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Gazprom Seeking Short-Term Debt Amid Market Rout: Russia Credit

OAO Gazprom is seeking to raise short-term funds outside Russia for the first time in almost a year after the worst month for emerging-market debt since 2008.

The world’s biggest natural-gas producer will meet investors in Switzerland from Oct. 3 and may sell dollar- denominated euro commercial paper, according to a person with knowledge of the plans. Moscow-based Gazprom’s July 2013 dollar bonds yielded 5.3276 percent on Sept. 27, the highest level since June 2010. They traded at the biggest premium to Petroleo Brasileiro SA (PETR4) debt in 15 months the previous day, data compiled by Bloomberg show.

Gazprom is looking at shorter-term paper as concern the world is headed for recession sent average yields on corporate debt in developing nations up 80 basis points this month, the biggest jump since October 2008, according to JPMorgan Chase & Co.’s Corporate EMBI Index. The government canceled an auction of 10 billion rubles of four-year bonds this week, the second debt sale it’s pulled in a row, after yields soared to a record.

“Even though I like the company, I see more risk for deterioration of global growth conditions,” Sergey Dergachev, who helps manage $8.5 billion of emerging-market debt at Union Investment Privatfonds in Frankfurt, said in e-mailed comments on Sept. 28. Bonds like Gazprom’s “will be punished first across the curve, and it does not matter whether these names have strong fundamentals or not.”

New Debt

Gazprom is boosting its borrowing program this year by 67 percent more than planned after the company raised its 2011 investments by 56 percent while building pipelines in Russia’s Far East and to Europe, the biggest consumer of Gazprom gas. The producer aims to keep its debt to earnings before interest, taxes, depreciation and amortization ratio at about 0.8. The ratio for Rio de Janeiro-based Petrobras, Brazil’s state-run oil producer, was 1.1 in 2010, data compiled by Bloomberg show.

“One should borrow now because it may get worse later,” Petr Grishin, a senior credit analyst at VTB Capital, the investment banking arm of Russia’s second-largest lender, said by phone in Moscow. “Euro commercial paper will help them do so fast, easy and cheap.”

Negative Flow

Gazprom registered $4 billion of euro commercial paper two years ago, saying the funds would help the Moscow-based company manage short-term cash flows. A debut $600 million of three- month paper was sold at a 3.4 percent annual yield in September 2009.

While Gazprom had record earnings in the first quarter, the last time that it reported, the producer’s free cash flow swung to negative from 278 billion rubles ($8.8 billion) a year earlier as capital expenditures rose.

The increase in the investment program this year as well as rising mineral extraction taxes mean Gazprom is in need of financing now, said VTB Capital’s Grishin. The producer also faces a six-month delay in higher domestic fees, after the government pushed back an increase in regulated gas and transportation prices to July 1, he said.

Record Earnings

Officials at Gazprom’s press service declined to comment on the company’s borrowing plans when contacted by Bloomberg News. In June, Andrey Kruglov, the chief financial officer, said Gazprom has no “great need” to boost debt levels and “won’t borrow just for the sake of it.” The producer expects record earnings in 2011 as demand recovers from the global economic crisis and oil gains push gas prices higher, Chief Executive Officer Alexei Miller said in June.

Urals crude, Russia’s benchmark export blend, has slumped 14 percent from its 2011-high of $122.88 a barrel in northwest Europe in April. Oil is the country’s biggest revenue earner and Urals traded at $104.85 yesterday, below the $109 level the government needs it to average to balance its budget this year.

Weakening Ruble

Russia’s ruble notes due in August 2016 rose yesterday, sending the yield 30 basis points lower to 8.17 percent. The yield hit 8.74 percent on Sept. 26, the highest level since the notes were sold in August 2010. The yield on Russia’s ruble Eurobond due in 2018 rose two basis points to 8.194 percent. Russia’s dollar bonds due in 2020 climbed, pushing the yield eight basis points lower to 5.139 percent.

The cost of protecting Russian debt against non-payment for five years using credit-default swaps jumped six basis points to 297 basis points, up from as low as 122 on April 6, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Yield Premium

The extra yield investors demand to hold Russian debt rather than U.S. Treasuries rose one basis point to 391, according to JPMorgan EMBIG indexes. The difference compares with 254 for debt of Mexico -- rated the same level as Russia at Baa1 by Moody’s Investors Service, the third-lowest investment grade -- and 256 for Brazil, rated one step lower at Baa2 by Moody’s.

