Gazprom`s U-Turn: Problems lead Gas giant back to Europe Reviewed by Momizat on . Given the hype surrounding Russia`s and Gazprom`s  “pivot to the east” last year (see link), there was always a strong probability that reality would eventually Given the hype surrounding Russia`s and Gazprom`s  “pivot to the east” last year (see link), there was always a strong probability that reality would eventually Rating: 0

Gazprom`s U-Turn: Problems lead Gas giant back to Europe

Given the hype surrounding Russia`s and Gazprom`s  “pivot to the east” last year (see link), there was always a strong probability that reality would eventually intrude to upend the carefully staged managed conferences between Russia and China announcing the several hundred billion dollar- deals. Recent events appear to have confirmed scepticism of the gas monopoly`s and its owner`s summary dismissal last year of its European customer base in favour of the Chinese market.

First of all, the all important pricing mechanism between Russia and China would appear to be to the detriment of Russia, particularly given the downward plunge of oil and gas prices; the cost of the connecting pipelines are prohibitively expensive at a time when Russian budget finances are under strain; and events in the Chinese economy with a marked slowdown in growth, have all played their part. The simple fact was that this was a project whose future (uncertain) economic benefits could not possibly compensate for the problems of the here and now, as being faced by Gazprom.

Gazprom`s first half results for 2015 point to some interesting, but also worrying trends which Gazprom have occasion to consider for their company`s future business strategy and development:

  • Volume decreases in virtually all its key markets: Europe has decreased 6.5 percent; Former Soviet Union i.e. including Ukraine, by an eyewatering 32 percent; and even its core Russian market by 4.3 percent.
  • Price decreases of 26 percent in Europe and 29 percent in the Former Soviet Union which probably do not appear to take into account the full decrease in oil prices with which the gas price is fixed albeit with a timelag.

The gas giant managed to eke out a modest price increase in its own domestic (and still largely monopoly) market. Its only saving grace has been the massive depreciation in the ruble that overall managed to make its USD denominated exports worth more in RUR.  The Russian government, through its own straitened circumstances, has sought to “cream off” that windfall through increased customs taxes and excise duties.

While China, and the Far East in general, appear to be perfectly sensible targets for business penetration, the reality is that the government needs to pay its bills now and therefore Europe still remains its most vital and lucrative market.

A small, but still meaningful, grasping of that reality took place on  September 7, 2015 when Gazprom announced the first of four spot auctions for the sale of gas. Hitherto Gazprom has sought only longterm gas supply contracts tied to the price of oil and has vigorously resisted EU attempts to revise its business arrangements on this score. Indeed, the European Commission has cited the pricing methodology as one of its objections to Gazprom`s conduct of business in the EU.

Gazprom and the European Commission are currently locked in a dispute with the latter already  presenting the former with its Statement of Objections. Gazprom might be liable to billions of EURs in fines if it is found to be operating European competition rules.

The spot market auctions, which will only amount to around 2 percent of annual sales, are an attempt to change the “mood music” of recent years whereby Gazprom has essentially stated that the EC has no role in, let alone right to seeking, amended behaviours from the gas giant. The dismissive comments of Gazprom`s senior management last year have recently changed to a markedly more moderate tone.

In addition, there is also the EU`s Third Energy Package which aims to promote market liberalisation. Gazprom filed a dispute in April 2014  concerning the Third Energy Package at the World Trade Organisation, arguing that the legislation discriminates against Russian natural gas pipeline transport services and service suppliers.

Interestingly, this may be where, oddly enough, Gazprom may now be seeking to take advantage of. It is clearly interested in making full use of the Opal pipeline – a natural gas pipeline in Germany alongside the German eastern border which is one of two projected pipelines connecting the Nord Stream pipeline to the existing pipeline grid in Middle and Western Europe.

In December 2014, the Russians were forced to cancel the South Stream project which would have sought a southern equivalent to the Nord Stream pipeline that circumvents Ukraine via the Baltic sea. The European Commission appeared to have scotched the project in the light of the conflict in eastern Ukraine and the annexation of Crimea. A replacement – Turkish Stream – is still very much at the post drawing plan stage, and interestingly, may yet become a hostage, akin to South Stream`s fate, to the growing tensions developing between Turkey and Russia over the latter`s involvement in Syria.

Therefore the announcement onSeptember 4, 2015 that Gazprom had agreed with its Nord Stream partners, including E.On and BASF, to add two more lines to the existing Nord Stream pipeline which would double its existing capacity, should be seen in the context of its deteriorating business model and its announcement of spot auctions.

The expansion of Nord Stream is heavily predicated on Gazprom being granted full use of the Opal pipeline. It is currently restricted, under EU rules, to no more than 50 percent use. Gazprom needs that restriction removed if Nord Stream Two is to make any sense.

The EU will need to give this issue the fullest consideration as it seeks to somehow balance its geo-economic interests i.e. by virtue of Europe`s proximity to oil and gas reserves in Russia, versus the countervailing geopolitical interests of allowing a reinforcement of existing Russian dominance of the EU energy market, promoting a strategy of diversification of its energy supplies, and allowing the Russians to further circumvent Ukraine as a transit country, with a time element thrown in for further measure.

By time element, it is simply meant that period to the post Putin era.

The next talks between Gazprom and the European Commission to resolve antitrust and market abuse issues were scheduled for the second half of September 2015. The absence of any firm information from either side suggests that Gazprom is intensively lobbying for an out of court settlement, notwithstanding its previous stated  intentions to avoid the EC.

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