Poland Counts the Cost

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Poland counts the cost of turning down Russian gas taps Efforts to diversify supplies away from its eastern neighbor has come at a price PGNiG workers at the Grotow gas and oilfield in Poland. Polish authorities have reduced the share of Russian gas imports from 89 per cent in 2016 to 60 per cent in 2019. Polish energy relations with Russia have been difficult for many years, with Warsaw keen to diversify away from its eastern neighbor. Poland’s energy decision-makers may be close to achieving their goal, but they are also learning the hard way that free markets are a double-edged sword.

On May 26, westward flows of natural gas via the Europol pipeline, one of the main transit routes for Russian gas to Europe via Poland, came to a complete halt for a day only to restart at much more volatile levels.

This followed the expiration of a long-term transit contract between Russia and Poland nine days earlier. Since then, Gazprom has been free to book capacity at regular auctions under EU rules rather than being tied down by a less flexible contract arrangement with Poland. Gazprom, as the only large user of Europol, has gained an advantage since it can bargain the cost of transit down. For the third quarter of 2020 it will be paying for a Polish transit tariff that is 2.5 times less than for Ukrainian transit.

Earlier this month, the Polish regulator approved a 16.5 per cent tariff rise for gas transit via Europol effective next year, designating the expected additional revenues for the construction of the Baltic Pipe. But hopes for additional transit revenue maybe just a pipe dream because amid a gas supply glut in Europe, Gazprom has now started treating Europol as a balancing route, filling it only after all its other pipelines with ship-or-pay arrangements (for example Nord Stream and Ukraine) have been utilised. Poland’s apparent loss of bargaining power extends to future gas purchases too, given that Poland’s gas supply contract with Gazprom is set to expire at the end of 2022.

PGNiG, the Polish state oil and gas company, has officially informed Gazprom that the contract will not be renewed as the country is planning to switch to alternative deliveries of LNG and Norwegian pipeline gas. Polish authorities’ plans of replacing Gazprom gas with US liquefied natural gas, dubbed “molecules of freedom”, seemed to bode well for the transatlantic partnership in which Poland has been trying to become the main conduit of US policies in Europe. They also seemed to offer Poland lower LNG prices compared with Gazprom’s oil-indexed legacy contract.

What these plans did not consider was the possibility of traded gas prices in Europe falling below gas prices in the US, a move that has taken the markets by surprise this year. Poland faces difficult trade-offs between the multiple goals of meeting the environmental targets set out by the EU, providing the economy with sufficient volumes of natural gas, diversifying its gas supply at competitive prices, and ensuring energy security. Recommended EU energy Danish delay threatens Nord Stream 2 progress The Polish authorities managed to reduce the share of Russian gas in total gas imports from 89 per cent in 2016 to 60 per cent in 2019, and the country has now developed a portfolio of both LNG, with supplies from Qatar and the US, and alternative pipeline options that might replace all its Russian gas imports by the middle of the 2020s.

Ironically, Poland’s efforts to diversify gas supply sources had already improved its negotiating leverage with Gazprom, but instead of using this advantage to obtain better commercial terms, the Polish government decided to physically eliminate Russian gas by building expensive alternative infrastructure. This included a large LNG import facility plus an economically questionable pipeline under the Baltic Sea that mirrors the existing capacity for bringing Norwegian gas to northwest Europe via Germany. This apparent fixation on “ideological physicality” in Poland has translated into an excessive politicisation of gas in the Polish energy economy and a needless burning of bridges with Russia before new alternatives have been firmly established.

As a result, Poland seems to have sacrificed commercial reality on the altar of political desire, as it has effectively cut off one of its cheaper and cleaner sources of supply while also reducing its bargaining position.

Meanwhile, the results of a recent arbitration case between PGNiG and Gazprom show that reducing the cost of Russian imports could have been achieved without building nearly so much diversification infrastructure. Embracing the opportunities offered to final gas consumers by the liberalised, competitive wholesale trading gas markets in northwest Europe could have achieved the same goals without burdening Poland with expensive and risky new projects.

Vitaly Yermakov is a senior research fellow at the Oxford Institute for Energy Studies and a former commodity strategist for Sberbank CIB

The Commodities Note is an online commentary on the industry from the Financial Times