The yield spread on Russian bonds is 56 basis points below the average for emerging markets, down from a 15-month high of 105 in February 2010, according to JPMorgan Indexes.

Gazprom is raising investments to 1.28 trillion rubles as it builds domestic pipelines and the Nord Stream network, the company’s first direct link to Europe. The pipeline bypasses Ukraine, where pricing disputes have disrupted Gazprom’s winter supplies to Europe at least twice since 2006.

Cash Squeeze

The three-month MosPrime rate, the average rate banks say they are charging to lend to each other, climbed two basis points to 6.66 percent on Sept. 27, the highest level since December 2009, data compiled by Bloomberg show.

Gazprom has 300 billion rubles of bonds registered, and none of them were sold in the first half of the year, according to CFO Kruglov. Since Standard & Poor’s cut the U.S.’ top credit rating on Aug. 5, 15.7 billion rubles of debt has been sold in Russia, down 91 percent from the same period last year, according to data compiled by Bloomberg.That is the lowest amount sold in that period since 2007.

‘State Coffers’

The $10 billion Nord Stream project is designed to carry 27.5 billion cubic meters (971 billion cubic feet) of gas a year under the Baltic Sea to Germany. Gazprom plans to double the amount of gas conveyed by the end of 2012.

“Nord Stream is a very good project, very much needed for our partners, for Gazprom, for the Russian economy,” Prime Minister Vladimir Putin said on Sept. 6, after the first gas was pumped into the link. “It’s a big, significant source of export revenue for the state coffers, for Gazprom’s earnings so it can develop its production.”

Oil and gas account for 17 percent of Russia’s gross domestic product, compared with less than 10 percent of Brazilian GDP, government data show. Energy sales contribute as much as 40 percent of budget revenue.

Arctic Yamal

Including the projects from these regions, Russia may boost natural-gas output to 1 trillion cubic meters a year from about 650 billion cubic meters now, Putin said in October 2010, while discussing the country’s 20-year gas development program.

“Gazprom standalone credit quality is extremely strong and six-month risk could be very well placed,” Union Investment’s Dergachev said. “In Switzerland, commercial papers are very welcome.”

To contact the reporters on this story: Anna Shiryaevskaya in Moscow at ashiryaevska@bloomberg.net; Denis Maternovsky in Moscow at dmaternovsky@bloomberg.net

To contact the editors responsible for this story: Gavin Serkin at gserkin@bloomberg.net; Will Kennedy at wkennedy3@bloomberg.net

UPDATE 2-Europe's fear of Russian gas behind Gazprom raids

* EU launches investigation into Gazprom's subsidiaries

* Raids linked to EU efforts to cut dependence on Russian gas

* EU, Russia compete for sources of gas

* Gazprom eyes bigger EU gas market share (Adds details, comments, background)

By Vladimir Soldatkin

MOSCOW, Sept 28 (Reuters) - Russian gas exporter Gazprom said it would cooperate with an EU competition probe of its units, while sources on both sides said on Wednesday the real source of tension was Europe's fear of its growing reliance on Russian gas.

A European Commission official said raids on the units this week were part of efforts to cut dependence on Russian gas, and Gazprom sources suggested the EU was acting out of worry over progress on Russia's pipeline projects that would increase Moscow's share of European energy markets.

Officials from the executive Commission launched the raids in central and eastern European states to investigate firms involved in the supply, transmission and storage of natural gas. The Commission has said the raids were linked to suspicions about anti-competitive practices.

A Commission official, who declined to be named, told Reuters the raids were part of the EU's efforts to wean itself off reliance on Russian gas and concerns about Gazprom's power as a state-controlled entity.

"The Commission has been much concerned about Gazprom for quite a while. There have been a number of informal discussions between the Commission with EU governments and companies about Gazprom," said the official.

Gazprom is Russia's biggest company and the world's largest gas producer. President Dmitry Medvedev is a former chairman, and some critics have accused Prime Minister Vladimir Putin of using energy exports as a lever in geopolitical maneuvering.

