Gazprom Is Los­ing Its Mar­ket Mus­cle

Com­pe­ti­tion forces the Rus­sian en­ergy gi­ant to make nice “Gas di­ver­si­fi­ca­tion be­came a mantra for both the EU and Rus­sia”

Bloomberg Businessweek (Asia) - - Global Economics - −Elena Mazneva, Anna Shiryaevskaya, and Kelly Gil­blom, with Ilya Arkhipov, Tino An­dresen, and Alex Mo­rales

Gazprom, the state-con­trolled, Moscow-based nat­u­ral gas gi­ant has long played a dou­ble role: as an in­stru­ment of Krem­lin for­eign pol­icy; and as a ma­jor source of tax rev­enue for Vladimir Putin’s gov­ern­ment.

Things have changed. Gazprom has long been ac­cus­tomed to dic­tat­ing terms be­cause of its size. In the Euro­pean Union, it sup­plies about 30 per­cent of the gas. But with a 70 per­cent drop in prof­its, the Rus­sian com­pany finds it­self fight­ing to pro­tect its share of a mar­ket it de­pends on for as much as a third of its rev­enue of $100 bil­lion. Gazprom is no longer a po­tent diplo­matic tool at a time when cus­tomers have many more op­tions.

By 2025, says the In­ter­na­tional En­ergy Agency (IEA), gas im­ports by the EU will ac­count for 77 per­cent of its consumption, up from 63 per­cent now. Gazprom will not nec­es­sar­ily be sup­ply­ing Europe with those ex­tra im­ports. Amer­i­can com­pa­nies will be pro­vid­ing liq­ue­fied shale gas to Euro­pean power plants start­ing next year. “U.S. shale gas will pro­vide a very im­por­tant op­por­tu­nity for Euro­pean con­sumers to strengthen their hands,” says Fatih Birol, ex­ec­u­tive di­rec­tor of the IEA. U.S. ex­ports may make up half of flex­i­ble liq­uid nat­u­ral gas vol­umes head­ing to Europe by 2020, says Philip Olivier, chief ex­ec­u­tive of­fi­cer of Engie Global LNG, a ship­per of flex­i­ble LNG. “Flex­i­ble” means the gas can be shipped any­where.

It’s not just Amer­ica. “There will be com­pe­ti­tion be­tween Amer­i­can gas, Rus­sian gas, Al­ge­rian gas, Mid­dle East­ern gas,” To­tal CEO Pa­trick Pouyanné said in Oc­to­ber. In re­sponse, Gazprom has dropped the blus­ter and threats it used with Euro­pean clients that protested Moscow’s ac­tions in Ukraine last year and whose gov­ern­ments im­posed sanc­tions on Rus­sia. (The Western sanc­tions don’t re­strict pur­chases of Rus­sian nat­u­ral gas.) In­stead, the com­pany is pay­ing more at­ten­tion to cus­tomer needs, an­nounc­ing plans for a pipe­line that would trans­port its gas di­rectly to the EU and push­ing to set­tle an EU an­titrust claim that could cost it bil­lions of dol­lars.

The new ap­proach com­ple­ments Rus­sia’s at­tempts to ease ten­sions with the West over Ukraine and boost co­op­er­a­tion in fight­ing ter­ror­ists in Syria. Those ef­forts have met with lim­ited suc­cess, but Rus­sia is per­sis­tent. “The po­si­tion of Gazprom and the Rus­sian side is be­com­ing flex­i­ble in light of the chang­ing sit­u­a­tion, de­fend­ing our in­ter­ests but also tak­ing into ac­count the de­mands of the Euro­pean side,” says First Deputy En­ergy Min­is­ter Alexey Tek­sler.

Gazprom is try­ing both to ap­pease the Euro­peans and look for new cus­tomers. “In the af­ter­math of the Ukraine cri­sis, gas di­ver­si­fi­ca­tion be­came a mantra for both the EU and Rus­sia,” says Si­mone Tagliapietra, en­ergy fel­low at Bruegel, a think tank in Brussels. But “Rus­sia needs the EU gas mar­ket as much as—if not more than—the EU mar­ket needs Rus­sian gas.”

