Over the recent years both geopolitical and market developments, as well as energy security considerations brought the Southeast Europe (SEE) and East Med regions back as important parts of EU’s energy strategy. Some may consider SEE to include East Med, but geographic/cultural conditions and gas quantities justify considering them separately.
However, there is neither a market mechanism to buy or sell gas in an efficient manner in these regions, nor a pricing mechanism to determine spot prices. Gas exchange is still based on long-term bilateral agreements. The lack of established market conditions hampers development and increases the potential for these markets to be coerced by dominant players. The development of regional natural gas trading hubs can prove critical to overcoming such inefficiencies.
A key element of such hubs is pricing indices that more readily reflect regional supply and demand fundamentals (compared to the traditional oil indexation), while facilitating both financial and physical hedging for buyers.
Trading hubs can help prevent the emergence of dominant market players keen to dictate their terms or serve political interests. In fact, under the energy hub trading framework players become more inter-dependent, hence the former can foster cooperation, economic and political stability in a region and limit conflicts.
Against the backdrop of the EU energy security debate and the discussions over new infrastructure projects, national governments in the region have been keen on promoting the idea of establishing gas hubs in their countries. Adoption of and compliance with EU regulatory systems can help harmonize the operation of such hubs.
At the same time, beyond political strategies, from the market perspective there are some fundamental questions that have to be considered as far as the establishment of gas trading hubs are concerned.
First of all, one has to look into the definition of a gas hub, which can be different depending on its set up, as well as the maturity of the liberalized markets. It requires a deregulated gas market, where suppliers are free to import or produce energy and customers are free to chose their suppliers, which is still not the case today in most countries of SEE and East Med. A gas hub is a trading platform for physical and/or financial transaction of gas, which offers a range of services and facilitates trading activities. But it also requires flexible gas supplies, adequate infrastructure and storage.
Gas hubs can be virtual (balancing) and physical:
- In the case of virtual gas hubs, e.g. NBP (National Balancing Point) in the UK, TTF (Title Transfer Facility) in the Netherlands, the hub provides a trading platform for the entire county or a trans-regional zone, which allows all gas to be injected into the grid at any point within the zone. The point of extraction therefore does not matter. In a virtual hub, the whole gas transportation grid is defined as being the hub.
- Physical hubs, e.g. Zeebrugge in Belgium, are established at a physical intersection of pipelines and therefore the traded gas has to pass through a precise location. Although virtual trading hubs are offering more flexibility with their entry-exit systems, an advantage of a physical gas hub, such as Zeebrugge, is that it has the capacity to transport large volumes of gas.
Historically, the British gas markets were the first to open up back in the 90’s and in over a ten-year period they reached a level of maturity, with NBP becoming a benchmark. This is undoubtedly a success story and a model that Europe looks up to.
EU Requirements and vision of the liberalized gas markets
First of all, let us look into the requirements for the liberalized EU gas market and its set-up put forward by the European Gas Target Model (GTM) 1, 2. The GTM ultimately aims at establishing well functioning wholesale gas markets with ‘entry-exit’ zones (EE), where entry capacity is allocated separately from exit capacity so that any gas that enters the zone can be delivered, at least commercially, to any exit point in that zone .
The GTM also sets out some specific criteria for the well functioning wholesale market and the EE zones, establishment of which is envisaged in three possible models:
- national market areas, with one EE zone per country;
- trading regions, with one EE zone for transmission – but not distribution – and one Virtual Trading Point (VTP) between at least two countries;
- cross-border market areas, with one EE zone for both transmission and distribution and one Virtual Trading Point between at least two countries.
The characteristics of a well-functioning wholesale market are rather specific and are well-described in references [1,2]. Key among these are :
- it should receive gas supplies from at least three sources;
- the annual gas demand within the EE zone should be not less than 20 bcm.
In the following part of the analysis we examine how the above applies to SEE and East Med markets.
