nabucco vs south stream the effects and feasibility

24th World Gas Conference Buenos Aires, Argentina

5-9 October 2009

NABUCCO VS. SOUTH STREAM: THE EFFECTS AND FEASIBILI TY IN THE CENTRAL AND EASTERN EUROPEAN REGION

Main author: Mr. Roland Lajtai Energy and Utilities Advisory Services, KPMG in Central and Eastern Europe Budapest, Hungary Co-authors: Ms. Annamária Czinkos Energy and Utilities Advisory Services, KPMG in Central and Eastern Europe Budapest, Hungary Mr. Tamás Dinh Energy and Utilities Advisory Services, KPMG in Central and Eastern Europe Budapest, Hungary Keywords: Natural Gas, Nabucco, South Stream, Feasibility, Security of Supply, Central and Eastern Europe

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Nabucco vs. South Stream: The Effects and Feasibility in the CEE Region

1 Abstract As natural gas becomes the second largest and fastest growing energy source in the world, natural gas has a growing importance in the energy supply of the European Union (EU). Because the EU natural gas extraction has not increased in line with domestic demand, the EU is becoming increasingly dependent on non-EU natural gas imports, which is currently exceeding 60 percent of its consumption. Assuming that the current market and regulatory trends continue in the EU, the natural gas demand level is anticipated to increase by 87 percent to over 140 bcm by 2030. Even though the potential natural gas import sources of the EU possess proven reserves capable of supply for about 100 years at the current level of extraction capacity and speed, the EU is required to diversify its natural gas import sources to avoid occurrences of economic and political challenges. Most particularly the Central and Eastern European (CEE) countries are vulnerable to incidents like the latest natural gas dispute between the Russian Federation and Ukraine. The highest priority goal of the EU and the CEE countries is to reduce their dependence on natural gas imports and maintain the security of the natural gas supply in the long term. A conceivable solution is the construction of the Nabucco and the South Stream pipelines. This discussion paper is to examine and compare the viability of both the Nabucco and the South Stream projects, and to introduce their effects on the natural gas security of supply of the CEE region. Based on the market circumstances, we will examine and compare the environment, the effects on security of supply, and the viability of both the Nabucco and South Stream projects in the CEE region. We analyze the environment of the pipeline projects according to political, economic, social and technological aspects, examine the security of supply based on three pillars, and evaluate viability regarding financial aspects, time frame challenges, and competition issues. With the help of the analysis methodology, we will show both the supportive and preventive environmental influencing factors of the pipeline projects as the pipelines are the arms in the energy political dueling of the dominant market powers. Hence, the security of supply and the resulting economic and social development of the EU Member States are at stake. Our quantitative based analysis of the security of supply in the CEE region is based on a supply-demand balance analysis, a production source diversity assessment and a transit route diversity assessment. After the consideration of political and strategic motivations, the viability of the projects will be discussed touching upon economic criteria and the requirements of implementation. By the end of the analysis we will show that the Nabucco project would be able to support the production source diversity, while the South Stream project would be able to support the security of supply via the transit route diversity. It will be also indicated to what extent both projects would contribute to the security of supply, thus maintaining the economic and social development of the dependent countries in the CEE region. Please note that in this discussion paper all the information available as of 15 July 2009 was considered. Disclaimer The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG Tanácsadó Kft. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although KPMG endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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CONTENTS

1 Abstract ........................................... .......................................................................................................... 2

2 Introduction....................................... ........................................................................................................ 4 2.1 Natural gas demand in the Central and Eastern European (CEE) region............................................ 4 2.2 Natural gas supply in the CEE region................................................................................................... 4

2.2.1 Alternative sources of natural gas................................................................................................ 4 2.3 Infrastructural overview......................................................................................................................... 4 2.4 Introduction of Nabucco and South Stream ......................................................................................... 5

3 Objectives ......................................... ........................................................................................................ 7

4 Development ........................................ ..................................................................................................... 8 4.1 Analysis of the pipeline projects’ environment ..................................................................................... 8

4.1.1 Political environment.................................................................................................................... 8 4.1.2 Economic environment ................................................................................................................ 9 4.1.3 Social environment .................................................................................................................... 10 4.1.4 Technological environment ........................................................................................................ 10

4.2 Measuring security of supply effects .................................................................................................. 11 4.2.1 Introduction to the analysis methodology .................................................................................. 11 4.2.2 Supply-demand balance assessment........................................................................................ 12 4.2.3 Production source diversity assessment ................................................................................... 16 4.2.4 Transit route diversity assessment ............................................................................................ 21

4.3 Feasibility of the pipeline projects....................................................................................................... 25 4.3.1 Financial viability constraints ..................................................................................................... 25 4.3.2 Timeline constraints ................................................................................................................... 26 4.3.3 Competition between Nabucco and South Stream.................................................................... 26 4.3.4 Other competing projects in the region...................................................................................... 27

5 Results............................................ ......................................................................................................... 29 5.1 Assessment of the projects’ feasibility................................................................................................ 29 5.2 Assessment of the pipeline projects from a security of supply point of view...................................... 29

6 Conclusions ........................................ .................................................................................................... 32

Annexes............................................ .............................................................................................................. 33 List of figures................................................................................................................................................ 33 Additional figures.......................................................................................................................................... 34

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2 Introduction Currently natural gas is one of the boiling market segments in energy and natural resources. In the last decade the natural gas demand has increased significantly as it has become one of the most important primary energy sources supporting the development of countries all over the world. As the supply-demand balance is upset and competition increases, the security of supply lands in the spotlight for many regions lacking natural gas.

2.1 Natural gas demand in the Central and Eastern E uropean (CEE) region Besides North America and the Far East, Europe and the Russian Federation consume the largest volumes of natural gas in the world. Natural gas demand in Europe varies greatly with regions mostly due to the level of economic and social development. The countries of the Central and Eastern European (CEE) region1 are demanding proportionally less gas than the rest of the European countries. This is mostly due to their heritage of firmly coal based industry and economy. As the European Union (EU) has begun the process of market integration and the environmental considerations are getting stronger, the CEE countries have begun to substitute coal with the much cleaner natural gas in many areas. Hence this trend is expected to continue especially in the EU Member States. The demand for natural gas in the CEE region is expected to increase as significantly in the future as it has increased in the last decade. The future development of the CEE region is highly dependent on the security of the natural gas supply. In order to satisfy the continuously growing demand, a sufficient supply source portfolio is required together with a stable and transparent infrastructural background.

2.2 Natural gas supply in the CEE region Domestic supply is limited within the EU and the output volume can only satisfy less than half of the total internal demand. The only natural gas exporters are Denmark and the Netherlands, while the United Kingdom and Romania are producing to satisfy their own domestic demand. As a result, the EU is dependent on import sources to satisfy the demand levels, which amounts to about 64.5 percent of the total natural gas consumption. The natural gas dependency is at different levels in the various regions of Europe. Major gas imports are coming from the Russian Federation with 39.1 percent, Norway with 23.5 percent, North Africa with 11.6 percent, and in the form of LNG at 9.9 percent.2 In addition to the import reliance, the portfolio of accessible import sources also differs with regions. Gas dependency is the most critical in the CEE region due to the nearly sole dominance of the Russian gas imports. As the CEE demand is projected to increase and the domestic extraction is unable to grow, an increasing volume of import will be required which will increase the dependency of the CEE as well as the EU. To prevent the increase of dependency, the EU requires access to alternative natural gas sources especially in the CEE region.

2.2.1 Alternative sources of natural gas While natural gas production is almost solely dominated by Russia, a small number of transit countries are controlling the available transport routes to the CEE region. As a result of the limited source portfolio and the transport route reliability, the natural gas security of supply to the CEE region is low. The EU and the CEE have defined the goal to reduce the Russian dependency by gaining access to alternative natural gas sources. Potentially gas from the Middle East countries, Commonwealth of Independent States (CIS), Africa, and liquefied natural gas (LNG) could provide alternative sources for the CEE region. It is often stated that LNG would not be able to compete with the pipeline gas in the CEE region, however, it requires an in-depth analysis to prove this. On the other hand, the sensitivity of contracting with the Middle East and CIS countries must be evaluated from both a political and an economic point of view. Another target of the EU is to increase the security of the Russian supplies. An alternative solution for increasing the reliability of the Russian imports would be to reduce the dominance of transit countries through transportation route diversification.

2.3 Infrastructural overview The imported gas reaches the EU via transmission pipelines and in the form of LNG. The market share of transmission pipelines amounts to 85 percent in the EU, while in the CEE region imports arrive solely through pipelines. Currently the majority of the natural gas imports enter the CEE region via the Brotherhood 1 Please refer to Figure 21 on page 34 for an overview of the CEE countries 2 BP Statistical Review 2009

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and Yamal pipelines, however, almost the full capacity of the Yamal pipeline is transited further to Western Europe, while the Brotherhood also supplies countries in the SEE region. Via these pipelines, a maximum of 181 billion cubic meters (bcm) of gas can enter the CEE region per annum, while Western European import pipelines can provide 7.7 bcm of natural gas annually (excluding the capacities that are currently unutilized and due to gas supply circumstances, might remain so as well). Recently, the transmission of the contracted amount of gas has been reduced, delayed or even stopped due to disagreements between Russia and the Ukraine, the almost exclusive transit country between Russia and the CEE region, which causes security of supply concerns. In reaching alternative sources of natural gas, infrastructural development has a leading role. Gas pipeline investment is especially crucial in Europe if the EU aspires to bring gas to its markets from increasingly isolated producing regions. Apart from the long distance transition possibilities, improved intra-regional connections are needed to provide greater flexibility, security and competition in the gas supply within the EU and its regions. When the Western European developed region is compared to the CEE region, a significant difference can be observed in the infrastructural development level. The CEE investments remain relatively weaker inside the region, and long distance pipelines are subject to delay and cost escalation, if not remaining at the planning stage. In order to guarantee the natural gas supply in the CEE region, new pipeline projects are under development. The two significant transmission pipelines projects affecting the security of supply of the CEE region and the EU are the Nabucco and South Stream pipelines.

2.4 Introduction of Nabucco and South Stream Two major gas pipeline construction initiatives are present in Central and Eastern Europe, which are aiming to improve the security of the supply situation of the region. The Nabucco project would ensure the route diversification while it would also provide access to alternative gas sources. The South Stream pipeline project which is promoted by Russia would mostly account for a route diversification through bypassing the currently dominant transit country, Ukraine. Figure 1 below sums up the main characteristics of the projects. Figure 1: Key figures of Nabucco and South Stream

Nabucco South Stream

Length 3,300 km onshore pipeline. 3,700 km out of 1,000 km offshore section.

Capacity 1st stage 8 bcm per year. After 2020: 31 bcm per year.

63 bcm.

Potential sources

Azerbaijan, Turkmenistan, Kazakhstan, Egypt, Iran and Iraq.

Russia, Central Asia, Azerbaijan or also North African or Middle Eastern gas via swap deals.