Gazprom sources suggested the probe was linked to progress on its South Stream pipeline project, a rival to the EU-backed Nabucco link that would bring Caspian region to Europe while bypassing Russia.

"My guess is that it comes as Russia is speeding up its projects, including the South Stream underwater link," one of Gazprom sources said.

The raids were carried out as rivalry between Russia and the EU over Caspian hydrocarbon resources heats up and a pricing row with Ukraine, a transit country for Russian gas supplies to Europe, persists.

Gazprom, Russia's largest company with capitalisation of $113 billion, is looking to increase its gas supplies to Europe this year by 12 percent to 155 billion cubic metres. It also eyeing a 30 percent share of the European gas market, up from around 25 percent now, in coming years.

In a statement published on Wednesday the company said that the Commission had not informed it of any claims and the raids did not amount to accusations it had broken competition law. Gazprom added that it was ready to fully cooperate over the probe with the EU authorities.

The raids were carried out in Gazprom's subsidiaries including Gazprom Germania and the Czech Republic's Vemex, which earlier this month bought a controlling stake in Czech energy retailer RSP Energy.

A Commission spokeswoman said regulators had just begun their investigation and had not yet drawn any conclusions.

"We're at the beginning of the investigation, we have our suspicions and we have to see whether these are confirmed on the basis of the evidence we find and our analysis," spokeswoman Amelia Torres told a daily news briefing in Brussels.

THIRD ENERGY PACKAGE

The EU is working on implementation of the so-called Third Energy Package, which imposes limits on the ownership of EU pipeline infrastructure by gas suppliers and calls for the "unbundling" of over-concentrated ownership.

Under the rules, Russia could be forced to sell off parts of its pipeline network in the EU, which has sought to liberalise the gas and power markets in recent years.

Wielding its antitrust tools and the threat of fines up to 10 percent of a company's global turnover, the EU executive has in recent years forced E.ON (EONGn.DE: Quote, Profile, Research), RWE and ENI to open up or sell their pipelines to rivals. E.ON and GDF had also to dismantle their market-sharing deals.

A group of experts from European regulators is expected to meet Russian colleagues in Moscow on Oct. 6-7 to discuss the package among other issues.

Vladimir Feigin, president of the Energy and Finance Institute in Moscow and a member of the Russian delegation, said the European Commission was taking a "dangerous path" with the raids.

"It's not a simple demonstration of muscles.... There are lots of issues, which are highly politicised, including Gazprom's long-term contracts," he said.

These contracts have been the subject of heated debates with the Russian company's clients, including Germany's E.ON (EONGn.DE: Quote, Profile, Research), which call for a spot price mechanism as a way to obtain cheaper gas.

Gazprom sources told Reuters that it may take years for the European Union's competition authority to analyse the results of its raids and draw any conclusions. (Additional reporting by Melissa Akin in Yuzhno-Sakhalinsk and Charlie Dunmore and Foo Yun Chee in Brussels; Editing by Douglas Busvine, Steve Gutterman and Anthony Barker)

Gazprom Gas Supply Contracts Are Focus of EU’s Antitrust Probe

Sept. 29 (Bloomberg) -- OAO Gazprom’s natural gas contracts are the focus of European Union antitrust investigators’ raids across central and eastern Europe that sought to uncover information on prices and supplies to customers.

The probe is looking at companies with long-term natural gas supply contracts with Gazprom and was “a way to circumvent confidentiality clauses” that prevent regulators from getting data on capacity, Bulgaria Energy Minister Traicho Traikov told reporters in Sofia.

Gazprom, which supplies about a quarter of European gas needs, has been looking to further expand in Europe, its biggest market by revenue. At the same time, Europe’s dependence on Russia’s state-owned gas monopoly has spurred the EU to try to diversify energy supplies and trade more gas within its borders by opening up markets and pipelines.

“We are on the verge of a battle between the cartel of consumers and the cartel of suppliers,” Alexander Rahr, an analyst at the Berlin-based German Council on Foreign Relations, said by phone yesterday. “The EU did a bit of muscle-flexing, as Gazprom is trying to reach separate agreements with companies behind Brussels’ back.”

