nabucco vs. south stream

8/2/2019 Nabucco vs. South Stream

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=#$>/!'?!5'@,/@,)!! Table of Contents..............................................................................................2

Introduction ....................................................................................................... 3

Two Pipelines, One Goal - How did it come to this? ................................................. 3

Background ......................................................................................................4

Natural Gas Demand in Europe ................................................................................ 4

Europes Struggle for Independence and Russias Gas War with Ukraine................. 4

Nabucco vs. South Stream David vs. Goliath?....................................................... 5

Modeling the European Gas Market ..................................................................6

The Network ............................................................................................................ 7

The Economic Model ............................................................................................... 7

Parameters, Indices, Variables and Equations .......................................................... 8

Scenarios ........................................................................................................ 11Scenario 1: Base Case (None of the Two Pipelines Constructed) ........................... 11

Scenario 2: Nabucco Constructed ......................................................................... 12

Scenario 3: South Stream Constructed.................................................................. 13

Scenario 4: Both Pipelines Constructed ................................................................. 15

Conclusions ....................................................................................................16

References ...................................................................................................... 17

Appendix: GAMS Model .................................................................................. 18

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Natural gas is the second most consumed primary energy source in Europe. Not only is

the burning of natural gas a much cleaner process than burning oil or coal in regard to

CO2 emissions, but also its heat to weight ratio is higher than any other fossil fuel

(Rutherford 2011).

Figure 1: Primary energy consumption in Europe (Data: BP 2010)

It is assumed that because of its many advantages and the general decrease in oil

production, demand for natural gas will surpass demand for oil in Europe within the

next 25 years (IEA 2009). The current events in Japan, which started new discussions

about nuclear power generation worldwide, will probably reinforce and speed up that

process.

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Europes biggest supplier of natural gas is Russia. Pipelines from Russia to Europe

satisfy a third of the European gas demand. Roughly eighty percent of the Russian

natural gas flows through Ukraine.

Due to a payment dispute in January 2006, Russia briefly interrupted gas supplies to

Ukraine. In January 2009 a second conflict between Russia and Ukraine led to a severe

40%!

24%!

16%!

6%!12%!

2%!Primary Energy Consumption in Europe!

Oil!Gas!Coal!Hydro!Nuclear!Alternative!


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lack of gas supply in Europe for twenty days. The conflict between Russia and Ukraine

was one of the main drivers in Europes search for alternative gas suppliers.

Figure 2: Projected European gas supply from 1990 to 2030 (Rutherford 2011)

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For our purpose, we assume that the probability of either pipeline being up and running

by 2015 is equal. Many politicians and economists however doubt that the assumed

scenario is realistic. One of the many issues of constructing the Nabucco gas pipeline is

the question of where to get the natural gas from.

Figure 3: Planned routes of Nabucco and South Stream (BBC 2009)


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So far the only candidate for supplying half of the pipelines capacity is Azerbaijan with

its Shah Deniz 2 gas field (Erdogdu 2010). According to the Russian Ambassador to the

EU Vladimir Chizhov, the only [] possibility for Nabucco to become a profitable and

viable project would be to connect [the pipeline] to Iranian gas. But then it [would be] up

to those countries that will be consuming the gas to make up their mind whether they

will be importing gas from Iran or they will side with those, who would rather bomb Iran

(EUX.TV 2008). Also there is uncertainty about whether the two pipelines are competing

or not.

Both, the consortium behind Nabucco and Gazprom declare that the two pipeline

projects are not in competition (Nabucco Gas Pipeline 2011, South Stream 2011).

The following table gives an overview of both projects.

Nabucco South Stream Total length [km] ~4000 ~3700

Capacity [bcm/year] 31 63

Construction Cost [bEur] 8-14 19-24

Partners OMV, MOL, Transgaz,

Bulgargaz, BOTAS, RWE

Gazprom, Eni

Goes through Turkey, Bulgaria, Romania,

Hungary, Austria

Russia, Bulgaria, Greece,

Italy, Serbia, Hungary,

Croatia, Slovenia, Austria

Destination Austria Italy, Austria

First gas supply 2015 2015

Table 1: Comparison of Nabucco and South Stream (Nabucco Gas Pi peline, South Stream)

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There are four possible future scenarios with regard to the construction of Nabucco and

South Stream: No pipeline gets built, Nabucco gets built, South Stream gets built or

both get built. We want to assess the relative market price changes and the changes in


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market shares for the suppliers in the different scenarios. In order to evaluate the effect

of the two pipelines on the European market, we consider a simplified network.

