How Poland Tried To Win But Lost The Gas Game

Energy supplies from Russia to western Europe have always been on long term contracts with mostly fixed pricing. These constructs allowed Russia to make the large invest in the necessary infrastructure while the buyers gained energy security. The European Union, under U.S. influence, has tried to destroy that model. But its attempts to ‘open the energy markets’ has led to insecure supplies and extreme prices.

Poland’s current situation can be seen as an example for the ‘success’ of such policies.

In 1992 Russia, Belarus, Poland and Germany agreed to build the Yamal-Europe pipeline to bring natural gas from new gas fields in Russia to Poland, Germany and beyond.

The pipeline has a capacity of some 33 billion cubic meter (1.2 trillion cubic feet) per year. In 1996 Poland and Gazprom of Russia agreed on a contract that would deliver up to a third of the pipeline’s capacity to Poland for 25 years. The price was, as usual at that time, bound to the oil price with a defined delay in rising and lowering the gas price but in principle following the movement of the global oil markets. Gazprom, which had to invest billion to develop the Yamal fields and pipelines, insisted on a 85% minimum (‘take-or-pay’) amount of gas that Poland would have to pay for independent of its actual demand for it.

All was well up until November 2014 when Poland’s gas operator PGNIG suddenly found that it paid a too high price for the gas coming from Russia. (It is not just a coincidence that this came a few months after the U.S. arranged coup in the Ukraine and the return of Crimea to Russia.)

In March 2015 Poland sued Gazprom to gain lower gas prices:

PGNiG, Poland’s largest gas distributor, has filed a lawsuit against Gazprom and Gazprom Export in the Stockholm arbitration court, saying it wants conditions similar to the European gas market.

“The steps taken by PGNiG aim to bring the contract in line with the current conditions in the European natural gas market,” the company said in a statement published Thursday. It also emphasized that the claim doesn’t exclude a negotiated outcome or a new deal with the supplier.

Poland considers the fall in oil prices a reason for demanding a bigger reduction, as the Russian gas price formula is based on the oil price. The country is also against the ‘take or pay’ system which forces customers to pay for deliveries they may not necessarily need or use.

It took the arbitration court five years to come to a final decision. In March 2020 Poland’s gas company thought that it had won and celebrated the results:

“The Arbitral Tribunal has sided with PGNiG, thus confirming that the price of gas in the Yamal Contract failed to reflect the price level on the market and was overstated”, said Jerzy Kwieciński, President of the Management Board of PGNiG SA, and added: “the Tribunal changed the calculation formula for the price of the Russian gas by tying it very closely to the price level on the European market, which for PGNiG means a huge improvement of the terms of our gas imports gas”.

The award has been binding on both parties from the moment it was announced. From now on, the price that PGNiG will pay to Gazprom for natural gas will be based on the new price calculation formula, which is very closely and directly tied to the gas price level on the Western European market. The Tribunal’s ruling applies from 1 November 2014, that is, the date on which PGNiG sent its contract price review request to Gazprom. This means that the Russian company will be required to pay back to PGNiG an estimated USD 1.5 billion, which is the difference between the price calculated based on the new formula and the amounts actually paid by PGNiG since 1 November 2014 until 29 February 2020.

During the five and a half years PGNIG had received about 50 billion cubic meter of gas at a price of about $500 per thousand cubic meter. Of some $25 billion it had paid over that time it regained some $1.5 billion or 6%.

The win was rather marginal but Poland thought that the new price mechanism the arbitration court had put into the contract would further work to its advantage. The European Union had worked to ‘liberalize’ the European energy markets by discouraging long term contracts and by introducing commodity exchanges for energy. Instead of being determined by long term investments and contract obligations energy prices would now follow short term speculations.

Then came the pandemic, bad weather for wind energy, a surge in energy demand from China and the markets went crazy. The prices at the European commodity exchange for natural gas went from some $400 to $500 to up to $2,000 per thousand cubic meter. The usual suspects blamed Russia for the price increase but as the German government confirmed Russia and Gazprom are fulfilling all their contractual obligation. It isn’t Russia that was withholding gas to Europe but the U.S. which now is happily selling to China at even higher prices than it can achieve in Europe.