Investment cost

EUR9 billion (USD11.7 billion). EUR19-24 billion (USD24.7-31.2) (Calculation for the initial 30 bcm/year capacity).

Key project sponsors

European Union, United States of America. Russia.

Main purpose of the sponsors

Reducing dependency from Russian gas and Russia. Alternative route to reduce the dominance of transiting countries, like the Ukraine. Decreasing the power of Russia.

Alternative route to reduce the dominance of transiting countries, like the Ukraine. Increasing gas sales to Europe. Increasing influence on Europe.

Transit countries

Turkey, Bulgaria, Romania, Hungary, Austria Russia, Bulgaria, Serbia, Hungary, Austria, Slovenia, Greece and Italy

Companies involved

Nabucco Gas Pipeline International GmbH: OMV (Austria), MOL (Hungary), Transgaz (Romania), Bulgargaz (Bulgaria), BOTAŞ (Turkey), RWE (Germany). (Equal shares of 16.67%).

South Stream AG, equally owned by Gazprom (Russia) and Eni (Italy). The establishment of joint ventures of Gazprom and local companies for construction and operation are in progress.

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Status The intergovernmental agreements were signed on 13 July 2009. Construction is planned to start in 2011.

The project related intergovernmental agreements have been signed with Italy, Bulgaria, Serbia, Hungary and Greece.

Planned launch date

2014 (with an initial capacity of 8 bcm). 31 December 2015.

Main concerns

Natural gas sources are not agreed and contracted yet.

High costs due to the offshore section. Route but no source diversification.

Map

BG

GRTR

IR

AZ

GE

RU

AL

MK

RS

KOMG

HRSI

BA

IT

HUAT

SK

RO

CZ

PL

UA

South Stream

Nabucco

BG

GRTR

IR

AZ

GE

RU

AL

MK

RS

KOMG

HRSI

BA

IT

HUAT

SK

RO

CZ

PL

UA

South Stream

Nabucco

Source: Official website of Nabucco, 2009; Gazprom, 2009; and all sources referenced in the document

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3 Objectives This discussion paper is analyzing the two projects from multiple angles, but remaining on rational ground being led by professional practices. This is especially important as currently various political as well as economic analysis exist on the market discussing these pipeline projects. The goal of this discussion paper is to examine and compare the viability of both the Nabucco and the South Stream pipeline projects from a neutral and professional perspective, and to introduce the potential effects of the projects on the natural gas security of supply of the CEE region.

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4 Development Analyzing the two pipeline projects will be performed according to the methodology detailed in Figure 2: Methodology of the analysis. After a general environmental scanning the security of supply effects will be considered indicating the value added by each of the proposed pipelines. Additionally, the feasibility of the pipelines will be considered to be able to conclude on their viability from all aspects. Figure 2: Methodology of the analysis

First of all we consider the environmental playground of the pipeline projects to be able to determine the external market factors that influence their implementation in either a supportive or preventive way. The political, economic, social and technological aspects of the environment are analyzed for each project.

The expected effects of the pipeline projects on the CEE region’s security of supply are assessed. To identify the individual and joint effects of the differentprojects, a scenario analysis methodology is applied.

Being aware of the environmental and strategic aspects of the pipeline projects, their feasibility is measured. The analysis applies a three pillar analysis including financial requirements, time frame challenges, and competition issues. The purpose of this third level of the analysis is to consider the economic aspects of the projects also.

Based on the three layer analysis built up in the development section, the pipeline projects are summarized. After the combination of the individual analysis and their outcomes, the viable scenarios are compared with each other highlighting the positive impacts and expected advantages of the pipeline projects on security of gas supply in the CEE region.

Environmental

analysis

Security of supply

impact analysis

Feasibility

analysis

Summary of the

pipeline project

analysis

Source: KPMG analysis

4.1 Analysis of the pipeline projects’ environment The environment of the Nabucco and South Stream pipeline projects is analyzed through the four dimensions of the so-called PEST analysis. During a PEST analysis all relevant political, economic, social and technical forces will be introduced that are likely to greatly influence the development and the implementation of the projects.

4.1.1 Political environment National and international politics may strongly influence the international investment projects either in a supportive or in a hindering way. The progress of the projects depends highly on the number of involved countries and on the extent of their commitment, as the more parties take part the more negotiations and coordination are required. The political stability of the participating countries also determines the success of the project, as in case of political change the involvement and contribution of the countries may be modified by the new government. The support or opposition of the politically dominant countries and international organizations can also have a driving effect on the implementation of the investment projects according to their interests and political considerations. The Nabucco project currently involves five transit countries, namely Turkey, Bulgaria, Romania, Hungary and Austria. With the exception of Turkey the other four countries are members of the EU which supports the project. In May 2009 Nabucco was chosen to be a priority project receiving EUR200 million for the first construction stage. The EU support and the extent of its contribution have been under strong debate lately, changing hectically from time to time, and since this sum aids only the initial part, further debates may follow later. The project company for the pipeline construction and operation has already been set up by the leading natural gas transmission operator companies of each country, but the governments have only signed the crucial intergovernmental agreements recently on 13 July 2009. After long discussions specifying the requirements and responsibilities of the countries the final agreement has been agreed on, and signed in

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Ankara, Turkey.3 As a result of the observed time-consuming decision-making processes, overall the project may be delayed. It is expected that Turkey, the only non-EU member transit country, will play a significant role in the Nabucco project as it is responsible for the first and largest part of the pipeline. This outstanding position is in the spotlight for the EU, however, the signed intergovernmental agreement and discussions about the future EU accession of Turkey is expected to ease on this situation. The project is also promoted by the United States of America in order to decrease Europe’s dependency on Russian gas supply through the diversification of the gas sources and as a result, to lessen the dominance of Russia. South Stream presently involves seven transiting countries; Bulgaria, Serbia, Hungary, Austria, Slovenia, Greece and Italy, excluding the project leader Russian Federation. In contrast to Nabucco, the countries have already confirmed officially their interest to participate in the project. Five countries have signed an Intergovernmental Agreement with Russia, only Slovenia and Austria are behind. However, they have already announced their participation intention. Even though the majority of the participant countries are EU member states, with the exception of Serbia and Russia, no EU support can be expected due to the Russian dominance in the project. The route plan has not been finalized yet, as it has been changing frequently as a result of the intergovernmental negotiations. Due to the Russian pressure urging Romania to take part in the South Stream project, the final route of the offshore section is still pending. With Romanian participation the length of the undersea pipeline could be reduced by 100 km while the costs of the offshore section by 12 percent.4 The South Stream project is driven by the Russian Federation, which has a strong interest in the project since it would enable larger gas sales to Europe and thus strengthen Russia politically. The South Stream would also reduce Ukraine's leverage on Russian exports of gas to Europe, a major portion of which are currently transited through Ukraine. Since Ukraine has cut gas flow to Europe on multiple occasions, Russia is aiming to decrease Ukraine’s role by diverting a part of its gas export. As a less expensive alternative in the resolution of the Ukrainian conflict, Russia is endeavoring to take over the control of the Ukrainian transit pipeline. In the event of success, the relevance of the South Stream project would be questioned for Russia, possibly resulting in a cancellation of the project. The definite decision-making procedures of Russia and its strong influence on the countries in the South Eastern European region (SEE) provide an advantage to South Stream. Moreover, Russia is expected to finance a significant portion of the project providing a direct support to the realization. The SEE region, where both Nabucco and South Stream are planned, is a developing region. However, the transit countries are the leading regional countries. These countries have on average moderate political risks, though the financial crisis enhances the possibilities of political turns.

4.1.2 Economic environment The economic environment determines the feasibility of the investments through its influence on the financial possibilities and capabilities of the investors, the costs of the construction and the revenues of the future operation. The current conditions of the financial and energy markets are considered unfavorable since the national and regional economic growth rates fell to negative, the financing became very expensive and the price of the natural resources stands on a historically low level. The countries involved in the projects are facing serious economic difficulties with extremely low or even shrinking GDP growth, high inflation, and weakening and fluctuating exchange rates. Due to the international credits for the treatment of the effects of the worldwide financial crises, the public debts have increased dramatically. Additionally, the countries may receive further credits on worsening conditions and there is risk that the public debts exceed a critical level. The financing concept of Nabucco has been outlined but still not finalized. The participating countries are urging the EU to support the pipeline construction since the main objective of the project is the improvement of the security of supply of Europe and especially the CEE. As mentioned above, as a result of several rounds of discussions the EU Commission has included the Nabucco pipeline in its list of priority projects, which means a EUR200 million (USD260 million) budget to finance the first stage of construction.5 The European companies which have set up the Nabucco joint venture are unlikely to have sufficient finances to fund the project without the support of the EU. The European Bank for Reconstruction and Development (EBRD) has expressed its intention to take a senior role in financing the Nabucco project after the intergovernmental agreements on the Nabucco pipeline are signed. EBRD plans to be a substantial financier within the context of an international consortium consisting of international financing institutions and possibly commercial banks, maximizing its contribution up to 35 percent. The bank is currently ready to allocate EUR1 billon (USD1.3 billion), which would be enough to launch the project implementation in 2010.6 Overall, if the countries ensure their political commitment to the project the financing will not be a problem. 3 Reuters: EU, Turkey sign Nabucco gas transit agreement, 13 July 2009 4 Jamestown Foundation: Gazprom Seducing Romanian Government With South Stream, 24 October 2008; Romania Watch: Bulgaria could lose South Stream deal to Romania – report, 20 October 2008 5 Russia Today: Nabucco survives as EU priority project, 21 March 2009 6 The Baltic Course: EBRD to step up for Nabucco, financing MOL, 16 June 2009

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The financing concept of South Stream proposes a 50-50 percent financing of each transit country or its responsible gas company and Gazprom. The offshore sections are shared equally by Gazprom and the Italian Eni. It requires large contributions from the involved states for the construction of the pipeline section and an even larger contribution from Gazprom for the entire pipeline. Gazprom is the most indebted company in Russia, and already has several huge infrastructure development plans besides South Stream including the Nord Stream pipeline project, gas field developments, storage building plans; all of which are to be financed. Due to the global financial crisis the European gas demand has fallen and the customers have been postponing their gas purchase to take advantage of the decreasing prices, which also puts Gazprom under considerable economic pressure. Nevertheless, Gazprom is strongly backed by the Russian Federation, which would provide a high degree of support if necessary.7