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In the market for natural gas in Europe, there are only a few large suppliers and a few

large consumers (Mathiesen 2010). We consider Europe as one market supplied by five

players. We call the players Team Russia, Team Europe, Team Others, Nabucco

and South Stream. Each player supplies the European market with a certain natural

gas volume over a certain distance for a certain transportation cost. For the calculation

of the transportation costs of Nabucco and South Stream, we pick existing

representative pipelines for each of the Teams Russia, Europe and Others (OME 2005, The Harriman Institute 2011). The average lengths and transportation costs of the

representatives will serve as parameters for the calculation of the transportation costs of

Nabucco and South Stream. The pipelines considered for the calculation are listed in

table 2.

Players Representative Pipel ines

Team Russia

Yamal, Brotherhood, Urengoy Center,

Nord Stream*

Team EuropeEuropipe 1, Franpipe, Midal,

Interconnector, Megal, Netra, Transaustria

Team OthersMaghreb-Europe, Trans-Mediterranean

(Transmed)

Table 2: Representative pipel ines for the supplying players

* Since construction of the Nord Stream pipeline started in April 2010, we assume that

it will be running by the time the Nabucco and the South Stream pipelines are built.

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Numerous models of natural gas markets with realistic data and a high level of detail

have been developed before. E.g. Egging and Gabriel (2006) developed an equilibrium

model for the European natural gas market, which allows for both perfect competition

and Cournot strategic producers and also considers players in storage and

transmission. In their paper A complementary model for the European natural gas


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market Egging and Gabriel (2008) describe an extensive model, which includes 52

countries, traders, pipeline and storage operators, marketers, Liquefied Natural Gas

(LNG) trade and final consumption. Lochner (2011) uses the TIGER natural gas

infrastructure and dispatch model to investigate security of supply issues. Lochner also

applies the TIGER model to the 2009 Russia Ukraine crisis. Even higher levels of detail

are found in the Gas Systems Analysis Model (GSAM) for North America (Gabriel et al.

2003) and the Rice University World Gas Trade Model (Hartley and Medlock 2006).

In the present paper, we consider natural gas as a homogeneous good. Consumers

have no preference from which supplier to buy. There will be one price for natural gas in

the European market (Mathiesen 2010). A competition, in which the suppliers make

volume decisions and not price decisions, is called Cournot competition.

Since we only have five suppliers in one market, the market power of each supplier will

have to be considered. So instead of assuming a perfectly competitive market, in which

all suppliers are price-takers, we look at the natural gas market in Europe as an

oligopoly, where the output decisions of each supplier affect the other suppliers profits

(Rutherford 2011). Therefore we are not interested in the competitive equilibrium, but

the Nash equilibrium.

Lars Mathiesens paper On Modeling the European Market for Natural Gas shows the

differences between volumes and prices of the competitive and the Nash-Cournot

equilibria based on a simple numerical example (Mathiesen 2010). In the example, four

producers supply six markets. In order to use Mathiesens model as a framework for

our purpose, we increase the number of suppliers to five, reduce the number of

markets to one, adjust the transport costs and add capacity constraints (upper limits)

for the market deliveries of each player. We also only consider the volumes and prices

of the Nash-Cournot equilibrium.

In the following, we describe all indices and variables of the model and then derive the

profit equation step by step. In order to find the Nash-Cournot equilibrium, the profit

equation is then optimized with the modeling system software GAMS.

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The parameters to define for our model are the transport cost and the capacity

constraints for every supplying player.

In order to have a somewhat realistic representation of the transportation cost, data for

existing pipelines from Russia to Europe, within Europe and from Algeria to Europe will


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be used (OME 2005). The transportation costs of the Nabucco and South Stream

pipelines are then calculated by dividing the average transportation cost of the selected

representative pipelines for each of the three players by the average length of the

pipelines and multiplying it with the length of Nabucco or South South Stream

respectively:

Cost(Nabucco) =Avg_Cost(Russia)

Avg_Length(Russia)" Length(Nabucco)

Cost(SouthStream) =Avg_Cost(Russia)

Avg_Length(Russia)" Length(SouthStream)

!The capacity limit for Team Russia is the current supply of natural gas to Europe withthe additional capacity of the Nord Stream pipeline. The capacity limit for Team Europe

is the projected indigenous production for the year 2015. The capacity limit for Team

Others is the projected capacity of Algeria and other non-European countries for the

year 2015. The capacity limits of the Nabucco and South Stream pipelines are their

own full capacity (Nabucco Pipeline Project, South Stream). The resulting relative gas

supply capacities to the market Europe are depicted in figure 4.

