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Pipeline or pipedream?

November 7, 2011

Changes on the European energy market paint an uncertain picture for the future demand of gas. A downturn could harm the profitability of Gazprom and dash its hopes for the Nord Stream pipeline.

A stack of pipes
The massive pipes comprised much of the cost of project

When Russia's state-controlled energy giant, Gazprom joined forces with German partners BASF/Wintershall and E.ON to build the ambitious Nord Stream pipeline under the Baltic Sea, the estimated total cost was about 4 billion euros – two billion for each phase of the project.

But as is so often the way with large infrastructure projects, once the pipeline construction was underway, it became clear that it was going to take almost double the money to get the job done.

Nord Stream AG spokesman Jens Müller attributed the project's ballooning budget to rising metal prices, explaining that the 200,000 12-ton pipes had accounted for a sizeable chunk of the overall cost

“The next largest area of outlay was for laying the pipes, which in some cases required the use of three specialist lay barges," Müller told Deutsche Welle. "That cost something in the realm of two billion."

Other expenses on the project, 70 percent of which is financed by 20 banks, include the quality control of installation work, certification and wages.

Nord Stream operators optimistic

The Baltic Sea pipeline has been built to last for the next five decades at least, and with such a long life expectancy, Müller says it won't take long to write off the costs.

Matthias Warnig, managing director of the German-Russian gas pipeline consortium, predicts it will take between 14 and 15 years to recoup the expense - if Nord Stream works to full capacity.

Under the terms of the Nord Stream business agreement Gazprom-Export pays for the exclusive right to transport 55 billion cubic meters of gas annually, regardless of whether it does so or not.

Reaching full capacity

A gas stove being lit
The Nord Stream pipeline was conceived on the basis of rising gas consumption in EuropeImage: dpa

According to Warnig, the pipeline has so far received orders to deliver more than 22 billion cubic meters annually, less than half its capacity.

But Vladimir Feygin, President of the Russian Institute for Energy and Finance, says the shortfall is nothing to worry about.

"It is a typical situation," he told Deutsche Welle. "Such huge pipelines are generally only built when there are long-term contracts in place which ensure they can run at half capacity."

That said, he is aware of the culture of short-notice on the European gas market, and says he expects further contracts to be forthcoming. And when that happens, the new pipeline means Gazprom will be in a flexible enough position to provide new customers with what they want.

Shifting demand

Nord Stream was first conceived on the basis of rising gas consumption and prices in Europe. But with the EU investing more heavily in alternative energy sources and promoting greater energy efficiency, the electricity and gas markets in the union are not what they once were.

What's more, EU states have been importing higher levels of liquefied natural gas (LNG), which has led to a significant fall in gas prices. Josef Auer of Deutsche Bank Research in Frankfurt says the situation is unlikely to change.

"We don't expect to see gas demand increase in Europe, and particularly not in Germany," he told Deutsche Welle. "But perhaps in other regions of the world, and that could push the prices up again."

On that basis, and given that both Britain and the Netherlands will produce less gas over the coming 20 years, he says Nord Stream is looking at a rosy future.

Nonetheless, it is also facing the real economic prospect that European countries will not need as much Russian gas in times to come, and certainly not at the prices predicted just a few years ago.

Authors: Andrey Gurkov, Markian Ostaptschuk / tkw
Editor: Stuart Tiffen