Trade Dynamics To Persist Despite Diversification Efforts

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

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

  • The regional production outlook is far more positive for gas than oil. Regional gas output is expected to rise 18.4% from 2013 to 2022, compared to an increase of around 5.9% for oil. Net importers and exporters alike could see substantial rises in output from greenfield projects - particularly from offshore production in the Caspian, Black and Arctic Seas.

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

  • Both oil and gas consumption is expected to rise alongside economic expansion. Oil demand in the region is projected to grow 30% between 2013 and 2022, while gas demand growth is expected to come in at 14.1%. However, it should be noted that these impressive growth rates are based largely on Central Asian countries growing from a low base.

  • 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 CEE as regional production expansion trails behind demand growth.

  • Oil export capacity is also anticipated to fall on the back of an expected decline in oil output growth in Russia while demand in the region rises, particularly in Turkey.

  • 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 and Turkmenistan have firm plans to add to their downstream capacity over the forecast period, while less efficient facilities in other CEE countries may have to downsize due to growing international competition.

A Mutually Dependent Relationship

Gas Production Set For Strongest Growth
Regional Oil Production (LHC, '000b/d) & Gas Production (RHC, bcm), 2013-2022

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

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

  • The regional production outlook is far more positive for gas than oil. Regional gas output is expected to rise 18.4% from 2013 to 2022, compared to an increase of around 5.9% for oil. Net importers and exporters alike could see substantial rises in output from greenfield projects - particularly from offshore production in the Caspian, Black and Arctic Seas.

Gas Production Set For Strongest Growth
Regional Oil Production (LHC, '000b/d) & Gas Production (RHC, bcm), 2013-2022
  • 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 - accounting for an averaging of around 72% of the region's gas and 74% of oil over the ten years from 2013-2022. However, Russia's dominance will lessen and Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan will strengthen their relative positions, contributing to a larger share of the region's oil and gas supply and exports.

  • Both oil and gas consumption is expected to rise alongside economic expansion. Oil demand in the region is projected to grow 30% between 2013 and 2022, while gas demand growth is expected to come in at 14.1%. However, it should be noted that these impressive growth rates are based largely on Central Asian countries growing from a low base.

  • 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 CEE as regional production expansion trails behind demand growth.

  • Oil export capacity is also anticipated to fall on the back of an expected decline in oil output growth in Russia while demand in the region rises, particularly in Turkey.

  • 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 and Turkmenistan have firm plans to add to their downstream capacity over the forecast period, while less efficient facilities in other CEE countries may have to downsize due to growing international competition.

Russia Refining Strength
Regional Refining Capacity, 2013-2022 ('000b/d)

A Mutually Dependent Relationship

Russia and the Central Asian countries are net exporters while Eastern European countries are net importers. Substantial efforts have been made to maximise domestic production in import-dependent states such as Poland, Ukraine, Bulgaria, Turkey and Romania, but it will take time before discoveries are developed for commercial use. These countries are increasingly looking to maximise output from their maturing resources as well as develop the untapped potential of both the Black Sea and shale gas in order to minimise the legacy dependency on Russian gas imports. However, due to falling production and the early stage of exploration the current energy trade status quo in the region will largely remain over the duration of our forecast period from 2013-2022.

Russia To Remain Top, But Turkmenistan Strengthening
Comparison Of Net Gas Export Capacity In CEE Countries, 2013f & 2022f (bcm)

Most of the CEE 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, which has 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. Russia has 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. This was recently witnessed with Russian pressure on Ukraine, forcing the country to abandon a free trade agreement with the EU.

However, Russia is just as reliant on Europe for gas export markets and is struggling to maintain its dominant supplier position - with growing alternative supply sources coming from Azerbaijan, Norway and LNG exporters. That said, as a result of stagnating European demand, Russia and central Asian countries are increasingly developing new trade routes to the East, and specifically to China.

Weaning Off Russian Oil And Gas Proving Difficult

Russia remains the dominant supplier of oil and gas to Eastern Europe and with that status carries significant political bargaining power. However, large import markets, such as Germany, also have reciprocal bargaining power due to the volumes of gas they purchase and Russia's dependency on the income from this. Over 2013, many European utilities with long term gas import contracts, managed to renegotiate prices with Gazprom to include a greater level of gas indexation. This softened prices for importer countries, which were being impacted by the oil-indexed gas pricing that Gazprom favours, but highlights the limited options for European gas consumers to diversify.