!Figure 4: Relative gas supply capacit ies of the supplying players (Data: BP 2010) !

To show that the market price depends on the supply volume of all suppliers, we

calculate the inverse demand function and define that the market demand equals the

total supply.

32%!

39%!

10%!6%!

13%!

Gas Supply Capacities!

Team Russia!Team Europe!Team Others!Nabucco!South Stream!


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Suppliers: i"{Team Russia, Team Europe, Team Others, Nabucco, South Stream}!Market price: P!Demand: D !

Transport cost: tc(i) !Marginal cost: MC(i)!Marginal

Revenue:

MR(i)!! !

Supply: Q(i)!Revenue: !

R( i)!Profit: "(i)!Cost: C(i)!

Table 3: List of indices and variables

Let

D = a + b " P!be the demand function,P = "

a

b+

1

b# D !the inverse demand function and let

D = Q( i)i" .

Based on the inverse demand function, the profit equation to be optimized can be

derived. The profit equation simply states that the marginal cost plus the transportation

cost has to be greater than marginal revenue.!The profit function of supplier i!is"( i) = R(i)#C(i)!and his revenue isR( i) = P "Q(i).

!In order to maximize profit we take the time derivative of the profit function and set it

equal to zero. This gives the condition that the marginal revenue of i! is equal to themarginal cost of i, where marginal revenue and marginal cost are the derivation of

revenue and cost respectively. The profit equation is

MR(i) ="R(i)

"Q(i)= #

a

b+

2

b$Q(i) = P # b $Q(i) %

"C(i)

"Q(i)+ tc(i) = MC(i) + tc(i).


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We will not consider the possibility of forming cartels between any of the players Team

Europe, Team Russia and Team Others because of the unstable nature of collusion

(high incentive to cheat in a profit-seeking cartel, Rutherford 2011).

!

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!We want to show the impact of the implementation of the two pipelines Nabucco and

South Stream on the European gas market, namely the market price change and the

change of market shares. We look at four scenarios. The first scenario, where none of

the two pipelines is built, serves as a base case. In the second and third scenario we

look at the situation where either one or the other pipeline is constructed. In the fourth

and last scenario we let both pipelines run at their full capacity. In each scenario we let

the market react to the different capacity limits and let the model show us the market

price and market shares.

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In the Base Case, only Team Russia, Team Europe and Team Others supply the

market. Since operators usually run pipelines at almost full capacity, the capacity

constraints are adjusted so that roughly 90% of the capacities of every player are

utilized to fully satisfy market demand (EIA 2008). Figure 5 shows the market shares of

the three teams.


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!Figure 5: Market shares without Nabucco and South Stream

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Now we add the Nabucco pipeline to the Base Case scenario and look at how the

volumes and the market price change.

Figure 6.1: Market shares with the Nabucco pipeline constructed

With Nabucco constructed, the market price drops by 3.9%. The market shares of

Teams Russia and Europe drop by 6.1% and 5.7% respectively. Team Others and

Nabucco run at full capacity.

42%!

44%!

14%!

Base Case!

Team Russia!Team Europe!Team Others!

38%!

40%!

14%!8%!

Nabucco Constructed!

Team Russia!Team Europe!Team Others!Nabucco!


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Because the Nabucco pipeline project is led by a consortium of European companies,

we add the additional volume supplied by the Nabucco pipeline to the volume of Team

Europe. This leads to an increase in the market share by 13.5%. The new situation is

depicted in figure 6.2.

Figure 6.2: Market shares with Nabucco added to Team Europe

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If we add only the South Stream pipeline to the base case, the results change as

depicted in figures 7.

41%!

44%!

15%!

Nabucco Added to Team Europe!



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Figure 7.1: Market shares with South Stream constructed

The market price compared to the base case drops by 8.4%. The volumes of Team

Russia and Team Europe drop by 13.1% and 12.4% respectively.

