Www.eprg.group.cam.ac.uk The Economics of the South Stream Pipeline in the Context of...

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The Economics of the South Stream Pipeline in the Context of Russo-Ukrainian Gas

Bargaining

Chi-Kong ChyongJudge Business School & Electricity Policy Research Group

University of Cambridge

30th USAEE/IAEE North American Conference – 11 October 2011

Thanks to ESRC (UK) and NearCO2 (EU) for funding


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Contents

I. The context

II. The South Stream System

III. South Stream Cost

IV. South Stream Value

V. South Stream and Ukraine’s transit profits

VI. Conclusions


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The context

• EU-Russia gas trade is important for

– Russia:

• Gas exports generate 4.5% of Russian GDP or half of Gazprom's revenue

• Tax receipts from gas exports amount to 30% of Russia's defence budget

– and for Europe:

• 25% of European consumption is covered by Russian gas


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The context (2)

The EU-Russia gas trade is highly dependent on Ukraine


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The context (3)

• Several transit disruptions through Ukraine since the fall of the USSR raised concerns about its realiability…


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The context (4)

Gazprom’s solution: Export route diversification strategy since early 1990s


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Research question

• Given that Nord Stream is under contruction

Will South Stream be built?


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Contents

I. The context





VI. Conclusions


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The South Stream system• Off-shore pipeline under the

Black Sea (A-B): Total Capacity: 63 bcm; Length:~900 km

• Northern route:1. Bulgaria-Serbia (B-F):

~960km; 2. Serbia-Hungary (F-G):

~530km3. Hungary-Slovenia (G-H):

~610km4. Hungary-Austria (G-J):

~350km5. Slovenia-Austria (H-I):

~220km

• Southern route:1. Bulgaria-Greece (B-C):

~416km2. Greece (C-D): ~690km3. Greece-Italy (D-E): ~200 km

• Cost estimates:– Gazprom (2010): €15.5 Bn

Source: based on South-stream.info


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The South Stream System in Russia• South Stream would begin

at Pochinki

• From Pochinki to Beregovaya (South Stream offshore):

1. Existing lines ~ 32 bcm;2. A new pipeline from Pochinki

to Beregovaya ~ 32 bcm

• Possible gas sources:1. Fields in operation: Nadym-

Pur-Taz (NPT) region2. Yamal Peninsula (Gryazovets-

Pochinki bi-directional pipeline ~ 36 bcm)

3. Central Asia

• Total anticipated pipeline expansion in Russia ~2200 km

Source: adapted from eegas.com

Existing fields


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Contents

I. The context





VI. Conclusions


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South Stream Construction Cost

• Cost of onshore pipelines: – Based on

engineering model (WB, 2010)

• Cost of offshore pipelines:– Based on

econometric estimation

• Project-related uncertainties:– Monte-Carlo

simulation with key assumptions

South Stre

am offs

hore

Bulgaria-S

erbia

Serbia-H

ungary

Hungary-A

ustria

Hungary-S

lovenia

Slovenia-Austr

ia

Bulgaria-G

reece

Greece

-Italy

US$

Bn

0

1

2

310

11

12

13

14

15

Total

US$

Bn

19

20

21

22

23

24

25

26

27

Average

90% Conf. interval

Gazprom’s most recent estimate


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Transporting gas to Germany and Italy

• On average, it is cheaper to use the Ukrainian route to export gas to Germany and Italy

• Transporting gas from Azerbaijan is cheaper through South Stream


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Transporting gas to Southern Europe


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Contents

I. The context





VI. Conclusions


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Deriving South Stream value

Low Demand case

Base case

High Demand case

Western and Southern Europe

-0.2% +0.7% +1.9%

Central and Eastern Europe

-0.2% +0.8% +1.9%

Balkan Countries

-0.2% +0.8% +1.9%

Demand Scenarios: 2011-2030Source: Base and Low Demand cases - IEA (2009) High Demand case - IEA (2000-2007)

• South Stream value = changes in Gazprom’s profit when South Stream is built versus when it is not built.

