Sample News Story
Gas Blazes Trail in Former East Germany
28/12/1996
Eastern Germany is arguably the fastest-growing gas market in Europe. In the short period since the fall of the Berlin wall in 1989, a new gas company, VNG, has emerged, natural gas has displaced the rag bag mixture of gases that used to pass through the former country’s pipes, and most amazing of all, the gas market share of primary energy has surpassed that in western Germany. Oil, fleeter of foot (and road), has been unable to stop gas taking a large share of the declining lignite market, and competition between municipally-generated local power and centrally-generated power for the grid has spurred gas growth.
The surprise success of gas in eastern Germany – the former "Democratic People’s Republic" now known as the "five new bundesländer(1)" in the re-unified federal republic – has been based as much on an embracing of existing infrastructure (district heating connections do wonders for CHP economics) as new investment. This has enabled gas quickly to capture a bigger slice of the residential (and power generation) market than might otherwise have been possible. Likewise, the success of this sector of the market has spurred efforts to develop small CHP schemes in office and commercial buildings on a scale rarely seen anywhere, let alone emerging markets.
Competition Since the formal unification of Germany in October 1990, overall energy consumption in the former East Germany has fallen sharply, partly because it has become a whole lot more efficient and a great deal less wasteful. In contrast with that general trend, consumption of gas has grown and grown – to the point where gas now accounts for a greater share of total energy use in eastern Germany than it now does, or even did, in what used to be called West Germany.
Hello there During the last five years, gas has become the glamour fuel in eastern Germany. As the table (see next page) shows, 1990 gas use totalled 281 PetaJoules (PJ) – about 7.5 Bcm(2) – or just 8.5% of overall energy consumption. By 1995, gas consumption had risen to 467 PJ – a 66% increase – and its share of the total energy market had almost tripled, leaping to 22%. Thus, in half a decade, eastern Germany has surpassed by 3% the natural gas share which took western Germany three decades to build up.
Look at this This growth rate would have been no mean achievement by itself, in any market in the world. That it happened during a 36% slide in overall energy consumption in eastern Germany during the 1990-95 period was all the more remarkable. Rather than relying on overall market growth, gas had to boost its business in eastern Germany by competing for a share of other energy sources’ shares of a shrinking market.
Out of sorts That gas performance contrasts strongly with what has happened since political unification to consumption of coal and lignite ("brown coal") in eastern Germany. Lignite used to be East Germany’s biggest single source of fuel: a whopping 2,260 PJ of energy consumption in 1990, and no less than 68% of total energy supply in that year; but by 1995, lignite consumption had dropped by 64%, to 806 PJ and a much more modest market share of 38%. Coal consumption has declined to less than half its 1990 level, while its share of the (shrinking) energy market has slipped from 4.1% to 3.1%. Nuclear power has been dumped altogether.
Remember this Any tendency to gloat on behalf of gas should, however, be counter-balanced by noting the consumption of oil, the close cousin and competitor of gas in energy markets throughout the world. Taking advantage of its greater logistical flexibility and virtual transport monopoly, gas use has risen in eastern Germany by 50% since 1990, to reach 785 PJ in 1995. At the same time, oil’s share of a diminishing energy market rose from 16% to 36%. Gas is not yet king in eastern German energy, at least not quite yet. That said, the record so far suggests that gas has good prospects in a market where primary energy consumption is not expected to change significantly in the immediate future.
Quick work Several factors lie behind the rapid growth in gas consumption seen in eastern Germany since unification. One was the rapid conversion — and capitalisation — of the former state gas supply company, VEB Verbundnetz Gas (VEB VNG), into a private entity, Verbundnetz Gas AG (VNG) in June 1990 — ie, less than a year after East Germany went to the wall as a distinct political entity, and still several months before the formal unification. Willpower in the east to push through political change found an echo among potential investors in not only the then West Germany but also further afield, as the current pattern of share-ownership of VNG clearly illustrates (see table on next page).
Negotiate The rapid privatisation of VEB VNG prior to political re-unification helped to promote an equally quick clarification of ownership issues. This in turn paved the way for speedy negotiation of the contractual relationships between the newly-privatised VNG and foreign and domestic gas producers. At the same time, VNG also negotiated sales contracts terms with the rapidly re-emerging municipal utilities (the "Stadtwerke") and regional gas distributors.