Again, since the South Stream pipeline project is led by the Russian company

Gazprom, we add the volume of South Stream to the volume of Team Russia. The total

volume supplied by Team Russia increases by 31.6%.

Figure 7.2: Market shares with South Stream added to Team Russia

34%!

36%!

13%!

17%!

South Stream Constructed!

Team Russia!Team Europe!Team Others!South Stream!

51%!36%!

13%!

South Stream Added to Team Russia!



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!

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Finally, we look at the scenario where both pipelines are running simultaneously (Figure

8.1). The market price in this case drops by 12.4% compared to the base case. Both

pipelines and Team Others supply at full capacity. Team Europes volume drops by

18.2% and Team Russias volume drops by 19.2%. If we add the volume of Nabucco

to the volume of Team Europe and the South Stream to Team Russia, we get the

scenario in figure 8.2. The total volume of Team Europe increases by 1.6% while the

total volume of Team Russia increases by 25.4%.

Figure 8.1: Market shares with Nabucco and South Stream constructed

Figure 8.2: Total market shares of Team Europe and Team Russia with pipel ines added

30%!

32%!

13%!8%!

17%!

Both Pipelines Constructed!

Team Russia!Team Europe!Team Others!Nabucco!South Stream!

47%!40%!

13%!

Both Pipelines Added to their Respective

Teams!



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5'@&>%)B'@)

We showed the reactions of the European market for natural gas, when the Nabucco

and/or South Stream pipelines are constructed. From the four different scenarios, the

market price drops to its lowest value in the fourth scenario, where both pipelines are

implemented. But while Russias market share increases by over 25 percent, Europes

market share stays almost the same. The only scenario in which Europe substantially

increases market share and therefore gains energy independence, is the one where

only the Nabucco pipeline is built. Perhaps the most realistic case from a purely

economic point of view in the short term is scenario 3, where only the South Streampipeline is implemented. With a market share of over 50 percent, Russia would strongly

dominate the European natural gas market.

The increasing demand for natural gas in Europe will somehow have to be satisfied.

Europes pursuit of energy independence and energy security may lead to further

disputes and finally, to compromises. The Nabucco Gas Pipeline and the South Stream

project are currently the prime examples of European struggle for energy independence

and the Russian race for market dominance in Europe.

To get an insight in the possible strategic decisions of the players involved with the

Nabucco and South Stream projects and the influence of political positions and

interests, Haas paper Nabucco vs. South Stream - A Game Theoretical View on the

Race of Gas Pipelines can be considered (Haas 2011).


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2/?/./@&/)!

BBC.http://news.bbc.co.uk/2/hi/8360629.stm

BP. 2010. BP Statistical Review of World Energy June 2010 . BP.

Egging, Rudolf G., and Steven A. Gabriel. 2006. Examining market power in the European

natural gas market. Energy Policy34 (November): 2762-78.

Egging, Rudolf G., and Steven A. Gabriel. 2008. A complementary model for the European

natural gas market. Energy Policy36 (July): 2385-2414

EIA. 2011. www.eia.doe.gov/pub/oil_gas/natural_gas/analysis_publications/ngpipeline/usage

Erdogdu, Erkan. 2010. Bypassing Russia: Nabucco project and its implications for the European

gas security. Renewable and Sustainable Energy Reviews 14 (December): 2936-45.

Euractiv. 2010. Europe's southern gas corridor: The great pipeline race http://www.euractiv.com/en/energy/europes-southern-gas-corridor-great-pipeline-race-

linksdossier-498558

EUX.TV. 2008. http://www.youtube.com/watch?v=MQpNIz6HYKs

Gabriel, Steven A., Julio Manik, and Shree Vikas. 2003. Computational experience with a large-

scale, multi-period, spatial equilibrium model of the North American natural gas systems.

Networks and Spatial Economics 3 (2003): 97-122.

Haas, Patrick. 2011. Nabucco vs. South Stream - A Game Theoretical View on the Race of GasPipelines. ETH Zurich, Zurich.

Harriman Institute. 2011. www.energy-pipelines.harrimaninstitute.org/transnationalpipelines

Hartley, Peter, and Kenneth B. Medlock. The Baker Institute World Gas Model. In Natural Gas

and Geopolitics, Cambridge University Press 357-406.

IEA. 2009. Natural Gas Market Review 2009. IEA.

IEA. 2009. World Energy Outlook 2009. IEA.

