CEE: Gas Prospects Stronger, As Regional Dynamics Evolve

BMI View: Our forecasts suggest that Central and Eastern Europe (CEE) will see a strong increase in both oil and gas consumption. We also expect growth in gas production and exports, though underlying the aggregate trade balance is a clear divide between net importers in Eastern Europe and net exporters in Russia and the Central Asian countries. Diversification of gas imports thus remains a key strategy for Eastern Europe, while Russia and Central Asian countries look to East Asia for new growth markets.

The key themes that have emerged in BMI's Central and Eastern Europe (CEE)'s oil and gas forecasts are:

  • The regional production outlook is more positive for gas than oil. Regional gas output is expected to rise on an average of 9.8% compared to an increase of around 4.5% in oil output over our 10-year forecast period between 2013 and 2022. Net importers and exporters alike could see substantial rises in output from greenfield projects particularly from offshore production.

  • Gas Set To Perform Better
    Regional Oil Production (LHC, '000b/d) & Gas Production (RHC, bcm), 2010-2022

BMI View: Our forecasts suggest that Central and Eastern Europe (CEE) will see a strong increase in both oil and gas consumption. We also expect growth in gas production and exports, though underlying the aggregate trade balance is a clear divide between net importers in Eastern Europe and net exporters in Russia and the Central Asian countries. Diversification of gas imports thus remains a key strategy for Eastern Europe, while Russia and Central Asian countries look to East Asia for new growth markets.

The key themes that have emerged in BMI's Central and Eastern Europe (CEE)'s oil and gas forecasts are:

  • The regional production outlook is more positive for gas than oil. Regional gas output is expected to rise on an average of 9.8% compared to an increase of around 4.5% in oil output over our 10-year forecast period between 2013 and 2022. Net importers and exporters alike could see substantial rises in output from greenfield projects particularly from offshore production.

Gas Set To Perform Better
Regional Oil Production (LHC, '000b/d) & Gas Production (RHC, bcm), 2010-2022
  • The prevalent market dynamics - which see Eastern Europe as net importers and Central Asia (Azerbaijan, Turkmenistan, Kazakhstan and Uzbekistan) and Russia as net exporters - will remain largely unchanged over our forecast period.

  • Russia will continue to account for most of CEE's output averaging around 72% of the region's gas and 74% of oil over the ten years from 2013-2022. However, Russia's dominance will reduce and Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan will strengthen their relative positions, contributing to a larger share of the region's oil and gas supply.

  • Both oil and gas consumption is expected to rise alongside economic expansion. Oil demand in the region is projected to grow 31% between 2013 and 2022, while gas demand growth is expected to clock in at 18.7%. However, it should be noted that this impressive growth is based largely on Central Asian countries growing from a low base.

Strong Consumption Growth Driven By Central Asia
Regional Oil Consumption (LHS, '000b/d) & Gas Consumption (RHS, bcm), 2010-2022
  • Gas export capacity will rise considerably in Azerbaijan and Turkmenistan over our forecast period, which together will add over 77.5bcm by 2022 to CEE net gas exports. However, growing regional gas demand will result in a decline in net gas export capacity in Central and Eastern Europe as regional production expansion trails behind demand growth.

  • Oil export capacity is also anticipated to shrink on the back of an expected decline in oil output growth while demand rises, therefore reducing the volumes available for export.

  • Despite strong oil demand growth, refining capacity will remain relatively stable in most countries as there is already sufficient downstream supply throughout the region. Only Russia, Turkey, Turkmenistan and Bulgaria have plans to add to their downstream capacity over the forecast period.

  • At present, the refining capacity of most Eastern European countries is likely to stagnate. However, if the poor refining environment currently plaguing these countries - high feedstock prices, weak prospects for significant domestic demand growth - persists, this will pose further downside risks to our forecast for the region's refining capacity.

Again, Russia Top The Table
Regional Refining Capacity, 2010-2022 ('000b/d)

A Mutually Dependent Relationship

Russia and the Central Asian countries are net exporters while Eastern European countries are net importers. The promise of shale gas and Black Sea gas resources has increased exploration activity in import-dependent states such as Poland, Ukraine, Bulgaria, Turkey and Romania, but it will take time before discoveries are developed for commercial use. Hence, the current energy trade status quo in the region will largely remain over the duration of our forecast period from 2013-2022.

