East-West Divide To Continue


BMI View: Our forecasts suggest that emerging Europe as a whole will continue to be a net oil and gas exporter. However, this aggregate trade balance masks a clear divide between net importers in Eastern Europe and net exporters in Russia, Central Asia and the Caspian. Refining capacity will remain stable in most countries as there is already sufficient downstream supply throughout the region, though Eastern European countries risk a decline in this capacity if the refining climate remains hostile to fuel producers. Gas consumption growth, albeit lower than that of oil, will also be strong and its geopolitical impact will remain crucial.

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

  • In production terms, the outlook for gas is far more positive than the outlook for crude oil, with net importers and exporters alike seeing substantial rises in output from greenfield projects, including offshore drilling and unconventional gas.

  • Production mainly takes place in Russia and Central Asia (Kazakhstan, Azerbaijan, Uzbekistan and Turkmenistan), while the small resource bases of Eastern European countries (Bulgaria, Poland, Romania, Slovenia, Slovakia, Croatia, Czech Republic, Hungary, Ukraine, Turkey) will leave these countries as net importers of oil and gas. Despite growing exploration in the latter group - boosted by the promise of vast technically recoverable shale and offshore resources - the prevalent market dynamics with importers in Eastern Europe and exporters in Russia and Central Asia will largely remain unchanged to the end of this decade.

  • Although Russia will continue to account for most of emerging Europe's output, Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan will strengthen their relative positions and will provide the wider region with increasing volumes of both oil and gas.

Gas: Brighter Prospects Than Oil
Regional Oil Production ('000b/d, LHS) & Gas Production (bcm, RHS)
  • Both oil and gas consumption is expected to rise alongside economic expansion . However, for both oil and gas, our forecasts show that consumption growth is expected to be greatest in Uzbekistan, Turkmenistan and Azerbaijan.

Moving To Cleaner Fuel
Projected Average Year-On-Year Gas Consumption Growth Rate, 2012-2021 (%)
Moderate Oil Demand Expected
Projected Average Year-On-Year Oil Consumption Growth Rate, 2012-2021 (%)
  • Nonetheless, the region is still expected to be a net exporter overall, with gas export capacity projected to grow while oil export capacity shrinks.

Capacity To Spare
CEE's Net Oil Exports ('000b/d, LHS) & Net Gas Exports (bcm, RHS)
  • Despite strong oil demand growth, refining capacity will remain stable in most countries as there is already sufficient downstream supply throughout the region. Russia will continue to account for the majority of the region's refined fuels production and only producers or transit countries with access to large and secure crude feedstock - such as Azerbaijan, Turkey and Turkmenistan - will see their downstream capacity increase substantially over the forecast period.

  • At present, the refining capacity of Eastern European countries is likely to stagnate. However, if the poor refining environment currently plaguing these countries - high feedstock prices, weak domestic demand from poor growth - persists, this will pose a key downside risk to our forecasts.

Russia Remains King
Regional Refining Capacity, 2012-2021 ('000b/d)

The Ties That Bind

Russia and the Central Asian countries are net exporters while Eastern European countries are net importers. The promise of shale gas and Black Sea gas resources has increased exploration activity in import states such as Poland, Ukraine, Bulgaria and Romania but it will take a long time before discoveries are developed for commercial use. Hence, the current energy trade status quo in the region will remain over the duration of our forecast period from 2012 to 2021.

Status Quo To Remain
Comparison Of Net Gas Exports Among CEE Countries, 2012-2021 (bcm)

This pattern has determined the direction of regional oil and gas flows. Most of the region's trade movements occur via pipelines rather than through sea routes and liquefied natural gas (LNG), due to the lack of access to coasts and port facilities. With the exception of Turkey and, to a smaller extent, Balkan countries which have access to Middle Eastern and North African resources and can serve as transit nations, the prevailing trade dynamics (flows from Russia and Central Asia to Eastern European markets) will persist.

The legacy of the Cold War has left importer countries highly dependent on Russia for crude oil and gas. This is particularly the case for gas and many of these countries are often locked into long-term supply deals at fixed rates indexed to oil prices with Russian state-owned gas export monopoly Gazprom. However, Russia is just as just reliant on them for export markets.

Geopolitics will continue to play a crucial role in the region's energy trade. Russia will use its abundant energy sources as a bargaining chip to achieve its political goals of enticing more countries (namely Ukraine and Central Asian republics) into its customs union with Kazakhstan and Belarus. Many import-dependent countries are taking measures to resist Moscow's draw.

New Kids On The Block
Breakdown Of CEE New Capacity, 2011-2021 ('000b/d)

Loosening The Bear Hug

Rapidly expanding gas demand has placed Russia - the region's main producer with more than 70% of Emerging Europe's production - under the spotlight. The country's reputation as a reliable gas provider took a hit in 2006 and 2009 when disputes with Ukraine resulted in supply disruptions in many European markets. Gas exports have returned to their usual levels, but tensions arose once more in 2011-2012. This reveals the political risk to CEE importers' dependence on Russian gas.

