Tuesday, September 02, 2014

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Gazprom Goes on the Offensive

Gazprom has seemed to be on the ropes for some time. In the core European markets demand is falling on the back of the shale and LNG revolutions. Once-loyal customers from Poland to Austria are clamouring for discounts and a shift to spot indexing. The EU has, in a rare moment of unity, launched a major antitrust investigation in September.

And at home, the company’s once-unquestionable status as primus inter pares is under pressure as rivals like Novatek and Rosneft look to take a larger share of the domestic market and even European exports (a hope that was admittedly later quashed).

Profits are being hammered as a result, down 50% in the third quarter compared with 2011. The company is increasingly looking to Asia but China, the biggest prize, has not been an easy customer. Meanwhile Russia’s attempt to move with the times and promote LNG has been slow and patchy.

After all this, it’s no wonder that headlines are appearing proclaiming that the energy giant is “in crisis”. But with the South Stream pipeline now under construction, Ukraine on the back foot, and Moscow warning of reprisals for the EU, is Gazprom really that down on its luck?

Of course, it would be inaccurate to judge Gazprom just by its balance sheet. It is to all intents and purposes an arm of the Russian state, and notwithstanding occasional criticisms by Vladimir Putin it will remain so. Whether or not it fulfils Moscow’s policy objectives is a far better yardstick, and there it looks like the company is more successful – in the short term. In the long term, Gazprom and the Kremlin are still probably on the wrong side of (gas) history.

First of all South Stream. The pipeline, despite being one of Putin’s favourite projects, is moving ahead with relatively little fanfare. For both supporters and detractors, South Stream remains the 63bcm elephant in the room because Europe does not want to talk about it – either because it will crush competing Southern Corridor pipelines or because it is lumbering and irrelevant in today’s more nimble, liberalised market.

It’s indisputable that given current trends Europe does not need a Southern Corridor bringing around 20-30bcm/year and 63bcm from South Stream. Gazprom’s strategy has been to tie the pipeline to long-term purchase agreements with transit states, forcing them to buy enough cheap gas to make South Stream feasible. But when other supplies – from the Southern Corridor or from unconventionals – become widely available, pressure to renegotiate these contracts will, as in western Europe, become more and more acute.

 Much will depend on timing: if the Southern Corridor (particularly if Nabucco West is chosen) becomes operational earlier than South Stream then Gazprom’s negotiating power gets even weaker and the project becomes even more of a white elephant. This explains the decision to accelerate the construction of South Stream made last December, although the fact that Gazprom hasn’t even ordered pipes for the project suggests the launch date of 2016 could be just bluster.

 However in the short term if South Stream can stop or at least shrink the Southern Corridor, maintain Russian energy and political clout in south-eastern Europe, and eliminate Ukraine’s leverage as a transit state – all plausible - Putin will probably be satisfied. Ukraine is vital, and there is an argument for seeing the whole project as directed against Kiev, above all.

 Indeed Ukraine is another front where Gazprom is tactically strong at the moment. This is even more true after the bizarre tale of the ‘deal that never was’. On 26 November Ukraine signed a deal with Spain’s Gas Natural to build an LNG plant at Odessa. The $1.1 billion plant would allow LNG imports of up to 10bcm a year at a 20% lower price than Russian imports, reducing Kiev’s dependence on Moscow: Ukraine’s prime minister called it a “really historic moment”.

The only problem was that the Gas Natural signatory, Jordi Sarda Bonvehi, was an imposter. The company has never heard of him and denied that it had anything to do with the project. Ukraine was left rather red-faced and Bonvehi, a middleman between Spanish and Ukrainian companies, slunk away to Barcelona.

 Speculation that the affair was a Cold War-style attempt by Russia to scupper the deal is far-fetched but it’s undoubted that Moscow is the main beneficiary here. Kiev insists that it will build the plant alone if needs be, but that will take significantly longer and maintain Ukraine’s reliance on Russian gas in the near term.

 The following day Moscow moved to remind Kiev who was in charge. In response to Ukraine’s optimistic plan to cut Russian gas imports by 9 or 10bcm next year to 18bcm (some of the excitement apparently due to the bogus LNG terminal signing), Gazprom said that it would hit Naftogaz with punitive take-or-pay fines if Ukraine cuts import volumes – as much as $5.7 billion, as well as a lawsuit.

 Ukraine appears to be girding for combat – “I can assure you that we are ready for this”, Energy Minister Yuri Boyko said in mid-November – but so is Gazprom, and the LNG signing fiasco has undoubtedly weakened Kiev’s image. The subsequent resignation of the Ukrainian government has dealt a further blow to its negotiating power. A new winter gas war might be on the cards, one which Russia is likely to win.

Finally there is the core European market. The Commission’s probe into whether Gazprom uses its dominance to inflate prices and crush competitors is undoubtedly a headache, but the company is not going down without a fight. Shortly after it began Putin warned of “losses on both sides”. Deputy PM Arkady Dvorkovich was even more bullish on 22 November, saying “If there are consequences for us, there will be consequences for them” and hinting that import restrictions due to ‘regulatory risks’ would lead to a rise in prices.

Hiking prices would, of course, just underline the argument for diversifying away from Gazprom’s unwieldy contracts. But for now it would score some nice political points for Vladimir Putin.

So in the short term Gazprom and Putin undoubtedly have cards to play. Unfortunately everyone else in Europe is now playing a different game. Until Russia catches up it will be unable to turn tactical victories into strategic gains.

Alex Jackson is an analyst of political, energy and security issues in the Caspian region. He is based in London and can be contacted at ajackson320@gmail.com.

 

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