4.1.3 Social environment The CEE region has a total annual gas consumption of 75.5 bcm8 in 2008. Natural gas as a percentage of the total primary energy mix exceeds 24 percent in the concerned countries on an average, which is just a little below the EU average of 24.9 percent. It should be noted that this CEE average hides large differences within the region. On one hand, Hungary and Romania rely on natural gas for around 40 percent of their primary energy mix, while on the other hand Poland, Bulgaria and Slovenia have shares below 15 percent.9 As significant residential consumption – the use of gas for heating – implies, for these countries the security of the gas supply is of paramount importance, and any of the projects would have a positive impact on the standard of living of the inhabitants. The projects would strongly serve to increase the security of supply in the transit countries as well as in other countries receiving gas without being on the route. The people of those countries which experienced the gas crisis between Ukraine and Russia in 2006 and 2009 resulting in no or limited gas supply during winter months are already aware of the importance of the new sources. As a result of the above mentioned positive effects, the construction of the pipelines is expected to be supported by the population and by the governments. Based on the latest plans, Nabucco is expected to deliver 19.53 bcm10 natural gas at full capacity to the CEE if both Turkey’s demand (15% of full capacity) and expected exports to Western European countries (15% of full capacity) are taken into consideration, which would account for around 15 percent of the consumption of the concerned countries after 2020. Many countries are looking forward to sharing in the new supply source. It is interesting to see that non-transit countries like Poland11 and Slovakia12 have also expressed their interest in the implementation of Nabucco, which could lead to their explicit support as well. It is foreseen that in the SEE region, countries like Albania and Montenegro will become interested for an alternative source, however, the interconnections between Nabucco and the national grids are still outstanding. Since May 2009 the planned annual capacity of South Stream has been raised to 63 bcm per year. Out of South Stream’s full capacity, however, only the Northern route’s capacity – which will amount to 30 bcm according to our assumptions – would affect the security of supply in the CEE region. This way, South Stream could cover more than 25 percent of demand in the CEE region from 2019. Besides the CEE region, other countries like Albania, Macedonia and Montenegro are anticipated to be supplied. Beyond the CEE region, Italy, one of the largest gas consumer countries in Europe, will receive the remaining imported gas through the Southern route of the South Stream pipeline. The project was launched by Gazprom and the Italian dominant gas supplier Eni in 2007. Eni is striving to ensure the gas supply for the increasing demand of the Italian market, while also taking part in the construction and operation of the South Stream pipeline.

4.1.4 Technological environment As it was referred to earlier, the CEE region is not able to satisfy the majority (68.5%13) of its gas demand from the domestic market, it is highly dependent on import. The presently available technologies for natural gas transportation are transit pipelines including offshore and onshore pipelines and LNG tankers. Across Europe there are 16 existing LNG regasification terminals14, but due to the easy access to Russian and CIS natural gas in the CEE region, LNG has not gained any role so far. Recently several LNG plans have been drawn in the region also aiming to enhance the security of supply of the region. The choice of technology for natural gas transport applications depends on many factors like scale (capacity, size) of development and the distance to markets, which determines greatly the feasibility of the investment. As Nabucco and South

7 Upstreamonline.com: Moody's cuts Gazprom ratings, 3 April 2009 8 Eurostat, IEA, June 2009 9 Eurostat, June 2009 10 Nabucco official website, downloaded on 28 June 2009 11 Reuters: Poland's PGNiG eyes pipeline through Slovakia, 3 March 2009 12 University of Washington: Slovakia Position Paper Energy Security, downloaded on 28 June 2009 13 Eurostat, IEA, June 2009 14 Gas LNG Europe, downloaded on 28 June 2009

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Stream projects are designed to bridge a distance less than 4,000 km passing mainly overland and the delivery capacity of the pipelines is planned to exceed 30 bcm a year, LNG technology would be of limited economic interest. For the targeted markets, which are geographically scattered and the necessary interconnections are not available, these pipelines would also serve as distributors of gas along their routes. The Nabucco plans comprise only onshore sections amounting to 3,300 km with a total annual delivery capacity of 31 bcm, however, in the first project stage only up to 8 bcm will be delivered per annum. The deliveries would be gradually increased until 2020. Nabucco pipeline engineers began detailed planning along the gas route between the Caspian region and Europe in May 2009.15 South Stream is planned to be 3,700 km excluding the pipelines on the territory of the Russian Federation. The onshore section would amount to 2,700 km while the remaining 1,000 km will go under the Black Sea and Adriatic Sea.16 The pipeline offshore section under the Black Sea will have a length of around 900 km and a maximum depth exceeding 2,000 meters connecting the Russian and the Bulgarian costs. If Romania joins the South Stream project, the offshore section would land on the Romanian shore saving about 100 km in the undersea section. There is a moderate possibility that Romania changes its exclusive commitment to Nabucco and also takes part in South Stream. South Stream is planned to deliver maximum 63 bcm a year to Central and Eastern Europe and Italy, out of which 30 bcm is expected to be used for transit to the CEE region. The transportation distance is roughly equal from the Azeri fields to Austria along the two routes, though the route via Russia and the South Stream pipeline is more expensive due the higher investment costs of offshore sections. However, due to the double sized capacity, South Stream may benefit from economies of scale during construction and operation, since the double sized pipeline is not estimated to double the costs.

4.2 Measuring security of supply effects

4.2.1 Introduction to the analysis methodology The security of the natural gas supply can be defined as an adequate and reliable supply of the primary energy source to the final consumers. As such, each segment of the natural gas supply chain influences the level of security of supply in a given country or region. Security of supply is usually analyzed on the short or on the long run, or alternatively by the dimensions of internality and externality. The latter brings in a geographical dimension but also emphasizes the role of the internal market in ensuring the security of supply by providing price signals for market players so that they can channel natural gas to those consumers who most need it, and also for identifying a need of investment into the gas infrastructure. However, the internal market can only utilize the available gas supply. If we look at the supply chain, it is production assets (be it domestic or external) and transportation assets that essentially establish the natural gas supply. Distribution assets, storage capacities, gas hubs and every other part of the supply chain foster the security of supply through creating flexibility in the system and ensuring that the gas arrives to all consumers. However, at the same time they cannot substitute the formerly mentioned two segments. In other words, the internal market can only operate on the basis of the supply provided by production and transportation. Therefore, the latter determine the long-term security of supply, while other devices on the natural gas market influence the short-term security of supply. The focus of our current analysis is the effect that the Nabucco and South Stream pipeline projects might have on the CEE region’s security of supply. According to the reasoning above, the implementation of these projects influence the security of supply on the long run. Therefore, to be able to retain focus, our analysis framework excludes internal factors (like the ones mentioned in the last paragraph) that affect the short-term security of supply and concentrates on the (both domestic/internal and external) production and (only external) transportation segments. The analysis of the effect of the Nabucco and South Stream pipeline projects on the security of supply is analyzed on the basis of a scenario analysis. Four scenarios are identified: 1. Business As Usual 2. Nabucco Implemented 3. South Stream Implemented 4. Both Nabucco and South Stream Implemented

15 Technical planning starts on Nabucco gas route,12 May 2009 16 Consulting Services on Natural Gas Sector in Russia: South Stream Gas Pipeline Project, downloaded on 28 June 2009

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In the Business As Usual scenario, it is assumed that no infrastructure development will take place in either production or transportation. This implies no further exploration or production asset development in the region and also implies that no capacity changes are made to the existing transit pipeline infrastructure. A forecasted change of demand is, however, taken into consideration to illustrate the future situation of the CEE region considering the current supply side circumstances. In the rest of the scenarios, the implementation of Nabucco, South Stream or both pipelines is presumed, on a ceteris paribus basis – meaning no other infrastructure asset is assumed to be implemented than the one(s) specified in the scenarios. This way both the separate and joint effect of the pipelines’ implementation can be analyzed. In its definition at the beginning of this section, we emphasized two important characteristics that influence the security of natural gas supply: adequacy and reliability. Taking into consideration the supply chain segments that are the subject of the analysis, three aspects can be identified which characterize security of supply in the case of the different scenarios: supply-demand balance, production source diversity and transit diversity. Supply-demand balance shows us how adequate natural gas supply is in the region, that is, whether expected demand is satisfyingly covered with maximum possible supply. For the purpose of the analysis of the scenarios, a natural gas demand forecast for 2009-2030 is taken and maximum possible supply is determined, taking into consideration expected indigenous production and maximum possible supply provided by import pipelines and domestic production to the region. This way we can determine until which year the region’s supply is secured, which is a good measure of assessing the adequacy of supply. Production source diversity and transit diversity characterize the reliability of the natural gas supply. If a country (or region) is dependent on an external supply of a primary energy source – as it is in the case of the CEE region – diversification is the only way the risk of supply interruption can be mitigated. Both aspects are decomposed into the same three measures: distribution, reliability and substitutability of supply. It is important to note that throughout the analysis the CEE region is handled as one entity. Internal aspects of the natural gas infrastructure or the market are not analyzed in this study, and it is assumed that all natural gas that arrives into the region can be utilized throughout the countries without any difficulties (which assume that there are no bottlenecks in the transit or distribution pipelines). Of course these factors need to be analyzed as well, but to be able to focus on factors that affect long-term security of supply the above assumption has to be made. The exact description of the measures used and the methodology of their quantification is introduced below, in separate sections.

4.2.2 Supply-demand balance assessment The first of the defined three aspects of long-term security of supply is the supply-demand balance. For a sound security of supply, the expected demand should be covered by the maximum possible supply. In the case of the CEE region, the maximum possible supply can be determined by adding up the expected indigenous production and the maximum import pipeline capacity – as there are no LNG import capacities – which should be decreased by the expected exports from the region.17 This way the fact that a certain portion of the incoming pipeline capacity is utilized for transit through the region is also acknowledged. Matching the maximum supply capacity and the expected consumption is complex, however, as it has to be determined how much surplus capacity the pipelines should have above the expected consumption. There is a considerable swing in natural gas demand between the summer and winter months in the region, and the capacity of the import pipelines should be enough to cover the peak demand. This implies that in the summer months, when demand is lower, there is a certain amount of unused pipeline capacity, unless there is enough storage capacity that can provide adequate balancing flexibility. Therefore, on the annual level, a certain utilization rate has to be determined, with which the actual annually deployable capacity of the pipelines can be determined (as the ratio of the maximum capacity). For this, both the available storage capacity and the fluctuations of demand should be taken into consideration.

17 Normally, the maximum output of producer countries supplying gas into the relevant pipelines should be taken into consideration, but given that the maximum production capacity of gas fields is not available and that there is not so much headroom between expected demand and maximum supply capacity in the CEE region, it can be assumed that the producers could increase output enough to utilize the available pipeline capacity.