In continental Europe, the pace of gas hub development mirrors the dynamics of market liberalization, which is by no means homogenous. However, SEE markets are lagging behind for a number of reasons, including the heritage of limited existing infrastructure networks and reliance on a limited number of suppliers. Looking at the European markets on the whole, and despite the establishment of the successful TTF in the Netherlands, there are substantial hurdles to overcome. These include the lack of interconnectors, storage facilities, the issue of pricing transparency and liquidity, as well as the need for gradual change in the market culture and attitudes to gas trading.
Taking into account all of the above, it is clear that there is some way to go before gas trading hubs can emerge in SEE. The first step would be to establish physical transit hubs once the right infrastructure is in place. Most of the infrastructure projects, i.e. interconnectors, storage and LNG, envisaged in the region are expected to materialize no earlier than in 2018-2019.
It is hoped that the result of all of this is that there will be some gas quantities available for trading outside long-term contracts. Consequently, the establishment of a natural gas trading hub, initially to enable trading between Greece, Bulgaria and Turkey, would be possible and would ensure the determination of market prices through the trading of these flexible gas quantities.
One can name about half a dozen Projects of Common Interest (PCI) and other initiatives envisaged in Greece, Romania, Croatia and Bulgaria, which are certainly important for improving regional interconnection and energy security, along with upstream initiatives in these countries. All of these projects are well known and have been promoted by governments and the EU very actively over the last few years.
Among all the counties in the region, Turkey is currently the only country which satisfies many of the above-mentioned criteria, particularly with regards to demand. However, it is feasible for the EU member-states in the region to establish regional EE zones with a single VTP.
Currently, Turkey has the strongest position to become the gas hub in the region, given the volume of its national gas market and its projected growth, as well as the level of infrastructure development and six entry points for pipeline gas and LNG. With potential pipelines from Kurdistan, TANAP, the East Med and Turkish Stream (if it ever goes ahead) there might be at least eight entry points in the future.
Turkey imports LNG from spot markets in Algeria, Qatar and Nigeria, while Russia, Azerbaijan and Iran are its key pipeline gas suppliers. Once TAP is completed, Turkey will have at least one interconnector (and one exit point) to Greece.
Turkey’s indigenous gas production is very small, but it has licensed onshore and offshore blocks and exploration is in progress. Gas has been discovered in January 2016 by Valeura Energy in the Thrace Basin in Turkey and there are good prospects for gas discoveries in the Dadas shale formations.
Also, solution of the Cyprus problem may open the way for Israeli gas, and possibly Cypriot gas, to be exported by pipeline to Turkey for its own domestic use and onward transmission by pipeline to Europe, possibly creating another entry point.
However, Turkey lacks interconnectors, adequate storage, market liberalization and gas pricing transparency, and its regulatory systems need to be aligned to the EU.
Bulgaria also has aspirations to create a national market area hub to amalgamate the various competing projects within its territory and is seeking financial and political support from the EU. Bulgaria believes it can become one potential site of a wider Balkan hub, as Russian pipeline gas already passes through it, and coming by 2019 is gas from Azerbaijan and gas through the Greece-Bulgaria interconnector (IGB).
Work has also begun on the Serbia-Bulgaria interconnector expected to be completed by the end of 2018 to carry 1.8 bcm/y, most of which will be directed to central European markets. This is part of a plan to establish full interconnectivity with Serbia and Romania on the back of IGB.
The Bulgarian government has also licensed offshore blocks, hoping to develop indigenous gas resources.
It is also rumored that South Stream project has not been officially terminated and in the light of the deteriorating relationship between Russia and Turkey, it may be resurrected in a form of South Stream Lite stretching till Bulgaria.
Whichever projects go ahead, the EU and Bulgaria have formed a joint working group to review options and feasibility of such a hub. But there is a long way to go.
