The Impact of Securing Alternative Energy Sources on Russian-European Natural Gas Pricing Nathalie Hinchey Department of Economics and James A. Baker III Institute for Public Policy Rice University The 40th Annual IAEE International Conference, 2017

Motivation Research Questions What economic forces explain Russian gas pricing in Europe? Does diversifying supply sources reduce price? Do the profits of securing capital to diversify supply sources outweigh the costs?

Gas Price Discrepancies in Europe Motivation Gas Price Discrepancies in Europe

Lower Pricing in Western Europe Motivation Lower Pricing in Western Europe WESTERN EUROPE CENTRAL EUROPE SOUTH/EAST EUROPE LNG IMPORT TERMINALS 19 2 1 HUB PRICING 88% 53% 4% DIVERSIFIED SUPPLIERS  

Floating Storage Regasification Units Motivation Floating Storage Regasification Units In 2014, Lithuania negotiated a 23% price decrease with Gazprom Cost 96 million Euros + 66 million Euros/year Can this price decrease be explained by diversification? Or oil price collapse?

Presentation Outline Theoretical Model Empirical Model and Data Examine the Baltic Region Conclusions and Policy Implications

Asymmetric Nash Bargaining Theoretical Model Asymmetric Nash Bargaining European country forecasts demand 𝑄 𝑖 = 𝑄 𝑖 𝑅 + 𝑄 𝑖 𝐿 + 𝑄 𝑖 𝐼 Russia observes Asymmetric Nash Bargaining Solution = Price 𝑃 𝑖 𝑅∗ =𝑓 𝑄 𝑖 𝑅 , 𝑄 𝑖 𝐿 , 𝑄 𝑖 𝐼

Asymmetric Nash Bargaining Theoretical Model Asymmetric Nash Bargaining 𝐶=𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑒𝑥𝑡𝑟𝑎𝑐𝑡𝑖𝑜𝑛 𝜏 𝑈𝑆𝑆𝑅 𝑖 =𝐵𝑎𝑟𝑔𝑎𝑖𝑛𝑖𝑛𝑔 𝑃𝑜𝑤𝑒𝑟 𝑃 𝑖 𝐷 =𝐷𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑎𝑠 𝑃 𝑖 𝐷𝑜 =𝐷𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑝𝑟𝑖𝑐𝑒 𝑎𝑏𝑠𝑒𝑛𝑡 𝑅𝑢𝑠𝑠𝑖𝑎𝑛 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 𝑇 𝑖 𝑄 𝑖 , 𝐷 𝑖 =𝑇𝑟𝑎𝑛𝑠𝑝𝑜𝑟𝑡𝑎𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡𝑠 𝑃 𝑖 𝑅 =𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑅𝑢𝑠𝑠𝑖𝑎𝑛 𝑔𝑎𝑠

Profit Functions Russia’s payoff function: Theoretical Model Profit Functions Russia’s payoff function: 𝜋 𝑖 𝑅 = 𝑃 𝑖 𝑅 𝑄 𝑖 𝑅 −𝐶 𝑄 𝑖 𝑅 Russia’s payoff if negotiations breakdown: 𝜋 i 𝑅𝑜 =0

Theoretical Model Profit Functions European Country’s payoff function: 𝜋 𝑖 𝐷 = 𝑃 𝑖 𝐷 𝑄 𝑖 − 𝑃 𝑖 𝐼 𝑄 𝑖 𝐼 − 𝑃 𝑖 𝑅 𝑄 𝑖 𝑅 − 𝑃 𝑖 𝐿 𝑄 𝑖 𝐿 − 𝑇 𝑖 𝐼 𝐷 𝐼 𝑖 , 𝑄 𝑖 𝐼 − 𝑇 𝑖 𝑅 𝐷 𝑅 𝑖 , 𝑄 𝑖 𝑅 − 𝑇 𝑖 𝐿 𝐷 𝐿 𝑖 , 𝑄 𝑖 𝐿 If negotiations breakdown: 𝜋 𝑖 𝐷𝑜 = 𝑃 𝑖 𝐷0 𝑄 𝑖 𝐼 + 𝑄 𝑖 𝐿 − 𝑃 𝑖 𝐼 𝑄 𝑖 𝐼 − 𝑃 𝑖 𝐿 𝑄 𝑖 𝐿 − 𝑇 𝑖 𝐼 𝐷 𝐼 𝑖 , 𝑄 𝑖 𝐼 − 𝑇 𝑖 𝐿 𝐷 𝐿 𝑖 , 𝑄 𝑖 𝐿

