Gazprom’s threats may be empty rhetoric but the gas giant’s intentions in Europe’s downstream markets leaves governments in a quandary

Siân Green

The European Union’s concerns over security of supply were thrown sharply into focus once again in April when Russia’s Gazprom made clear its intentions to move into the downstream sector of Europe’s gas markets. Concerned about Europe’s negative reaction to its international strategy, the natural gas giant indicated that it would have little hesitation in focussing its expansion in other areas such as China and the USA.

“It is necessary to note that attempts to limit Gazprom’s activities in the European market and politicize questions of gas supply, which in fact are of an entirely economic nature, will not lead to good results,” the company said in a statement.

The veiled threat followed comments by Gazprom executives that the company was interested in purchasing UK gas company Centrica, which supplies over 50 per cent of the domestic gas customer base in the UK through its British Gas brand. While the UK government has indicated that it would not attempt to block such a deal, Gazprom’s strategy has raised questions over competition as well as security of supply in Europe.

High oil prices mean that Gazprom is flush with cash to fund its international expansion strategy. The company is keen to move away from being just a wholesaler in Europe, to being active in both retail and infrastructure across the continent. Holding interests in retail markets will present the company with a more secure hedge for the wholesale volumes that it sells, says Datamonitor managing consultant, Richard Greenwood: “The commodity cycle is volatile but the retail market is not. So when gas prices are high, the wholesale business will be profitable but when gas prices fall, retail prices tend not to follow so the retail side of the business would still make money.”

Gazprom, E.ON and BASF have signed a deal over the North European natural gas pipeline project
Click here to enlarge image

Gazprom is reported to have around ten European gas companies on its ‘watch list’, including a number of pipeline companies. Its strategy behind wanting to be in the infrastructure sector is less clear, given that pipelines are regulated natural monopolies. “There is no real reason why Gazprom needs to own transmission infrastructure – it’s a bit of a ‘vanilla’ investment,” says Greenwood. “However it might help them to build up a reputation in reliability,” he notes.

Any attempt by Gazprom to move into Europe’s downstream gas markets will be closely examined at a national and European Commission level over the competition issues raised. One of the main concerns is that Gazprom would be able to exploit a vertically integrated structure by using its wholesale business to subsidise its retail arm. While this might be good news for consumers in the short-term, it would be unfair on its competitors and certainly unacceptable to Europe’s competition commissioner at a time when the region is attempting to accelerate energy market liberalization.

EU energy commissioner Andris Piebalgs has said that the EU would apply the same competition rules to Gazprom as to any other company. It would, however, take into account Gazprom’s monopoly over Russian exports. Russia accounts for around 25 per cent of the EU’s natural gas needs and the EU wants it to open up its pipelines and markets to competitors and also reduce the term of the contracts it signs with Europe’s gas companies. Both suggestions have been rejected by Gazprom, which says that such moves would undermine the stability of the gas market.

But whatever conditions the competition authorities might impose, they will not be able to address the security of supply issues that have been highlighted by Gazprom’s strategies. These can only be addressed at the political level – a move which would anger Gazprom and contravene Europe’s anti-protectionist stance.

Europe cannot escape the fact that it is becoming increasingly dependent on Russian natural gas supplies but their reliability was questioned earlier in the year when gas supplies to Western Europe were interrupted following Moscow’s decision to cut off supplies to Ukraine. The Russian government’s ownership of a 38 per cent stake in Gazprom and the company’s resultant close ties with the Kremlin, makes Gazprom’s strategic manoeuvres seem political and this makes many European governments uncomfortable.

Poland and the Baltic states, for example, are unhappy about Gazprom’s deal with E.ON and BASF of Germany over the construction of the North European natural gas pipeline. This $10bn project will transport natural gas from Siberia directly to Germany across the Baltic Sea, bypassing the traditional Western European supply routes of Belarus, Poland and Ukraine. These countries are concerned that they, too, will become vulnerable to Russian blackmail – they argue that the pipeline project is uneconomic and therefore politically motivated; it would be more feasible to upgrade existing supply routes.

As part of the deal with Gazprom, E.ON and BASF are negotiating an interest in Russia’s Yushno Russkoye gas field. The pipeline project and an interest in Russia’s gas reserves are part of E.ON’s strategy of increasing security of supply.

Germany’s close cooperation with Gazprom is reported to have angered Piebalgs, who would probably prefer a more united European approach to security of supply. Piebalgs has a difficult balance to strike in coordinating policy on security of supply and ensuring fair competition without provoking Gazprom.

Piebalgs is unlikely to be too concerned about Gazprom’s threats, however. Gazprom earned $26bn – or two-thirds of its revenue – from the EU last year, and clearly needs Europe as much as Europe needs Gazprom. In addition, a lack of LNG and appropriate pipeline infrastructure means that it is unlikely to exploit other markets to the detriment of Europe. “Its threats are just a smokescreen,” says Greenwood. “There are alternative markets for its gas but there is longstanding infrastructure to Western Europe and it won’t turn its back on that.”