There are strong justifications and incentives for establishing a gas trading hub in Greece, both national and European. Greece currently has three entry points: two in the north, Turkey and Bulgaria, and the LNG Terminal Revithoussa, which also includes storage. The strategic importance of the Revithoussa terminal proved itself during the 2009 Russia-Ukraine gas crisis, when Greece did not encounter any supply cuts, and moreover, provided the necessary gas volumes to Bulgaria, which covered the needs of the country for two days.
The planned projects are:
- an FSRU (floating LNG storage and regasification unit), including storage, in Northern Greece, to be connected to IGB.
- the upgrade of Revithoussa.
- the Trans Adriatic Pipeline (TAP) interconnecting Greece to TANAP in Turkey.
- IGB – an FID to construct this was signed in December 2015.
The US based Cheniere Energy is considering participating in a holding company in Greece that will build and manage the FSRU and supply it with LNG. Greece sees this as part of its plan to strengthen its position as the preferred gas trading hub in the region, which is justified by the present and planned infrastructure and the number of entry-exit points in the country.
It has to be noted that the energy security argument in favour of the new LNG infrastructure is also heavily used by Croatia’s Krk LNG terminal developers, pointing out that it would be located closer to larger EU markets such as Austria, Hungary and central Europe, including Poland. At the same time, currently there is a so-called chicken-and-egg problem that the Croatian projects are facing: the FID in Krk LNG terminal is challenging to secure before the decision on building the LNG evacuation system to Hungary is taken and vice-versa. While demand uncertainty and political volatility constitute additional barriers.
With the Vertical Gas Corridor (connecting Bulgaria, Greece and Romania) established, the Revithoussa LNG terminal and TAP could bring an additional 3-5 bcm/y of Caspian gas in the region and possibly Russian gas if the Turkish Stream project ever goes ahead.
Greece has also progressed a plan for the creation of a natural gas storage facility at the South Kavala gas reserve in northern Greece. This is among EU’s priority projects, identified as important for energy security.
It is also worth noting that, according to the revised list of Projects of Common Interest (PCIs) issued by the European Commission (EC) on 18 November 2015 Greece attracts some 10% of the EU’s key strategic natural gas infrastructure projects in Central and South-East Europe (the region stretching from Poland, Czech Republic and Slovakia to Croatia, Hungary, Romania, Serbia, and Bulgaria all the way to Turkey).
To this end, if the additional US LNG volumes reach Greece via the new Alexandroupolis terminal (currently under consideration by the investors), Greece could become the first country in the region to comply with the objective set by the EU for South-East Europe (SEE) – that is, each EU member state in SEE should have at least three sources of gas to ensure security of supply.
At present Greece has three entry points for natural gas flows: two in the North (on the borders with Turkey and Bulgaria) and the LNG Terminal Revithoussa (importing LNG primarily from Algeria).
That said, Greece needs to develop the necessary market conditions and range of services, transparent financial systems, market culture and attitudes to gas trading.
A beginning has been made through the initiation of a plan to create a Greek Energy Exchange in Athens that will strive to play a significant role in the SEE market by offering a platform for energy-sector trading.
In terms of SEE, on the international level, Greece may find itself competing with Turkey, and potentially the East Med for the regional gas hub status.
However, at EU level (according to the EU aquis) a gas trading hub should be located on the territory of an EU member-state. Therefore, having in mind all the above-mentioned factors, Greece does have the potential to become the host of the regional virtual gas trading hub for South-East Europe. To that end, overcoming political and regulatory volatility remains key at the present stage.
Of the countries in the East Med region only Cyprus and Egypt can be considered as candidates for the establishment of a gas trading hub. Syria, Lebanon and Israel have constraints and problems which would not permit this in the foreseeable future.
Egypt is already producing 46 bcm per year and has substantial proven gas reserves, about 2.9 tcm according to International Energy Agency. It also has extensive infrastructure in place, with two LNG export plants at Damietta and Idku capable of liquefying and exporting 16 bcm gas annually, but at present lying idle.
