In this corner, we have the former head of the infamous KGB, President Vladimir Putin, he of the rugged outdoor, macho activities. And in the other corner, we have the bureaucrats in Brussels, representing 500 million Europeans.
In the middle, we have Russia’s most important company, the source of the bulk of the Russian government’s income tax revenue, Gazprom.
There is no referee. I repeat: There is no referee.
And the Queensbury Rules do not apply. Ask Ukraine and Belarus, both of whom tangled with Russia in the past over oil and gas prices, and paid a price when Russia simply said it would stop the flow until they came to their senses.
What is going on?
The EU wants Gazprom to obey its rules regarding the pricing of gas to all states within the Union.
Gazprom wants to retain the flexibility to divide-and-conquer, by having individual long term gas supply contracts with individual states, and negotiating separate prices with each customer.
Gazprom is majority owned by Russia, hold the world’s largest natural gas reserves (18% of the total), and produces 15% of world gas output. More importantly, Gazprom has a massive gas pipeline infrastructure – over 161,000 kilometres, a stock market valuation of more than $120 billion, and supplies more than one-third of the gas imports to Western Europe (150 billion m3 of gas in 2011).
What is the argument of the European Union?
The EU is pushing ahead with its aim of one single gas market:
The EU's executive "as a matter of priority" is enforcing its single energy market laws it says in a draft text, seen by Reuters, that states its determination to create a barrier-free market-place, which has angered dominant gas supplier Russia.
The EU claims Gazprom is abusing its position of dominance to discriminate against EU states:
Russia must abide by the European Union's internal market rules and stop offering widely varying prices to its member states, EU Energy Commissioner Guenther Oettinger said on Friday…
"The Russian partners have to accept our European Union rules," Oettinger told an energy conference in Vilnius, Lithuania, when asked about the Kremlin's decision.Major natural gas exporters, such as Russia, Norway and Qatar, sell their gas mostly under long-term contracts that are linked to oil prices.
The European Commission is investigating Gazprom, which is more than 50 percent owned by the Russian state, over suspicions that it was hindering the free flow of gas across the EU and imposing unfair prices on its customers.
"All gas exporters, be it from Russia or Norway, Algeria or Qatar, have to accept our internal market rules," Oettinger said. "The Russian partners understand our rules, but they don't accept them all. It is a different culture."…
"Vladimir Putin knows very well that Russia has to accept the rules of our internal market with 500 million consumers. It's the biggest business case for Gazprom," Oettinger said.
The European Union receives more than a quarter of its gas from Russia, but Gazprom is even more reliant on European revenues, with about 80 percent of its gas being sold to Europe.
Oettinger also said that Russian gas prices to the EU member states should not vary greatly. "It can't be that (Russian) gas in some member states is up to 30 percent cheaper than in other member states," he added.
What is the argument of Russia-Gazprom?
|Gazprom gas pipelines in Russia and the EU|
Russia has three main thrusts to its current argument with the EU:
· Putin has forbidden Gazprom from providing information to the EU unless the government agrees;
· Gazprom is relying on the sanctity of the market, arguing that it is behaving in accordance with commercial long term gas supply contracts entered into with individual states, while the EU is trying to help the weaker sisters at Russia’s expense; and
· Gazprom will accelerate its efforts to increase gas exports to better behaved buyers in the Asian markets, especially China.
As Forbes put it:
President Putin has made crystal clear to the European Union that he considers Gazprom to be a strategic asset of the Russian state over the anti-trust case accusing them of monopolistic practices. You know it’s ‘serious’ when Mr. Putin signs a decree telling everyone so: Messy legal arguments simply don’t apply when it comes to prized Russian assets.
The official Gazprom response was:
It’s no secret that a number of the EU’s relatively weak economies continue demanding that Gazprom unilaterally cut down prices, and such statements can be interpreted as nothing else but the European Commission’s support to the practice of subsidizing Eastern Europe with cheap gas at the expense of Gazprom. This is an attempt to meet the economic challenges of the EU, particularly of its new member countries, Eastern Europe, at the expense of Russia.
Who has the stronger negotiating position?
This remains to be seen. In the short term, Russia controls the flow of gas and could threaten to cut the gas supply as a negotiating tactic, as it has done before. This could win in the near term, but in the medium term Russia has many weaknesses, as the Forbes article points out.
Firstly, Gazprom’s legacy reserves are declining, and it urgently has to find new gas supplies, while its plant and equipment is not efficient:
Far more worryingly, production has flat-lined from 2001, and actually recorded an onshore drop from 556bcm in 2006 to 509bcm in 2012. Asset sweating is undoubtedly part of the problem, but the blunter point is once Bovanenkovo plateaus (at 100bcm) in 2016, the easy plays in Russia are gone. Gazprom’s remaining 35 trillion cubic metres of reserves are all in hard to reach places in the Yamal Peninsular, the Far East and Eastern Siberia – a daunting task when you consider Russia has to replace its entire 670bcm of gas by 2035 according to the IEA. That’s going to be very expensive indeed…
Unless Putin backs up his words with credible actions, not just fobbing off the EU, but putting more ‘state’ and cash back into Gazprom to progress its global ambitions, it’s going to suffer a slow and painful market death. That’s not exactly good news for Mr. Putin either.
Worse still, in the past few years competition has sprung up from places and sources Russia never anticipated.
It’s all about shale:
Shale gas, says Forbes, is a new menace placing in danger the medium and long term market position of Gazprom (including, as Eric Reguly points out in the Globe & Mail, shale reserves in Poland):
But the problem now, is that the gas world has transformed so far beyond anything Russia can be begin to comprehend from shale shifts, that it will never be able to maintain its global stake if it pretends to keep playing by upstream commercial rules…
Global shale developments have been rocketing ahead; Gazprom was caught sitting on its hands, watching the gas world change around them.
Putin has to balance any short term concessions he may be able to wrest from Europe against the need for long term certain buyers, if Russia is not to wither on the vine.
What will probably happen?
Forbes believes that Putin has to temper his immediate reaction to put a collar on his European buyers, and consider the longer term implications, because Russia’s position is not that strong:
Moscow’s rhetoric will continue banging on about oil indexed contracts, (tactical co-operation with Qatar might buy a bit more time on that front), but if Putin is smart, he’ll quietly start underwriting the transitional losses from oil indexed contracts towards gas prices based on gas fundamentals, and doing so from the Kremlin’s books. That’s not because the European Union has got on its high horse about indexation, but because Russia stands very little chance of selling its gas into China on an oil indexed basis. There is only so long Gazprom can keep trying to ice skate uphill without getting hurt…
Like it or not, if Russia doesn’t have the global volumes, it will be impossible to set the price.
In the meantime, let’s keep our eyes on this boxing match. As each fighter lands punches, we can expect Russian displeasure to be shown in other areas and other conflicts, as they punch each other to a standstill.
And anyone want to bet that Putin will decide to privatize those 49% plus shares in Gazprom that Russia does not own?