A proposed extension of the Nord Stream pipeline and the associated long-term contract with Russia is a better option for London than the spot market status quo, but the extension is marred by high initial investment costs. The best option for the United Kingdom to replace falling supplies from the North Sea continues to be long-term liquefied natural gas contracts, especially since the country already has a massive liquefied natural gas import infrastructure.
Qatar, the main supplier of British liquefied natural gas, has avoided long-term contracts with the United Kingdom in the past, but that trend is likely to be reversed. In Asia, Qatar already has come under pressure from an upcoming liquefied natural gas glut, and has acted to replace spot market trades by long-term contracts to secure market share. A similar dynamic is likely to take place in the United Kingdom, the largest individual consumer of Qatari natural gas, since the British market can feasibly become accessible to cheaper Russian piped natural gas. The BP-Gazprom potential pipeline agreement reflects upcoming potential shifts in the global natural gas market as piped natural gas moves into liquefied natural gas territory, a shift that is bound to be a wake-up call for Qatar to adapt its pricing practices in the British market.
Britain's Natural Gas Shortage
Despite still serving as a key transit state for natural gas re-exports to Ireland and Belgium, the United Kingdom is poised to lose a high percentage of its traditional North Sea supplies by the end of the decade. The United Kingdom has been preparing for the decrease in regional natural gas supplies by ramping up its capacity to import liquefied natural gas. Given its minimal energy infrastructure connectivity to the mainland, natural gas shipped by sea is at the moment the best option London has for addressing its upcoming energy deficit.
Liquefied natural gas currently accounts for close to 50 percent of British natural gas imports. The United Kingdom has developed a significant liquefied natural gas import infrastructure as part of its efforts to liberalize its natural gas market. It has five regasification terminals with an import capacity of around 50 billion cubic meters per year, almost double its annual liquefied natural gas import volumes of 25.3 billion cubic meters in 2011. Only minor expansions to its current facilities (most of which are already in the planning phase) would thus be needed before the United Kingdom could be able to rely nearly exclusively on the import of liquefied natural gas to offset the inevitable losses of North Sea production.
Doing so would render it exclusively dependent on shipments from a few large suppliers able to accommodate the expansion of the already significant British liquefied natural gas market.
Qatar's liquefied natural gas production trains are operating at almost 100 percent of capacity and the country has imposed a moratorium until 2015 on projects for expanding capacity, citing market concerns. However, Doha could steadily ramp up its production to counterbalance the output decline of North Sea fields. Between 2009 and 2011, Qatar was able to increase its liquefied natural gas production capabilities by 63 billion cubic meters per year.
Algeria has smaller natural gas reserves than Qatar, and its production costs are higher. But its proximity to Europe and its historic willingness to enter long-term sales contracts with European customers has made Algeria an attractive natural gas supplier to many in the European Union. It is set to expand its liquefied natural gas production capabilities by about 50 percent by mid-2013 to a total of 40 billion cubic meters per year. Given Libya's uncertain political and security future, Algeria is the only North African exporter that could significantly increase its liquefied natural gas exports to the United Kingdom (from 0.4 percent of total natural gas imports to 0.9 percent of imports) and be able to replace the falling output of the North Sea fields.
Reliance on spot priced liquefied natural gas has made British energy costs extremely volatile, making it difficult for London to maintain its current market structure for natural gas imports. This is because demand in East Asia for liquefied natural gas drives the prices the United Kingdom must pay. Prices peaked at nearly $600 per thousand cubic meters early in 2012, more than 30 percent higher than the average EU price during the same period. London has sought to insulate itself from price volatility by signing long-term natural gas import contracts, with limited success so far.