Your money, please The next step was to bring in much-needed expertise and investment from the more prosperous west. West German companies, most notably Ruhrgas, quickly entered into several technical and advisory co-operation agreements with VNG covering finance and West German law. This was the prelude for the sale of a 35% shareholding in VNG to Ruhrgas and of a 10% stake to Brigitta Erdgas und Erdöl GmbH (BEB, a subsidiary of Deutsche Shell and Esso AG) in August 1990. VNG had signed its first gas supply contract with BEB in June that year.
Hurry, hurry The sale of these shares to Ruhrgas and BEB was agreed even before economic and monetary union between the two halves of Germany came into effect during the summer of 1990. After howls of protest from other would-be investors, the East German privatisation agency, the Treuhandanstalt, sold the remaining 55% of shares in VNG to seven other buyers in September 1990 (GasBrief, September 1990, page 3). Thus, VNG already had virtually all its new shareholders on board even before political re-unification formally took place the following month. Before that, Klaus Liesen, then head of Ruhrgas, had been appointed to oversee efforts to co-ordinate intergration of the gas industry in the "five new states". By that time, Ruhrgas had already become (and still remains) the main west German partner in VNG.
Switch over The actual transfer of the outstanding 55% holding in VNG to the new owners was rather slow, especially compared with the speed of all that had gone before (Wintershall, for instance, only received its 15% plus one share in February 1992). However, this was perhaps a side-issue given that investors had already made clear their commitment to VNG. Technical and financial clout from the west was vital for VNG, given the massive costs involved in converting its gas grid from town gas to natural gas (see box below), and the fact that VNG’s capitalisation had been a major issue when the company was privatised.
Think twice ... Predictably, there were some initial hiccups. There are obviously different versions of history but no-one can dispute that Wintershall had originally intended to take a rather larger stake in VNG of about 25%, instead of the 15% plus one share it eventually acquired. Gazprom, the Russian gas supply company, also once hoped to purchase a substantial share package in VNG. Gazprom’s aspirations were thwarted by the financial and political problems which faced Russia. Less agreement can be mustered to explain why Wintershall also had to cut back its ambitions. One view is that, at the time, it was carrying out an expensive pipeline-building programme and this was putting financial resources under strain at both Wintershall and its parent company, BASF. The Treuhandanstalt, the privatisation agency, had stipulated that investors wanting to take part in VNG’s privatisation also had to participate in financing the renovation of the gas sector in eastern Germany; not surprisingly, Wintershall was hesitant about diverting massive sums into funding pipeline conversion in eastern Germany. Another view is simply that there was more competition for shares when the second 55% of shares were allocated.
.. and again The fact that Ruhrgas and BEB between them already held almost half of the total equity in VNG further complicated the outlook for Wintershall, as did the co-operation and advisory agreements into which Ruhrgas had entered with VNG. Both of these early developments meant that VNG had little or no incentive to follow Wintershall’s example of engaging in direct competition with other companies on gas deliveries. Instead, it quickly became clear that VNG was firmly anchored in the well-established west German system of bilateral demarcation contracts creating regional monopolies, vertical exclusive supply clauses and concessionary agreements. These close links with western German markets led to the adoption in eastern Germany of a gas industry structure based on geographical market protection and vertical contractual integration.
Signing up Eastern Germany had acquired some experience of gas-to-gas competition with the entry into the gas market of WIEH (Wintershall Erdgashandelshaus), the 50/50 joint venture formed by Wintershall and Gazprom. They rationalised much of their activities into Wingas (65% Wintershall, 35% Gazprom), although WIEH still remains the wholesale trading company. On entering the German market as a direct marketer, Gazprom allied itself with Wintershall, much to the irritation of its existing German wholesale customers, Ruhrgas and VNG.
Densely populated Eventually, however, WIEH had to enter into demarcation agreements with VNG and Erdgasversorgungsgesellschaft mbH (EVG), a company created after re-unification as the regional distributor in Thuringia, the most densely populated region in eastern Germany, and neighbouring areas (WIEH supplies to VNG, which in turn supplies EVG, which is owned jointly by Ruhrgas and VNG, each with 50%). Wingas restricts its direct selling to western Germany (except for certain specified customers along the Stegal line). Following a long dispute about Russian gas supplies for VNG, WIEH in January, 1994, signed a 20-year supply contract with VNG, to which the demarcation agreements covering eastern Germany except West Berlin were annexed.