• A computational, strategic gas market model (Chyong & Hobbs, 2011) is used to calculate the South Stream value under:

1. Different demand scenarios, and2. Different values of transit fees through Ukraine

• Major assumptions: 1. Nord Stream is built by 2013 (55 bcm)2. Ukraine’s transit fee is fixed exogenously

Short-run transit cost

Current transit fee

High transit fee

0.50 2.07 5.11

Transit fees through Ukraine ($/tcm/100km)


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South Stream Value

Average

90% Conf. interval


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Contents

I. The context





VI. Conclusions


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Ukraine’s transit profits


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Ukraine’s net benefit of not raising the transit fee over 30 years

An impatient Ukraine would raise its transit fee, triggering the construction of South Stream

Naftogaz’s WACC*

*Source: (Vitrenko, 2008; Kovalko&Vitrenko, 2009)


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Conclusions

• The value of South Stream investment is only positive when:– Gas demand in Europe is expected to be very high (+1.9% p.a.), or– When Ukraine raises its transit fee considerably

• Naftogaz’s corporate governance issues make its discount rate very high, which explains its willingness to bargain with Russia

• If Ukraine bargains to raise its transit fee sufficiently high, then South Stream would be built leading to the undesirable longer-term outcome of being completely bypassed by Gazprom

• To avoid this outcome, Ukraine would need to find ways to reduce the very high discount rate of Naftogaz, perhaps via restructuring and privatization


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THANK YOU


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Back-up slides


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The Economics of Nord Stream

• Nord Stream investment is profitable :

– The Nord Stream route is shorter than the Ukrainian one

– If Ukraine lowers its transit fee, the Nord Stream value would increase significantly

– The Nord Stream security of supply value is marginal

The paper can be downloaded from www.eprg.group.cam.ac.uk


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Methodology & assumptionsOnshore pipeline costing

Offshore pipeline costing

Assumptions

1. Shareholding structure: Gazprom 51%2. Financing strategy

• 30/70 equity-debt financing• Cost of equity financing:

• Gazprom 9-15%; • Non-Gazprom: 9-10%

• Cost of debt financing: margin+EURIBOR (1.24-5.4%)

3. O&M costs (fraction of initial investment cost):• For compressors 4% p.a.• For pipelines – 0.3% p.a.

4. Taxation and depreciation based on national laws

Source: (World Bank, 2009)


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Model DescriptionMarket structure

1. Producers, traders and transit countries maximize profits

2. Producers’ behaviour: 1. Oligopoly -> Cournot game

(against traders’ derived demand)

2. Perfect competition

3. Pipeline transmission & LNG terminals -> Competitive (Tariff + “Congestion Price”)

4. Traders have two options for behaviour:• Oligopoly -> Cournot game

(against Consumer demand)• Perfect competition

5. Transit countries: 'conjectured transit demand curve'

Producer A

Producer B Market B

Market A LNG Liquefaction B

Market C

LNG Regasifier C

Producer C

Supplier C

Supplier B

Supplier A

TSO

Pipeline gas

LNG

TRANSIT COUNTRY

Supplier D

Market D

COUNTRY C

COUNTRY D

COUNTRY A COUNTRY B


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Model DescriptionRepresenting market power in the gas supply chain

• Producers anticipate traders’ reaction (Asymmetric/Leader-Follower game)

• Traders and Producers: Cournot Game (i.e., game in quantities) -> the player believes that if he changes his output (gas sales), his competitors will maintain sales by cutting or raising their prices

• Market power of transit countries:– transit market power is represented by the conjectured transit demand curve approach,

which assumes that large transit countries (e.g., Ukraine and Belarus) believe that they face a declining effective demand curve for their services with an assumed slope (exogenous parameter)

• Consumers are represented by aggregate inverse demand functions of each market in the model


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Current ModelOther features

• Model data set:– 25 gas markets from Western, Central

and Eastern Europe and from the FSU

– 27 producing regions (FSU, Europe, MENA)

– Detailed presentation of the FSU gas network

– Production costs: various sources

– Production capacities and outlooks: IEA, EIA and other public data

– Details on transmission network in Europe: ENTSOG

– Details in (Chyong and Hobbs, 2011)

Consuming countries Producing countries Finland Slovak Republic Algeria Romania Baltic States* Czech Republic Azerbaijan Russia Austria Hungary Denmark Trinidad and Tobago Belgium Romania Egypt Turkmenistan Spain and Portugal Poland Germany UK France Turkey Hungary Ukraine Netherlands Italy Uzbekistan Italy Kazakhstan UK Libya Germany Netherlands Slovenia Nigeria Bulgaria Norway Balkan States** Oman Croatia Poland Greece Qatar

*Baltic States: Estonia, Lithuania, Latvia

**Balkan States: Serbia, Bosnia and Herzegovina, Macedonia and Albania

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