gas on the natural gas market in the region was associated mainly with the hope for an earlier diversification than the one promised with Azeri gas, which even under the most optimistic estimates is scheduled to reach South Eastern Europe after 2019.

The news that the first tanker has arrived in Turkey is not really news. To paraphrase the famous bankers’ saying : gas just like money goes where it is least needed – the Turkish natural gas market features pretty solvent demand, diversification and sound growth prospects. It is probably the most diversified in the region – the country receives gas from Azerbaijan, Russia, Iran and the global market of LNG through its two terminals in Marmara and Aliaga. It is expected that in the span of two years gas will arrive from Iraqi Kurdistan, and the chances of Turkey acting as main buyer and transit country for considerable amounts of gas from the Eastern Mediterranean on its way to Europe are second to none.

This makes the country a natural gas hub in the region, not because Turkish leaders pretend so, but based on pragmatic reading – the level of consumption, the liquidity and the achieved real diversification of suppliers and routes.

The problem with LNG supplies until recently has been that they do not necessarily add to the bargaining power of importing countries versus Gazprom. The bulk of the contracts from Algeria, Nigeria and Qatar are long-term and oil-indexed. Prices are higher than those for Russian natural gas. But when the world gas market was hit by the American shale revolution, there was a real shift in the relationship between buyers and sellers, turning upside down old dependencies and addictions. The change was made possible precisely because the United States was both leading in the production and import of natural gas, allowing its transformation into an exporter of natural gas and of groundbreaking technology for its production, to swing the entire global oil and gas market.

The changes did not only affect trade and directions of gas flows from the Middle East and from America to Europe and the Far East. The balance of power between buyers and sellers shifted in favor of the former. In major gas markets, such as Europe, the seller in Russia was no longer able to dictate terms unilaterally and impose requirements related to commercial criteria on transactions. A sharp increase in the share of gas traded on shorter terms and referenced to spot markets soon followed. The psychological barrier of 50% spot traded gas was crossed with trends unequivocally pointing to further gains on the European gas market.

After some hesitation following market volatility and a search for the optimal way to enter the EU market with lower gas prices, the US shale gas logically landed on EU shores. US gas exporters created an impression of trying to avoid the largest national gas markets in Europe as if in order not to directly compete with Russian and Norwegian gas.

First deliveries to Europe were made to terminals in Spain and Portugal, markets that are virtually isolated from the rest of the EU gas market. The last shipment of US LNG ended up in a Scottish harbor, again far from Eastern Europe. The main US gas exporting company Cheniere, in spite of early predictions, chose to target markets outside Europe – Latin America and the far and even the Middle East.

Subsequent water testing trips and meetings with gas importers and government officials in Southeast Europe convinced them that the chances for significant sales to current clients of Gazprom are very limited.

Firstly, because gas companies in the region are hooked to long-term supply contracts for Russian gas, most of which are sealed with intergovernmental agreements which make current contracts “difficult to terminate.” Most of them feature the considered insurmountable “trap” clause of “take or pay” or a re-export ban. But that was the lesser evil, as due to new EC directives and a series of changes to existing ones, such clauses were declared contradicting EU law and restricting free trade with gas.

The EU commission intervened on several notable occasions to help buyers disregard restrictions on the resale of Gazprom gas, reasserting the new level playing ground, as any Russian gas on EU territory may be freely traded – bought and sold.

Secondly, following many years of monopoly dependence many importers, monopolists themselves, as well as the respective political elite, almost casually developed “Stockholm syndrome” towards Gazprom, fearing the worst and unforeseen repercussions in the event of infringement of contract terms.

Thirdly, the ongoing investigation by the European Commission against the Russian gas monopolist for its long time abuse of its dominant position actually offered windows of opportunity across the EU gas market, where gas importers could claim incurred losses or damages under Gazprom’s abuse of the terms of “take or pay” and “restrictions on re-export.” Most recently there have been 7 cases over the last four years in which EU importers have initiated litigation against Gazprom, five of which were settled out of court at the insistence of the Russian company, which essentially agreed with the buyers’ terms on gas over-pricing. Gazprom lost the other two cases in the court of arbitration.

Each year Gazprom allocates about $4 billion in its budget to cover the costs of similar settlements. However, Gazprom does not have to compensate Bulgargaz and Bulgartransgaz. The Bulgarian gas companies are among the few in Eastern Europe that prefer not to collect their dues, which are estimated at roughly 400 million dollars.