The market risk of high gas prices has also brought Russia to loggerheads with import countries. Unhappy with Gazprom's oil-linked gas price formula - which led to a spike in gas import bills as oil prices soared in 2011 and 2012 - many of Russia's traditional long-term partners have started to challenge their long-term supply contracts with Gazprom .

In October 2011, Turkey's state-run Botas chose not to renew its 1986 long-term contract which expired in December 2011. In November 2011, Poland's Polskie Górnictwo Naftowe i Gazownictwo (PGNiG) filed for arbitration proceedings against Gazprom. Ukraine is also persisting in its efforts to negotiate prices downwards with Russia, upon whom it is wholly dependent for its gas import needs. The culmination of this dissatisfaction came in September 2012, which saw the European Commission launch an inquiry against the gas exporter's alleged abuse of market power in EU markets. This inquiry specifically targets its gas sales to Poland, Czech Republic, Slovakia, Hungary, Bulgaria and the Baltic States.

The Russia House
Breakdown Of CEE Gas Production (LHS) & Consumption (RHS), 2011-2021

Its partners have also taken active steps to reduc e their reliance on Russian gas. These include:

  • Developing domestic gas resources - both conventional and unconventional;

  • Striking supply deals with Caspian countries;

  • Encouraging pipeline routes that bypass Russia;

  • Using control over the pipelines that carry Russian gas to Europe as political leverage;

  • Building infrastructure to support LNG imports.

We see these developments as major risks to export demand, particularly for Russian gas. Nonetheless, strong regional interdependence is likely to endure through our forecast period. It will take time for alternative pipelines to be built, LNG terminals to be constructed and domestic gas resources to be sufficiently developed before other sources of gas can supplant Russian imports to meet countries' growing needs. Moreover, if Gazprom bows to pressure and adjusts its gas price formula, the prospect of cheaper gas could reduce the incentive for importer countries to diversify their gas sources. Hence, the switch away from dependence on Russian exports in the CEE will be relatively small between 2012 and 2022, though the downside risks are certainly higher beyond this period.

Central Asia: Beneficiaries Of Europe's Russian Fatigue

Azerbaijan stands to be the biggest beneficiary of the region's gas diversification strategy. Several pipeline projects are competing to win a final investment decision (FID) that would see the transport of Azeri gas to Central Europe and into Western Europe without passing through Russian territory. The main contenders include the revised and EU-backed Nabucco West and the Trans-Adriatic Pipeline (TAP) projects, which in their current form could both be combined with the planned Trans-Anatolian Pipeline (TANAP). There is also a possibility that these pipelines could be expanded in the future to carry other Central Asian resources through the Caspian, to the advantage of Kazakhstan, Uzbekistan and Turkmenistan.

For this reason, we expect Central Asian countries - Azerbaijan, Turkmenistan and Kazakhstan - to drive the CEE's gas production growth between 2012 and 2022. Connecting infrastructure to the European market will provide the incentive for upstream players to increase investment in these countries' untapped offshore acreages in the Caspian Sea. Turkmenistan's growth will also be driven by a long-term pipeline gas supply deal with China.

Central Asia Driving Gas Output Growth
Average Y-o-Y Growth In Gas Production, 2012-2021

Looking To LNG

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

These import projects will see CEE's net LNG exports decrease over our 10 -year forecast period, negating the effect of Russian LNG exports that are currently going out from Gazprom's Sakhalin-2 plant and are expected to rise when the first phase of Novatek 's Yamal LNG project comes online in late 2016.

Construction delays at these import terminals, however, present upside risk to our forecasts.

Turning To Sea-Bourne Gas
CEE's Net LNG Exports, 2012-2021 (bcm)

Russian Retaliation

Russia is fighting back against these attempts at diversification, coming up with alternative pipeline pro jects of its own:

  • Nord Stream: In November 2011, it inaugurated the 27.5bn cubic metres (bcm) Nord Stream pipeline, which connects it directly to Western Europe. This is an attempt to weaken the bargaining power of transit countries such as Ukraine and Poland. The second trunk line of Nord Stream was completed in June 2012 and will be commissioned on October 8 2012, bringing the system's total capacity to about 55bcm. Talks are in progress for a third and fourth line - which would travel along a different route - and a decision for these could be made by end-2012, according to Gazprom's chief executive Alexei Miller.

  • South Stream: The planned 63bcm subsea pipeline will connect Russia to Central Europe via the Black Sea, bringing it into direct competition with the proposed Azeri routes. One of the project partners, Serbia, announced on September 12 2012 that it will commence construction of its section of the pipeline in December 2012.

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