Asymmetric Nash Bargaining Price Theoretical Model Asymmetric Nash Bargaining Price 𝑃 𝑖 𝑅∗ = 𝜏 𝑈𝑆𝑆 𝑅 𝑖 𝐶+ 1−𝜏 𝑈𝑆𝑆 𝑅 𝑖 [ 𝑃 𝑖 𝐷 − 𝑃 𝑖 𝐷𝑜 𝑄 𝑖 𝐿 + 𝑄 𝑖 𝐼 𝑄 𝑖 𝑅 + 𝑃 𝑖 𝐷 − 𝑇 𝑖 𝑅 (𝐷 𝑅 𝑖 , 𝑄 𝑖 𝑅 ) 𝑄 𝑖 𝑅 ] 𝜕 𝑃 𝑖 𝑅∗ 𝜕( 𝑄 𝑖 𝐿 + 𝑄 𝑖 𝐼 ) = 1−τ 𝑈𝑆𝑆 𝑅 𝑖 𝑃 𝑖 𝐷 − 𝑃 𝑖 𝐷𝑜 1 𝑄 𝑖 𝑅 <0 𝑃 𝑖 𝑅∗ = max 𝑃 𝑖 𝑅 ∈𝑅 𝜋 𝑖 𝐷 − 𝜋 𝑖 𝐷𝑜 𝜏 𝑈𝑆𝑆 𝑅 𝑖 𝜋 𝑖 𝑅 1−𝜏(𝑈𝑆𝑆 𝑅 𝑖 )

Data Eurostat Trade Database from 2009-2015 12 EU members Empirical Model and Data Data Eurostat Trade Database from 2009-2015 12 EU members Quantity in TJ/ Prices USD USSR includes Satellite countries Heating Degree Days (18 Degrees Celsius) Distance in 1000 KM between capitals Trade partners: Russia, Norway, Qatar, Algeria

Empirical Model and Data Estimated Model 𝑃 𝑖,𝑡 𝑅 = 𝛽 0 + 𝛽 1 𝑞 𝑖,𝑡 𝑜 𝑞 𝑖,𝑡 𝑅 + 𝛽 2 𝐵𝑟𝑒𝑛 𝑡 𝑡 + 𝛽 3 1 𝑈𝑆𝑆𝑅 𝑖 + 𝛽 4 𝐷 𝑅 𝑖 + 𝛽 5 𝐷 𝑅 𝑖 𝑄 𝑖,𝑡 𝑅 + 𝜖 𝑖,𝑡 Expect 𝛽 1 <0 Instruments: HDD and Distance from Oslo

Correlated Random Effects Empirical Model and Data Correlated Random Effects Used Panel Data in Estimation 𝜖 𝑖,𝑡 = 𝑐 𝑖 + 𝑣 𝑖,𝑡 Fixed Effects not appropriate due to importance of time invariant parameters Use Correlated Random Effects 𝑐 𝑖 = 𝛾+𝜑 − 𝑞 𝑖 𝑜 𝑞 𝑖 𝑅 + 𝑎 𝑖

Empirical Model and Data Results

Lithuanian FSRU Independence Examination of the Baltic Region Lithuanian FSRU Independence Lithuania saved 130,000,000.00 Euros in 2016 from diversification More than offset the annual cost of 75,600,000 Euros in 2016 FSRU can supply 90% of the Baltic’s gas demand Possibilities to supply Estonia and Latvia

Conclusion and Policy Implications Empirically shown that diversification secures lower prices from Gazprom European policy is supportive of those who seek to diversify Floating LNG terminals are making diversification more feasible This research provides support for EU diversification initiatives