The Russian Option
BP announced Nov. 25 that it has engaged in talks with the Russian government and other shareholders of the Nord Stream natural gas pipeline consortium over the possibility of extending the pipeline to the United Kingdom. The talks come weeks after Russia's state oil company Rosneft acquired BP's Russian venture TNK-BP, freeing BP to resurrect its decadelong plan to connect Russia's natural gas fields directly to the United Kingdom. A provision of the contract between the two groups stated that BP could only explore Russian opportunities within the scope of TNK-BP, but this provision is no longer binding after BP's exit from TNK-BP.
Expanding Nord Stream to the United Kingdom is the only alternative for the United Kingdom if it wishes to maintain a balance between piped and shipped supplies of natural gas. It would also allow the United Kingdom to secure long-term contracts for piped natural gas to insulate itself partially from the risk associated with spot market liquefied natural gas prices and supply volatility.
For its part, Russia has recently shifted its natural gas strategy regarding the European market, a major source of hydrocarbon revenue for the Kremlin. It has become more accommodating with its natural gas customers, negotiating lower prices and more flexible contracts to ensure Russia's market share in Europe over the long term.
Having access to the United Kingdom market would be a boon for Gazprom's efforts to increase its presence in Western Europe. The pipeline would secure another large and reliable revenue stream for Gazprom, especially if it is able to undercut the price of traditional liquefied natural gas imports. This makes it likely that Moscow would offer London a very competitive natural gas deal on a long-term contract.
If the pipeline is built, Russia would likely offer the United Kingdom prices similar to those it charges Germany, or around $380 per thousand cubic meters. By comparison, British liquefied natural gas prices reached a two-year high of $582 per thousand cubic meters in February, and current prices stand at around $390 per thousand cubic meters. As Russia's giant natural gas fields in the northern Yamal Peninsula come online in 2016, Gazprom will be able to offer large volumes of possibly less expensive natural gas to customers on the Nord Stream line.
In late September, Gazprom and British energy company Centrica signed a contract for 2.4 billion cubic meters of natural gas to be delivered over a three-year period via the Belgium-United Kingdom interconnector. Despite its relative small scale, this previous deal highlighted Russia's willingness to adapt to the particulars of the United Kingdom natural gas market. The deal dropped the traditional oil-indexation pricing favored by Russia for a spot price indexation system in line with British market regulations.
The plans to extend Nord Stream to the United Kingdom are in the earliest phases, with little more than a tentative completion date of 2016 being floated by BP and Gazprom. The pipeline's route has not been mentioned, nor has the price of the project, though the high cost of the original Nord Stream line to Germany suggests a final price tag of several billion euros.
High initial investment costs remain the largest obstacle for the project. Russia already has had to shoulder the $5 billion cost of doubling the Nord Stream pipeline capacity and is preparing to break ground on the $16 billion South Stream project in December. Gazprom has few funds available for another multibillion-dollar project at present; only a direct financial intervention by the Kremlin would unlock the needed capital. The United Kingdom, too, is not in a strong position to fund the project. The financial crisis has severely limited the availability of capital for large infrastructure projects, especially given the debt incurred when the United Kingdom conducted a large-scale expansion of its liquefied natural gas import infrastructure in 2009.
The United Kingdom's new options for sourcing natural gas represent the increasing supply-side pressures Qatar, as well as other liquefied natural gas suppliers such as Algeria, will face when trying to consolidate or expand their market share in northwestern Europe. Qatar traditionally has sought to diversify its interests by carefully balancing its exports to both Europe and large Asian energy consumers. London is not alone in being able consider new ways of sourcing its energy needs, however, since Russian outreach to Japan and an anticipated growth in Indo-Pacific liquefied natural gas producers are poised to significantly change the Asian natural gas marketplace as well. With pressures mounting on both sides of the globe, Qatar as the global leader in liquefied natural gas exports will have to adapt its business strategies not only to retain valuable market share but also to sustain long-term sources of revenue that are critical to supporting its national interests and foreign policy ambitions.
Editor's note: An earlier version of this analysis misstated the amount of natural gas to be delivered in the Gazprom-Centrica deal.