North Africa challenges Russia.

It is well known that north African gas producers are targeting growing demand across the Mediterranean in the European Union (EU). Algeria's success in developing a comprehensive network of gas pipelines to Spain and Italy to complement its liquefied natural gas (LNG) sector, has persuaded Italian firm Eni-Agip to construct another pipeline from Libya to the European mainland. Yet research by UK analysts Prospex reveals that the North African region will provide almost 50% of European gas imports within five years, despite having just 4.4% of the world's reserves. How is this being achieved?

Algeria, which currently dominates North African gas supplies to the EU, trails behind Russia as a European supplier at present, providing 28% of European imports. But, Prospex argues, new Algerian projects, allied to the Egyptian LNG sector and the Western Libyan Gas Project, will allow North Africa as a unit to overtake Russia as a supplier, with nearly 50% of EU imports. Prospex concludes: "The region will retain this market share over the decade to 2020 as the European gas market continues to grow. Its importance to Europe will only begin to decline from 2020, and then only gradually." The gas projects currently under development are therefore obviously just a foretaste of what is to come.

If integrated gas and electricity markets evolve as planned across the EU and North Africa, Prospex holds up the possibility of Algeria and Libya using their gas reserves to generate electricity for export to the EU. The report points out: "North African operators able to sell power when European power prices are high, and gas when they are low would, in theory, be in a highly advantageous trading position." However, all five North African countries are currently struggling to meet domestic demand for electricity, the EU's power markets are still not as open as many would wish and subsea transmission lines are expensive to install.

The EU is a particularly attractive market for gas producers in all parts of the globe. Apart from being one of the world's biggest energy consumers in its own right, gas fired generation capacity is making up an increasing proportion of the generation mix in almost every member state. Despite rising gas prices, the European Commission (EC) is keen to see generators move away from coal fired capacity on environmental grounds, so demand for gas is rising steadily in both long-standing members and the new accession states of East and Central Europe.

At the same time, gas production within the EU and outlying European Economic Area (EEA) states is falling, particularly in the North Sea, so imports are rising even more quickly.

The gas markets of the EU are particularly attractive to producers on their doorstep, such as Algeria and Russia, since gas can be piped directly to customers. Europe's cross-border gas infrastructure is improving year on year as new pipelines are put in place. Although many gas suppliers and consumers wish to see long-term contracts maintained, the EC is pushing for the introduction of spot prices on natural gas that would make it easier for gas to be traded within the EU. If such a genuine gas pool is created, any pipeline from Algeria to Spain, for example, could be used to supply Algerian gas to a customer anywhere in Europe.

Russia is currently the biggest exporter of gas to the EU and yet taps just a fraction of its total reserves of 1,680 trillion cubic feet for export. However, despite the region's far smaller reserves, North Africa has one great advantage over Russia--its flexibility in being able to deliver gas by pipeline or in the form of LNG. Russia's lack of warm water ports means LNG carriers would have no year-round access to reserves. The country's first LNG project is being developed on the Far East island of Sakhalin thanks to advances in ice breaker technology, but this will not affect the European market and shipping technology seems unlikely to enable similar developments in Western Russia.

Increasingly important gas markets, such as the UK, which is the EU's biggest gas market, are able to opt for a mix of piped and LNG gas, so North African producers are able to win out on both counts. At the same time, Europe's Mediterranean member states, such as Italy and Spain, which are unable to easily access the North Sea gas fields and which have limited gas reserves of their own, are switching whole swathes of their generating capacity over to gas, so North African producers are far more conveniently placed to supply them than Russia or even other LNG producers such as Qatar or Trinidad and Tobago.

North Africa as a whole has total gas reserves of 7,651 billion cubic metres (bcm), an impressive figure in comparison with European reserves but a drop in the ocean when set against the huge Russian and Middle Eastern fields. However, with the exception of Algeria, relatively little investment has been put into exploring for gas and developing those fields that have been uncovered over the past 50 years because of the focus on oil. As a result, the region's proven reserves are likely to rise over at least the next decade. Increased exploration activity in Egypt has already transformed that country's gas industry and even more important finds are likely in Libya.

Gas consumption within North Africa is more limited than many imagine, given the wide publicity attracted by gas to power projects in Egypt and Tunisia. Egypt and Algeria dominate regional consumption of 61.8 bcm, accounting for 50% and 35% respectively. Egypt's domination is not surprising; it accounts for 55% of all electricity consumption in the region and is by far the most populous country in North Africa.

In the longer term, gas consumption in the region is expected to rise by 75% between 2003 and 2010, partly because of the Egyptian Electric Holding Company's (EEHC) plans to develop a string of new gas fired plants but also because of the development of Tunisian independent power producers (IPPs). Demand for electricity is expected to rise by 63% over the same period; meaning that 20,000MW of new capacity must be added, with gas fired plants expected to contribute the lion's share. This will absorb some of the region's gas production but should not have any impact on exports of either natural gas or LNG.

The gas trade is a key element in the European strategy to turn North Africa into an outer ring of the EU. While the five North African states are unlikely to become member states, preferential trade agreements have already been concluded with the Maghreb countries, alongside deals to cooperate on a whole host of issues, from immigration to textile supplies. North Africa's governments seem content to benefit from their geographical location on the fringes of Europe and although they are increasingly keen to boost trade with the rest of Africa, the success or otherwise of their economic links with the EU is likely to be the factor that determines their economic fortunes over the next few years.