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Observing the swing in the region’s demand and the available storage capacities in the period of 2005-2008, it can be seen that the available storage capacities are likely to be able to provide the flexibility needed. The annual capacity of the region’s storage assets, both input and output capacities taken into consideration, is around 16 bcm. This was more than enough in the mentioned period for balancing the differing utilization of the pipelines in the summer and in the winter. Accordingly, a 100 percent utilization of the pipelines could be supposed. However, to compensate for possible technical issues (e.g. maintenance or unexpected malfunctions), the maximum deployable capacity of all pipelines on the long run was supposed to be 90 percent. Figure 3: Supply-demand balance measures

Supply-demand balanceNatural gas demand in the

CEE region

Domestic natural gas

production in the CEE region

Import natural gas supply into

the CEE region

Last balanced

year

Supply-

demand

balance


Business As Usual The natural gas demand in the CEE region is forecasted to increase gradually with an average annual growth rate of 2.9 percent between 2008 and 2030. This means that the 75.5 bcm annual consumption of 2008 is expected to grow by 87 percent to over 140 bcm by 2030. At the same time, annual indigenous production of the region will sharply decline from over 20 bcm after 2012 and remain around 6 bcm from 2020, taking into consideration the fact that the average production/reserve ratio of the region is 12 years (assuming stagnating production levels). Only Poland and Romania has enough natural gas reserves (with 27.1 and 54.6 R/P18 respectively)19 which allow it to maintain production after 2020 if no further exploration or production asset development is assumed to take place. The CEE region had a total of 189 bcm annual import pipeline capacity in 2007, while the utilization of the pipelines was around 62 percent in the same year. This means that there was an overall surplus capacity of 71 bcm in the region’s import pipelines.20 Simultaneously, export pipeline capacities amounted to a nominal 100 bcm, out of which 64 percent was utilized, which leaves 36 bcm annual surplus export capacity. The region’s exports through these pipelines were forecasted by assuming that their utilization increases at the same rate as natural gas demand is expected to increase in the respective destination countries. As it can be seen in Figure 4, the assumptions outlined above indicate that the maximum possible supply is expected to gradually decline until 2020, both due to diminishing production and decreasing available pipeline capacities. Assuming no infrastructure capacity development either in the gas transportation or the gas production sectors, supply-demand balance is ensured until 2013. In 2014, there is already a gap between the expected supply and demand, and the gap is expected to further increase throughout the years 2015-2030.

18 Reserves to production ratio, which indicates the number of years until the proven reserves could last at the current production level 19 BP Statistical Review 2009 20 It is important to remark here that while the region has import capacities from Western Europe (via Italy and Germany), these capacities were not taken into consideration when summing up the import capacities for the purposes of the supply-demand balance, as it is improbable that these Western European countries would export natural gas to the region (or in the case of Germany, export more than before) on the long run as they are short of supply themselves.

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Figure 4: Expected supply-demand balance on the natural gas market of the CEE region (2008-2030)

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Source: Eurostat, IEA, Datamonitor, GIE, EIA, KPMG Analysis

Nabucco implemented In the case of Nabucco’s implementation, the same supply forecast was used as in the case of the Business As Usual scenario, complemented with a forecasted additionally available pipeline capacity according to publicly available information on the Nabucco pipeline project. Nabucco is expected to be implemented gradually, with an initial capacity of 8 bcm per annum in 2015, which will be expanded to 31 bcm by 2020.21 However, these numbers should be modified as not all of the imported capacity would reach and stay in the CEE region. Turkey’s demand is taken into consideration in the calculation, which is supposed to be 15 percent according to publicly available information. However, due to the gradual nature of this addition, Nabucco can only provide adequate supply until 2016. From this year on, taking into consideration the rate of the expected demand growth, additional transit capacities will be needed to cover demand, as seen in Figure 5. Figure 5: Expected supply-demand balance in the case of the implementation of the Nabucco project (2008-

2030)

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Extra capacity provided by Nabucco Maximum external supply capacity without Nabucco

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Source: Eurostat, IEA, Datamonitor, GIE, EIA, www.nabucco-pipeline.com, KPMG Analysis

21 www.nabucco-pipeline.com, Project timeline 26 January 2009, downloaded on 29 June 2009

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South Stream implemented In the case of South Stream’s implementation, the same supply forecast was used as in the case of the Business As Usual scenario, complemented with a forecasted additionally available pipeline capacity according to publicly available information on the South Stream pipeline project. South Stream is expected to bring 63 bcm of natural gas under the Black Sea to Europe. The currently planned onshore connection is in Bulgaria, from where the pipeline is planned to be split into two directions, one going to Austria through Bulgaria, Serbia and Hungary (alternatively crossing Slovenia as well), the other pipeline targeting Italy through Greece (and Bulgaria). There is no information available, however, on how the capacity of the 63 bcm pipeline will be split between the two directions. A viable assumption is a slightly modified 50-50 percent share, which gives the Italian direction 33 bcm and the Austrian direction 30 bcm. This assumption can be supported by the fact that Italy is well-known to be having gas supply shortage problems, which makes it presumable that it will receive a greater share of the available natural gas supply. At the same time it cannot be doubted that the Northern direction enjoys importance as well. According to public statements on the South Stream project, the pipeline can be expected to start out with the planned full capacity on both directions by 2016. Nonetheless, the question arises: How much of the 63 bcm total pipeline capacity can be taken into consideration as relevant from the CEE region’s security of supply point of view? As the whole of the South Stream capacity arrives into Bulgaria, according to currently known plans, the whole capacity could be the basis of analysis. Still, it is clear that the Italy-bound branch of the pipeline will be exclusively used for transit towards Italy, which means only the pipeline capacity of the Austrian branch – that is, 30 bcm – is taken into consideration when assessing the CEE security of supply, even though not all 30 bcm is expected to stay in the CEE region. Based on the above defined assumptions, South Stream is expected to ensure a supply-demand balance in the period 2016-2019 in the case of its implementation. However, as it can be seen in Figure 6, South Stream might come too late if it is the only pipeline to be implemented. In 2014 and 2015, a supply-demand gap is expected, which will be filled in by South Stream from 2016 with its immediate 30 bcm capacity, causing the temporary emergence of unused capacities as well. 2019 will be the last year in which supply and demand will expectedly be balanced by South Stream. It is clear that according to the assumptions utilized, South Stream itself cannot provide adequate supply to the CEE region from 2020 onwards. Figure 6: Expected supply-demand balance in the case of the implementation of the South Stream project

(2008-2030)

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Extra capacity provided by South Stream Maximum external supply capacity without South Stream

Indigenous production Expected consumption

Source: Eurostat, IEA, Datamonitor, GIE, EIA, Gazprom, KPMG Analysis

Nabucco and South Stream implemented In the case of both pipelines’ implementation, the same supply and demand forecasts were used as in the case of the Business As Usual scenario, complemented with a forecasted additionally available pipeline capacity according to publicly available information on the Nabucco and South Stream pipeline projects. From the description of the other scenarios it is apparent that 30 bcm additional annual capacity is assumed to be brought around by South Stream and an almost identical capacity, 31 bcm by Nabucco. It could be seen from the previous analyses that none of the pipelines can ensure a supply-demand balance on its own

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in the future. Actually, in the case of Nabucco it could be seen that due to its gradual implementation, it can only provide enough import capacity until 2016. Although planned to start with full capacity in 2016, the South Stream pipeline can keep the supply and demand balanced until 2019 only. Obviously the implementation of both pipelines results in the longest manageable supply-demand balance. In the event that both Nabucco and South Stream are implemented, the supply-demand balance of the CEE region can be ensured until 2026. This is no surprise as in this case the capacity – that it is calculated with – is doubled in comparison to the other scenarios. The expected supply-demand balance in the scenario where both pipelines are implemented can be seen in Figure 7. Figure 7: Expected supply-demand balance in the case of the implementation of the both pipeline projects

(2008-2030)

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Source: Eurostat, IEA, Datamonitor, GIE, EIA, Gazprom, www.nabucco-pipeline.com, KPMG Analysis

4.2.3 Production source diversity assessment In the case of the production segment, security of supply can be ensured by ample diversification of the available production sources and by keeping production source reliability as high as possible. Accordingly, three measures were defined for the assessment of production source diversity: 1. Distribution of supply between producers (Distribution Index) 2. Substitutability between producers (Substitutability Index) 3. Reliability of production (Reliability Index) It is apparent that the greater the number of production sources and the more even the distribution of supply between them, the greater will be security of supply. These two characteristics are analyzed in an integrated way by the square sum of the different producers’ shares in the supply to the region, similarly to the Hirschmann-Herfindahl Index (HHI) which is used for market concentration assessments. Thus, the Distribution Index for production varies between 0 and 10,000, the latter representing the total concentration of supply in the hands of one producer. Therefore, the smaller the Distribution Index is the higher production diversity is. Together with an even distribution, the ratio of substitutability between the different producers is also important for the assessment of production source diversity. The evenness of the supply distribution reports on how much supply is divided between producers, but provides no indication as to how secure the production is from the point of view of one producer interrupting supply for any (internal affairs, external affairs, economic etc.) reason. Substitutability is the measure which characterizes this kind of situation the best. In our approach, it is measured by the ratio in which the largest producer’s supply can be substituted by all of the other producers. Thus, the Substitutability Index is expressed in percentages. There is no specific

17


level defined for the expected level of substitutability, but apparently the higher the substitutability is the higher production diversity is. Finally, reliability of production characterizes the inherent risk present in choosing a certain set of producer countries as supplier counterparties and/or in channeling production from domestic sources into natural gas supply. Every country has its own country risk rating issued by independent international financial institutions. In our approach, these individual ratings should be averaged, weighted by the share of the individual countries in production, including domestic producers as well. For the analysis, the rating system of the Economist Intelligence Unit was used, whose risk ratings vary between 0 and 100, 100 representing the highest risk. Therefore, the smaller the risk rating is, the higher the Reliability Index will be. A peculiarity in our analysis of production source diversity is that the different scenarios are not assessed with the same time frame in mind. Instead, they are assessed with taking into consideration the last year in which the supply and demand of the region is balanced assuming the implementation of the relevant pipeline(s). This way the uncertainty of the assessment can be greatly reduced as opposed to assessing production diversity for the same year in all scenarios. If demand is significantly lower than the maximum possible supply provided by available production sources, then distribution between production sources is not characterized only by the capacity available for the region (which is mostly curbed by transit capacities), but also by their utilization. In this case, apparently an additional set of assumptions has to be made. Demand being significantly higher than maximum possible supply in the year of assessment has the same implication: additional assumptions have to be made on how uncovered consumption will be satisfied. Figure 8: Production source diversity measures


Business As Usual Production source diversity was analyzed by taking 2014 as the basis of assessment, as 2014 is the last year in which demand is satisfied if no additional infrastructure investment is assumed to take place. As such, this is the year in which distribution, substitutability and reliability of production sources can be best assessed for the Business As Usual scenario. The CEE region’s gas imports are expected to be overwhelmingly dominated by Russian gas. The current, small Norwegian import is supposed to be sustained, which will give a slight counterpoint to the Russian dominance in imports. At the same time, domestic production is expected to cover 10 percent of demand. The corresponding distribution of supply between production sources can be seen in Figure 9.22

22 The amount of gas supplied to Europe by Gazprom contains Middle Eastern gas. In this respect, Russia could be handled as an intermediary (transit country) between Middle Eastern producers and European consumers. However, Middle Eastern countries sell their gas to Gazprom first, and as such, Russia can not be considered a transit country. Therefore all gas provided by Russia to Europe was identified as being Russian originated gas.

