Industry Trend Analysis - Market Share Risk From Nord Stream II Delay - JUNE 2017

BMI View: Russia ' s natural gas pipeline expansion plans into Europe will continue to face political hurdles, with EU sanctions expected to be rolled over, delaying progress on the Nord Stream II pipeline beyond its targeted 2019 start up. The longer the delay to Gazprom's new midstream capacity, the higher the risk that it will lose out on Europe's expanding gas market.

2017 is set to be a crucial year for Gazprom and Russia's natural gas export ambitions to Europe and China. European demand is improving, especially in the UK and Germany, while domestic production is struggling as weak oil prices restrain upstream investments. Gazprom is in a strong position to take advantage of this gas deficit in Europe, though will need to progress key pipeline projects in 2017, or will face challenges with securing market share over the longer term. 10bcm of gas is due to begin delivery from Azerbaijan from January 2020, while we anticipate lower LNG prices will see more gas directed towards the European market ( see ' Bucking The Global LNG Trend ' , March 1).

Gazprom has announced aggressive capital expenditure plans for pipeline and upstream projects targeting both Europe and China. In 2017, Gazprom has allocated RUB64bn for the development of the Chayandinskoye gas field and will be putting RUB159bn towards the Power of Siberia pipeline. Combined, the approximately USD3.9bn allocated to the projects to supply China, will support progress over 2017 and make the 2019 start up target achievable.

Europe will be a more challenging arena, with greater uncertainty surrounding both the Turkstream and Nord Stream II pipelines.

More Capacity Into Europe Remains A Challenge
Russian Gas Pipelines Into Europe
** Strings 3 & 4 would add another 55bcm. Source: Gazprom, BMI

Gazprom will be spending RUB111bn (USD1.95bn) on Nord Stream II and RUB42bn (USD740mn) on TurkStream respectively in 2017 according to the company's investor presentation. There will also be around RUB37bn (USD650mn) spent on expanding the production capacity of the Bovanenko field, gas from which will predominantly supply Europe. Capacity at the field is due to increase to 115bcm in 2017, from 90bcm in 2015.

The larger sum of money being place behind the Nord Stream expansion indicates Gazprom's priority with pushing this project forward over a less politically contentious TurkStream. The capital allocation for Nord Stream II is around 18% of the total USD11.0bn budget, as opposed to just closer to 6% of the USD12.0bn TurkStream budget. This suggests to us that the Nord Stream project is more strategically important to Gazprom, hence its efforts to continue the project after the fall through of the European consortium that was supporting the pipeline ( see ' OPAL Exemption Slows Nord Stream II Push ' , October 31 2016).

We maintain our view that even if Gazprom funds the Nord Stream II project itself and pushes forward with the project, the EU's Third Energy Package rules will restrict the total Nordstream capacity of 110bcm entering the EU to a maximum of 55bcm. Furthermore, there is insufficient takeaway capacity from the EU entry point at Greifswald, Germany. The NEL pipeline (20bcm) and the OPAL pipeline (35bcm) have the capacity to accept more Russian gas, though Gazprom only has access to 50% of the OPAL pipeline and 65% of NEL (under long-term contracts). Only around 31bcm of gas can therefore be sent into Europe via Nord Stream II, though up to 37.5bcm can be sent including short-term deliveries.

In order to get more gas into Europe, by passing Ukraine, Gazprom would either need an exemption for the OPAL pipeline, or the construction of the proposed EUGAL pipeline. EUGAL would add up to an additional 51bcm of capacity along the same route as OPAL from Greifswald Germany to the Czech border. EUGAL is being developed by GASCADE, which Gazprom jointly owns with BASF. Planning approval procedures are due to take place from mid-2017 to mid-2018, with construction starting in late 2018 at best. In our view, EUGAL will be essential to Nord Stream II moving forward as with this new pipeline, Gazprom could send as much as 62.5bcm of gas to Europe via Germany, more if it is given an exemptions or short-term supply allowances.

Sanctions Indicate Delays To Continue

The current political environment indicates EU sanctions on Russia will be rolled over to the end of 2017, while we see little likelihood of the EU lifting sanctions in early 2018 prior to Russian Presidential elections in March (see 'Western Sanctions On Russia To Persist Till Late 2018', April 10). Under these circumstances, we expect continued push back from the EU against efforts divert gas supplies around Ukraine, which will delay pipeline expansion efforts of both EUGAL and Nord Stream II. We believe this will be postponed to a point where Gazprom will be forced to reopen negotiations with Ukraine's Naftogaz regarding gas transit through the country. The current Gazprom-Naftogaz transit contract expires end-2019. Without the added leverage of Nord Stream II, gas transit through Ukraine to Europe will continue.

EU Improving Gas Market Flexibility

In this situation, we expect the Gazprom will face challenges in growing its gas exports to Europe over the longer term, following strong growth in 2016 and likely 2017 ( see ' Gazprom To Continue Expansion At Slower Pace ' , January 4). The EU's gas network is becoming increasingly flexible with greater accessibility to natural gas via LNG and, from 2020 Azerbaijan. We expect LNG to be more competitively priced with European hub prices, bringing more liquefied gas into Europe. Yamal LNG, set for a 2018 start up, could benefit here.

LNG To Head To Europe
NBP vs Asian LNG Price (USD/mnBTU)
f = BMI forecast. Source: Bloomberg, BMI