Companies found to violate EU competition rules can be fined as much as 10 percent of annual revenue. Earlier EU probes led RWE AG to sell its gas-transmission network and E.ON AG to shed its German power grid in settlements that helped them avoid large penalties.

Watching Probe ‘Closely’

Gazprom said Sept. 27 that EU officials visited its German and Czech units to study documents and that the company was cooperating with regulators. The raid doesn’t mean that Gazprom breached any antitrust rules, both Gazprom and the EU said.

RWE AG, E.ON AG AG’s Ruhrgas and Hungary units, OMV AG and Poland’s Polskie Gornictwo Naftowe I Gazownictwo SA said Sept. 27 that they were also raided by the European Commission. As many as seven other companies in Bulgaria, Latvia, Estonia and Slovakia also said they were raided.

Russia expects the EU investigation to respect the rights of Russian investors and gas suppliers, the country’s energy ministry said in an e-mailed statement. Russia is watching the probe “closely,” Prime Minister Vladimir Putin’s spokesman Dmitry Peskov said by telephone.

Destination Clauses

EU regulators are likely to focus on so-called destination clauses in Gazprom contracts signed in the 1980s and 1990s that forbid customers from selling gas outside one country and now contravene EU rules that encourage gas to be sold across the 27- nation bloc, said Chris Rogers, an analyst at Bloomberg Industries.

“One of the problems with gas contracts is that they’re super-secret,” Rogers said in a telephone interview. The only way for regulators to secure information on gas prices or volumes “is if they go and grab them for themselves.”

A lengthy EU investigation “makes life more complex” and may slow down negotiations on new contracts between Gazprom and two of its biggest European customers RWE and E.ON, Rogers said.

Gazprom has been in arbitration with RWE, its main partner for supplying the Czech Republic, and E.ON, Germany’s biggest utility, about prices for gas under long-term contracts. E.ON and RWE are seeking to weaken the link between gas and oil prices in Gazprom’s supply contracts as oil costs surged. The companies lost hundreds of millions of dollars in the past year as they sold gas to customers at less than it cost to source.

Selective Discounts

The raids may pressure Gazprom to provide the same pricing to all European gas customers, Valery Nesterov, an oil and gas analyst at Troika Dialog in Moscow, said by phone. Gazprom has “selectively” provided discounts to some partners, he said.

While the raids are the first time Gazprom has been targeted by EU antitrust regulators, the company in June said that the European Commission set “unacceptable conditions” for the company’s planned purchase of a stake in Central European Gas Hub AG in Austria.

“Europe doesn’t want to give away control of the market to Gazprom fearing it may take roots there,” Rahr said. “The EU is making its position tougher while Gazprom just wants to make money in the EU.”

The EU approved legislation in 2009 to spur more competition and investment in the energy industry that would separate companies’ control over energy infrastructure and energy supplies. The EU separately plans to oversee energy contracts between European nations and suppliers such as Gazprom to make sure they respect competition rules.

Lithuania’s government in January asked the EU to investigate Gazprom for refusing to cut gas prices after it announced it would split ownership of gas sales and transmission. Overgas, Bulgaria’s biggest private natural gas distributor which is partly owned by Gazprom, also complained to the EU in November after state-owned Bulgartransgaz AD blocked access to a high-pressure pipeline, Overgas spokeswoman Nerry Terzieva said in a phone interview.

--With assistance from Elizabeth Konstantinova in Sofia, Ilya Arkhipov in Moscow, Milda Seputyte in Vilnius, Ilya Arkhipov in Moscow, Aaron Eglitis in Riga, Edith Balazs in Budapest, Ott Ummelas in Tallinn, Radoslav Tomek in Bratislava, Stefan Nicola in Berlin, Zoe Schneeweiss in Fuschl am See and Ben Farey in London. Editors: Anthony Aarons, Will Kennedy

To contact the reporters on this story: Aoife White in Brussels at awhite62@bloomberg.net. Anna Shiryaevskaya in Moscow at ashiryaevska@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net.

