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Why Poland Upped Its Reliance on Gazprom


In late October, nearly a year after the Russian-Ukrainian crisis left Poland with a 2.5 billion cubic meter shortfall of natural gas for 2009, Polish state-controlled gas monopoly PGNiG (PGNI.WA) and Gazprom (GAZP.RTS) agreed to significantly increase the amount of the fuel Poland will buy from the Russian company starting next year.

If approved by the Polish and Russian governments, the deal would see Gazprom's gas exports to Poland rise to 10.27 billion cubic meters a year through 2037 instead of the current 7 billion cubic meters. Whether the deal undermines Poland's oft-repeated supply diversification goals or ensures a steady supply of natural gas remains to be seen.

Radoslaw Dudzinski, PGNIG's deputy chief in charge of strategy, said the value of the contract is a function of the nine-month moving average of light and heavy gas oil prices and is adjusted quarterly.

"At current crude oil prices and the zloty's exchange rate to the dollar, the 10.27 billion cubic meter contract is worth about 7.7 billion zlotys ($2.8 billion), but that can change quickly as the price of oil or exchange rates shift," said Kamil Kliszcz, an energy analyst at BRE Bank in Warsaw.

One thing the agreement cannot forestall is a repeat of the situation that occurred in January, when Russia closed the tap on Ukraine, which in turn stopped pumping gas on to Poland and other European countries.

During the standoff, Poland could have used more interconnectors, which would have enabled it to import last-minute supplies from other countries in the European Union, as well as an up-and-running liquefied natural gas terminal. There are plans to build such a terminal, but it won't be ready until 2014 at the earliest.

The EU's largest ex-communist member has managed to cope with the shortfall this year thanks to sluggish economic growth, which has limited demand for gas. But now that Poland has locked in an additional supply, it is unclear whether GDP growth and annual gas consumption will start increasing quickly enough to absorb the extra gas as soon as 2010, when the new agreement comes into effect, analysts said.

SUPPLY SECURITY

"The agreement ensures a predictable, stable supply [of gas] in the future, based on a long-term contract," Economy Minister Waldemar Pawlak told the daily Dziennik Gazeta Prawna. "If there will be a bit too much of this commodity, nothing bad will happen."

State-controlled PGNiG echoed Pawlak's lack of concern about over-supply when it said it expects to sell about 18 billion cubic meters of gas by 2015, up from 14 billion now, mainly thanks to several gas-fired power plants in the works.

But analysts are concerned the added volume will come on-stream too soon to be consumed by the plants, which haven't been built yet.

"PGNiG may have to pay for gas it doesn't want," said Pawel Burzynski, an energy analyst at Polish bank BZ WBK in Warsaw.

Under the terms of the contract with Gazprom, PGNiG would have to pay a fine if it bought less gas than a specified yearly minimum.

Poland relies overwhelmingly on coal-fired power plants for its electricity. Cleaner-burning, gas-fired power plants are among the favored solutions to the expected carbon dioxide emissions limits Poland will face in coming years.

"The EU climate change package puts great pressure on [Poland] to reduce its coal burn," said Dieter Helm, an Oxford University professor and adviser on energy policy to the British government.

PGNiG, which says Polish per capita gas consumption is two-thirds lower than in Western Europe, is itself involved in three power-plant joint ventures that will require about 1.2 billion cubic meters of gas per year, the company said. Other Polish electricity producers are planning to build gas-fired plants expected to use about 2 billion cubic meters per year.

Over-supply concerns are exacerbated by Poland's plans to build a liquefied natural gas terminal on the Baltic coast. The terminal, scheduled for completion in 2014 and with capacity to supply Poland with about a third of its gas needs, would free the country to buy LNG from any global producer.

Earlier this year, PGNiG agreed with Qatargas for the Qatari company to start shipping liquefied gas to Poland in 2014. Government and PGNiG officials hailed the deal as a decisive step toward energy diversification, but detractors noted the gas was more expensive than Russian gas.