Still problems This does not, however, mean that Wingas is necessarily out of the woods yet. Both of its demarcation agreements in eastern Germany have been contested by the Federal Cartel Office, the Bundeskartellamt, in Berlin. While the adoption in eastern Germany of the same demarcated market structure which had become the norm in western Germany provided the stable environment needed for large investments following unification, it also brought about the usual drawbacks – the creation of dominant market positions and the possibilities that these might be abused, or misgivings about a lack of transparency on price and cost. Conflicts such as these lie at the centre of the "Spreegas test case" (see box on next page).
Wrong again Gas has meanwhile enjoyed a price advantage over competing primary energy sources in post-unification eastern Germany. This probably surprised analysts and advisors who argued in 1990 that it would be faster (in terms of the construction time needed to install or convert infrastructure) as well as cheaper to transport fuel oil by tanker trucks into eastern Germany, than to go to the bother of building new gas pipelines or converting old ones from town gas.
Home run Gas is deemed already to have won the race against fuel oil in the residential heating market. A recent comparative analysis of space-heating installations carried out by the ifo Institute for Economic Research in Munich underlined the relative competitive edge gas has over rival fuels. The study included a calculation that the monthly cost of a gas-fired heating system in a semi-detached house averaged DM 220, compared with DM 275 for light fuel oil and DM 292 for district heating (see table below). Gas sales to residential customers totalled almost 145.4 billion kWh in 1995, against about only 5 billion kWh in 1990.
Power The competitive market advantage of gas is not limited solely to the residential sector. Gas-fired CHP electricity generation projects (linked to district heating systems already in place) with short lead-times and relatively low investment costs have also turned out to be well-suited to the needs of eastern Germany’s notoriously cash-strapped municipalities. Installation of CHP gas turbines to produce heat and electricity reached an annual rate of 80 units/year in 1995. By the end of last year, installed gas-fired power generation capacity totalled 1,276 MW, compared with only 17 MW in 1992. Electricity production from small-scale gas engine gas-fired units is currently increasing at a rate of about 100 MW/year.
Russian role Rapidly rising gas sales have made VNG the second-largest gas importer in unified Germany. Growing demand has also obliged it to contract supplementary gas supplies and, in the process, to make efforts to reduce dependency on imports of Russian gas. Until unification, East Germany had relied solely on Russia for its gas imports under a number of inter-governmental agreements signed between 1974 and 1986. Shortly after unification, a first contract for gas supply from western Germany was signed with BEB, although, it was not until 1992 that Russia’s absolute monopoly on gas imports into eastern Germany ended. However, for the time being, Russian gas will remain VNG’s largest source of imported gas.
More of the same? Russian gas is currently supplied under revised versions of the old Yamburg and Orenburg supply contracts. While Gazprom delivers Yamburg volumes directly to VNG, Orenburg gas is sent to WIEH, which in turn sells it to VNG under the 20-year contract it signed with VNG in 1994. Deliveries under the contract were set at 3.5 Bcm/year, rising to 7 Bcm/year in 1998, once the supply contract for Yamburg gas
Bring on the trolls Norwegian gas first flowed into eastern Germany in October this year (GasBrief, October 1996, page III). Supplies from Norway are scheduled to rise quickly, reaching an annual volume of 4 Bcm within two years. VNG has secured diversified supply contracts under which imports of Norwegian gas and German output each meet about a quarter of gas demand in eastern Germany. Russian gas covers the remaining 50%. VNG has also contracted emergency and back-up supplies from a number of companies in western Germany, notably Ruhrgas.
Catch this Developments in the eastern German energy market during the last five years suggest a number of trends are likely to emerge in the future. One is that lignite use will continue to fall substantially, opening up opportunities for further substitution with natural gas. In addition, the residential heating and power generation markets should continue to drive further gas expansion (although it is suggested that fuel use in the heating sector may slow down in response to increasing efficiency at plants and improved insulation).
Strong prospects The eventual upshot of this, at least in VNG’s view, is that the gas share of the energy market in eastern Germany will reach about 25% by 2010. This in turn suggests that natural gas consumption in what was once the Democratic People’s Republic of East Germany will reach about 185 billion kWh/year (666 PJ/year) in 2000 and some 200 billion kWh/year in 2005.
New world Not only would this be twice as much as the total volume of (the various sorts of) gas carried in pipelines at the beginning of this decade: furthermore, it would all be natural gas. This would be good going for eastern Germany, where in the grand old days of the GDR the then state-owned VEB VNG proposed that the country should convert to natural gas as long ago as 1969, a suggestion to which the government failed to respond for reasons which remain obscure to this day.