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Figure 9: Distribution of supply in the CEE between producers assuming business as usual scenario (2014)

Norway3%

Domestic production

10%

Russia87%

Source: GIE, Economist Intelligence Unit, KPMG Analysis

The distribution introduced above results in a Distribution Index of 7,640 for the Business As Usual scenario. This reflects the alarming rate of concentration in natural gas supply which is caused by the high level of Russian dominance in natural gas production for the region. Substitutability understandably shows a similar picture to distribution of supply, owing to the fact that there is limited unused capacity on transit pipelines that supply other than Russian gas. In fact, there is a very limited number of such pipelines as well. The Substitutability Index for the Business As Usual scenario is 10.59 percent. Reliability of producers reflects the Russian dominance as well. Taking into consideration the distribution of production between the region’s countries, the reliability of indigenous production is 32 and the reliability of external production is 58 on the 0-100 scale defined earlier. These result in an overall Reliability Index of 55 for production sources in the Business As Usual scenario. Nabucco implemented Production source diversity was analyzed by taking 2016 as the basis of assessment, as 2016 is the last year in which demand is satisfied if the Nabucco pipeline is implemented as planned (and no other infrastructure projects are). Nabucco is expected to mitigate Russia’s strong domination in the region’s natural gas supply, although its effect will be limited due to the progression of its implementation. As stated earlier, Nabucco is planned to start operation in 2015 with an annual capacity of 8 bcm, which is to be expanded to 31 bcm by 2020. At the same time, Nabucco’s sources for gas are not fixed yet. The two most probable sources are Azerbaijan and Iraq, both of which can well be presumed to have sufficient gas reserves to provide gas to the pipeline. Thus in our analysis we assume that Nabucco will be supplied in equal shares by the two countries. Similarly to the Business As Usual scenario, the current, extremely small Norwegian import is supposed to be sustained. Indigenous production and Norwegian imports complemented with the slight additional supply provided by Azerbaijan and Iraq through Nabucco (in 2016, only 8 bcm annual capacity is expected to be in operation) will foster the decrease of Russian dominance in imports. As a result, Russia’s share in the region’s natural gas supply is expected to decrease to 79 percent by 2016 should Nabucco be implemented according to the currently known schedule. The expected distribution of supply between production sources in the event that Nabucco is implemented can be seen in Figure 10.23

23 Please see previous notes on the handling of Middle Eastern gas provided to European countries by Russia.

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Figure 10: Distribution of supply in the CEE between producers assuming Nabucco is implemented (2016)

Azerbaijan4%

Iraq4%

Norway3%

Domestic production

10%

Russia79%


The distribution introduced above results in a Distribution Index of 6,425 for the Nabucco implemented scenario, which is a moderate decrease from the Business As Usual scenario. This reflects Nabucco’s negative effect on Russia’s domination in the region’s natural gas supply. However, it has to be seen that Russia’s share is still extremely high in this scenario. Substitutability as well is somewhat more favorable in this case, due to the additional surplus capacity in the Nabucco pipeline.24 As a consequence, the Substitutability Index for the Nabucco implemented scenario is 13.72 percent. Nabucco’s addition to the supply mix does not mean any benefit for reliability though. Due to the fact that the risk of supplier countries channeled in by Nabucco is estimated to be quite high, reliability is modified unfavorably by Nabucco’s implementation, though only slightly. From an unchanged reliability of indigenous production (32) and the modified reliability of external production (59), an overall Reliability Index of 56 is the result for production in the Nabucco implemented scenario. South Stream implemented Production source diversity was analyzed by taking 2019 as the basis of assessment, as 2019 is the last year in which demand is satisfied if the South Stream pipeline (and no other infrastructure project) is implemented. In contrast to Nabucco, South Stream is expected to strengthen Russia’s strong domination as producer in the region’s natural gas supply. As mentioned earlier, South Stream is planned to start operation in 2016 with the whole of the planned annual capacity of 63 bcm, out of which 30 bcm is assumed to be available for consumption in the CEE region. Apparently the full capacity of the pipeline will be filled by Russian gas.25 Similarly to the other scenarios, the current, small Norwegian import is supposed to be sustained. At the same time, it has to be marked that due to the increase of consumption, the share of this import in the region’s natural gas supply will decrease. As a result, Russia’s share in the region’s natural gas supply is expected to increase to 91 percent by 2019 if South Stream is implemented. The expected distribution of supply can be seen in Figure 11. 24 Maximum utilization on the long term is assumed to be 90%, but the remaining capacity can be supposedly utilized in the case of an emergency. 25 Please see previous notes on the handling of Middle Eastern gas provided to European countries by Russia.

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Figure 11: Distribution of supply in the CEE between producers assuming South Stream is implemented (2019)

Russia91%Domestic

production7%

Norway2%


The distribution introduced above results in a Distribution Index of 8 275, which is an increase from the Business As Usual scenario. It reflects South Stream’s effect on Russia’s domination in the region’s natural gas supply. That is, Russia’s share will expectedly be further increased from its already alarmingly high level. The change of substitutability is similar to that of evenness of distribution. With the increase of Russia’s share in production, the Substitutability Index for the South Stream implemented scenario slightly decreases to 9 percent. Through South Stream’s addition, Russia’s country risk gets an even higher influence in reliability than in the Business As Usual scenario. With the change of indigenous production reliability to 35 (due to the shift of production to a smaller circle of countries as it phases out in others) and the increased weight of external production reliability of 58, an overall Reliability Index of 57 is the result for production sources in the South Stream implemented scenario. Nabucco and South Stream implemented Production source diversity was analyzed by taking 2026 as the basis of assessment, as this is the last year in which demand is satisfied if both pipelines (and no other infrastructure project) are implemented. In case both pipelines are implemented an interesting counter-effect between the two projects can be expected. On the one hand, South Stream will increase Russia’s share in supply as a producer but on the other hand, Nabucco will bring in two additional production sources: Azerbaijan and Iraq. This has interesting effects in the three dimensions of production diversity, as can be seen in Figure 12 and in the following paragraphs. Figure 12: Distribution of supply in the CEE between producers assuming both pipeline projects are

implemented (2026)

Azerbaijan8%

Iraq8%

Norway2%

Domestic production

5%

Russia77%

Source: GIE, www.nabucco-pipeline.com, KPMG Analysis

The distribution introduced above results in a Distribution Index of 6,027, which is a marked decrease from the other scenarios, though still reflecting a high level of production source concentration. It reflects the combined effect of the pipelines’ implementation, which affect distribution of supply in opposite directions.

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The change of substitutability is not as favorable as evenness of distribution. The fact that South Stream is implemented gives Russia a large share in production, which can only be counterbalanced by the additional unused capacity brought in to the game by Nabucco. The inclusion of this capacity has a limited effect, however. The Substitutability Index for the both pipelines implemented scenario is 9.86 percent, which is only slightly higher than substitutability in the South Stream Implemented scenario, and is markedly lower than substitutability in the case of the Business As Usual and Nabucco Implemented scenarios. Through South Stream’s addition of Azerbaijan and Iraq, two historically unstable countries are additionally included in the production source mix together with Russia. This results in an actually markedly higher risk for production than in the other scenarios. The resulting Reliability Index is 59.

4.2.4 Transit route diversity assessment Similarly to the production segment, the keys to ensuring the security of supply in the transportation segment of the natural gas supply chain are ample diversification and the management of reliability through the choice of transit countries. Accordingly, our approach to analyzing transit diversity is greatly similar to that of production diversity. The three measures defined for the assessment of transit diversity are: 1. Distribution of supply between transit routes (Distribution Index) 2. Substitutability between transit routes (Substitutability Index) 3. Reliability of transit (Reliability Index) The first aspect of this analysis methodology that needs explanation is the definition and choice of transit routes as the unit of analysis in the assessment of transit diversity. In our approach, security of supply is interpreted as being determined by the political and economic risk of the different segments of the natural gas supply chain, instead of being determined by their technical risk. Therefore, when analyzing transit diversity, the dimension of the analysis is the distribution of transit capacities between different routes. On the long run this kind of differentiation characterizes transit diversity much better than an analysis on individual pipelines would, because if any political and/or economic issue emerges in the transportation segment, it will not affect one pipeline only; it will affect all pipelines that run through a given political entity – as has been seen several times in the near past. Due to the geographical situation of the CEE region, every transit route that comes from Russia crosses a maximum of one transit country. This applies to all scenarios. Normally, transit pipelines cross several countries before they reach their destination country, but this is not the case for the CEE region. As a consequence, analysis by transit routes is equivalent to analysis by transit countries in the current analysis. Therefore in the following, transit routes and transit countries will be used as synonyms. It is apparent that the greater the number of transit routes and the more even the distribution of supply between them, the greater will be security of supply. These two characteristics can be integrated well in the Distribution Index, which is defined as the square sum of the different transit countries’ shares in the supply to the region, which follows essentially the same logic as the corresponding measure in production source diversity assessment. As a reminder, the lower the Distribution Index is (in the range of 0 to 10,000) the higher transit diversity is, which means lower scores are more favorable for security of supply. Together with an even distribution, the ratio of substitutability between the different transit countries is equally important. Evenness of supply distribution tells us how much supply is divided between transit countries, but provides no indication as to how much transit is secured if a transit country interrupts supply for any (internal affairs, external affairs, economic etc.) reason. Substitutability is a good measure for taking into consideration this kind of situation when assessing security of supply. In our approach, the Substitutability Index is measured by the ratio in which the largest transit country’s supply capacity can be substituted by all of the other transit countries. Thus, the Substitutability Index is expressed in percentages. There is no specific level defined for the expected level of substitutability, but apparently the higher substitutability is, the higher transit route diversity is.

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Figure 13: Transit route diversity measures


Reliability of transit characterizes the inherent risk present in choosing a certain set of transit countries as supplier counterparties, just as in the case of production diversity. The Reliability Index for transit is calculated by averaging individual transit country ratings weighted by their share in transit capacity. The same 0-100 scale was used here as in the case of production source diversity assessment. The measures for the different scenarios are calculated with the same years as a basis as in the case of the production diversity assessment. Business As Usual Transit diversity (similarly to production source diversity) was analyzed by taking 2014 as the basis of assessment, as 2014 is the last year in which demand is satisfied if no infrastructure projects are assumed to be implemented. The vast majority, 92 percent, of the CEE region’s gas imports was transported through Ukraine in 2007, which reflects the share of transit capacities between the three countries that transport natural gas into the region. With the current infrastructure in mind, whose capacity is expected to be sustained throughout the period of analysis26, Ukraine’s maximum deployable export capacity into the CEE can be assumed to be 153 bcm annually, which will be complemented by the import capacities from Belarus (10 bcm) and Germany (7 bcm), the latter transiting mostly Norwegian natural gas.27,28 The expected distribution of supply between transit countries in the Business As Usual scenario can be seen in Figure 14. Figure 14: Distribution of transit capacity between transit countries assuming business as usual scenario

(2014)

Ukraine

90%

Belarus

6%

Germany

4%

Source: GIE, BERR

26 It should be noted that as referred to earlier this capacity also includes transit volumes toward Western Europe. 27 As mentioned earlier in the Supply-Demand Balance section, the region has additional, currently unutilized import capacities from Germany and Italy. These capacities are not taken into consideration in the Distribution Index; however, a given portion of them is calculated with in the case of the Substitutability Index, as it is presumable that in the case of a supply fallout, these capacities can be utilized as well. 28 As mentioned previously, 90% maximum utilization was supposed for all pipelines.

