Fundamentals of Gazprom's dispute with Europe

26/ 04/ 2006

MOSCOW, April 26 (Igor Tomberg for RIA Novosti) -- Last week's squabble
between Russia's gas giant Gazprom and EU officials might have been a storm
in a teacup but for key disagreements on energy security it has underscored.

Coming in the run-up to the St. Petersburg G8 summit, it has also made
increasingly clear that energy suppliers' and consumers' preferences are not
as compatible as they once seemed.

The shootout began on April 18 as Gazprom CEO Alexei Miller told EU
ambassadors at the Austrian embassy in Moscow what has been perceived as an
ultimatum across Europe.

"Little good will come of attempts to restrict Gazprom's activities on the
European market and politicize gas supplies issues, which are entirely
within the economic boundaries. One needs to remember about our proactive
advance toward new markets like North America and China," the Gazprom
executive said.

A response came quick from Ferrand Tarradellas Espouny, a spokesman for EU
Energy Commissioner. "We expect that [Gazprom] will continue to respect its
commitments, " he said, underscoring that the EU needs to diversify both the
origin of supplies and supply routes.

Gazprom's tough stance stems from major shifts in its vision. The recent
strong performance on the stock market, unfortunately, went way ahead of
real progress in the upstream sector. In search for new sources of cash,
Gazprom is shifting focus downstream, trying to take control of distribution
and retail in consuming countries, a lucrative market since European end
users currently pay over $500 per 1,000 cubic meters of gas for what costs
their distributors around $230.

Gazprom also seeks new opportunities in electricity. Back in 2004, Miller
said his goal was to make Gazprom an integrated and diversified energy,
rather than purely gas, producer. Now he seems to be finally delivering on
his promises as Gazprom has taken over the Razdanskaya thermal power plant
in Armenia and is looking at Beryozovskaya hydropower plant in Belarus and
toughly bargaining for Moldovan trunk power transmission lines in return for
favorable gas prices.

The strategy on the EU energy markets does not differ much. Here, Gazprom is
considering a controlling interest in German energy utility Concord Power
GmbH, which builds a 1.2MW power plant near Greifswald, the destination of
the North European Gas Pipeline which is to go on stream within years.
Gazprom was looking at similar assets in the Netherlands as well, Dutch
economy minister Laurens Jan Brinkhorst said.

Revealingly, while the Dutch government is allowing a Russian company to
engage freely into local mergers and acquisitions, other European nations
think differently. The British Cabinet is hastily amending M&A legislation
to block Gazprom's bid for its gas distributor Centrica; Gazprom was not
invited to the privatization of Gaz de France; asset swaps with Italian Eni
are being bitterly disputed.

The asset swap policy which is thus seriously impeded should give the
Russians access to European generating capacities and retail networks.
Russia sees this as a key instrument in providing what is known as the
"security of demand." As opposed to the 'security of supply," it says demand
should be guaranteed as well as supply because the costs of energy
production and transportation are getting only higher. To develop large
Arctic projects like Yamal or Shtokman and provide well-to-door delivery
through, say, the North European Gas Pipeline costs between $10 to $15
billion, a huge investment which will hardly be there if demand is not

What the European Union is doing, including in its new energy strategy known
as the Green Book, is in fact shooting itself in the foot by demanding
guarantees from suppliers while offering in return no guarantees whatsoever.
If implemented as is, the Green Book will inevitably ruin the current system
of Gazprom's long-term bilateral deals with EU companies.

The European Commission proposes a single EU-Russia framework agreement
under which Gazprom will have to sell its gas at the EU border, and European
retailers, rather than operating within a certain territory under current
contracts with the Russian giant's export arm Gazexport, will be free to
compete for customers across the Union. For new Eastern European EU members,
this means a capability to block bilateral deals, for example between Russia
and Germany, which they might consider unfavorable. For Gazprom, this means
loss of a large part of its revenue.

Meeting with head of the European Commission Jose Manuel Barroso last month,
Russian President Vladimir Putin proposed an alternative framework, in which
global energy security is interpreted as security of demand as well as
security of supply. The essence of the bargain is that Russia is ready to
give foreigners access to its upstream in return for inviting Russian
companies into European downstream and power generation. Analysts say the
Russian government links an agreement on this deal with progress on Russia's
ratification of the Energy Charter.

The good news is that we all can see the bottom line: genuine global energy
security will only come through a common language spoken by suppliers and
consumers, a language of understanding and mutual guarantees. The bad news
is that a lot of unilateralist rhetoric, a shade of the "energy egotism"
that Putin called "a road to nowhere" in his op-ed in The Wall Street
Journal, is still in frequent use.

Gazprom has taken a tough stand in its dispute with the European
bureaucrats, a move it has all grounds for. Sooner or later, Europe will
have to drop its unilateralist rhetoric as its consumers are facing few
alternatives to Russian gas in the foreseeable future. Meanwhile, Russian
energy providers need to take a big effort to turn eastwards - to China,
Korea, and other Asia-Pacific countries - to become less susceptible to
European pressures.

Dr. Tomberg is a senior research fellow at the Center for Energy Studies,
Institute of World Economy and International Relations (IMEMO) of the
Russian Academy of Sciences.