Ed Crooks Gazprom’s Nord Stream and South Stream gas pipelines are go, but are they needed?

Gazprom, Russia’s gas export monopoly, expects both of its controversial new pipelines, Nord Stream and South Stream, to start construction this year.

After all Gazprom’s troubles during the downturn, and delays to high-profile gas production projects, to be pushing ahead with these plans might seem an expensive waste of time.

Weak European demand and rising production of US shale gas and middle eastern LNG, creating a global “gas glut”, have driven down prices and raised questions about whether either pipeline is really needed.

Those questions are, however, based on a false premise.

The real issue is whether the pipelines still make strategic sense for Gazprom. The answer is that they clearly do.

The central point about Nord Stream and South Stream is that they do not depend on any additional volumes flowing from Russia to the EU. As Gazprom says itself (about South Stream), its purpose is

to diversify the Russian natural gas supply routes… [in order to] significantly raise the energy supply security of the entire European continent.

In other words, it is to by-pass Ukraine, which is now the transit country for about 80 per cent of Russia’s gas exports to the EU. Once South Stream is in place, Gazprom will no longer be reliant on its fractious relationship with Ukraine to serve its customers in the EU.

The impact of the most recent flare-up, in January 2009, was severe, and even when the gas is flowing Gazprom has to pay Ukraine’s transit fees.

South Stream will not end altogether Gazprom’s need to use Ukraine – at 63bn cubic metres a year, its capacity is roughly half of what flowed through the country to the EU in 2009 – but it will give the Russians options and increase their bargaining power enormously.

What is more, Gazprom’s expectation of rising European demand looks soundly based. The IEA suggests it is possible that EU gas demand will be lower in 2030 than in 2007, if Europe follows policies to curb the threat of global warming. But that will mean the EU exceeding all its targets for developing renewable energy and energy efficiency, and a decline in Europe’s demand for gas for power generation: a projection that will require a sharp change of direction from present trends.

The longer gas looks likely to remain cheap, the more likely European power generators are to invest in gas-fired rather than coal-fired plant. Continued policies to cut carbon dioxide emissions will make gas increasingly attractive: switching out coal for gas is by far the cheapest way to cut emissions from power generation.

Meanwhile, EU gas production seems to be in inexorable decline. It is technically possible that the success of US shale gas could be repeated in Europe – some of the same geological conditions are present – but political and regulatory problems suggest that any renaissance in gas production is likely to be still-born.

That means the EU will need more imported gas, which will put Russian exports in a straight fight with LNG. There may be a lot more LNG on the market for longer than was expected a couple of years ago, because the US will not need to import it, but Russian pipeline gas is still likely often to have the competitive edge. Even if it costs a little more than LNG sold into spot markets in the UK, for example, there will be a premium worth paying for long-term supply security.

The timescales also back Gazprom’s judgment. Nord Stream is expected to delover its first gas in 2011, South Stream in 2015. That means that in their early years they may suffer from a period of excess demand – Nord Stream especially – but they will be built to last for five decades or more. Making a call on that investment based on market conditions in the first half of the 2010s would be rash, to say the least.

Gazprom itself argues that the EU will need all the new imprt infrastructure it can get: Nord Stream, South Stream, the competing Nabucco pipeline project, new LNG terminals, and more. From the European consumer’s point of view, it will be best to act as if that is the case. It will always be better to have too much capacity than too little.