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The distribution introduced above results in a Distribution Index of 8,160 for the Business As Usual scenario. This reflects the alarming rate of concentration in natural gas transit in the hands of Ukraine. Substitutability is accordingly low, as apparently the two alternative transit countries cannot provide enough substituting capacity. Therefore the Substitutability Index for the Business As Usual scenario is 6.0 percent. Reliability of producers shows Ukraine’s dominance in transit capacities as well. Taking into consideration the distribution of transit capacities between the individual transit countries, the overall Reliability Index of transit in the Business As Usual scenario is 62 on the 0-100 scale defined earlier. Nabucco implemented Transit diversity (similarly to production source diversity) was analyzed by taking 2016 as the basis of assessment, as 2016 is the last year in which demand is satisfied if the Nabucco pipeline is implemented as planned (and no other infrastructure projects are). Nabucco is expected to mitigate Ukraine’s strong domination in the region’s natural gas transit, although only slightly. As described, Nabucco is planned to start operation in 2015 with an annual capacity of 8 bcm, which is to be expanded to 31 bcm by 2020 – numbers that need to be decreased by 15 percent to take into consideration Turkey’s demand. As a consequence, Nabucco is expected to ensure satisfaction of demand until 2016 only; due to which fact in the transit diversity calculations its capacity is included at 10.1 bcm only. The expected distribution of supply between transit countries in case Nabucco is implemented can be seen in Figure 15. Figure 15: Distribution of transit capacity between transit countries assuming Nabucco is implemented (2016)

Ukraine

85%

Belarus

6%

Germany

4%

Turkey

5%

Source: GIE, BERR, www.nabucco-pipeline.com, KPMG analysis

The distribution introduced above results in a Distribution Index of 7,381 for the Nabucco implemented scenario, which is a moderate decrease from the Business As Usual scenario. This reflects Nabucco’s slight negative effect on Ukraine’s domination in the region’s natural gas transit. However, it has to be seen that Ukraine’s share is still extremely high in this scenario. This clearly implies security of supply concerns. Substitutability is also only slightly more favorable in this case, due to the limitedness of the additional surplus capacity provided by the Nabucco pipeline.29 The Substitutability Index for the Nabucco implemented scenario is 6.6 percent, which is still in the very low segment. Turkey’s addition to the ‘transit route mix’ does not mean any benefit for reliability of transit. Due to the fact that the share of Turkey in transit is almost negligible, reliability will expectedly not be changed by Nabucco’s implementation – even though the risk of Turkey is much lower than that of Ukraine. Reliability Index is thus 62 in the Nabucco implemented scenario. South Stream implemented Transit diversity (similarly to production source diversity) was analyzed by taking 2019 as the basis of assessment, as 2019 is the last year in which demand is satisfied if the South Stream pipeline (and no other infrastructure project) is implemented. 29 In the case of substitutability, the full capacities of pipelines are taken into consideration.

24


Similarly to Nabucco, South Stream is expected to mitigate Ukraine’s strong domination in the region’s natural gas transit. As mentioned earlier, South Stream is planned to start operation in 2016 with the whole of the planned annual capacity of 63 bcm, out of which 30 bcm is assumed to be available for consumption in the CEE region. South Stream is special from the point of view that it excludes any transit countries between the pipeline’s gas supplier, Russia, and the CEE region. At the same time, for the purpose of the analysis it is vital to include Russia because otherwise the distribution, substitutability and reliability indices would not show a realistic picture. Therefore, Russia is included in the analysis as an equivalent of a transit country. With the 30 bcm capacity available for the CEE region, South Stream is expected to significantly decrease Ukraine’s dominance to 77%, as illustrated in Figure 16. Figure 16: Distribution of transit capacity between transit countries assuming South Stream is implemented

(2019)

Russia

14%

Germany

4%

Belarus

5%

Ukraine

77%

Source: GIE, BERR, Gazprom, KPMG analysis

The distribution introduced above results in a Distribution Index of 6 265 for the South Stream implemented scenario, which shows a marked decrease in concentration as compared to the Business As Usual scenario. However, Ukraine’s share in transit is very high even in this scenario. With the emergence of Russia as a player in transit, the Substitutability Index for the South Stream implemented scenario slightly increases to 7.7 percent. Through South Stream’s addition, Russia’s country risk also influences reliability, which results in an overall Reliability Index of 62, which is no change compared to the other scenarios due to Russia’s high risk assessment. Nabucco and South Stream implemented Transit diversity (similarly to production source diversity) was analyzed by taking 2026 as the basis of assessment due to the known reasoning. In contrast to the situation in production diversity, both pipeline projects have a positive effect on transit route diversity. Therefore in the Nabucco and South Stream Implemented scenario, the effect of the pipelines’ implementation is added up. This way Ukraine’s share in transit can be significantly decreased to 69 percent as it can be seen in Figure 17. This has a profound effect on the measures defined, as described below.

25


Figure 17: Distribution of transit capacity between transit countries assuming both pipeline projects are implemented (2026)

Turkey

11%

Russia

12%

Germany

3%

Belarus

5%

Ukraine

69%

Source: GIE, BERR, Gazprom, www.nabucco-pipeline.com, KPMG analysis

The distribution introduced above results in a Distribution Index of 4,991 for the both pipelines implemented scenario, which shows a significant decrease in concentration in comparison to all other scenarios. Ukraine’s share in transit is the most mitigated in this scenario. With the emergence of both Russia and Turkey as players in transit, the Substitutability Index for the South Stream implemented scenario slightly increases to 8.2 percent, which is clearly the highest value among all scenarios. The situation in reliability of transit is not so favorable though. Through both pipelines’ addition, Turkey’s and Russia’s country risk gets an influence in reliability, but owing to the fact that their risk rating is not so low either, an overall Reliability Index of 61 results, which does not show much change compared to the other scenarios.

4.3 Feasibility of the pipeline projects As shown in the previous section the realization of the pipeline projects would surely improve the security of gas supply in Europe. Even though, the pipelines would have a positive social and political support, the financial viability and feasibility of the projects are key points of the implementation.

4.3.1 Financial viability constraints The technological solution of transit pipelines determines the total cost of the project. The key technical parameters include capacity and length of the pipeline and the number of pump stations. The geographical terms of the route have also a significant influence on cost considering installation of pipelines under sea or through mountainous terrains. As of June 2009, Nabucco is estimated to cost up to EUR9 billion30 (USD11.7 billion) which results in specific costs of EUR2.73 million (USD 3.55 million) per kilometer and EUR0.29 (USD 0.38) per cubic meter of transit capacity. The predicted costs of the project have been continuously increasing from the very beginning. Initially according to the first feasibility study, which was completed in 2005, Nabucco constructions were projected to amount to EUR4.6 billion (USD5.98 billion), while in 2008 a 70 percent increase was declared by the Nabucco Gas Pipeline International company to EUR7.9 billion (USD 10.27 billion).31 The price forecast grew in 2008 due to the accelerated material and service costs and the reconsideration of the investment plan. In 2009 the economic tendencies have turned dramatically and the falling construction and engineering costs may outpace rising financing costs to cut Nabucco's cost to below the EUR9 billion (USD 11.7 billion) projection.32 In February 2009 Gazprom estimated the cost of South Stream at EUR19-24 billion (USD24.7-31.2 billion), depending on the final choice of routes for certain pipeline sections, but this estimate is at least twice as high as the sums quoted barely a year before.33 The pipeline from Russia to Bulgaria on the seabed of the Black Sea would involve costs of at least EUR4 billion (USD 5.2 billion). The two overland routes into Europe would together cost another EUR15-20 billion (USD 19.5-26 billion). This estimate has been doubled during

30 SETimes.com: South Stream, Nabucco competition escalates, 1 June 2009 31 Reuters: Nabucco pipeline cost rises to 7.9 bln euros, 29 May 2008 32 Upstreamonline.com: Turkey demand 'not on Nabucco agenda',29 May 2009 33 Jamestown Foundation: Gazprom Reveals Unaffordable Costs of South Stream Project,12 February 2009

26


the last years, however, the original plans of EUR10 billion (USD 13 million) were already considered to be underestimated by independent experts. The specific costs of South Stream with 30 bcm capacity would amount to EUR5.1-6.49 million (USD6.63-8.44 million) per kilometer and EUR0.63-0.8 (USD0.82-1.04) per cubic meter. With these projects costs South Stream is looking financially unfeasible. However, in the latest announcements Vladimir Putin, Russian Prime Minister, expressed his expectations about a fall in the project’s cost to about EUR10 billion (USD 13 billion) due to lower prices on materials and services.34 In the light of the doubled capacities this cost estimate may prove optimistic.

4.3.2 Timeline constraints Planning, licensing and construction of international pipeline investments require generally a multiple year long time frame, depending on the scale, the number and the commitment of the participants and the technology. During the planning phase, the technical, commercial and financial feasibility of the project is to be examined and the parties must agree on the plans and make investment decisions. On the technical side, the length, capacity and the different geological features of the route strongly influence the timeline of the project. According to the project developers the final investment decision of Nabucco should be made in early 2010. Construction is scheduled to start in 2011 to ship first gas in 2014 with an initial pipeline capacity up to 8 bcm. After this stage the extension of pipeline capacity and installation of pump stations will take place in order to continuously increase the pipeline capacity up to 31 bcm until 2020.35 The deadline is considered feasible, however, it is challenging especially due to the high number of the involved parties. The following step of the project development, namely the agreement between the transiting parties and the gas suppliers, represents the highest risk to the completion. Gazprom has set the South Stream pipeline launch date for December 31, 2015, although the partners will endeavor to complete the project earlier if possible. The pipeline sections of the countries will be constructed in parallel, which enables the completion of the pipeline according to the plans. It is important to note that the undersea section holds a risk of unexpected circumstances, which can lead to the delay of project completion.