The Empire Strikes Back: European Energy and the Return of Gazprom

http://www.ensec.org/index.php?option=com_content&view=article&id=328:the-empire-strikes-back-european-energy-and-the-return-of-gazprom&catid=118:content&Itemid=376
Wednesday, 28 September 2011 00:00 Matthew Hulbert and Dr. Christian Brutsch
Compared to the Eurozone’s public finances, European energy policy looks decidedly bright. Capacity margins are high, prices are low, even emissions have dropped of late. The EU's 'Third Package' of gas and power market reforms, which took effect in March, is set to further enhance supply security, increase competition and improve consumer choice and services. It all sounds very good, but the problem is that such 'policy hits' are grounded in weak fundamentals–not silver bullet policy making.  Shale gas developments have turned LNG markets on their head, while deep seated financial frailties and economic slumps have kept fundamentals weak and growth anemic across EU27 states. That's making energy policy look good, and political populism all too easy.
But with growth showing tentative signs of recovery and climate policies still placing a premium on natural gas over coal, complacency and energy populism will come with costs. Nowhere more so than on natural gas – and the 158 billion cubic meters (bcm) of Russian supply that the EU will gobble up this year. After dipping to 2002 levels in 2009, EU gas consumption has surged by 7.2% in 2010, with most analysts expecting that by 2013, demand should have rebounded to pre-crisis levels. Increased LNG shipments to Asia have already added upward pressure on prices, and Germany’s snap decision to decommission its last nuclear power plants in 2022 will sustain demand growth for the foreseeable future. The European Commission, meanwhile, has taken its eyes off the Asian ball and remains undecided how it should deal with Russia, its single largest supplier. If RWE, Germany's second largest electricity producer, and Gazprom, the world's biggest gas firm, implement their recently announced Memorandum of Understanding (MoU) and establish a joint venture to manage coal and gas plants across Germany, the UK and the Benelux countries, the EU's Third Package might well follow Germany’s 2011 decision to toss nuclear power into the dustbin of history. 
 

Thanks to European politicking, Moscow holds the energy aces. Berlin's accelerated nuclear phase out may be popular, but it is likely to add as much as 20bcm/year to German gas imports alone. The French ban on shale gas drilling is hardly going to help reduce energy dependency, while Europe's renewed commitment to democracy and good governance in its neighborhood may chime with European values, but has done little to reassure the authoritarian rulers who control alternative upstream sources in Central Asia and the Middle East that Europe is a credible energy supply bet. Any European state that follows Germany's nuclear example, emulates France's disdain for fracking,  or thinks it can 'play nice' and win with suspect neighbors will simply strengthen Russia’s hand.

Missing the point?

Overly dramatic? Perhaps. Conventional wisdom in Europe holds that Gazprom is in deep trouble.  The main reason for this relates to cheap spot markets that have been growing in liquidity. Oil indexed gas from Russia is deemed too expensive for European consumers to bear, with independent benchmarks on Western European hubs the preferred option. Move over or lose market share is the clarion call from consumers: current price spreads clearly point towards this way of thinking between UK wholesale hub and oil-indexed Russo-German border prices. Unsurprisingly, producers have been screaming murder. In 2010 Gazprom reportedly agreed to cut oil indexation levels in some long-term contracts to 85%, but insisted that the three years exemption would not change its long-term contract system. Algeria went a little further and called for the formation of a fully fledged gas cartel. So far, it was only really Norway that took price corrections on the chin by rapidly revising contractual relations to retain its stake in European supplies.

You’d think that with Gazprom on the ropes and shale gas starting to blossom beyond US shores that European capitals would not offer Russia an opportunity to regroup. Not so. In June, the German government shocked utilities, already out of the money on oil-indexed prices and burdened with an onerous nuclear fuel tax, when it reversed the October 2010 amendment that had extend the lifespan of nuclear plants by an average of 12 years in exchange for an annual €2.3bn ‘fuel rod tax’. Faced with a massive capital expenditure program, ratings downgrades and a negative outlook, RWE went cap in hand to Gazprom to offer the Russian company a major downstream stake in a rare and combustible blend of commercial and political brinkmanship.

