Originally published on 2012/12/09

Russian president Vladimir Putin will be happy that the year 2012 is coming to an end very soon. It has not been the easiest or most successful year in his career, nor has it been a particularly good one for the Russian state. Whilst the former KGB-officer secured a third non-consecutive term as president in March 2012, Russians seem increasingly fed up with a lack of liberal reforms,  failure to crack down on corruption and even stronger implementation of authoritarian structures and censorship. Though, more troubling for Putin is the current state of Russia’s most important foreign policy tool: Gazprom, the world’s largest natural gas extractor and the main source of Russia’s budget income, rather than mass protests since December 2011.

Gazprom: A gas-giant in trouble

Whilst natural gas prices have been rising in the last decade, Russia’s coffers were overflowing, allowing the country to repay its international debt and perform a more assertive, at times even aggressive, foreign policy. However, due to lower demand from Europe, the shale gas revolution in the US and increased global competition from more than a dozen LNG-exporting nations, Gazprom has found itself facing severe drops in its annual revenue. A number of important contracts have been renegotiated as E.ON (Germany), Eni (Italy) and PGNiG (Poland) all demanded modifications to existing long-term contracts due to falling global gas prices. Others, such as OMV (Austria), Edison (Italy) and GDF (France) reached similar agreements with Gazprom. The most important modification concerns linking an increased share (usually around 25% of the contracted volume) to spot-market prices instead of maintaining an oil-linked indexation. Not only has Gazprom lost its supremacy in negotiating gas-supply deals, it was forced to make major concession to most of its important trade partners in order to prevent a falling out with them.

The developments on the European market are disappointing, causing problems for Moscow but things are getting even worse. Initially, the EU expected an increase in its gas demand and Russia was considered the single most important source to cover it. Whilst this was good news, it is no longer valid. Russia may remain a major source of natural gas imports, but it is unlikely that gas demands will reach the pre-crisis levels before 2020, maybe even later. To illustrate the gap between estimates concerning gas consumption in 2030 made before andduring the crisis, one can consider the figures provided by Eurogas for EU natural gas consumption by 2030: 625mtoe (2007)  and 500-540mtoe (2010).
Furthermore, due to the EU’s more determined diversification efforts after the last gas crisis in 2009, especially in regards to natural gas imports, more gas will be imported from other suppliers around the world. The number of LNG terminals in the EU is likely to reach around 25, including new terminals in the Baltic Sea region. Both Poland and the Baltic states will then receive LNG from suppliers like Qatar, Nigeria or Angola, whilst the UK and the Iberian peninsula will be turned into major LNG destinations. Even the United States might join the club of LNG exporters, capitalising on its abundant cheap shale gas reserves.

..and then there was shale gas.

Shale gas has been quite a buzz word for energy enthusiasts, in particular after the spectacular shift in the US energy balance resulting in cutting its imports and enabling it to become a net exporter in the near future. Shale gas has had a major impact on US energy consumption and its trade balance (greatly reducing the need to import gas). Other countries are determined to lessen their energy import dependency by replicating the US experience. Not surprisingly, one of the most active supporters of the shale gas exploitation in Europe is Poland, but other countries in the region, such as Lithuania and Ukraine have expressed similar hopes and ambitions. Both Poland and Ukraine have adopted new energy strategies, that include, among others, increasing domestic natural gas production, mostly from shale. Results from test drills in Poland have been mixed, with more positive results in the northern part of the country. However, despite some setbacks, such as a major reduction in shale gas reserve estimates (reduced by around 90% from initial estimates!), Poland is convinced that shale gas production will begin by 2014, and it is likely that its neighbours will exhibit renewed interest in shale gas then. The EIA predicts the largest reserves in Poland, Lithuania and Ukraine, followed by smaller, yet still significant amounts in Romania, Bulgaria and Hungary. Their exploitation would significantly change the market dynamics in the wider Central Eastern European region and would break Russia’s grip over energy supplies.

EU-antitrust case against Gazprom

Shale gas, greater diversification, competition and LNG is not yet the end of bad news for Russia. In September the European Commission announced that it was launching an antitrust probe against Gazprom to investigate Gazprom’s long-term contracts in CEE in order to determine if Gazprom has imposed unfair prices by maintaining oil-linked indexation of natural gas prices and preventing gas trade between importer countries (so-called destination-clauses), thus impeding upon their diversification efforts. Whilst Gazprom has claimed to have adhered to market and competition rules, Moscow seems to have been gripped by panic. All claims aside that Gazprom is an entity registered outside the EU, Putin is fully aware that Gazprom has to face EU antitrust provisions. In order to prevent any harms to Russia’s economic interests – such as forcing Russia to apply fair rules to all consumers instead of exploiting their infrastructural heritage – the new law was passed that forbids Gazprom’s executives to cooperate with the EU without the formal consent of Putin. This will certainly slow down the investigation, but it is unlikely that it will be a successful move for Russia in the long-run, not only because around a dozen of Gazprom-linked offices were raided last year to collect evidence of market distortion, but also because the EU (and its predecessors) has not lost an abuse-of-dominance case since 1958. Putin is right to worry, and so is Gazprom, given that should the company be found guilty, it can be fined up to 10 per cent of its global turnover.

What’s left for Putin? Hope that the global economy will recover in 2013, that China will need more gas and turn to Moscow and the faint hope that in the long-run Gazprom will avoid the fate of Microsoft and others that fell prey to the EU’s antitrust lawyers.

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