Holding Fast To Status Quo
Comparison Of Net Gas Export Capacity By CEE Countries, 2013f & 2022f (bcm)

Most of the central and eastern European region's trade movements occur via pipelines rather than liquefied natural gas (LNG), due to the lack of access to port facilities and the proximity to Russian resources. With the exception of Turkey and, to a smaller extent Balkan countries, which have access to Middle Eastern and North African resources, the prevailing trade dynamics (flows from Russia and parts of Central Asia to Eastern European markets) will persist.

The legacy of the Cold War has left importer countries highly dependent on Russia for crude oil and gas. This is particularly the case for gas and many of these countries are often locked into long-term supply deals at fixed rates indexed to oil prices with Russian state-owned gas export monopoly Gazprom. Russia has also used its abundant energy sources as a bargaining chip to achieve its political goals of enticing more countries (namely Ukraine and Central Asian Republics) into joining its customs union with Kazakhstan and Belarus.

However, Russia is just as reliant on Europe for gas export markets and is struggling maintain its dominant supplier position with growing alternative supply sources from Azerbaijan, Norway and LNG exporters. The South Stream pipeline project, which will transport gas from Russia into Eastern Europe via the Black Sea, is one attempt to secure the market. Russia and central Asian countries also looking to send their resources East to China as demand growth from Eastern Europe remains limited. Turkmenistan, Uzbekistan and Kazakhstan have already agreed gas supply contracts with China, while Russia remains in deep negotiations.

Weaning Off Russia Oil And Gas

Russia remains the dominant supplier of oil and gas to Eastern Europe and with that status carries significant political bargaining power. For example, Gazprom offered to finance the construction of the Bulgarian section of the South Stream project in exchange for 15 years of transit rights. Also with a strong influence in Serbia, this will enable Gazprom to have control of gas deliveries deep into central Europe via its new South Stream route.

With so much influence on the European market, the risk of high gas prices has also brought Russia to loggerheads with importing countries. A large number of gas European based importers have managed to renegotiate gas prices that were formerly purely indexed to oil, which have seen considerable cost increases spikes with oil prices remaining high. At points, LNG spot prices have been more competitive than pipeline gas. The move to renegotiate came following a 2012 European Commission inquiry against the gas Gazprom's alleged abuse of market power in EU markets. This inquiry specifically focused on gas sales to Poland, Czech Republic, Slovakia, Hungary, Bulgaria and the Baltic States.

Poland's Polskie Górnictwo Naftowe i Gazownictwo (PGNiG) successfully filled a suit against Gazprom, which led to an unspecified downward price revision for the state-owned firm. Other European firms have also been successful in renegotiating prices by reducing the level of oil indexation in contracts. Ukraine is also persisting in its efforts to negotiate prices downwards with Russia, upon whom it is wholly dependent for its gas import needs, though it has less bargaining power than EU backed Eastern Europe.

Other active steps taken to reduce reliance on Russian gas include:

  • Developing domestic gas resources, both conventional and unconventional, and improving recovery rates from existing fields;

  • Developing bi-directional pipeline infrastructure to improve the efficiency of gas trade and diversity;

  • Building infrastructure to support LNG imports and increasing supply diversity by sourcing gas from different countries;

  • Encouraging pipeline routes that by-pass Russia;

  • Reducing high intensity gas use from heavy industry and power stations.

We see these developments as major risks to import demand, particularly for Russian gas. Nonetheless, strong regional interdependence is likely to endure through our forecast period. Alternative import infrastructure is beginning to materialise, such as LNG in the Baltic's, domestic gas in Romania and Azeri gas in Turkey. While these changes will not be sufficient to remove the Russian political grip they will increase supply competition. While Russian gas exports to Europe are expected to reduce over the forecast, dependency in CEEs will remain.

Azerbaijan Main Benefactor Of Eastern Europe's Russian Fatigue

Azerbaijan stands to be the biggest beneficiary of the region's gas diversification strategy. Following the apparent selection of Trans-Adriatic Pipeline (TAP) to carry on Azeri gas from Turkey into Europe in June 2013, the path is now set for Azeri gas to be brought into Europe by 2019. There is also a possibility that these pipelines could be expanded in the future to carry other Central Asian resources through the Caspian Sea, to the advantage of Kazakhstan, Uzbekistan and Turkmenistan. However, countries east of the Caspian are increasingly pushing output in the direction of China.