Egypt is not an EU member state and lacks all else required to establish a VTP. However, it has the potential to become a physical trading hub, with gas exported in the form of LNG. ENI’s CEO Claudio Descalzi has already made such a proposal based on the development of the giant gas field Zhor discovered August 2015. He said "By sharing future resources as well as export and transportation infrastructures of Israel, Cyprus and Egypt, the area could become a regional gas hub able to also provide an important contribution to the European energy security.”
The geopolitics of the region and commercial challenges will need to be overcome to attract Israeli and Cypriot gas for liquefaction in Egypt and export to Europe and beyond. Such discussions have been in progress for a while now, but they are facing hurdles both political and commercial. The total cost of taking the gas from Israel and Cyprus to Egypt, liquefying it, transporting it to Europe and regasifying it, make it difficult to compete with piped Russian gas. If this does not succeed, Egypt can still proceed and create a physical trading hub based on its own substantial quantities of gas. But even then, there are substantial hurdles to overcome, including lack of pricing transparency, as well as market culture and attitudes to gas trading.
In any case, once the various gas development projects, such as North Alexandria, Atoll and Zhor gas fields, progress Egypt will be able to resume LNG exports based on Union Fenosa’s and BG’s long-term sales contracts, currently under force majeure due to the lack of gas for export.
Apart from the discovery of the 160 bcm Aphrodite gas field, Cyprus has neither the gas volumes nor the infrastructure required to establish a gas hub. However, there is potential in the longer term, especially given its strategic geographic location. Cyprus is the only EU member country in the East Med region, fully aligned to EU regulatory systems.
The East Med potentially holds substantial amounts of natural gas, some already discovered but with a lot more to come. Even though substantial quantities of this gas can be consumed within the region, mostly by Egypt, Israel and Turkey, potential discoveries are such that eventually there will be exports to Europe and beyond.
Cyprus has already designated an area at Vasilikos at the south of the island as an energy centre for the eventual development of an LNG plant.
It is feasible to establish an East Med regional EE zone with a single VTP based in Cyprus. But with limited infrastructure and no gas trading platforms, lack of pricing transparency and liquidity, and no market culture there is a long way to go to achieve this. And it will require concerted effort and support from the EU to turn the East Med into a gas trading hub. The good news is that during his January 2016 visit to Cyprus EC Commissioner Maroš Šefčovič confirmed that such a concept would be of interest to the European Commission and has the potential to obtain EU support.
Creating a new East Med gas hub could benefit all countries of the region to better exploit their gas reserves. It is in EU’s interests to support such a scheme.
Requirements and cooperation
At present, in order to be able to compete for the place of the VTP in a regional EE zone, each country in a region would have to establish a robust interconnection system, LNG terminals and storage facilities, as well as unlock its indigenous production potential; all of which require immense investments in the sector.
Considering the capital intensity of the necessary infrastructure projects and the length of the investment cycle, it is clear that the current pricing and political dynamics create serious challenges for projects in the region to pick up steam. This environment in turn triggers the "survival of the fittest” market mechanisms, so ultimately the country that will be able to be first in securing relevant investments in its energy infrastructure and interconnectors will be able to become the key player in the regional gas trading zone.
At the same time, cooperation between countries in the SEE region is absolutely crucial to lift the transnational projects, and it would then be possible to utilize the strategic positioning of Greece in terms of the import and storage of LNG, as well as the gas volumes coming from the Turkish and Bulgarian borders. Both Turkey and Bulgaria can benefit from such a cooperation with Greece, jointly forming a regional EE zone with the VTP based in Greece.
Similarly, Cyprus, Israel, Egypt and eventually Lebanon can join to form an East Med regional EE zone with the VTP based in Cyprus. However, events in the region may challenge this.
Clearly, the political benefits of cooperation in the energy sector would be immense for the SEE and East Med regions, which have always been characterized by inherent political fragility and tensions.