Other active steps taken to reduce reliance on Russian gas in CEE 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 bypass 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; however, the impact of any changes is likely to become more pronounced over the longer term. As a result, we expect strong regional interdependence to endure over the course of our forecast period. Alternative import infrastructure is beginning to materialise, such as LNG in Poland and Lithuania, while the TANAP pipeline through Turkey is expected to deliver Azeri gas to central and eastern European markets by 2019.

High potential for offshore domestic gas production in Romania and growing exploration of shale gas in Ukraine could play a role in reducing dependence. While these changes will not be sufficient to remove the dominance of Russian gas supply they will increase security of supply. Russian gas exports to Europe are expected to trend downward over the forecast period, though dependency on Moscow among CEE markets will remain.

Azerbaijan Main Beneficiary Of Eastern Europe's Russian Fatigue

Azerbaijan stands to be the biggest beneficiary of the region's gas diversification strategy. Following the 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 period at the earliest.

The Caspian Connection
Southern Corridor Developments

Azerbaijan and Turkmenistan will drive CEE 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 acreage in the Caspian Sea. However, 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 expand robustly over the coming years.

Azerbaijan And Turkmenistan Gaining
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 country's two other terminals were only utilised at a capacity of 64% and increased pipeline gas from Azerbaijan and possibly Israel 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 future supplies from Azerbaijan have held back progress.

South Stream Looking Weak

Since successfully securing long-term demand in the gas markets of Germany and central Europe via the Nord Stream pipeline, Russia's efforts to further reinforce its position in Europe have been stifled. The South Stream project, which would pipe as much as 63bcm of gas under the Black Sea to Bulgaria and on to central Europe, is still facing considerable political and legal opposition. In its current format the South Stream pipeline does not comply with the EU's Third Energy Package (TEP), which requires the unbundling of gas suppliers and infrastructure owners for major infrastructure projects. Furthermore, EU legislation outlines that third party access must be granted to transmission and distribution systems without discrimination between system users. Gazprom would thus require an exemption from the European Commission in order to move forward with South Stream as proposed.

Financing of the South Steam project, which is now thought to require investment of US$46bn due to domestic improvements, could prove difficult for Gazprom. As well as South Stream, Gazprom is looking to finance the Vladivostok LNG project (US$6-12bn), an expansion of the Yamal-Europe II pipeline (US$5bn). With shrinking profits from weak demand and lower renegotiated gas prices with European customers, it will be a challenge for Gazprom to fund all of its proposed ventures.

Despite domestic competition to capture LNG markets on the back of recent liberalisation, Gazprom appears to be committed to South Stream and remains in negotiations with the EU regarding its legality. However, if the South Stream project does not move forward, CEE will remain dependent on Russia for gas supplies. With the Ukraine now edging towards Russia, pipeline capacity into Europe should be sufficient.

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:

Black Sea Gold
Countries Surrounding The Black Sea
  • Ukraine: The Ukrainian government signed an offshore oil and gas production-sharing agreement with Eni and EDF. The agreement concerns a 1,400 sq km offshore area off Western Crimea in the Black Sea. The area lies to the north of Romania's Domino discovery.

  • 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 discovered gas. 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.

  • 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 jointly explore the Western Chernomorsky block in the Russian Black Sea. The block covers an area of 8,600sq 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, and may allow the country to become self-sufficient.

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. The Romanian 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), although it is in very early stages of analysis. Shell's footprint in CEE shale extends from Ukraine to Turkey. Both Chevron and Shell have committed to shale gas production sharing agreements potentially worth up to US$10bn in Ukraine. However, ExxonMobil withdrew from Poland, although it remains active in Russia's Bazhenov shale oil play. Statoil is also looking at Russian shale oil and in December 2013 signed an agreement to assess commercial production in the Domanik shale.

Shale exploration in the region is still at an early stage. Poland's troubles in generating commercial results from early exploration of its shale gas potential are 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 pace of activity.

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

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