The Trans-Caspian gas link, bringing Turkmen gas into Europe via a subsea pipeline to Azerbaijan, could also finally move towards realisation, following a 'serious and substantive' discussion between Turkmenistan, Azerbaijan and the European Union (EU) on the project's viability in late May 2013. However this project is a long term development and is unlikely to impact the current outlook until the very end of the forecast at the earliest.

The Caspian Connection
Southern Corridor Developments

Azerbaijan and Turkmenistan will drive the CEE's gas production growth between 2013 and 2022. Connecting infrastructure to the European market will provide the incentive for upstream players to increase investment in these countries' untapped offshore acreages in the Caspian Sea. Although much of the interest is related to resource movements to the east and not west.

Turkmenistan's growth will also be driven by a long-term pipeline gas supply deal with China. If a final investment decision (FID) for the Turkmenistan-Afghanistan-Pakistan-India (TAPI) pipeline follows through, the landlocked country will be provided with another two big growth markets. However, we highlight the risk that Turkmenistan's export growth could come at the expense of suppressing domestic demand, which is expected to chart an impressive 67% increase between 2013 and 2022.

Kazakhstan's long-term export potential is also highly dependent on a satisfactory regulatory environment. Much of the rise in gas production is expected to come from further development of the Karachaganak gas condensate field. However, the progress of Phase II had been obstructed by disagreements with the government over revenue-sharing arrangements that were only resolved in June 2012. Government interference, which contributed to Statoil's decision to quit the Abai Caspian Sea project, has led us to downgrade our long-term outlook for both oil and gas production in Kazakhstan. Nonetheless, the country is in good stead to capture supply opportunities from Europe's Russian fatigue, though deliveries to Eastern Europe will have to transit through Russian pipelines.

Russia's Pie Is Shrinking
Change In Share Of Gas Production, 2013f (LHS) & 2023f (RHS) (%)

Moving From Pipeline To LNG

Greater LNG imports are expected from the region , with planned projects scheduled to come online in the next 10 years. These include:

  • Poland: Swinoujscie LNG terminal, located on the Baltic Coast. It is under construction and will bring 2.5bn cubic metres (bcm) of gas to the country when operational at the end of 2014;

  • Lithuania is set to install a floating storage and regasification unit (FSRU) at Klaipeda on its Baltic coast. The facility is expected to have an import capacity of between 2-3bcm a year, with start up anticipated for 2015.

  • Croatia has two rival LNG projects at Krk and Adria on the Adriatic coast. Both are awaiting a final investment decision, though it is likely only one will go ahead. An optimistic start date of 2016 has been set for the projects.

  • Turkey may add two further LNG terminals at Aliaga and in the Gulf of Saros, though in 2012 the countries two other terminal were only utilised at a capacity of 64% and increased pipeline gas from Azerbaijan and Iraq could help growing demand.

  • Ukraine, Romania and Bulgaria have all mulled adding LNG import terminals. Difficulties in financing the projects as well as stagnant gas demand and new supplies from Azerbaijan have held back progress.

Russia is also looking to bolster its LNG exports through a second terminal at Sakhalin as well as terminals at Vladivostok and Yamal. The final investment decision is yet to be made on these facilities and the gas produced from them will increase the export capacity.

Russian Alternative
CEE LNG Imports Versus Russian LNG Exports, 2011-2022 (bcm)


The St. Petersburg Economic Forum, held in June 2013, opened the possibility of a gradual liberalisation of Russia's gas export policy that would allow for Rosneft's proposed Sakhalin LNG project to come online in 2018 and Novatek's Yamal project to ship LNG from as early as 20 17 . There are continuing hints that Russia will ease Gazprom's LNG export monopoly and allow terminals operated by other companies to export.

Besides LNG projects, Russia has also come up with alternative pipeline projects of its own:

  • Nord Stream: In November 2011, it inaugurated the 27.5bcm Nord Stream pipeline, which connects it directly to Western Europe. This is an attempt to weaken the bargaining power of transit countries such as Ukraine and Poland. The second trunk line of Nord Stream was commissioned on October 8 2012, bringing the system's total capacity to about 55bcm. Talks are underway for a third and fourth line - which would travel along a different route and could deliver gas to as far as the UK - though this seems unlikely at the present time.

