Gazprom's Power Play

Through its state-controlled gas company, Russia is trying to acquire stakes in Europe's energy distribution networks. In the long run, it will likely succeed

The Kremlin is trying to break down the barriers into Europe's gas and oil distribution networks. It will probably succeed.

Moscow has long sought to use its energy resources to regain the influence it lost with the breakup of the Soviet Union. But the headline-grabbing shutoffs of oil to Belarus and gas to Georgia and Ukraine in the past year are only the most visible part of the story.

For the last several years, the state-controlled gas monopoly, Gazprom, has been trying, with limited success, to get significant stakes in gas distribution networks in Central and Eastern Europe, while private Russian operators have been buying gasoline retailers across the region.

So far, Gazprom has little to show for its efforts - a 50 percent share in GWH and 25 percent in Centrex, both in Austria, and offers from German companies BASF and E.On to swap some of their assets to be allowed to participate in gas exploration in Russia.

Energy companies could be spooked by Gazprom's image as the Kremlin's tool for settling political scores and pressing its influence, a reputation that was only enhanced when Gazprom hiked gas prices to Ukraine in January 2006.

For example, attempts to get significant stakes in the British energy supplier Centrica and the Polish gas distribution monopoly PGNiG failed in 2006. The Polish government postponed an initial public offering for PGNiG after it was clear that Gazprom would snap up a significant share of the company.

In Britain, although Prime Minister Tony Blair said the government would not block Gazprom's purchase of Centrica, the prospect of a Kremlin-controlled company taking over the country's largest natural gas supplier caused a fuss in the media. In February 2006, U.K. Energy Minister Malcolm Wicks told The Observer newspaper that there could be "a national interest issue" at stake if Gazprom took over Centrica.

Rumors persist, however, that Gazprom would like to bid for Centrica.

According to an analysis by London-based Epsilon Corporate Finance, 12 attempts by Russian companies to buy shares in European firms fell through in 2006. The total value of stock involved was $49 billion, and five of the failed deals, worth $33 billion, involved Gazprom.

In February of this year Gazprom stepped up pressure on European customers by suggesting that a stable energy supply to the EU could depend on Russia's ability to secure interests in key European gas companies.

"We are interested in stable supplies of energy resources for our customers," the RIA Novosti agency quoted Alexander Medvedev, deputy head of Gazprom, as saying at a 21 February briefing in Moscow. He added that the European community should follow Blair's open-door example.

"If other members of the European Union would follow the example of Tony Blair, this would have a positive impact on the European energy sector," he said.

As it tries to gain influence in the gas distribution sector of the European Union, experts say that Gazprom will increasingly offer to its target companies the possibility of participating in lucrative Russian energy exploration.

"The political grounds are pretty obvious here. In accordance with a new policy, foreign companies would only be able to get access to Russian natural resources if Russia, and Gazprom in particular, would be able to get access to distribution, transportation, and refinery assets in Europe," said Nelli Sharushkina, of the Moscow office of the Energy Intelligence Group.

"It is clear that this policy has certain problems, but in time it could start working, as it did in relation to the German BASF, for instance, which got the right to work on the Yuzhno-Russkoye deposit in exchange for letting Gazprom increase its presence in one of its gas distribution branches. At the same time another German company, E.On, has offered Gazprom its assets in Hungary, and developments of the same kind are expected to take place in the near future in relations between Gazprom and Italian energy operators," the expert said.

LUCKY LUKOILWhile the gigantic, Kremlin-supported Gazprom negotiates the political waters, smaller, privately owned Russian oil operators have had an easier time expanding in Europe. The most successful of such companies is Lukoil, which has a strategy "to become a global transnational oil company" within the next 10 to 15 years. The company's management has declared that in several years half of Lukoil's business will be outside Russia, particularly in Eastern Europe.

It's well on its way. According to the UN Conference on Trade and Development, Lukoil has the second-largest foreign assets of any nonfinancial, multinational company in southeastern Europe or the Commonwealth of Independent States - behind Gazprom.

Lukoil controls the Petrotel SA refinery in Romania, the Neftokhim refinery in Bulgaria, and the Odessa refinery in Ukraine, among other holdings.

"Lukoil already has a pretty strong position on the retail markets of Eastern Europe, in the southern region in particular. The company has set up a number of joint stock companies in Bulgaria, Romania, and Macedonia, being especially strong in the Balkans," said Alexander Razuvayev, head of the analytical department at Moscow-based financial company Megatrastoil.

"In the future, the Balkan countries will become a part of the EU and in this way Lukoil would get broad access to the gasoline distribution markets in the European Union," he said.

When it comes to snapping up retail operations, a Lukoil spokesman said the obstacle is economics, not politics.

"Politics in the European Union is not the issue. The problem is that nobody will sell big stakes in their oil business in Europe and if somebody would, the price would be very high because this business is extremely profitable," Lukoil spokesman Vladimir Simakov said.

In February the European Commission approved a deal between Lukoil and American oil and gas giant ConocoPhillips that would increase Lukoil's share of the retail markets to 6 percent in Poland, 10 percent in Bulgaria, 11 percent in Cyprus, 22 percent in Romania, and 29 percent in Finland.

"We have bought 376 gas stations in total and will be busy with rebranding activity. We'll be repainting the gas stations in Lukoil colors," the spokesman said.

Lukoil has made the biggest inroads in Moldova, where it holds about 35 percent of the retail gasoline market. But Simakov said the company is not likely to get that kind of market share in any EU country because of anti-monopoly regulations.

"The highest level could be up to 25 percent there," he said.

Russian energy firms are getting richer and in time will be more able to deal with the financial obstacles that Simakov describes. It is only a matter of time, some experts say, until the political barriers come down as well.

"The competition between European and Russian oil and gas operators is already underway. Russian companies have the same financial resources as their Western competitors, and the only additional complication they have to implementing their plans in Europe is political obstacles. But in the long run they will surely deal with that," Razuvayev said.

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