Oil and gas in the capitals

	Vol. 228 No. 10
ØYSTEIN NORENG, CONTRIBUTING EDITOR, NORTH SEA

Even if the North Sea is a mature petroleum province, with a declining output of crude oil, it’s gotten a boost from the recent oil price spike. Natural gas output could be most positively affected, and development will affect not only the European market, but also potential supplies to the US, as well as demand for Russian gas. Total North Sea gas output is flattening as UK levels are declining and only Norway’s output is still growing.

According to Barclay’s Oil Data Review of Sept. 19, 2007, the combined oil production of Denmark, Norway and the United Kingdom is set to decline from 4.73 million bpd in 2006 to 3.99 million bpd in 2008, a loss of almost 16% over two years, further reducing Europe’s self-sufficiency in oil. Higher prices and eventually more lenient fiscal conditions might slow the decline of North Sea oil output, but hardly reverse the trend. For natural gas, the outlook is less sombre. In the UK, natural gas output peaked at 10.5 Bcfd in 2000, declining to 7.7 Bcfd in 2006. But, the UK decline was more than made up for by increases in Denmark from 0.8 to 1.0 Bcfd and in Norway from 4.8 to 8.5 Bcfd, during the same period. Norway has become the world’s fifth-largest natural gas producer, ranking after Russia, the US, Canada and Iran, and a major exporter due to the limited domestic demand. In the coming years, Norway’s gas output and exports are set to rise further, possibly offsetting the anticipated further decline in UK output.

Historically, the bulk of Norwegian natural gas exports has gone to the European continent, with France and Germany as the major markets. Norway is the LNG supplier to France, the second-largest to Germany. The new Langeled pipeline to the UK, opened in 2006, is destined to take a major share, perhaps a fifth of the UK natural gas market, making Norway the UK’s major import source.

In spite of strong positions in the major European markets for natural gas, there are problems on the horizon. New development justifies at least one more major natural gas pipeline project, but the issue is where and on what terms. Even if France, Germany and the UK have a declared interest in more gas from Norway, the outcome is not evident.

In the European natural gas market, the three major suppliers, Algeria, Norway and Russia, have not engaged in cut-throat competition over market shares, but instead have moved carefully not to upset each other’s major gas sales projects. They have been unwilling to risk a major price decline resulting from a weakening collective bargaining position, even if they do not move in concert. The historical organization of the European gas market, an oligopoly of three national monopolies facing a group of single buyers, embodied this particular trading pattern, where bargaining positions were decisive rather than costs. The historical trading pattern with long-term contracts and price indexation to oil ensured secure natural gas supplies, although it was costly to the consumers due to lack of competition and high intermediary profits. Nevertheless, since the early 1970s, European consumers have enjoyed stable and secure natural gas supplies with remarkably little disruption.

For several years, the European Commission has strived for energy market reform, aiming at opening transmission networks and reducing intermediary profits to enhance competition and lower prices to end-users. Unbundling the vertically integrated or controlled networks to ensure transparency and competition has been one major objective, the other one being the diversification of supplies and the abolition of the oligopoly by attracting more sellers and by undoing the national monopolies of Algeria, Russia and Norway. Otherwise, a liberalization of the EU gas market would seriously weaken the bargaining position of numerous gas buyers in relation to a few sellers.

The outcome has been a mixed success, so far. The EU has scored successes in opening the natural gas and electricity markets, but in practice not in Germany, and by making Norway abolish its natural gas sales monopoly. Natural gas supplies are being diversified through new sellers, but essentially by overseas suppliers of liquefied natural gas. Pipeline natural gas supplies to Europe remain heavily concentrated with a few sellers. The EU setbacks are evident by the recent refusal of France and Germany to unbundle vertically integrated companies, to separate transportation from supplies and sales.

After a brief push for liberalization, Algeria is again tightening control of gas exports, but Russia remains the major hurdle. The refusal to ratify the European Energy Charter means that Russia’s transmission network will not open and export sales remain the monopoly of Gazprom. This highlights a serious internal setback; the inability of the EU to corral Germany, the largest member state and the largest EU energy market, into a common stance in relation to Russia.

The German government has recently declared that energy is not an EU responsibility, stressing that the European Commission has no competence in unbundling the integrated German gas and power companies. On this point, Germany has the support of France, which likewise refuses to consider unbundling the national electricity company, EdF. The inability to prevent horizontal integration likewise represents a major setback for the European Commission. Instead of unbundling and more open competition, there is an emerging consolidation of natural gas and electricity utilities in large groups, such as German E.on-Ruhrgas and Franco-Belgian Suez-Gaz de France.

To sum up, the European Commission is seriously weakened in its dealings with the major gas supplier, Russia, through the German refusal to accept a common stance, and in its internal energy market reform efforts through the refusal of the two major member states, France and Germany, to consider unbundling integrated gas and electricity companies. The lack of political cohesion evidently enhances uncertainty about the development of the European gas market, in addition to the uncertainty caused by markedly higher gas prices caused by indexation to oil prices that rise for reasons unrelated to natural gas, but accompanied by even higher consumer taxes.

Against this backdrop, Norway might find LNG exports to North America a competitive outcome, indirectly leaving more space for Russian gas to Europe.