Gazprom’s room to ma­neu­ver is lim­ited. All the gas for Europe is shipped by pipe­line, mean­ing Rus­sia can’t di­vert it to other mar­kets. Links to China aren’t ex­pected to be built un­til af­ter 2019.

Rus­sia shelved plans to turn Tur­key into a con­duit to Europe af­ter the Turks downed a Rus­sian war­plane near the Syr­ian border in Novem­ber.

Gazprom’s “ex­port pol­icy has al­ways been bal­anced and adap­tive,” says spokesman Sergei Kupriyanov. He ar­gues that Euro­pean cus­tomers have be­come more in­ter­ested, not less, in Rus­sian gas, given Europe’s own de­cline in pro­duc­tion.

The Krem­lin’s tra­di­tional hard­line ap­proach to cus­tomers was on dis­play last year when ten­sions over the cri­sis in Ukraine led to the worst breach in re­la­tions with the West since the Cold War. “Europe has lost,” Gazprom CEO Alexey Miller de­clared af­ter Rus­sia signed its first gas sup­ply deal with China. He said an­other deal would come in the “near­est fu­ture” that would al­low Rus­sia to re­di­rect some EU-bound gas from deep in West Siberia to Asia.

In Septem­ber 2014, Gazprom started to limit gas de­liv­er­ies to some EU mem­bers, in­clud­ing Poland and Slo­vakia. They had been sup­ply­ing gas to Ukraine to re­place sup­plies that Rus­sia had cut off in a pric­ing dis­pute with its neigh­bor. Rus­sia warned that the con­flict with Kiev could dis­rupt sup­plies to Europe, as had hap­pened in 2006 and 2009. In both those episodes, Gazprom cut off gas to Ukraine. Be­cause Europe got most of its Rus­sian gas via Ukraine, Gazprom’s ac­tions im­posed short­ages on the EU as well.

In Jan­uary 2015, Miller told the EU’s new en­ergy chief, Maros Se­f­covic, that Gazprom would cut off ship­ments to Europe via Ukraine af­ter the cur­rent pipe­line con­tract ran out in 2019. That would force cus­tomers to build new pipe­lines. “We don’t work like this,” a stunned Se­f­covic told re­porters in Moscow.

But since the spring, the pres­sure has been grow­ing on Gazprom. The plunge in gas prices has be­gun to bite. Gazprom expects rev­enue in Europe in 2016 to be down 16 per­cent, the low­est in 11 years. Its gi­ant Siberian fields are op­er­at­ing far be­low ca­pac­ity. It says pro­duc­tion this year will fall to a record low be­cause of weak de­mand, pri­mar­ily from Ukraine, which isn’t buy­ing much.

In April, Brussels un­sealed an an­titrust com­plaint al­leg­ing Gazprom sold gas to Poland and the Baltic states at prices up to 21 per­cent higher than the av­er­age. If the charges are proven, the gas gi­ant could pay as much as $3.8 bil­lion in fines, VTB Cap­i­tal in Moscow es­ti­mates. Gazprom de­nies all the charges.

In ne­go­ti­a­tions to ex­port more gas to China, talks have stalled. Af­ter a Septem­ber visit to China again failed to yield a deal to ex­pand ship­ments, Gazprom hastily signed a pact with five big EU com­pa­nies in­clud­ing oil ma­jor Shell and util­ity E.ON to build a pipe­line un­der the Baltic Sea to Ger­many. Rus­sian of­fi­cials say they’re ready to of­fer lower prices to gas cus­tomers that help fund con­struc­tion, as well as con­ces­sions to en­sure the pact wins EU ap­proval. The com­pany later made a for­mal of­fer to set­tle the EU’s an­titrust charges.

Miller has pub­licly backed off from threats to cease ship­ments via Ukraine af­ter 2019. Gazprom is also giv­ing in to Euro­pean clients’ calls for more pric­ing flex­i­bil­ity. Slowly, Gazprom is learn­ing how to op­er­ate like an or­di­nary com­pany that has to work on its cus­tomer re­la­tions.

The bot­tom line As Rus­sia tries to defuse ten­sions with the West, Gazprom is blus­ter­ing less and promis­ing more.

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