Gas market expert: Ukraine's outrage is unfounded

English2021. okt. 12.Zsófia Végh

Ukraine's reaction to the Hungarian-Russian gas contract is unjustified, especially since it was Hungary that withstood for the longest time in the region and resisted renewing the long-term contract, Borbála Takácsné Tóth, senior research associate at the Regional Centre for Energy Policy Research (REKK) told növekedé She believes that gas prices in Europe will grow this winter, but they are expected to decline thereafter.

How justified was the conclusion of the new Russian-Hungarian long-term gas contract?

It was essential from many aspects: from the geopolitical situation to the realities of the wholesale market in our region. Russian gas remains unavoidable in the energy mix, although fortunately resources are expanding and becoming more diversified. In South-East Europe, 

in the Balkans, two new sources have become available since the beginning of the year: liquefied natural gas through the LNG terminal on the island of Krk and a TAP pipeline transporting  gas from Azerbaijan.

In spite of that, the Russians play a decisive and dominant role in our region. 

I do not think that the gas supply of Hungary is conceivable without Russian import, and the Russians wanted to sign a large-scale long-term contract

- therefore the negotiations had to be carried out with the aim of reaching an agreement on mutually acceptable terms. 

The new contract was signed for 10 + 5 years, while the previous one was for 20 years. 

In the gas market, contracts shorter than 1 year are considered short-term, those of 1 to 3 years are medium-term, and those over 3 years are regarded as long-term. And even long-term contracts are getting shorter, so the 15-year validity of the newly signed contract is considered quite long.

At the same time, there are exceptionally long contracts; for the 3,500 km long southern corridor the Azeris signed 20-year contracts for example, which were supposed to deal with the risks of the large infrastructural investment - investors had to be assured that there are signed contracts to guarantee that the investment will pay off.

In Hungary, although it was necessary to lay down a few kilometres of pipes at the southern entry point, there was no need for a long-term contract for that. It was included in the asset fund by the regulator - that is, Hungarian consumers are going to finance it through tariffs. 

No major development was necessary on the Hungarian side so that the gas could come from the south; the large pipes (TurkStream, Balkan Stream) were built out by Russia so that they could bypass Ukraine. 

Of course, this will ultimately have to be paid for by European consumers, but that is another question. 

The length of the contract therefore was not justified by the investment, but by the fact that the Russians are key players and they wanted to do it that way. 

For Hungary, predictability is an important point. And due to market realities, it is inevitable to have a longer-term contract with the Russian partner in the portfolio.

Is there any basis for Ukraine's indignation? 

I have read the reaction of the Ukrainians and I find it completely unjustified. Russia’s strategy is clear: they have been working on a solution to bypass Ukraine since 2009. It has been their geopolitical-strategic goal, and all of their major investments projects - the North, South and Balkan Streams – were carried out to this end. 

This is the last element of this infrastructural investment, which, the Russians point out, guarantees secure supply for Europe, saying that they are minimizing the risk of Ukrainian transportation. This is a fierce battle of narratives, as it can be interpreted quite differently from the other party’s point of view. 

But there is no reason why the Ukrainians, in desperation, should put the blame on Hungary for losing their transit role, because the whole of Europe played a part in allowing the Russians to achieve their plans.

Moreover, everyone gave in much earlier than Hungary: we were the ones who withstood the longest. Our long-term gas contract with Russia expired in 2015, and since then Hungary was trying to postpone renewing the contract until we are in a slightly better position due to resource diversification, and the single European gas market is achieved. 

For a very long time, Hungary resisted signing the new long-term contract. 

Practically everyone in the region had signed it earlier: Austria and Croatia committed themselves for 10 years in 2018 - before the LNG terminal on the island of Krk was completed -, in the same year also Slovenia signed the contract for 5 years. The Czech Republic and Slovakia also signed long-term contracts with the Russians for all their gas demand. All these countries accepted that Russian gas would be delivered from the west instead of the east.

Borbála Takácsné Tóth 

Bulgaria and Serbia, on the other hand, have been receiving gas from the south and not through Ukraine, the former for two years, the latter only since January. The annual volume of Ukrainian transit was as much as 120 billion cubic metres in 2000, which was reduced in the year of the Crimean annexation in 2014 to about 60 billion cubic metres, because the Blue Stream (a direct pipeline to Turkey under the Black Sea) and the North Stream 1 (a direct pipeline under the Baltic Sea to Germany) had been completed in the meantime.

When all these routes are built out and Hungary accepts that the Russians are only willing to transport gas from the south, then it is completely incomprehensible that it should provoke such strong reactions by Ukraine, because it is obvious that it is not up to Hungary whether Ukraine will have any transit or not. 

Moreover, Hungary stood up for Ukraine when the Ukrainian transit agreement with Russia expired in December 2019: Hungary did its best to avoid committing itself to Russia, and so

the Russians were forced to re-sign the Ukrainian transit contract because neither the southern nor the northern pipeline had been completed.

Thus, Ukraine was granted another 5 years for some transit delivery by the Russians. This political compromise can be attributed in part to Angela Merkel

- as the German gas industry contributed to the end of all transit through Ukraine. The chancellor ruled, in order to ensure peace between the parties, that they would maintain the Ukrainian transit for a while - this agreement expires in 2024. 

Within the EU, the biggest beneficiary of the elimination of the Ukrainian route is Germany; outside the EU it is Turkey, as both have become major transit countries. 

Hungary is a very small player in this big political game, and, in addition, the loss of Ukrainian transit means a decrease in transit for us as well; we have been going without the Serbian transit, for example, since January. 

