Blaming Gazprom is only half of the story Derek Brower, Journalist AND so another squabble ends with Gazprom the victor. Shell, once the kind of company that dictated terms to others, got a taste of the new medicine. The Kremlin is the alchemist, and its gas monopoly the distributor. The deal signed in Moscow on Thursday over Sakhalin 2’s liquefied natural gas (LNG) project puts Gazprom in control of it. The Kremlin will now have full oversight of the project’s costs. And sometime soon the gross collection of ecological charges against Sakhalin Energy, the consortium developing the LNG plant, will be either dropped altogether or converted into a light fine for the operator. Along with its medicine, Shell swallows a great deal of pride. It has become a familiar pattern. Western or independent Russian companies think they have a won a good deal, and then Gazprom decides otherwise. In the Barents Sea, a handful of western firms fought for a slice of the Shtokman field – another mooted LNG development – and then Gazprom cancelled the tender and said it would develop it on its own. And it doesn’t just happen on Russian territory, either. In Central Europe, a project called the Nabucco pipeline (in honour of the Verdi opera) would have brought natural gas from the Middle East and Central Asia into Europe. For politicians in Europe panicking about the continent’s ever-rising dependence on Russian gas, it was a beautiful idea. And then Gazprom wrecked that project, too. In the summer, the Russian company signed a deal with Mol, Hungary’s national energy firm, to develop a pipeline that would target the same markets in Central Europe as Nabucco. That put the EU’s “anti-Russian” line in doubt. In November’s Petroleum Economist I revealed that Nabucco’s partners had, in response, now started to negotiate with Gazprom about taking Russian supplies through a pipeline whose original strategic purpose was to avoid exactly that. Once that story broke, even politicians in Brussels started to cool towards the project. And then there is “Nord Stream”: another pipeline – and another victory for Gazprom. Without even a feasibility study crossing the desks of planners in Brussels, that line between fields in northwest Siberia and Germany was presented last year as a fait accompli. It goes under the Baltic Sea, avoiding Poland and other Baltic transit countries. And that means that it is both a potential ecological nightmare and a project that fundamentally endangers the security of energy supply in the countries between Russia and Germany. Do we need more examples? How about the new Balgzand-Bacton pipeline (BBL) between the Netherlands and the UK? Gazprom has said it wants a position in the UK’s lucrative downstream market. Now, through a deal with the Netherlands’ Gasunie, it has a stake in the BBL, and with it an increased presence in the UK. Or what about Central Asia, at the other end of the supply chain? The EU got a rare strategic victory this month when the South Caucasus Pipeline (SCP) came on stream, taking gas from Azerbaijan to Turkey – and eventually Europe. But Gazprom already has the means to make that line insignificant. It can prevent Turkmenistani and Kazakhstani gas flowing through the SCP by blocking any attempt to build a pipeline under the Caspian Sea. And, elsewhere in the region, it has already stopped Iran from exporting its gas through Armenia into Georgia and Ukraine – and eventually Europe. Ruthless and efficient All of these victories for Gazprom and its masters in the Kremlin have two themes in common. The first is Gazprom’s ruthless efficiency in executing its strategy. The company’s executives long ago latched onto Europe’s language about “security of supply” and threw it back in the faces of Brussels’ bureaucrats. “You want security of supply,” one senior Gazprom executive told me a few weeks ago. “We want security of demand.” What Gazprom wants is markets. What Gazprom does is secure them. There are lots of legitimate complaints about how it executes this strategy. The most basic is that Gazprom shows little regard for legally binding agreements. On Sakhalin, the Kremlin threatened to revoke a production-sharing agreement (PSA) unless Shell cave in and give Gazprom a stake. The eco-charges that Oleg Mitvol and his minions at Rosprirodnadzor, the environmental watchdog, brought against the consortium applied pressure – $30bn of pressure – from another angle. But those Gogolian charges were absurd. Few doubt that Shell and its partners were guilty of many environmental abuses. But the decision to prosecute Shell, and not a thousand other abusers in a land of rampant ecological destruction, was political. So was the decision about Shtokman. Russia was under no obligation to form a joint venture with any of the companies that had bid to participate in the field. But reneging on an agreement to do so was more evidence that signatures on contracts in Russia mean very little when the government – or Gazprom – decides it made a mistake signing up in the first place. The deal with Mol was another example of Gazprom’s ability to execute its market strategy. The EU upped the ante with Nabucco. So Gazprom called Brussels’ bluff. Unlike Nabucco, Gazprom already has gas to send down any new pipeline it builds to Central Europe. That is enough to kill the EU’s project. As Aleksandr Medvedev, head of Gazprom’s foreign arm Gazexport, told me recently: “Unlike the Verdi Opera, there will be no execution in this Nabucco.” As for the now-notorious deal-making of Nord Stream, what better way could there have been to ensure the progress of that project into Germany – which Gazprom now calls a “hub state” – than to corrupt one of the EU’s greatest chancers, Gerhard Schroeder? Thanks to Schroeder, the Nord Stream consortium won preferential credit from German banks. Thanks to Schroeder, now an executive at the same consortium, Gazprom gets a line into its hub state – and compromises its neighbours’ security in the process. Kto vinovat? But should the EU or anyone else really blame Gazprom for all of this? Gazprom is not ExxonMobil. Had the US company pursued a policy of expansion in the same way its public image would now be in tatters; its reputation as a safe company to deal with would be shot; it would be facing legal challenges on a number of fronts; and its share price would have fallen into the Gulf of Mexico. Gazprom, though, is different. Blaming it for ruthlessly trying to secure markets for its gas is like blaming a security service for poisoning someone it doesn’t like, or blaming Schroeder for being corrupt. Or blaming a leopard for its spots. As the foreign economic arm of the Russian state, Gazprom has been charged with winning Russia the influence it craves on the world’s stage. It does