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Friday, April 28, 2006

Russia leaving Europe short of gas?


Russia’s president, Vladimir Putin, has reiterated that the country could direct its gas exports away from Europe if gas monopoly Gazprom’s downstream expansion in the EU is blocked. Although Mr Putin’s comments were more measured than those of Alexei Miller, the head of Gazprom, they rest on an equally shaky basis. For the next decade at least, Russia has no alternative to Europe as a major gas customer, and even after this period the costs of switching to Asia or North America could be prohibitive. Also, conditioning supplies on other deals enforces European concerns over whether Gazprom is a political tool rather than a reliable commercial venture. Given the sizeable risks and the limited potential rewards, why are Messrs Putin and Miller pushing so hard on this question?

Speaking in Siberia on April 27th, after a meeting with Germany’s chancellor, Angela Merkel, Mr Putin said that European scaremongering over the risks inherent in greater reliance on supplies of Russian gas was creating an atmosphere that would force Russia (meaning Gazprom, although Mr Putin notably used the term “us”) to seek other markets for gas. Two weeks earlier, the Financial Times reported that the UK Department of Trade and Industry had considered options for blocking a rumoured bid by Gazprom for Centrica, the UK’s largest gas distributor, on national security grounds. This would most likely have involved changes to existing legislation.

Although Gazprom subsequently denied an interest in buying Centrica, Mr Miller appeared to be incensed at the prospect of the UK government—and perhaps others in Europe—putting obstacles in the path of Gazprom’s expansion. The company aims to become a major energy player in Europe, through increased supplies and the acquisition of transportation and distribution assets. Apparently responding to the reports, Mr Miller threatened on April 18th to redirect Gazprom’s exports to China and North America—both of which are set to experience a huge increase in gas demand in the next 20 years—if Europe blocked Gazprom’s downstream expansion.

Another fine mess

Mr Putin’s comments were notably softer than Mr Miller’s. He insisted that Russia would honour existing contracts and noted the country’s long track-record of supplying gas to Europe—even during times of East-West tension, such as the early 1980s. He also acknowledged that Europe was Russia’s largest and most stable gas partner.

Nevertheless, both Russia’s president and the CEO of Gazprom have sought to link gas supplies with Russia’s ability to acquire downstream assets in Europe. As an approach, it would seem to have some merit, if UK Prime Minister Tony Blair’s recent statement that the UK would not block Gazprom from buying Centrica was prompted by Mr Miller’s threat. In general, however, this is unlikely to further Russia’s or Gazprom’s interests; indeed, it could easily be counterproductive.

Firstly, a threat to divert supplies away from Europe is barely credible. Russian gas is not a commodity that, like its oil, can easily be shipped to remote locations. Gazprom at present has no capacity to liquefy natural gas; as a result, it is dependent on pipelines for its gas exports—and all of these lines run to European countries. For as long as Western Siberia remains the centre of Russia’s oil industry, it is difficult to envisage Gazprom being able to direct the lion’s share of its exports to non-European markets. A pipeline to China from Western Siberia would take years to build and would be extremely expensive—and, if Russia’s disinclination to commit to an oil pipeline to China over a more expensive route to the Pacific coast is any guide, the country is also uneasy about tying itself to a single customer. Nor would it be commercially viable to liquefy West Siberian gas and ship it to North America.

Large-scale development of other regions would potentially allow Russia to diversify its export base. Fields in Eastern Siberia are closer to China, although it would be much cheaper to extend the existing Western Europe-Siberia pipelines to the new fields than to build a new line from Eastern Siberia to China. Also, the Shtokman field in the Barents Sea—for which Gazprom has just postponed to May the announcement of its project partners—has been earmarked as a source of liquefied natural gas (LNG) for export to the US market. The rise of Shtokman and Eastern Siberia could allow Russia to diversify away from a reliance on the European market, but this is far removed from a scenario whereby Russia turns its back on Europe and sells gas instead to customers that are much more difficult to reach. Underlining this, Gazprom and Germany’s BASF on April 27th signed a deal that gives the Germany company a 35% stake in the Yuzhno-Russkoye field, which will be the primary source of gas for the planned 1,200 km North European Gas Pipeline (NEGP) that will bypass eastern Europe to deliver gas to Germany via the bed of the Baltic Sea.

Secondly, threats to redirect supply on grounds not related to the profitability of that transaction stoke fears over Gazprom’s reliability. Mr Putin has said that Gazprom is a multinational like any other, but it is difficult to imagine ExxonMobil or Shell threatening to cut crude supplies to a country unless they were allowed to acquire refining or retail assets. Gazprom’s reputation has already been dented by two episodes of supply disruption in January 2006 and a perception that the government has used the company to punish unfriendly former Soviet states by restricting gas supplies and hiking prices (even if the reality is much less straightforward). In the current environment, Gazprom’s interests would be best served by avoiding controversy and studiously honouring its export contracts; attempts to bully its way into gas distribution in the EU’s largest gas market will only serve to increase security-of-supply anxieties.

Moreover, the acquisition of Centrica would not be particularly valuable for Gazprom. As several commentators have noted, Centrica’s margin in a competitive market is low; by acquiring the distributor, Gazprom would assume significant additional debt while gaining only a modest income stream. With regard to the UK market, the most lucrative opening for Gazprom is as a gas supplier rather than to become involved in distribution. Of course the acquisition of Centrica would guarantee Gazprom an export market, but if the company’s projections for Western European gas production and demand are correct then it should not need to buy Centrica in order to achieve this.

Thinking big

Given these considerations, it is worth asking why Messrs Putin and Miller reacted so strongly to reports that a UK ministry was merely considering restrictions on Russian investment. The answer probably lies in the centrality of Gazprom to Mr Putin’s plans for Russia and the determination of the Kremlin that Gazprom should become the world’s leading energy company, with interests in gas, oil and power at home and abroad.

For Mr Putin, Russia’s energy resources are central to his aspirations for the country to regain its global standing. The country’s military resources are limited; its nuclear arsenal is virtually an irrelevance in day-to-day diplomacy; and its permanent seat on the UN Security Council has proved to be less influential than Russia might have hoped, as the US-led invasion of Iraq showed. Economically, Russia is getting stronger but it remains much weaker than the G7 or China, and its long-term growth prospects are clouded by a shrinking population and over-reliance on resources. Viewed from this perspective, energy is perhaps the only sphere in which Russia is and will remain a world power—the country is the world’s second-largest oil producer and exporter, as well as being the leading global gas producer and owner of 25% of the world’s gas reserves.

Gazprom is central to Mr Putin’s vision of Russia as an energy superpower; this is clear in the government’s initial preference for the gas monopoly to take control of Yukos’s main subsidiary, Yuganskneftegaz, and its subsequent support for Gazprom’s acquisition of Sibneft. It is also clear in the government’s refusal to countenance gas-sector reform, which would threaten Gazprom’s dominance of domestic production and monopolies on transit and exports.

Gazprom is already a vast empire, with interests in banking, the media and agriculture as well as gas, oil and electricity. The Kremlin is eager to see the giant grow still further, and to be involved in all aspects of the gas trade as it concerns Europe, from production to distribution. In this regard, any move to block Gazprom’s expansion is not simply a commercial matter—it interferes with Mr Putin’s national strategy.

Source: ViewsWire Eastern Europe
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