Compared to these big political games, it is a negligible development that Hungary, taking reality into account, concluded this contract for the new entry point on favourable terms. After all, if our gas will no longer come from Ukraine, it is better if it comes from the south.

If we had not accepted the southern entry point, we would have had to buy Russian gas from the west, the most liquid and competitive market, which would have been worse from a market point of view, as it would have occupied capacity from competing Western sources. 

How was Hungary able to not commit itself for so long? 

It was a pretty serious political chess game, which the Russians can play very well, and they also have the gas. Hungary also played well in this geopolitical game, withstanding for a relatively long time. 

We met the expectations of solidarity with the Ukrainians to the maximum - when the Ukrainian transit agreement expired at the end of 2019 and the Russians re-concluded it, Hungary remained uncommitted unlike many other countries that agreed with the Russians. 

And I have to stress once again that the Hungarian long-term contract expired in 2015, which had lasted for twenty years, and now we are in 2021. 

As the country's consumption fell from 15 bcm in 2005 to 10 bcm in 2008, there were unused quantities left in the contract. In the gas market, the contracts usually contain a take or pay clause, i.e. if someone does not take over the contracted amount, they still have to pay for it.

However, the Russians made a gesture towards Hungary and so we were able to call the remaining amount without having to pay take-or-pay for it.

I don’t know exactly when that amount ran out, but in recent years it was probably through annual agreements that we received gas. 

Another such gesture on the part of the Russians was when in the spring of 2019 the full annual quantity was delivered and stored in Hungarian storage facilities, so that regardless of the outcome of the Ukrainian negotiations, the Hungarian supply would not be jeopardized. 

These gestures must have a certain price; one such “request” might have been to accept that gas would be delivered from the south from October 2021. 

This had not happened earlier because Hungary was careful with the timing. It was not possible to postpone it much longer, as the Russians had already been very clear about it in 2019. For some reason, this entry point had not been completed before, but the October 2021 deadline had been determined for some time. 

This date had probably been chosen because it was estimated that the Krk and TAP pipelines would be operational by then - there was nothing else to wait for.

However, the European Commission announced that it would look into the Russian-Hungarian agreement. 

Russia has a more than 40 percent share in the European gas market, and its share will grow even further. European gas production is declining; Dutch production has already fallen significantly, and it will fall even further next year with the shutdown of the Groningen gas field. In Norway, fossil energy production is the subject of political debate: it is not clear how long gas and oil will remain in the energy mix. British production also fell sharply. 

Thus, Russia could further increase its already significant share. 

There had been examples in the past when they took advantage of their dominance; the European Commission had previously launched an investigation into Gazprom's dominant pricing policy, which was concluded with an agreement: Gazprom undertook not to discriminate among its Eastern European customers on the basis of price. 

Moreover, in 2016, Donald Tusk, the former Polish prime minister, wanted a joint European gas procurement initiative to be included in the regulations related to the energy union, so that Gazprom could not play one member state off against the other.

This did not happen eventually; it failed as a proposal because it completely contradicted the logic of the EU market. However, an obligation was included that if a country signs a contract for more than 20 percent of its consumption, it must notify the Commission about it, which may, if it considers it appropriate, review the contract. 

If Hungary’s annual consumption is 10 bcm, then the now contracted quantity exceeds 20 percent of that amount. The Commission does not examine whether the country had the right to change the entry point where the Russians deliver the gas into the country.

The Ukrainians complain that instead of Beregdaróc, Hungary will take over the gas at the Serbian border, but this does not have a market-distorting effect.

And if it is true that the pricing was on a TTF basis, then this is not to be criticized either. The European Union is not trying to teach member states a lesson, but to protect them from having to pay for items that harm their interests. For example, when Gazprom stipulated in the previous long-term contract that buyers are not allowed to resell the gas they purchased, this violated the common market and energy policy of the EU. In this respect, the Commission can examine the current contract, as well.

How long will record high gas prices stay with us? What steps can be taken?

I don’t think anyone should take any steps. This is a market situation to which the market will react. I would not consider individual regulatory intervention to be right, we cannot keep prices outside the borders, and even Europe is not a big enough player to compensate for the fluctuations in Asia. 

Curbing demand could be a solution; we hope we will not have a cold winter. 

And for consumers, the high prices could be a good motivation to invest in energy efficiency or switch of fuel. Our domestic energy strategy also contains the goal of reducing residential gas consumption, and this is now an excellent opportunity to start this process. 

Looking at the forward prices, it seems that they will go up this winter, but they are expected to return to the 20 euro/mwh level later. 

There is no justification for these high prices, in the European market in particular, - there are no structural factors behind them - gas consumption in the EU will not increase but decrease in the medium and long term. 

The question arises as to why Russia does not sell more gas once the price is so high if they have plenty of supply.

They have probably considered whether it is more profitable for them to sell larger quantities and thus the price will go down, or sell less but at a higher price. It seems that they have opted for the latter.

As Russia is not a member of the EU, there is no way to force them, only to ask them.

The higher prices have the greatest impact on two areas: On the one hand, they encourage producers to increase production - mainly shale gas producers in the US will react to the price increase in this way. On the other hand, high prices promote energy conversion, the greening of energy. 

And yet, coal-fired power plants were put back into operation in the summer to cover the higher consumption. 

It takes time for renewables to gain more ground; it is faster to restore coal power plants. But even coal-fired power plants produce energy expensively if we look at the current electricity prices; which means that the current situation is very favourable for renewables. Coal can provide a solution to the increasing demand temporarily, but not in the long run.