There Is No Silver Bullet for Gazprom

Natural Gas Europe had the pleasure of interviewing Dr Andreas Goldthau, Associate with the Geopolitics of Energy Project at Harvard University’s Belfer Center for Science and International Affairs and Professor of Public Policy at Central European University. Dr Goldthau is also a Fellow with the Global Public Policy Institute. We discussed his recent publication Between a rock and a hard place: International market dynamics, domestic politics and Gazprom's strategy co-authored with Dr Andrey Belyi, University of Tartu.

NGE:  Dr Goldthau, Gazprom is facing numerous challenges nowadays. Is it possible to range them from the greatest to the least?

AG: I do not think it is the best way to frame it. There are a number of challenges that Gazprom is facing. Taking together, however, they provide you with a perfect storm. So, rather than asking what is the worst of those challenges or the most difficult, I would ask what do these problems combined do to Gazprom and its business model and the answer is -  it is not pretty.

NGE: As you wrote, the company is squeezed between a rock and a hard place. What are the options for Gazprom in such circumstances?

AG: First of all, we need to understand what is the rock and what is the hard place. The first challenge for Gazprom is a fundamental change in the European market. The Europeans are importing less gas, for a number of reasons, but mainly because of the economic downturn and new import options. Moreover, on top there is the Commission pressuring Gazprom with regulation – Brussels took Gazprom’s old business model consisting of LTCs, destination clauses and discriminatory pressing practices, and replaced it with a market regulatory framework – which is a big headache for Gazprom. Besides, there is a huge politicization going on when it comes to gas trade in the context of the Ukrainian crisis.  Gazprom has proven to be open to serving as the Kremlin's foreign policy tool in that conflict. This did not make things better for Gazprom's standing as an international gas company.  And finally the situation within Russia is worsening for Gazprom: Novatek, Rosneft and other companies are emerging as big competitors on the domestic market. So, Gazprom’s gas export monopoly comes under the pressure as well.  All together  the changing gas market dynamics, a new regulatory framework in which Gazprom has to operate on the European market plus the company getting squeezed within Russia itself -  that is exactly the rock and the hard place between which Gazprom gets squeezed.

When it comes to the solutions, there is no real silver bullet, but a whole bunch of things Gazprom could do. Combined, they might get the company out of the woods but there is no guarantee.  The first option is to try to search for new markets and to pivot away from Europe. That is exactly what Gazprom is doing at the moment – they are pivoting to China and signed a prominent deal for the Power of Siberia pipeline. This is not going to do away with Gazprom's problems, though.  Volumes delivered to the Asian markets are small for now and not high-priced, and they require a lot of money because Gazprom has to develop new fields to service them. They cannot substitute the European market.

The second option is to do what Gazprom has done in the past but in a much smarter way: “fight fire with fire”.  The company could take on the legal challenge on the European market. There are arbitration cases that Gazprom has entered  - it is not a silver bullet either, but it would get the company a bit more into regular business practices and will show  that they are trying to fight on a market basis and not with a geopolitical toolbox.

The third option I would call “giving into new reality”. If you are in such a challenging situation you have to change your business model.  Gazprom has tried to use the Kremlin’s power to shield them against the EU regulation. That won't work. In his recent speech in Berlin Alexei Miller hinted at the fact that Gazprom could give into some of the demands by the European Commission.  That sounds more promising.

The final option is to try and create long-term expectations on the European market.  In this case it is necessary to depoliticize the business model – to separate politics and trade and  I do not think Gazprom is ready for this. Still, this would be the best strategy for Gazprom.

NGE: You mentioned that one option is depoliticizing gas trade. What would it require?

AG: Well, this would be a bold move for Gazprom. It comes with two elements. First, Gazprom would have to give up its export monopoly in natural gas.  This would benefit both Gazprom’s business model and it would balance production capacity within Russia with Russian exports. What is more important, the European Commission would like it because the biggest problem it has with Gazprom is not necessarily the big market share but the dominant position. Giving up on the export monopoly would satisfy Brussels' demands relating to competition on the EU market as Rosneft and Novatek could participate in trade, despite the fact that all of the suppliers come from Russia.  The second thing Gazprom needs to do is to flank this by a clear signaling strategy.  We see a lot of standoff talk between Gazprom and the Commission, but it is necessary for Gazprom to signal that they are willing and committed to change.

NGE: Talking about the antitrust case,  do you agree with Pierre Noel on the statement that Gazprom’s pricing policy reflects dysfunctional gas market in the EU?

AG: I would give it a yes/no answer. He is right that rather than blaming Gazprom at first place, the EU should try to do its homework. There is a lot to be done. Look at the East European gas markets:  we see national state-owned energy companies that retain monopolies in distribution, a lot of regulated prices, very little competition and very poorly handed gas sectors. There is a reason why the European Commission has launched a whole bunch of procedures against Central European countries for violating the Second and the Third Energy Package.  

Nevertheless, the European gas market is not like any other gas market.  It is very specific, and certainly not like the oil market or the American market - it is a market that relies on very few suppliers and that only gradually will be in the position to function on the basis of gas-on-gas competition. That gives Gazprom an easy game to come up with discriminatory pricing practices. Russia has clearly used the weak position of several Central and Eastern European countries to establish its dominant business model. So, there are both sides to blame.

NGE: How do you foresee the result of mutual claims filed by Naftogaz and Gazprom in Stockholm court?

AG: Well, this is a question for specialists in international arbitration.  I would find it very hard to believe that any ruling in Stockholm will be decisive on future contractual agreements between both companies. The legal case is one but the political context is the other. I am not in the position to fully judge the legal details of all this but I can say that it is a very politicized issue that a purely legal settlement cannot solve. We need a bigger picture solution for gas trade and transit through the Ukraine and for contractual patterns going forward beyond 2015. 

NGE: Do you think that Gazprom will manage to remain the key player in the European market?

AG: Absolutely, no doubt.

NGE: For how long?

AG: If they play the cards well, then forever. There are two simple reasons for that. The first is that Gazprom has an advantage when it comes to the European market – it is close and the infrastructure is established since the Soviet period. So, there are running costs but no infrastructure costs. This is a huge competitive advantage because other companies have to build pipeline and re-gasification terminals and have to put in place related infrastructure.

The second reason is that Gazprom still operates on comparably low production costs which allow the company to reassess prices depending on the market environment. Gazprom has proven to be very flexible, especially the last four years. They had a very good idea of where the market is and have adjusted prices accordingly to put themselves between the Asian market - the LNG import market in  Japan and Korea - and the American market. German import prices are hovering around $10 per mmBtu - that is exactly what the sweet spot is for American LNG to possibly enter the market. So, Gazprom is able to price themselves exactly at the spot where the additional LNG capacity will not be economic  in the EU.  

In this context it is important to stress that Gazprom has started to shift its export strategy. They no longer go for retaining a price level, they now retain market share. That means that Gazprom will be very flexible when it comes to pricing mechanisms – something they have not been in the past. If that's the case there is no reason to assume that they would lose market share in Europe. Why should they? It is gas that is close, it is reasonably priced and it has competitive edge over imports from Qatar and Australia.

Marina Zvonareva is a Natural Gas Europe analyst focused on Russia’s international energy relations. Follow her on Twitter: @ZvonarevaMar1na