Europe Wrestles with the Gazprom Cronies
By reactivating its antitrust case against Russia's state-owned natural gas producer, Gazprom, the European Commission will probably help five former Communist countries get Russian gas at lower prices. Arguably, however, it shouldn't have bothered: These and other countries are doing a lot by themselves to make their energy markets more competitive. And Russia is wrong to cling to Gazprom's politicized business model. It's in everyone's interest to turn the company into more of a market player.
The EC says Gazprom is doing three things wrong: It's hindering cross-border gas sales in Bulgaria, Estonia, Latvia, Lithuania, Poland, Hungary, the Czech Republic and Slovakia; extracting unfair prices from the first five of these countries; and making gas supplies conditional on increasing Gazprom's control over infrastructure in Bulgaria and Poland. Gazprom calls the charges "groundless," but after arguing with Margrethe Vestager, the European competition commissioner, the company will probably agree to change its behavior. It may even avoid a fine, which in the worst-case scenario could amount to 10 percent of the company's global revenue, or about $10.3 billion based on 2014 data.
The reason Gazprom will settle the charges -- as it intended to do before Russia's annexation of Crimea last year scuppered the talks -- is that the Russian supplier understands that it must adapt to changes in the European market.
The central and most contentious issue is pricing. Gazprom imposes resale limitations to protect the different prices it sets for different countries. As for the infrastructure-related clauses, they are unsustainable anyway, because Europe has made it clear that it will strike them down, as it did with the ill-fated South Stream pipeline project.
Gazprom, however, can hardly defend the way it links its natural gas prices to those of oil products. The point was originally to make sure consumers did not switch to fuel oil when it became cheaper, as Jonathan Stern and Howard Rogers of the Oxford Institute for Energy Studies have pointed out, but this rationale became "increasingly questionable" as gas "displaced oil (on a virtually irreversible basis) in the domestic and power generation sectors." Gas now has other competitors, including renewable energy and cheap coal imported from the U.S. Also, over the past decade, spot markets for energy have sprung up, aided by increased liquefied natural gas imports from Qatar, Yemen, Peru and Russia itself. Recent arbitrations between Gazprom and its European clients have almost universally called on Gazprom to include spot prices in its pricing formulas and increase their weight over time.
The European Commission has decided to intervene in countries where Gazprom has little or no competition -- though that is changing. Lithuania and Poland have built major LNG import terminals that are just coming online, and Latvia and Estonia have similar plans. The antitrust case is no replacement for diversification: Russia's neighbors know it's not a particularly reliable partner and is prone to mixing politics with business. These countries' energy markets will soon be as competitive as those of Central Europe, where the EC isn't taking issue with Gazprom's pricing. Sooner or later, with or without interference from Vestager, the Russian supplier would have to negotiate new terms.
Nobody in Europe is talking about eliminating Russian gas from the energy mix altogether. If it loses some market share by 2040, according to a 2014 Brookings Institution paper, it will be to Russia's own LNG:
Yet in the near-to-medium term, every country will have alternative energy sources, and Gazprom will no longer be able to dictate terms. Yet it still has the wherewithal to remain competitive. Last year, its production cost stood at $1.20 per million British thermal units, while the average export price reached $11.6 per MMBtu. In a recent speech, Gazprom's chief executive, Alexey Miller, complained bitterly about the European criticism of Gazprom's pricing policies, but added, "We will work with those models and under those rules that will be in effect on the European market."
This means the traditional Kremlin practice of using Gazprom as a political tool in Europe is not long for this world. It wasn't working, anyway: one can hardly say that the countries most dependent on Russian gas are Russia's fiercest champions in the European Union. Quite the contrary, Poland and the Baltic states constantly call on Europe to brace for a possible attack by Russian President Vladimir Putin. Gazprom's bossiness in these countries has been an irritant, proof that Russia has designs on its former satellites. And overcharging them wasn't particularly lucrative: The combined exports to all five countries mentioned in the EC statement of objections are 20 percent less than to Turkey alone. The old approach is not worth fighting for.
Miller and Putin know this. Their plan is to develop a counterweight to the European market, using Gazprom's excess production capacity to supply gas to China and other Asian markets. It looks politically motivated, but Gazprom's multibillion-dollar Asian project makes good business sense: Like Europe, the state-owned company also needs to diversify. What the Kremlin needs from Gazprom is not its hypothetical political influence but its revenues, which account for about a tenth of Russia's exports.
So there will be no standoff with Europe over the antitrust charges, no supply cuts or political fallout. It's more practical for Putin to start treating Gazprom as a market player, not some sort of strategic instrument. The transition is easier to make in increasingly sophisticated and competitive foreign markets than in the regulated domestic one, where Gazprom sells more than half of its output at prices that are 80 percent below the average export ones. At home, the natural gas producer is destined to remain a political tool for now.
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