DIVERSIFICATION

Given Russia's history as Poland's former imperial and communist-era master, successive Polish governments have for years paid lip service to gas supply diversification away from the country's large neighbor to the east, but actual implementation of such a strategy is time-consuming and costly.

"Russian gas is the cheapest," Burzynski said. "But as a society we don't want to pay more, so effectively we don't want to diversify."

Pawel Magierowski, a partner at the Baker & McKenzie law firm's energy practice in Warsaw, says that attitude is changing.

"From a short-term business perspective, it makes sense to keep buying from Russia and accept the risks. But currently we are seeing the beginning of acceptance of the decision to pay more for security," Magierowski said.

During January's gas conflict between Russia and Ukraine, Poland was not completely cut off from gas supplies, as it was still receiving gas via Belarus, but the shortfall forced PGNiG to cut supply to industrial consumers. Polish households, which use gas for cooking and heating, were spared, but chemical and fertilizer factories had to grind to a halt.

That stoppage, and possible future gas supply problems, in turn spooked potential investors just as Poland gears up to privatize many state-controlled chemical and fertilizer companies in a bid to wipe out a yawning budget deficit.

"The current contract, which gives more volume, is good for the chemical-fertilizer companies," Burzynski said

INTERCONNECTORS

Even if it wanted to diversify, Poland has no way of quickly shifting its source of imports to a supplier other than Russia. It imports Russian gas via pipelines running through Belarus and Ukraine and extracts the rest of its annual gas supply, about one-third, domestically. For now, the map of Central Europe's pipeline network dictates that no matter what deal Polish and Russian gas companies strike, the country will be vulnerable to the fraught relationship between Ukraine and Russia.

Burzynski said interconnectors, pipelines that can send gas both ways between countries' fragmented gas pipeline systems, are the cheapest way for Poland to diversify its supply. They are a solution the European Union favors, and they proved key in easing the effects of the January crisis on many European countries.

"The projects linked to other directions, such as the LNG terminal or links to the gas systems of Germany, the Czech Republic, or Slovakia should be treated as complementary, guaranteeing more flexibility in crisis situations," Economy Minister Pawlak said.

Poland has just one interconnector—to the German network. Although Polish state-owned gas pipeline operator Gaz-System SA is working to increase this interconnector's capacity by two-thirds, to 1.5 billion cubic meters per year, the capacity pales in comparison with the 14 billion cubic meters Poland consumes annually.

The company is working on only one other interconnector, near the town of Cieszyn, which will enable Poland to import 0.5 billion cubic meters from the Czech system by 2011, said Gaz-System spokeswoman Malgorzata Polkowska.

Asked whether there were other planned interconnector projects, Polkowska mentioned the Baltic Pipe, which would link Poland to the Danish gas system, and another one with Lithuania. But both projects are on hold as the Polish companies that might buy gas from these two directions say they do not need these links, Polkowska said.

Andrzej Szczesniak, an independent energy expert based in Warsaw, said more interconnectors to Germany would break PGNiG's monopoly in Poland. He likened successive Polish administrations' failure to build more interconnectors to a homeowner who doesn't buy flood insurance and then demands a bailout.

"Poland hasn't done anything in 15 years, not one pipeline," Szczesniak said. "There are several [interconnector] projects ready, but some politicians say they don't want it because it would be Russian gas [flowing through them].

"It would link us to the European Union system and the German system, which is an energy hub," Szczesniak said. He noted that there is no way of knowing if gas from a new German interconnector would be more expensive, as unpredictable market mechanisms would come into play.

Ironically, the new, larger contract with Gazprom might allay the over-supply problem. "As the situation stabilizes, gas consumption will grow," Szczesniak said. Entrepreneurs thinking about kicking off projects that need natural gas, such as the planned power plants, may be more likely to go ahead with them now. "But as use grows, it becomes even more important to have more than one supplier," Szczesniak added.

Burzynski, on the other hand, emphasized there was no point in getting emotional and complaining about dependence on Russia. "The relationship with Russia is symbiotic," he said.

Intelligent Eastern Europe

Marynia Kruk is a business journalist in Warsaw.

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