The most difficult barrier to overcome, however, with the arrival of non-Russian gas, including US shale gas, was the marked change in the trade policies of Gazprom. The Kremlin quickly adapted to the new realities, changed tactics and concentrated on protecting market share by lowering prices from roughly $450 per TCM to less than $150 per TCM in just two years. At price levels around 130 dollars per thousand cubic meters, US LNG has difficulties competing with Russian gas, especially when considering sporadic deals with spot benchmarks.

Despite fluctuations in crude oil prices, the rising competitiveness of gas and oil extracting technologies allows US shale gas to maintain its edge in Europe, further helped by the mandatory requirements by the European Commission for enhancing the resilience of national gas markets to risks associated with the supply problems along more than one parameter – high prices or interruption in gas flows. This has been achieved in almost all EU countries, but not in Bulgaria.

Turkey has taken the decision to import US LNG in the context of heightened tensions between Russia and Turkey following the shoot down of the Russian plane and the hard reboot of bilateral relations.

Deliveries of  LNG to the Asian part of Turkey formally fall outside the scope of direct competition with Gazprom, which mainly supplies the European part – the area around Istanbul. Henceforth, the new gas imports are more likely to compete with other LNG suppliers than harm Russian interests.

But Turkey has yet again demonstrated its firm resolve and ability to expand its maneuvering space precisely because of its plethora of entry points and links to the global LNG market through its two terminals.

Delivery of the first American liquefied shale gas in the region is logically directed to the largest market. The deal has a definite geopolitical context sending a message of solidarity United States with Turkey in the latter’s ambition to achieve better terms of trade with Gazprom and cease one-sided dependencies. These developments should be judged against the ongoing trade talks with Turkey seeking further price concessions, blending similar demands with strategic “talk” on the Trukish Stream.  So far not much progress has been achieved with the Russian side remaining cool to most of the Turkish demands. Overall, in spite of Russia and Turkey blending traditional commercial and strategic considerations in negotiations on gas talks, Turkish consumers continue to pay substantially more for Gazprom gas than their German analogues, in spite of the fact that Turkey is the third largest importer of Russian gas in Europe after Germany and Italy.

The token quantities of liquefied natural gas from America delivered to Turkey could hardly constitute a real challenge to the 27 billion cubic meters of imports from Russia. But the message was more than clear. Turkey can buy more and the US is ready to deliver.

The lack of a direct link to the most dynamic segment of the global gas market – the LNG trade – epitomizes the vulnerability of East and Southeast Europe and their total dependence on land pipelines.

Bulgaria, Romania and Ukraine have recently signed intersystem agreements allowing them and most countries in Eastern Europe to fully profit from US LNG imports from the South – terminals in Greece and Turkey. New EU regulations and these agreements have led to the release of unutilized capacity in transmission systems – in Bulgaria alone between 6-7 billion are free for third party use both in the national and the transit grid allowing for reverse gas and virtual trade.

There are still a number of constraints that must be overcome, including the full integration and harmonization of the tariff regimes and the terms for transmission and capacity trading, so to allow for a full loading of the Trans-Balkan pipeline, which offers an instant opportunity for bi-directional gas flows. However, capacities have to be aligned all along the routes from LNG terminals in Greece and Turkey to end users in Ukraine, Slovakia and Hungary.

The price of US LNG gas is tied to a Henry Hub quotation plus premium and transport. This has created confusion in regional gas companies, long accustomed to Russian long-term oil indexed contracts. Most have been unable to hedge price risk associated with stress referrals to markets outside Europe. Over time, however, gas trading in Europe will inexorably move towards adopting one or several common trading platforms as a price benchmark in EU gas trade and even move to the notion of interrelated global trade benchmarks, analogous to crude oil blends.

Although US shale gas could present a more immediate diversification option for the SEE region, its role should not be judged only on the merits of its price competitiveness. We should underestimate the range to which Gazprom could lower gas prices, even incurring short term losses, in order to retain market shares and keep competitors out of Southeast Europe. In most cases, the Russian gas monopoly could rely on its complex web of interdependencies with major EU traders. Much less so we should be expecting prices in the region or Europe to drop to US levels – 70-80 dollars per thousand cubic meters, at least until and unless Europe develops its own resources closer to market and at US price levels, which make production economically feasible.

The fact is, however, that it is just a mater of time before SEE gas importers jump on the LNG bandwagon and start using it to balance their internal supply and demand mix.

With or without our consent, in most cases grudgingly, we have joined and profited from the shale revolution.