  • South Stream: The planned 63bcm subsea pipeline will connect Russia to Central Europe via the Black Sea, bringing it into direct competition with the proposed Azeri routes. Gazprom has already secured the participation of Bulgaria, Serbia and Croatia for the project. In an interview with Reuters in May 2013, Kramer expressed his confidence that construction on the non-Russian sections of the pipeline will begin by 2015 as the venture draws close r towards securing finances for the US$39bn project.

In our view, attempts to loosen Russia's grip on CEE will have limited effect and we expect the country to continue to provide at least 70% of the region's gas volumes over the next decade. Nevertheless, offshore resources and to a lesser extent domestic shale gas in Eastern Europe , could pose a serious threat to Russia's hold over the region - an upside risk to our CEE gas forecasts.

Black (Sea) Gold Could Provide Relief

Eastern Europe is increasingly turning to untapped riches offshore in the Black Sea , even as Central Asia deepens its activities in the Caspian Sea. Following ExxonMobil 's gas discovery at the Domino-1 well offshore Romania, there has been heightened activity on the part of prominent players seeking to replicate Exxon's success. These include:

  • Bulgaria: OMV, Total and Repsol began a 3D seismic campaign in late June 2013 in the 14,000 sq km Khan-Asparuh Block offshore Bulgaria. The block lies directly south of Romania's Neptun block where ExxonMobil and OMV Petrom recently announced a sizable discovery. OMV will lead the 8,000 sq km 3D seismic programme but will hand over to Total for drilling operations. Exploration wells are anticipated for 2015-2016 and could provide considerable upside to our later forecast.

  • Russia: In June 2013, Rosneft signed a completion deed agreement with Eni following on from the strategic cooperation deal signed in June 2012. This agreement will see the pair will jointly explore the Western Chernomorsky block in the Russian Black Sea. The block covers an area of 8,600 sq km in water depths of 600-2,250m. Two exploration wells are expected in 2015/16.

  • Ukraine: ExxonMobil is planning a US$735mn seismic and drilling programme in its deepwater Skifska area. This will involve drilling two exploration wells as well as more extensive seismic work.

  • Turkey: Shell entered the Turkish Black Sea in February 2013 following an agreement with Turkish national oil company (NOC) TPAO. ExxonMobil is also reportedly in talks with TPAO seeking to farm-in to a deepwater block in the Black Sea. At least one well will be completed before 2015.

Commercial discoveries in the Black Sea pose upside potential to our reserves and production forecasts for countries with Black Sea coastlines. Upstream success will be a boon to Romania, Bulgaria, Ukraine and Turkey, which are currently net energy exporters. A ramp up of E&P efforts could considerably impact smaller consumption markets such as Bulgaria and Romania, if sufficient offshore gas resources are found. The Domino-1 discovery could drastically reduce Romania's import needs, covering around half the country's demand.

Black Sea Gold
Countries Surrounding The Black Sea

Shale Gas Showdown

Unlike many of their Western European counterparts, countries in CEE have been more receptive to shale exploration. Shale exploration is picking up across the region, and for the most part is led by major IOCs and the state.

The governments of Poland, Ukraine and Lithuania have actively promoted their countries' potential in a bid to attract private investment. In doing so, environmental concerns have mostly been downplayed as energy security takes precedence in policy - the main difference between Western Europe and CEE. The Romania government has also lifted a moratorium on shale gas exploration and allowed Chevron to begin exploratory work. However, this move has been met with strong public opposition.

Large Estimates Yet To Offer Shale Fortune
Technically Recoverable Shale Gas Resource Estimates (bcm)

The early industry response to these new opportunities has been mixed. Chevron has purchased acreage in nearly all prospective countries - Poland, Ukraine, Lithuania and Romania - though is in very early stages of analysis. Shell's footprint in CEE shale extends from Ukraine to Turkey. However, ExxonMobil withdrew from Poland, though remains active in Russia's Bazhenov shale oil play and has expressed interest in Ukraine. OMV Petrom also announced they are unlikely to devote significant resources to shale development in Romania until the end of the decade.

Shale exploration in the region is still at an early stage. Poland's troubles with generating commercial results from early exploration of its shale gas potential is indicative of the issues facing the development of shale gas in much of the region in the short term - deeper-than-expected wells and underdeveloped onshore oilfield service industries have slowed the speed of development.

Nonetheless, shale oil and gas in CEE remains a high potential area and could provide significant gas volumes to supplement domestic consumption. Continually improving knowledge of the different geologies as well as improving drilling efficiencies could see more positive results, particularly in the second half of our forecast period.

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