Russian gas supply impacts the European chemical and fertilizer industries

From Russia with gas

09 March 2010 21:51  [Source: ICB]

Europe's chemical industry weighs options on natural gas supplies, as Russia flexes its muscles

RUSSIA'S SUSPENSION of natural gas supplies to Ukraine and Belarus early this year and in 2009 crippled companies in Eastern Europe, and highlighted vulnerabilities to the West reminiscent of the OPEC oil embargo of the 1970s. Held hostage to a dispute between two former Soviet republics, all of Europe to the west of the Kremlin was forced to contemplate - at least, potentially - the division of scarce natural gas supply between feedstock-dependent industries and household consumers huddled against a cold January.

Rex Features/Chris Eyles

The more immediate victims - especially in the more prolonged (and more novel) crisis of early 2009, which lasted throughout the first three weeks of January - were to be seen among chemical companies and fertilizer producers in Central and Eastern Europe, with Slovakia, Austria, Hungary, Slovenia, Poland and Bulgaria particularly affected.

And to the west, at the far end of the pipeline, companies in the UK - which has far less gas storage capacity than many of its counterparts in mainland Europe - saw the potential for a spike in gas costs, as firms helplessly watched the commodity spike in flurries of spot trading in the UK and the Netherlands.

"For the most part, natural gas sold to large industrial users are sold under long-term indexed contracts of three to six months, and changes take a long time to feed through," says Jeremy Nicholson, director of the UK's Energy Intensive Users Group. "Prices to large users reflect the forward curve on the spot market."

But despite the extent to which the commodities markets might shelter industrial customers from price volatility, Nicholson notes, these price pressures are ameliorated in the medium to long term by both storage capacities at destination countries and the sourcing of alternative supplies, including liquefied natural gas (LNG) from the Middle East and shale gas being extracted from the ground in North America.

EASTERN DEPENDENCY
In former Soviet states - such as Belarus and Ukraine, as well as ex-satellites like Poland - governments are just struggling to adjust to the transition away from favorable terms formerly given under socialist bloc political arrangements to global pricing levels, leaving them with little or no means to pay for an increase of storage capacity.

Poland - which draws around two-thirds of its gas from Russia via pipelines across Ukraine and Belarus - is trying to convince Moscow to lock in reasonable gas prices over the long term.

Farther west, Germany and France (which have both been historically less dependent upon Russian largesse) are relatively more insulated. Germany, in particular, has been busy building up more natural gas storage lately, while both France and Germany have about 90 to 100 days of storage capacity in facilities that "date in many cases from the Cold War era," says Nicholson.

On the other hand, the UK - formerly more able to tap domestic, North Sea and Norwegian sources - is becoming "increasingly import-dependent" in terms of natural gas, he says, noting that the country has only enough capacity for "about a dozen days" of storage, or some 4% of annual demand.

The UK must also consider its geographical position. "If you are at the far end of the pipeline, disruption at any point of the chain could jeopardize supply," says Nicholson.

For his part, Alan Eastwood, economics adviser to the UK's Chemical Industries Association, argues that supply worries are becoming increasingly ameliorated by diversification: "Gas has become more widely available because there are more pipelines."

"Russia is only a marginal supplier," he says, noting that the UK is drawing much of its gas supply from not only domestic North Sea sources, but also via pipelines from Norway and the Netherlands.

Russia, apparently mindful that additional outlets will enable it to add some leverage to its natural gas relationships with the West, has started to initiate pipeline deals that would provide it with outlets to Japan, China and East Asia.

There is also much in the way of projects planned or underway that would diversify the routes taken by Russian natural gas to markets in Europe. The Nord Stream pipeline will ship gas under the Baltic Sea from Russia to Germany, while the South Stream pipeline will run under the Black Sea from Russia to Bulgaria. In addition, the Nabucco pipeline will run 3,300km (2,046 miles) from Turkey to Austria, via Bulgaria, Romania, and Hungary.

The catch is that each of these projects is years from completion. In the meantime, East European politics - particularly the relationship between Russia and Ukraine - have the capability to affect the West.

"In a way, you can say Western Europe is just a bystander," says Eastwood, maintaining that, while natural gas volatility might have eased in the short term, the issues that served to spark the gas crises are still very much on the table in the long term.

"Russia is legitimately concerned with getting paid," he says, and the supply cut-offs have also served it as a "reminder to the satellites, primarily the Central European ones." At the same time, Ukraine is trying to establish itself as an independent state and "Russia isn't too pleased."

Europe may also be compounding its own woes, according to Eastwood. The EU's so-called 20/20/20 policy, which calls for a 20% energy efficiency improvement, a 20% carbon emissions reduction and a 20% shift to renewable sources, all by 2020, is already "aggravating the problem," he says, by "making us more dependent upon imported natural gas" (particularly as an alternative to coal), and will loom larger "the further down that road we get."

The implications of this and other policy choices will to a greater or lesser degree continue to have an impact on the bottom lines of a variety of chemical company types, but it is the heavily feedstock-dependent fertilizer sector that is particularly vulnerable.

FERTILE GROUND FOR CONCERN
"Natural gas is mostly used for fertilizer production," says Johan van den Arend Schmidt, a partner at global consultancy PricewaterhouseCoopers. "No gas, no fertilizer - period." He notes that fertilizer producers were the most immediate victims of early 2009. "Last year, a spate of plants closed in Eastern Europe, so, obviously, we have to monitor this," says Mark Cryans, head of communications for the European Fertilizer Manufacturers Association in Brussels. Natural gas supply is "not really the same problem in Western Europe, given the difference in proximity." All the same, he says, "our individual members are concerned."

But experts agree that the broader economic impact of another pronounced European natural gas crisis make it more likely that the key players will try to avoid it.

"At the moment, most people are reasonably unconcerned," says van den Arend Schmidt, adding that while "people realize there's a risk of supplies being cut, Russia realizes that cutting off the gas is very counterproductive."

In the event of another major gas supply cut, "gas reserves will have to be used for domestic heating." But, given that scenario, he adds, the feedstock issue may well prove to be beside the point. "If there's no gas, the whole economy stops," and there would be "no demand for chemicals," anyway.

For the latest developments in gas markets, visit ICIS Heren

Author: Ed Zwirn

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