EU-RUSSIA: Economic Relations and

the Potential for Diversification

Natalya Volchkova

New Economic School

EU-RUSSIA: IS ENERGY A SOLID FOUNDATION

FOR ECONOMIC INTEGRATION?

European Gas Market – LNG becomes major competitor

240 bcm produced globally,130 bcm more by 2011

European regasification capacities will double by 2 015

LNG is becoming the marginal gas supplier to Europe

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LNG import to EU, bcm LNG as % of EU gas supply

Source for all charts: Eurostat, BP Statistical Review, Credit Suisse estimates, IEA (from Edward Morse (CREDIT SUISSE) presentation)ward

US gas surplus pushes LNG from US to Europe, increasing gas-on-gas competition, challenging

Russia, oil-linked prices

Source: Global Gas Strategies (from Edward Morse (CREDIT SUISSE) presentation)ward Morse

European Gas Market: disconnect between oil and gasEuropean Gas in 2010: All Change

EU demand growth – Disappearing Premium to Oil

Source for all charts: BP Statistical Review of World Energy, Credit Suisse estimates (from Edward Morse (CREDIT SUISSE) presentation)ward

2010 Europe gas demand: flat or, at best, up 0.5%.

Excess gas supply in Europe expected in 2010.

Spot gas in Europe sales expected to reach a 20% market share (from 13% in 2008 and 17% in 2009E).

Expecting a persistent disconnect between gas and oil prices, focus will be on renegotiating take-or-pay contracts.

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Gas Oil

Recent convergence in growth rates

European Gas Surplus To Widen, (BCM)

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Supply Demand

European Gas Market: changing fundamentals delink oil and gas prices

LNG Marginal Supply Cost Well Below Contract Prices Gazprom Contract Price (e) vs. UK Spot ($/mcf)

Source for all charts: Company data, the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates (from Edward Morse (CREDIT SUISSE) presentation)ward

Gas prices have decoupled from the oil price

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Gazprom oil-linked price UK spot gas

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Regasification Shipping costs Liquefaction costs Upstream gas cost Henry Hub

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Gazprom being a supplier with poor pricing flexibility is at riskRecent price developmentsLong-term oil and gas prices

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Gazprom production volumes Price divergence may last some time

• Over the long-term oil and gas equivalent prices have been closely linked • Market-based oil and gas prices have recently diverged – gas prices have been depressed due to weak demand, new supplies and ample storage• Oil-linked take-or-pay contract gas prices are, and will continue to be, significantly higher than market based prices• Gazprom suffered a 40% drop in export volumes in 1H09 year-on-year

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Monthly production 3yr average for month

Source for all charts: Eurostat, BP Statistical Review, Credit Suisse estimates, IEA, Company data (from Edward Morse (CREDIT SUISSE) presentation)ward

EU –Russia relations in energy sector

are subject to change

• Future of EU-Russia integration in gas market

will depend on the ability of Gazprom to

reconsider the approach to price setting

• China as a destination for Russian gas will also

put under pressure the integration capability

of EU-Russia relations

EU-RUSSIA: ARE ECONOMIC TIES

SUFFICIENTLY DIVERSE TO DRIVE BROADER

INTEGRATION?

EU-Russia trade: structure is defined

by comparative advantage

Экспорт из России в ЕС, млрд $

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Минеральное сырье

Товары, не класc. в других местах

Остальные товары обр. пром-ти

Машиностроение и транспорт

Товары обрабатывающей пром-ти

Химические товары

Масла, жиры и воски

Непищевое сырье

Напитки и табак

Продукты питания

Импорт в Россию из ЕС, млрд $

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EU-Russia trade: technological

composition is also driven by

comparative advantage

Экспорт в ЕС из России по технологичности, $

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Остальные Низко-технологичные

Средне-низко Средне-высоко

Высоко-технологичные

Импорт из ЕС в Россию по технологичности, $

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Остальные Низко-технологичные

Средне-низко Средне-высоко

Высоко-технологичные

Total Export from Russia to Western Europe, 2008

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Total Export from Russia to Eastern Europe, 2008

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Total Export from Western Europe to Russia, 2008

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Total Export from Eastern Europe to Russia, 2008

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EU-Russia trade links: above world-

wide average• The scope for further integration in good’s

trade seems to be quite limited

• The changed can be brought by policy integration:

– RTA

• bilateral flows will increase by 70%

– WTO

• Russia accession to WTO will increase

– export from Russia (bilateral) by 80% on average

– export to Russia (bilateral) by 40% on average

EU-Russia trade: intraindustry dimension

is substantially underexplored

• It requires

– a substantial upgrade of technological level of

Russian economy

– improvement of infrastructure, market institutions

etc

• Diversification of trade links between Russia

and EU is possible but not in the nearest

future

EU-RUSSIA: WITHER WTO

ACCESSION?

While EU-Russia negotiations were

the most difficult but …• … one can expect the highest return to

Russian accession to WTO coming from EU

– one of the most important effects of WTO on

Russian economy – through FDI and EU is the

largest investor in Russian economy

Другие страны

Германия

США

Ирландия

Франция

ШвейцарияВиргинские острова (Брит.)

Велико-британия

Кипр

Люксембург

Нидер-ланды