Commercially, RWE’s gamble might pay off if Gazprom’s entry into the downstream game made it more amenable to price discounts that would narrow the gap between term prices and lower hub-based spreads. A more flexible Russian partner might also add pressure on E.On, RWE’s main competitor in Germany, whose supply contracts expire in 2012 having voiced its preference for '100% spot'. But the fact that Alexey Miller, chairman of Gazprom, has been talking with both RWE and E.On about prospective tie-ups suggests that he is far more likely to pitch the utilities against each other rather than to make concessions. If discounts are offered, they will be given on the strict understanding that oil indexation will remain the basis of Russian supply pricing in any long term take-or-pay contract. In short, Gazprom intends to use RWE and E.On as 'sledge hammers' to crack the European spot market 'nut' before it really takes off.

That would be a shame. Spot markets can obviously play out any which way in terms of price, but moves towards independent gas benchmarks would have been in everyone's long term market interests – at least within the European context. To that extent, German politics has given Gazprom an unnecessary eleventh hour reprieve to retain European market share and a Russian 'market price'. Politicians will no doubt blame RWE for using Gazprom as collateral in its fight to overturn Berlin's nuclear ban. But they should keep in mind that the power utility has lost roughly 20% of its market capitalization since the German parliament decided to accelerate the nuclear phase out and wipe out roughly 30% of RWE’s installed capacity. The policy message is thus very clear. Chancellor Merkel must rethink the nuclear turn or RWE will hand Gazprom the keys to European downstream doors. A classic double catch: RWE is using Gazprom to salvage its nuclear position, just as much as Gazprom is using RWE (and potentially E.On) to maintain its pricing policy.

Eventually something has to give. If the German government doesn't budge on nuclear, RWE might find that its brinkmanship leaves it little choice but to turn the MoU with Gazprom into a contractual commitment. In the interests of consumers, industry and tax payers, things arguably shouldn’t get that far; if German courts agree that the government violated the utilities' property rights, or if Berlin comes to its senses and reinstates the October 2010 consensus that stretched the phase out until 2036, they probably won’t. But as the Eurozone debt crisis has shown, German politicians can be stubborn defenders of voters’ preferences, no matter the costs. And energy populism has a price. Even if Berlin keeps some nuclear generation capacity online, Germany will still have to look to gas to fill most of its gaps. This is exactly what Gazprom is banking on. Germany's nuclear window has offered the Russia a perfect opportunity to keep exports high and prices firm. If it all goes to plan, Russia will be able to feed Europe with discounted gas—on its own joint venture terms.

Russian hugs

Given the complexity of the games underway, it’s impossible to say how the RWE-Gazprom MoU will or won't play out. But the simple fact that utilities are considering the comforts of a Russian bear hug has set alarm bells ringing in Brussels and beyond. And with good reason: German brinkmanship has exposed the deep rooted frailties that pervade European Energy Policy on pricing, supply diversification and unbundling. Besides threatening a return to the oil-indexed dark ages, an RWE-Gazprom tie-up could deal the final blow to one of the few supply side measures among the EU’s 2020 energy infrastructure priorities: the Nabucco pipeline. 

RWE has long been the driving utility force behind Nabucco, and it does not take a clairvoyant to see the 'synergies' created from a tie up would ensure RWE tucked in behind Gazprom's South Stream initiative, not to fight the Russian giant tooth and nail for strategic control of the 'Southern Corridor'. No matter how much Brussels has invested branding the likes of TAP, AGRI or ITGI as 'European' projects, it is highly unlikely that any other pipeline will see the light of day besides South Stream. Today's spread bets on South Stream and Nabucco from countries and utilities involved, displays just how little credence 'projects of European interest' have among those who understand that to be commercially viable, one, and only one, pipeline project can prevail.

This hits on a deeper European problem. Even if Nabucco were to succeed, and even if Azerbaijan were to bet on the EU, rather than Russia, Gazprom would still have a downstream say. It already controls 20% of the German gas market through linkages with BASF, Wintershall and Wingas, and looks determined to use North Stream take offs to increase its stake in the Netherlands, France and the UK. More importantly, Gazprom also holds a 50% stake in OMV's Baumgarten transmission hub that is designated to connect Nabucco to European pipelines. Last but not least, the Russian firm has ramped up storage-capacity across multiple markets including Austria, Hungary and Netherlands, with a view to expanding facilities in Serbia, France, Belgium and Britain.

