Gas Revolution in Eastern and Central Europe

27 September 2018
The European Commission’s flagship policy to change the archaic CEE natural gas markets was accompanied by a wave of billion dollar gas infrastructure projects

The energy markets of Central and Eastern Europe (CEE) are going through some thorough changes as they become an inbuilt part of the larger European gas market.

The European Commission’s flagship policy to change the archaic CEE natural gas markets was accompanied by a wave of billion dollar gas infrastructure projects that were to integrate the market and enhance competitiveness and transparency – arguably a good thing for both consumers and producers. In such more liquid market (with a 20 percent growth of gas traded in competitive gas hubs from 2015- 17), CEE countries have already attracted a diversified range of suppliers, including U.S. Liquefied Natural Gas.

Essentially, this  is what drives CEE prices closer to Western European hubs. As a result, big suppliers (e.g. Russia) will not be able to dictate prices anymore. Yet, the gas revolution in Central and Eastern Europe deals with some challenges. The track record of compliance with EU regulations and market liberalization is poor. The role of gas in power generation is low. Coal power plants function in a favorable environment in spite of the deteriorating quality of air in many cities across Eastern Europe.

Regional energy security has long predominated the policy debate in Brussels. For years prices for gas in CEE nations were set by each country’s relative dependence on Russian gas, as dictated by existing infrastructure and their political affairs with Moscow. As a result, there is a trend that gas prices are higher in countries further east of Europe’s heartland. After a political crisis with Russia, the EU’s stress tests identified missing infrastructure links, so policymakers made a regional roadmap to create new gas networks that connect CEE gas markets with the rest of the European Union. Now, customers across Central and Eastern Europe are increasingly enjoying the benefits of the investments in gas infrastructure, as price differentials between countries begin to decrease.

policymakers made a regional roadmap to create new gas networks that connect CEE gas markets with the rest of the European Union
Gas pipelines

Indeed, completion of  breakthrough projects such as the Klaipeda FRSU (140 bcf/year) in Lithuania, the Swinoujscie LNG Terminal (180 bcf/year) in Poland, the bi-directional Poland-Lithuania Interconnector (8.4 million m3/ day), and the Finland-Estonia Interconnector (7.2 million m3/ day) have decreased the price gap with Western European hubs and increased gas flows through CEE. Austria’s Central Eastern Gas Hub has connected countries like Slovakia, the Czech Republic and Poland to the Western European grid, and offered them fair market prices. As a matter of fact, current price indexes in the countries are already converging with German hubs. The correlation between Germany’s NCG and the Central European Gas Hub have been steadily growing since 2008 to reach an almost 97 percent correlation in 2017.

Germany’s NCG and the Central European Gas Hub
Correlation European gas Hubs

This trend is expected to go on as more projects like the Central European Gas Pipeline (that connects Romania, Austria, Bulgaria and Hungary) or the Kirk LNG terminal in Croatia could come online. All of these stand to benefit consumers in Eastern and Central Europe as new infrastructure promotes competition between Norwegian, Russian and U.S. (liquefied) natural gas.

Theoretically, increased trade and competition should encourage individual markets to liberalize further. This yet has not been the case for Eastern and Central Europe. While CEE governments benefited from the infrastructure expansion funded by the European Union, they placed gas market liberalization reforms to the background.

Actually, there’s some resistance to the reforms, because they are considered to disrupt the longstanding monopolistic positions of the local energy businesses. For example, in the Czech Republic, the biggest power company has a 78 percent market share in the national electricity market, while the biggest gas importing company works with a comfortable margin of 82.3 percent. Polish state controlled oil and gas company PGNiG remains the dominating purchaser on both the retail and wholesale market. Next to this, PGNiG operates and owns all of the natural gas production and distribution networks. These regional “power houses” welcome imported U.S. LNG while it supersedes Gazprom’s supply monopoly. The same companies, however, are opposing the reforms, because they see their stable privileged position threatened by powerful international competitors.

The lack of political appetite from CEE governments to tackle these problems has set the provisions of The EU’s legislature, known as Third Energy Package. In 2009, it was adopted by the European Parliament.

The package requires the unbundling of incumbent companies, gives third parties access to infrastructure and greater regulatory market oversight. While Western Europeans enjoy growing competition and transparency in the energy market, most residential and industrial consumers across Eastern and Central Europe still cannot choose their power and gas suppliers. This is important because incumbency and corruption in the energy sector are still huge problems for many Eastern and Central European countries. Although almost all 15 CEE nations inherited a bureaucratized and highly regulated energy sector. To really cover gas market reforms and restructuring, the must up their ambition, accountability and political will. As a result, there will be an integrated market with the neighboring Western Europe.

The division between “old” and “new” European Union members is not only notable in terms of market performance and energy security, but also in the composition of the energy mix itself, that complicates integration of the CEE into the common European energy market. In spite of worsening air quality, Eastern and Central European countries keep burning enormous amounts of coal. While Western Europe’s coal consumption has been shrinking, Eastern Europe has not succeeded to significantly cut its own consumption. (Graph 1 & 2).

Eastern and Central European countries keep burning enormous amounts of coal
Poland energy mix 2017

Graph 1.

Eastern and Central European countries keep burning enormous amounts of coal
Chech Republic energy mix 2017

Graph 2.

Coal’s dominant position is not only about favorable economics, but it is also supported by a positive attitude towards the industry. According to a recent study conducted by the Poland Public Opinion Research Center (CBOS), Polish miners are respected more than teachers or doctors; 84 percent compared to 71 percent and 74 percent respectively. Falling far behind the European Union schedule for establishing renewable capacity in its energy mix, Poland finds out that even by 2050 coal will hold up to 50 percent of the market share in the country’s energy consumption. Without governmental initiatives to restructure the outdated energy markets, most of which rely on outworn and aging technology, the CEE region will put itself out of innovative private sector investments.

There are many reasons why the gas revolution in CEE countries is progressing so slowly. On the one hand, considerable advancement has been made both in terms of implementation of key gas infrastructure projects and in terms of conceptual thinking about integrating CEE into the common European energy market. On the other hand, illogical psychology of insecurity centered around protecting regional monopolies and internal coal industries has started to overtake the efficient market and policy debate in this part of Europe.

For a real revolution to happen, there must be a political will to get the process moving; there must be commercial appetite to succeed in a trading environment; and shifts in cultural attitude for all those changes to be implemented. Yet, CEE nations should meet these requirements.