Lochner, Stefan. 2011. Modeling the European natural gas market during the 2009 Russian

Ukrainian gas conflict: Ex-post simulation and analysis.Journal of Natural Gas Science and

Engineering 3 (March): 341-48

Mathiesen, Lars. 2010. On Modeling the European Market for Natural Gas. In Energy, Natural

Resources and Environmental Economics. Springer Verlag.

Neumann, Anne, Norman Viehrig, and Hannes Weigt. 2011. InTraGas - A Stylized Model of the

European Natural Gas Network. University of Potsdam, Potsdam.

OME. 2010.Assessment of Internal and External Gas Supply Options for the EU. OME.

Victor, David G., Amy M. Jaffe, and Mark H. Hayes. 2006. Natural Gas and Geopolitics: From

1970 to 2040. Cambridge: Cambridge.


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9DD/@ABYS!397+!7'A/>!

!$title Nabucco vs South Stream -- Canay Deniz 2011

set i Suppliers /Russia,Europe,Others,Nabucco,SouthStream/ j Markets /Europe/;

parameter a Intercept of the inverse demand function / 20 /,b Slope of the inverse demand function / 0.25 /,

nash Flag for computing the Cournot-Nash equilibrium /0/;

table t(i,j) Unit transport cost

EuropeRussia 2.39

Europe 2.03Others 1.35Nabucco 2.5

SouthStream 2.7;

nonnegativevariables X(i,j) Market deliveriesP(j) Market pricesMC(i) Marginal costD(j) DemandQ(i) Supply;

equations profit, supply, market, demand, cost;

profit(i,j).. MC(i) + t(i,j) =g= P(j) - (b * X(i,j))$nash;supply(i).. Q(i) =e= sum(j, X(i,j));market(j).. sum(i, X(i,j)) =e= D(j);demand(j).. P(j) =e= a - b * D(j);cost(i).. MC(i) =e= 1 + 0.1*Q(i);

model equil /profit.X, supply.Q, market.P, demand.D, cost.MC/;

P.L(j) = 11;Q.L(i) = 50;X.L(i,j) = 50;MC.L(i) = 6;

nash=1;solve equil using mcp;

parameter results Table of results;

results("Nash",i,j) = X.L(i,j);results("Nash",i,"sum") = sum(j, X.L(i,j));results("Nash","sum",j) = sum(i, X.L(i,j));results("Nash","sum","sum") = sum(j, results("Nash","sum",j));results("Nash",i,"MC") = MC.L(i);results("Nash","Price",j) = P.L(j);

results("Nash","sum","MC") = sum(i, Q.L(i)*MC.L(i))/sum(i, Q.L(i));

results("Nash","sum","Price") = sum(j, P.L(j)*D.L(j))/sum(j,D.L(j));


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results("Competitive",i,j) = X.L(i,j);

results("Competitive",i,"sum") = sum(j, X.L(i,j));results("Competitive","sum",j) = sum(i, X.L(i,j));results("Competitive","sum","sum") = sum(j, results("Competitive","sum",j));results("Competitive",i,"MC") = MC.L(i);results("Competitive","Price",j) = P.L(j);results("Competitive","sum","MC") = sum(i, Q.L(i)*MC.L(i))/sum(i, Q.L(i));results("Competitive","sum","Price") = sum(j, P.L(j)*D.L(j))/sum(j,D.L(j));

* Install pipeline capacity constraints:

X.UP("Russia","Europe") = *limit;X.UP("Europe","Europe") = *limit;X.UP("Others","Europe") = *limit;

X.UP("Nabucco","Europe") = *limit;X.UP("SouthStream","Europe") = *limit;


results("Capacitated",i,j) = X.L(i,j);results("Capacitated",i,"sum") = sum(j, X.L(i,j));results("Capacitated","sum",j) = sum(i, X.L(i,j));results("Capacitated","sum","sum") = sum(j, results("Capacitated","sum",j));results("Capacitated",i,"MC") = MC.L(i);results("Capacitated","Price",j) = P.L(j);

results("Capacitated","sum","MC") = sum(i, Q.L(i)*MC.L(i))/sum(i, Q.L(i));

results("Capacitated","sum","Price") = sum(j, P.L(j)*D.L(j))/sum(j,D.L(j));display results;

!*limit is replaced by the numbers according to the different scenarios.

nabucco vs. south stream

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