it brutally at times. It does it successfully, too. But the failings of the companies and politicians who deal with Gazprom also give the Russian company a head start. That is the second thing Gazprom’s successes have in common. On Sakhalin, for example, Gazprom was helped by Shell’s incompetence. The rise and rise of Sakhalin 2’s costs – which my sources tell me now stand at $26bn, compared with the $10bn Shell originally projected or the $20bn it is now owning up to – was a red flag to Russia’s bull. That’s one example of a Western company shooting itself in the foot when dealing with Gazprom. But what about the EU? Brussels seems to have made a pastime out of its incompetent relations with the company. Indeed, instead of making a scapegoat out of the Russian company, the EU and others should start attributing blame closer to home. And then it should do something about it. Enough of the slogans, already Doing, though, is not what the EU does best. Andris Piebalgs, the EU’s energy commissioner, and all the other luminaries of the European energy mess are much better at talking. Like a mantra, the same words come tumbling out of their mouths. To secure energy supplies, Europe needs more liberalisation, they say. Europe needs a common energy policy, they argue. Europe must start speaking with one voice to its suppliers. Fine words, all of them. But the EU has been saying the same thing for more than a decade. And the common voice, common energy policy and common liberalised energy market have not emerged. And while Europe has been stuck in its rhetorical game, Gazprom has exposed the deficiencies on the ground, using what Robert Amsterdam calls a policy of “disaggregation”, the old technique of divide-and-conquer. Pulling Mol away from its partners in the Nabucco project was a classic example. So was the decision to turn Germany into a “hub state”. Both successes for Gazprom relied on the company appealing to the narrow interests of Budapest and Berlin. Politicians in both countries know who votes for them. And they don’t want those voters to be without gas to heat their homes the next time Gazprom cuts off supplies to Ukraine. And those politicians manifestly do not care about their neighbours, either. Routing the Nord Stream pipeline under the Baltic Sea to Germany, instead of overland along a cheaper established overland route through Poland, means the Baltic States will remain at the mercy Russia and Germany for their energy. Russia has already cut oil supplies to the Baltic countries, so politicians in Riga, Tallinn and Vilnius are justifiably worried. Mol’s deal with Gazprom will turn Hungary into the next “hub state”, much to its neighbours’ irritation. Meanwhile, in the realm of jargon, Europe’s insistence on “short-term liquid” contracts, with “third-party” access to all infrastructure, has had two disastrous consequences. The first is that it has encouraged Gazprom to seek long-term contracts with suppliers it already has in its pocket, like the German companies involved in Nord Stream. Gazprom knows that with Germany and its biggest companies – and political donors – on side, exemptions to the “third-party” access rule will probably be rubber-stamped. It will help, when those decisions come to be made early next year, that Germany takes up the EU presidency next month. In any case, the third-party-access rule has also allowed “speculators” into Europe’s strategic energy supply sector. That word belongs to Medvedev, and it cuts to the heart of Europe’s problem. By allowing small companies to get access to big pipelines, traders with no real market of their own have been able to buy Gazprom’s gas. When they can’t sell it on – because they don’t have customers – they sell it back. To Gazprom. And Gazprom passes that cost onto customers. That has been happening for sometime on the TAG pipeline in Austria. Gazprom doesn’t like dealing with these companies. And nor should European customers who end up paying more for their gas because of them. In the background to Gazprom’s objections to Europe’s half-baked liberalisation are its own problems in the upstream. The company hasn’t been spending enough to develop the big fields on the Yamal peninsula, historically the source of its exports. The International Energy Agency believes that Gazprom is under-investing in the upstream by $10bn a year. That means Gazprom must rely on Central Asian gas to meet its own internal Russian demand, as well as its export commitments; making its strategy to prevent Central Asian gas reaching Europe all the more vital. But Gazprom’s need for money in the upstream also forces it to seek long-term contracts with European partners. That is established business logic – but it is logic that is not endorsed by the EU, which is still stuck ideologically insisting that a common, liberalised energy market is the way to secure long-term energy supplies. 2007: More of the same The EU has an opportunity to address all of this in a couple weeks, when on 10 January the Commission unveils its new Energy Review. Its findings will be covered on this blog. But what my sources in Brussels tell me is not encouraging. Genuine alternatives to the zero-sum game of ever-increasing liberalisation will not be part of the Review. There will be no widespread push to develop different energy sources, such as a renewed programme of nuclear energy, clean coal, or strategic prioritisation of LNG terminals. All of those policies would allow Europe to pursue its liberalisation hobbyhorse while at the same time consolidating genuine diversity of supply. But those policies are unlikely to feature in the Review. The Review will probably create a new common energy regulator. And there will be another attempt to force big companies like Eon and RWE to “unbundle” assets in the name of liberalisation. It will call on Russia to open its own energy markets and ratify the Energy Charter. But what it won’t do is get Europe out of its mess. To persuade companies like Mol, E.On or Gasunie to act against their shareholders’ interests and in favour of Europe’s fuzzy strategic goals will require more than fine words about deregulation. That means that 2007 is likely to bring more of the same: Europe worrying about Gazprom, and Gazprom dominating Europe. Europe worrying about its approaching gas supply crisis, and Gazprom repeating, as Medvedev said to me recently: “We are the guarantors of supply.” And so Europe will get more, not less, of Gazprom next year. But what it needs is more, not less of Gazprom’s ability to adopt a strategy, and then execute it. If the EU really wants to know how to build a common foreign energy policy, it shouldn’t be looking to its bureaucrats in Brussels to develop one. It should be watching Gazprom, learning, and then copying.