4.3.3 Competition between Nabucco and South Stream Nabucco and South Stream have been considered as competitors since the conception of both plans. The competition is for the same consumer markets, almost identical routes and in some extent the natural gas sources as well. If both projects are realized the risk might arise that the potential sales revenues must be shared between the two projects or their revenues would be fully jeopardized by one another. However, if natural gas demand in the region will follow the forecasted trend, both project’s ample utilization – and thus, profitability – can be secured simultaneously. As the demand-supply analysis indicated earlier, a competition of the two pipelines is expected between 2015 and 2026. The pipeline constructers on both sides have a strong interest to secure the consumer and the supplier markets of their respective pipelines. Also, both projects have strong political and strategic interests behind them (as it was described earlier), which can greatly influence the eventual outcome besides economic considerations. In fact three of the five countries, namely Bulgaria, Hungary and Austria, located along Nabucco’s route are also part of South Stream’s intended route, enhancing the competition since the transit countries would be the primary consumer countries and the financial sources for the constructions should be also provided by these countries and companies. On the technical side the pipeline construction will keep the transmission system operators of the transit countries very busy by reserving their financial and technical capacities. The competition between the pipeline constructions and their future operations puts a strong time pressure on the project developers. Both parties endeavor to ensure the key elements for the feasibility of the project. Acquiring the commitment of the consumers and the suppliers are crucial for the success of the projects. In this sense Nabucco stands in a worse position than South Stream, as the intergovernmental agreements are expected to be signed in July 2009. However, because the countries are EU-members the agreements are planned to be the same and will be signed at the same time. The leading gas companies of the involved states have been set up as a joint venture for the construction and the future operation, but the financing structure has not been finalized yet. South Stream possesses the commitment of two-thirds of the transit countries based on the signed intergovernmental agreements with the exception of Austria and Slovenia. Gazprom has also signed Memorandums of understanding for pipeline construction and operation with the national transmission system operators in those same countries. Since the missing countries are the last players on the transit routes their current participation is not so crucial. The South Stream seems to be 34 Grahamstack.wordpress.com: Hungary and Russia sign off on cheaper South Stream, 11 March 2009 35 Nabucco official website, downloaded on 28 June 2009

27


further on the project timeline, but expected to require a longer construction phase due to the offshore sections. Nabucco developers are aiming to provide a route and also a gas source diversification, however have no traditions of procuring gas from the targeted supply countries, namely Azerbaijan, Iraq, Turkmenistan and Egypt. It is important to note that except for accessing the Azeri supplies additional pipeline constructions would be required to the potential gas fields of Egypt and Iraq. As discussed earlier, the Nabucco is expected to be supplied mostly from Azerbaijan and Iraq. The negotiations between the Nabucco developers and the countries have been started but no direct commitment has been addressed so far. In May 2009 a new alternative for an Iraqi gas source arose. Two Nabucco consortium members, the Austrian OMV and the Hungarian MOL, have launched a EUR6.15 billion (USD8 billion) attempt to bring Iraqi Kurdistan gas to Europe through the Nabucco pipeline, by each acquiring a 10 percent share in the Kurdistan company owning the gas field license. The exploration of the field is expected to be able to fill Nabucco in its first stage of an 8 bcm annual capacity but requires the construction of an additional approximately 700 km pipeline to bridge the Kurdistan field and the Nabucco route. The final results of the negotiations between the potential transit, financer and supplier partners and the result of the Iraqi field’s exploration of MOL and OMV is expected to determine the outcome of the pipeline competition. Contrarily, South Stream would be supplied by Gazprom with Russian and Central Asian origin natural gas, which is ensured primarily by the already existing procurement channels of Gazprom. Moreover in March 2009 Gazprom approached Azerbaijan and the two sides agreed to start negotiations for Gazprom's purchase of Azeri gas beginning in January 2010, albeit without indicating the volume of gas to be sold.

4.3.4 Other competing projects in the region There are several plans in the region aiming to improve the gas supply both in terms of transit route and new sources. These routes vary considering the source, the technology and also the probability of realization. Figure 18 provides a summary on the projects concerned as competitors of South and Nabucco, while Figure 19 shows the proposed routes on a map. Figure 18: Key figures of other competing projects in the region

Route Length Planned capacity

Expected date of completion

Source

Nord Stream Pipeline

Russia-Germany (also under Baltic Sea)

2,137 km, out of 1,220 km undersea

1st stage: 27.5 bcm/year 2nd stage: 55 bcm/year

1st stage: 2011 2nd stage: 2012

Russia

Capacity extension of Yamal pipeline

Russia-Belarus-Poland-Germany

4,000 km Approx. 23 bcm/year

Planned only after Nord and South Stream

Russia

Galsi pipeline

Algeria-Italy (under Mediterranean Sea)

1,400 km, out of 565 km undersea

8 bcm/year 2013 Algeria

Adria LNG Croatia - Approx. 10 bcm /year

2014 Not known yet

Source: Nord Stream official pipeline, downloaded on 28 June 2009; Spacedaily: Analysis: Belarus lobbies for Yamal 2, 12 Feb 2009; Entrepreneur: The Galsi Pipeline, 23 February 2009; Euractiv: Russia’s Nord Stream pipeline project 'on track', 14 May 2009

Besides South Stream, Russia (Gazprom) is also planning other pipelines to serve the gas needs of Europe. Nord Stream would directly supply Germany and Western Europe via a 900 km long Russian onshore pipeline and a 1,200 km long undersea pipeline section. The total budget of Nord Stream is EUR7.4 billion (USD6.62 billion), and financed by joint venture companies, namely Gazprom, BASF/Wintershall Holding AG, E.ON Ruhrgas AG and N.V. Nederlandse Gasunie. Gazprom leads the consortium with a 51 percent stake. The project is seen as controversial in several countries, such as Sweden, Poland and the Baltic states due to environmental, strategic and political reasons.36 The project is on a good track, but the agreement and licenses of the mentioned countries are crucial to start the construction of the offshore part.

36 Euractiv: Russia’s Nord Stream pipeline project 'on track',14 May 2009

28


Figure 19: Competing projects in the region

Iran

Nabucco

South Stream

Yamal II

Nord Stream

Galsi

Adria LNG

BG

TR

IR

AZ

GE

RU

AL

MK

RS

KOMG

HRSI

BA

IT

HUAT

SK

RO

CZ

PL

BY

UA

RU

DE

FI

GR

Source: Nord Stream official pipeline, downloaded on 28 June, 2009; Spacedaily: Analysis: Belarus lobbies for Yamal 2, 12 Feb 2009; Entrepreneur: The Galsi Pipeline, 23 February 2009; Euractiv: Russia’s Nord Stream pipeline project 'on track', 14 May 2009

Yamal Europe II pipeline, the extension of the existing Yamal pipeline, is another initiative of Russia aiming to increase the deliveries to Western Europe through Belarus and Poland. This project has a lower priority than Nord Stream for Western Europe, since it would not diversify the transport routes and would even enhance the political power of the current transit countries. As a significant advantage it has a considerably lower construction cost due to the existing route and the already obtained licenses. Gazprom plans to start the project only after the completion of Nord Stream and South Stream. Galsi is a planned natural gas pipeline from Algeria to Sardinia and extending to Northern Italy. A joint venture has been set up by the Algerian producer Sonatrach (41.6%) and three Italian firms: Edison (20.8%), Enel (15.6%) and Hera Trading (10.4%). The Sardinian authorities hold the remaining 11.6 percent. As a result of an agreement between Sonatrach and Gazprom, it is possible that Gazprom will acquire a stake in the Galsi pipeline. Some technical difficulties arose in relation to the offshore pipeline, which may prolong the finalization of the project. Several LNG terminals are proposed all across Europe in order to increase and diversify the supply sources, however, only a part of them can be expected to be realized within the next decade. In the concerned Central and Eastern European region, Adria LNG project has a higher probability to be realized within 5 to 10 years. Adria LNG terminal is planned to be built in Krk, Croatia with a planned annual delivery capacity of 10 bcm. The current members of Adria LNG d.o.o. international consortium in the project are: E.ON Ruhrgas (Germany, 31.15%), OMV (Austria, 25.58%), TOTAL (France, 25.58%), RWE Germany 16.69%), GEOPLIN (Slovenia, 1.00%) Their ownership shares are going to be proportionally reduced, however, because a total of 25 percent is reserved for the Croatian companies Ina (Petroleum Refining and Sales Enterprise), HEP (Croatian Electricity Board), and Plinacro. Although the start-up is planned for 2014, the source of the liquefied natural gas is still to be arranged. The projects described above can be considered as competitors of Nabucco and South Stream, but in fact Nord Stream is the only project ensuring a significant enough delivery capacity that could question the necessity of the Nabucco and South Stream pipelines. The others have a lower impact due to the longer time frame of their implementation or their lower supply capacity.

29


5 Results

5.1 Assessment of the projects’ feasibility As the feasibility analysis of the pipeline projects show, both the Nabucco and the South Stream projects have a potential for implementation. Both projects have their key driving advantages and sponsors and also both projects would be required for improving and maintaining the security of the supply in the CEE region. Regardless of the competition present between the two projects, between 2015 and 2026, as they are competing for the consumer markets, project financers and gas suppliers, in the long term both of the pipelines are expected to be viable as the demand exceeds the supply capacity. On their planned route the projects greatly overlap concerning the transit countries which are expected to be the main consumers and the financers of each project. The transit countries have expressed their commitment to both pipelines in order to reduce their risk that they would end up without gas supplies in case one of the pipelines would not be implemented. Between the projects, there is a strong battling for potential supplier countries. Since gas sources for Nabucco have not been ensured yet, Gazprom is strongly targeting Nabucco’s potential supplier countries to allocate the potential future supply capacities before Nabucco could contract on them. Thus, the ultimate agreements with the consumers and suppliers including prices and timing are expected to account for significant milestones and key advantages in the project development. Even though any of these factors could determine the result of the rivalry of the projects, the pipeline commissioned earlier is expected to have a significant first mover advantage. It can be stated that each project threatens the potential revenues and profitability of the competitor, however this should not mean that only one of the projects can be viable, especially in the long term. The implementation of the projects is planned in stages which offer more time and flexibility for financing as well as a supply level which could better follow the gradually increasing demand. As the analysis showed, besides economic considerations, both projects have strong political and strategic interests behind them, which can greatly influence their implementation. Since the above listed factors and their combinations cannot be predicted, we consider both Nabucco and South Stream to be viable individually as well as combined.

5.2 Assessment of the pipeline projects from a secu rity of supply point of view Given that according to the feasibility analysis, the implementation of both projects can be expected on the long run, all four scenarios defined earlier are relevant in the assessment of the security of supply implications of the Nabucco and South Stream projects. These are the following: � Scenario 1: Business As Usual. In this case no infrastructure development is assumed to take place

in the production or transportation sectors. � Scenario 2: Nabucco Implemented. In this case no other infrastructure development is assumed to

take place. � Scenario 3: South Stream Implemented. In this case no other infrastructure development is

assumed to take place. � Scenario 4: Both Nabucco and South Stream Implemented. In this case no other infrastructure

development is assumed to take place. Business As Usual Due to the fact that in this scenario no infrastructure development is assumed, domestic production of the region is forecasted to sharply decline. At the same time, a constantly increasing natural gas demand is taken into consideration (according to Datamonitor’s forecast) both in the case of the region’s countries and in the case of the countries to which the region’s exports are destined. As a consequence, supply-demand balance can be ensured until 2014. Afterwards the gap between demand and supply is expected to gradually widen, due to dwindling production and increasing exports on the supply side and due to the increasing consumption on the demand side. Production diversity is quite low in the Business As Usual scenario37 due to the overwhelming dominance of the Russian natural gas supply and the limited surplus capacity on transit routes connecting the region to alternative producers, which implies a low level of substitutability. Also, Russia’s large share in supply implies a moderately high risk – and correspondingly, a low reliability – of production that can’t be counterbalanced by the diminishing domestic production of the CEE countries. 37 In all scenarios, production and transit diversity were both determined for the last balanced year identified in the respective supply-demand balance assessment.