As the Russia’s President Vladimir Putin described the situation it in his recent talk at the Valdai Club :

So, everything began to be brought to this spot market, but it largely holds gas on paper, not real gas. These are not physical amounts, which are not increasing (I will explain why in a minute). A figure is written on paper, but there is no physical amount, it is declining. So, a cold winter requires gas from underground storage; a wind-free hot summer means a lack of wind generation on the necessary scale. I have already mentioned the macroeconomic reasons, and these are the sector-based reasons.

What happened next on the European market? First, a decline in production in the gas producing countries. Production in Europe fell by 22.5 billion cubic metres during the first six months. This is first. Second, gas storage facilities were underfilled by 18.5 billion cubic metres and are only 71 percent full. The gas storage facilities were underfilled by 18.5 during the first six months of the year. If you look at annual consumption, this number must be doubled.

Primarily American, along with Middle Eastern companies withdrew 9 billion cubic metres from the European market and redirected the gas to Latin America and Asia. By the way, when the Europeans were formulating the principles governing the formation of the gas market in Europe, and said that all gas must be traded on the spot market, they were proceeding from the assumption that the European market is a premium market. But the European market is no longer a premium market, you see? It is no longer a premium market. Gas was redirected to Latin America and Asia.

I have already said that 18.5 billion cubic metres, plus double that amount, 9 billion (undersupplied to the European market from the United States and the Middle East), plus a decline in production of 22.5 billion – the deficit on the European market may amount to about 70 billion cubic metres, which is a lot. What does Russia have to do with it? This is the result of the European Commission’s economic policy. Russia has nothing to do with it.

Nevertheless Putin intervened and told Gazprom to pump more gas towards Europe. The wholesale prices in Europe have since come down to $1,000 per thousand cubic meter which is still more than double the amount Poland paid under the old price formula.

Poland, which in 2015 sued Gazprom to gain the new price formula, which tried to prevent the installation of the North Stream 2 pipeline between Russia and Germany and which announced that it will not renew the existing Yamal contract with Gazprom, is now asking Russia to lower the price of gas it has to pay under the revised formula:

The Polish oil and gas concern PGNiG announced that it had sent a letter to Gazprom with a request to reduce the price of gas supplied to Poland, justifying the request with an unprecedented leap in the European wholesale market.

“On October 28, 2021, PGNiG sent a letter to PJSC Gazprom and OOO Gazprom export, which modifies PGNiG’s statement of February 2020 to change the price of gas supplied under the contract for the sale of natural gas to Poland dated September 25, 1996 (as called the Yamal contract), in the direction of its reduction so that the revision process could take into account the current situation on the market, “- said in a statement.

Polish chutzpah has no bounds. “We want the old price formula back,” is what Poland is now saying.

Well, it is payback time and I do not think that Gazprom will consider to significantly change the pricing for Poland. Under the ‘pay or take’ clause in the contract Poland has to pay for or buy 8.7 billion cubic meter per year. With the current exchange prices of $1,000 there is now a $500 per thousand cubic meter price difference between the old contract price formula and the new one. If nothing changes Poland will have to pay some $5 billion more than under the old formula until the contract runs out at the end of 2022. The happy arbitration court win of $1.5 billion a year ago does not look good in comparison.

For solely political reasons Poland’s anti-Russian government is adamant that, after 2022, it will no longer buy natural gas from Russia. But Poland will have significant difficulties to get natural gas from other sources. Its plans for a new pipeline from Norway to Poland have been temporarily blocked for environmental reasons. It can buy LNG from the U.S. and Qatar but it will have to pay premium prices which will depend on speculative commodity exchange prices instead of the long term pricing formula Russia prefers.

It is quite likely that in 2023 Poland will end up like Moldova which two months ago let its gas contract with Russia run out without having secured alternative supplies at a reasonable price. A new contract with Gazprom will, following the EU’s preferred price formulas, have higher prices while Moldova is unwilling or unable to even pay the money its still owns from the old contract. It will be a dark and cold winter for the new anti-Russian government of Moldova which the EU and U.S. have helped to install.

One might hope that the European Union and the governments of its countries will learn from this. Energy supplies always require long term investment, long term contracts and price stability. They should never become political footballs.

Following U.S. hypocrisy, which demands more Russian gas for Europe while it opposes new Russian pipelines, is not in the best interests of Europe’s citizens.