This underpins why the RWE-Gazprom tie up is so crucial. Although the deal would have to overcome political opposition in Germany and to conform to the growing body of legislation that envelops the Third Energy Package, it will be hard to close the 'vertical integration' flood gates once Gazprom claims a major stake in German production and distribution. The Russian company is already talking with France’s GDF-Suez (a Nord Stream partner) and Italy is no doubt on the list. As Central and Eastern European states will be left to fend for themselves, the Third Package might well be remembered as a lore of 'legal niceties'.  Russo-German political and commercial realities will hold sway. As the fine print of European legislation points out, national regulators should take the 'utmost account' of the European Commission’s terms and opinions. But this won't cut much ice with utilities whose profits and survival depend on swap agreements with Gazprom, or with Moscow once Gazprom has a say on downstream rents.

From regional supplier to global player

Vertical control is of course exactly what any ambitious producer state dreams of. And the bad news for Europe is that things might get worse. While the EU has been caught up in increasingly parochial squabbles over energy efficiency, renewables, smart grids and the control of transmission systems, Gazprom has turned to the East, and is reportedly close to signing a 68bcm/y deal with China. True, we've been there before. Gazprom and CNPC struck a similar gas MoU in 2006 only to see it flounder on pricing problems. But the rationale of linking one of the world's largest energy consumers to one of the world’s biggest gas reserves remains as compelling as ever, and Beijing has already moved the debate on by offering prospective advanced payments of $25-40bn in return for 30bcm/y of discounted gas.

Although Gazprom will haggle to raise the current (alleged) $300/million cubic meters (mcm) target price, Moscow knows that it needs Chinese cash to consolidate its Eastern Gas Program and that spare funds could enable it to upgrade the integrated gas production, transportation and supply system that connects Eastern Siberia and the Far East. Gazprom also knows that while China may not be prepared to pay European gas prices, it is likely to agree to some kind of oil index link. Beijing is too cautions to buy into a buyers' market, not the least because both Sakhalin and Shtokman have been earmarked for LNG development and might produce as much as 62 million tons a year by 2030. Even before the Fukushima meltdown boosted Japanese demand, Gazprom had been discussing prospective LNG deals with the likes of South Korea, India, Vietnam, Thailand and Singapore down the line to secure market presence and market share well beyond traditional Western European hunting grounds.
 
There is no point in pretending that European politicians have woken up to these developments, let alone contemplated a 'doomsday' scenario in which Russia links its East Siberian reserves to the Unified Gas Supply System in a way that would allow it to switch between LNG or pipeline exports and route supplies to either the Atlantic or the Pacific basin at a mouse click. Even if the engineering and financial strains mean that Yamal will feed the EU for some time to come, Europe needs to understand that as the gravitational pull of supplies is shifting eastwards, Gazprom's—and Russia's—strategic focus will be on arbitrage not compromise.
 

Realignment

Gazprom's return thus highlights a number of bad moves the EU made while it was lulled by a soft gas market. Investment in storage capacity has been low, reforms to reduce pricing pressures have been meek and grid integration has been treated as a regional, if not local problem. More recently, the EU's plans for upstream diversification have been debunked by its blatant failure to project military power across the Middle East and North Africa, and Germany's decision to phase out its nuclear assets just as tighter markets were heralding the golden age of gas has been reckless at best; no matter what showings in local elections will prove, voter 'preferences' in Germany will not eclipse rising Asian demand, the energy needs of a European recovery, or potential supply side constraints as the downside risks of fracking and cracking unconventional gas become more apparent.  

 
European posturing has not only placed supply side eggs into predominantly Russian baskets, it has also encouraged Gazprom to renew its efforts to move downstream across the European value chain. If Russia manages to cement supplies to the East and enhance internationalization strategies across North African and Central Asian markets to boot, the prospects for European energy will be incredibly bleak, and even more so when markets will tighten.  Who knows, we might be truly grateful to retain an oil-indexed link by that stage to keep a lid on spiraling gas prices, and applaud those who turned a policy failure into a 'crowning success'. But like with the Eurozone debt crisis, we will still wonder whether the price to appease the German voter is worth paying.
 

Contributor Matthew Hulbert is the Lead Columnist for the European Energy Review based in Amsterdam and Dr.Christian Brutsch is Senior Lecturer, University of Zurich

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