30


Transit diversity is very low in the Business As Usual scenario as well, due to the overwhelming dominance of Ukrainian transit in the CEE region’s natural gas supply and limited surplus capacity on pipelines crossing alternative transit countries. In the reliability dimension, Ukraine’s share causes a high risk that can’t be counterbalanced by the almost negligible German import share. Nabucco Implemented Due to the gradual implementation of Nabucco’s capacity, it can only be expected to ensure a supply-demand balance until 2016 after its 2015 implementation. The starting annual capacity of 8 bcm of 2015, which is gradually expanded to 31 bcm by 2020 according to currently known plans, should be decreased to reflect the consumption of Turkey and also the expected exports from the CEE region towards Western Europe to determine the amount of natural gas that Nabucco can provide for consumption in the region. This amount (7.5 bcm in 2016) is simply too small to be able to cover the demand increase forecasted in the region. Production diversity is expected to be increased by the implementation of Nabucco. However, on the one hand, due to the fact that the operation will start with limited capacities only (as mentioned above), both the dominance of Russia in the region’s natural gas supply and the substitutability of production sources will only be slightly increased by the implementation of Nabucco until the year it can ensure supply-demand balance. On the other hand, the countries that are additionally included as producers of the region are politically and economically unstable, for which reason the reliability of production will actually decrease in the event that Nabucco is implemented. Transit diversity is expected to be only slightly increased by the implementation of Nabucco. This is due to the fact that Ukraine has an overwhelmingly high share in transit and also, Nabucco is included in the calculations with only a portion of its full capacity for the reasons described earlier. On the other hand, Turkey’s inclusion in the transit route mix by the implementation of Nabucco has no effect on reliability as Turkey’s additional pipeline capacity is rather limited in the year of analysis. South Stream Implemented According to the official communication, South Stream will start out with its full planned capacity of 63 bcm in 2016, out of which approximately 23 bcm will be available for consumption in the CEE region.38 Thus, South Stream brings in a huge additional supply capacity, which will consequently be adequate to cover demand until 2019. Nevertheless, production diversity of the region’s natural gas supply will be clearly decreased by the implementation of South Stream. Russian dominance in production is expected to further increase (to 91%), while substitutability between producers and overall reliability of production will decrease due to the increase of Russian domination. These imply a low production diversity – actually an even lower one than that of the Business As Usual scenario. In contrast, transit diversity of the CEE region’s natural gas supply will be clearly increased by the implementation of South Stream. The pipeline will bring in a large transit capacity on a route that avoids Ukraine. This clearly has a positive effect on the CEE region’s security of supply through fostering transit diversity. At the same time, however, Ukrainian dominance prevails in transit and the inclusion of Russia doesn’t affect reliability of transit, which stays on the original high level. Both Nabucco and South Stream Implemented Based on the previously discussed statements on Nabucco’s and South Stream’s individual effects on supply-demand balance, it is no surprise that in the case of both projects’ implementation, consumption can be covered until 2026 by maximum possible supply. This is also due to the fact that on the longer run Nabucco’s full utilization can be assumed. At the same time, however, between 2015 and 2026 there is an amount of expected unused capacity in the pipelines which foreshadows competition between the two pipelines (or rather Nabucco and every other Eastern pipeline). Production diversity of the CEE region’s natural gas supply will be somewhat decreased by the implementation of both pipeline projects. Here a counterbalancing effect is expected between the two pipelines: the implementation of Nabucco has a positive effect on the evenness of distribution, while South Stream has a positive effect on Russian dominance, which together result in an only slightly better distribution of supply than the sole implementation of Nabucco. This means a favorable change from the Business As Usual scenario nevertheless. Substitutability and reliability, however, are unfavorably changed. This is partly because South Stream increases the share of Russia in the production source mix and partly

38 Please see further explanation of assumptions in Section 4.2.2.

31


because Nabucco brings in politically unstable countries into it. Also, Russia’s share in production is still alarmingly high in this scenario, not surprisingly, as it is only Nabucco that can mitigate Russian dominance in the region’s natural gas supply. In contrast to production diversity, transit diversity of the CEE region’s natural gas supply will be significantly increased by the implementation of both pipeline projects, as both provide transit diversification. Ukrainian dominance in transit can be significantly mitigated from 90 percent in the Business As Usual scenario to 69 percent by calling both pipelines into life. At the same time, Ukrainian dominance remains in place and reliability of transit stays on a high level. The summary of the different scenarios’ assessment from a security of supply point of view can be seen in Figure 20 below. Figure 20: Comparison of scenarios by the dimension of security of supply

62 6262 61

8 160 7 381 6 265 4 991

7 600 6 4008 300

6 000

10,60% 9,00% 9,90%12,10%

56,80 59,1555,46 55,47

7,70%6,60% 8,20%6,00%

implemented

Reliability of transit (weighted average of

transit routes’ risk ratings)7

Substitutability between producers (ratio of the

largest transit route’s supply that can be

substituted by alternative transit routes)

6

Evenness of distribution in supply among

transit routes5

Transit route diversity

Reliability of production (weighted average of

producer countries’ risk ratings)4


largest producer country’s supply that can be

substituted by alternative producers)

3


producers2

Production source diversity

The year until which supply and demand can

be balanced1

Supply demand balance

BothSouth Stream

NabuccoNone

SCENARIOS

implemented

Reliability of transit (weighted average of

transit routes’ risk ratings)7


largest transit route’s supply that can be

substituted by alternative transit routes)

6


transit routes5

Transit route diversity

Reliability of production (weighted average of

producer countries’ risk ratings)4


largest producer country’s supply that can be

substituted by alternative producers)

3


producers2

Production source diversity

The year until which supply and demand can

be balanced1

Supply demand balance

BothSouth Stream

NabuccoNone

SCENARIOS

100

0

30%

0%

10 000

0

30%

0%

0

100

10 000

0

2014 2016 20192026

2009

2030


32


6 Conclusions As natural gas demand is significantly growing not only in the EU, but all over the world, the natural gas extractions and infrastructure projects will be in focus. In the EU and the CEE region, both the Nabucco and South Stream have its potential of serving natural gas consumers. Overall, both of the projects provide significant improvements in all three measurement categories concerning supply demand balance, production source and transit route diversification compared to the current market situation. Justifying the purpose of Nabucco, it would improve not only the transit route but also the production source diversity. As a result it would decrease the gas supply dominance of the Russian Federation in the CEE region. The higher diversity is to be reached via involving producer countries with high political risks. However, its scale is not sizeable enough to significantly improve the substitutability of the current supply sources. South Stream would support security of supply via transit route diversity by transiting Russian gas by-passing the Ukraine. It would notably improve the supply demand balance due to its larger scale, however, the dependency on Russia would increase significantly. In the short term, between 2015 and 2026, the pipelines are expected to compete with each other, unless the current transit flow through Ukraine, the dominant transit country, is not diverted to the South Stream pipeline. Besides the competition for consumer markets the rivalry for project financers and supply sources raise the uncertainty of the implementation of the projects. The major doubt of Nabucco’s implementation stands in the securing of gas supplies, while South Stream strives to secure its financial viability. It should be noted that based on recent statements a possible take over of the Ukrainian transit route by Gazprom might dissolve the relevance of the South Stream pipeline. Considering the long term future outlook of the expected CEE and EU demand levels, both projects would become a major pillar of natural gas security of supply. The additional capacity of both projects is of vital importance for the CEE region to be able to maintain the economic and social development of the countries. If both Nabucco and South Stream are implemented, their final aggregated annual capacity would reach 93 bcm, which would account approximately for the one-third of the total annual CEE supply. This way the natural gas demand of the CEE could be satisfied until 2026 without raising the need for further infrastructural development.

33


ANNEXES

List of figures

Figure 1: Key figures of Nabucco and South Stream ........................................................................................ 5 Figure 2: Methodology of the analysis............................................................................................................... 8 Figure 3: Supply-demand balance measures.................................................................................................. 13 Figure 4: Expected supply-demand balance on the natural gas market of the CEE region (2008-2030)....... 14 Figure 5: Expected supply-demand balance in the case of the implementation of the Nabucco project (2008-2030)................................................................................................................................................................ 14 Figure 6: Expected supply-demand balance in the case of the implementation of the South Stream project (2008-2030) ..................................................................................................................................................... 15 Figure 7: Expected supply-demand balance in the case of the implementation of the both pipeline projects (2008-2030) ..................................................................................................................................................... 16 Figure 8: Production source diversity measures ............................................................................................. 17 Figure 9: Distribution of supply in the CEE between producers assuming business as usual scenario (2014)......................................................................................................................................................................... 18 Figure 10: Distribution of supply in the CEE between producers assuming Nabucco is implemented (2016) 19 Figure 11: Distribution of supply in the CEE between producers assuming South Stream is implemented (2019)............................................................................................................................................................... 20 Figure 12: Distribution of supply in the CEE between producers assuming both pipeline projects are implemented (2026)......................................................................................................................................... 20 Figure 13: Transit route diversity measures .................................................................................................... 22 Figure 14: Distribution of transit capacity between transit countries assuming business as usual scenario (2014)............................................................................................................................................................... 22 Figure 15: Distribution of transit capacity between transit countries assuming Nabucco is implemented (2016)......................................................................................................................................................................... 23 Figure 16: Distribution of transit capacity between transit countries assuming South Stream is implemented (2019)............................................................................................................................................................... 24 Figure 17: Distribution of transit capacity between transit countries assuming both pipeline projects are implemented (2026)......................................................................................................................................... 25 Figure 18: Key figures of other competing projects in the region.................................................................... 27 Figure 19: Competing projects in the region.................................................................................................... 28 Figure 20: Comparison of scenarios by the dimension of security of supply .................................................. 31 Figure 21: Overview of the countries considered as part of the CEE region in this paper.............................. 34

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Additional figures

Figure 21: Overview of the countries considered as part of the CEE region in this paper

BG

HRSI

HUAT

SK

RO

CZ

PL


nabucco vs south stream the effects and feasibility

Documents

natural gas supply

natural gas security

eu natural gas extraction

energy supply

natural gas demand level

noneu natural gas imports

latest natural gas dispute

cee region