Gazprom seen moving away from supplying end consumer

By bne IntelliNews January 25, 2015

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Gazprom's cancellation of the planned South Stream pipeline from Russia to Bulgaria and onward to the EU marks a fundamental change in policy for Gazprom, find leading experts in a new report, because the state-owned gas group will go back to what it does best – finding and moving gas.

According to Jonathan Stern, Simon Pirani and Katja Yafimava of the Oxford Institute for Energy Studies - the leading international experts on Russia's energy sector - Gazprom's cancellation of South Stream is only one part of a wider shift indicating Gazprom has abandoned its decade-old strategy of trying to sell gas directly to European consumers, and will revert to its traditional core competence of extracting and piping gas to its neighbours.

Overlooked at the time it may have been, but Gazprom's CEO Aleksei Miller announced this global shift at the same time as announcing the cancellation of South Stream. “The principle of our strategy in relation to the European market is changing. The decision on stopping South Stream is the beginning of an end to our operation model of the market within which we oriented ourselves towards supplying [gas] to the end consumer,” Miller said in comments to press, as quoted by Interfax.

“But you can’t win love by force. If the buyer doesn’t want the purchase to be delivered home, well then perhaps he needs to get dressed and go to the store, and if it happens in winter, get dressed warmer," Miller continued in ironic vein.  "Well he could also take some package…which can well be the Third Energy Package, but what counts most is that it should not be empty,” he added sarcastically, referring to EU competition legislation introduced in 2011 in the energy sector that requires energy suppliers and distribution network owners to be unbundled – effectively barring Gazprom from supplying gas directly to consumers in Europe.

The South Stream cancellation was only one episode that showed Miller meant business in dropping Gazprom's long-standing strategic goal of supplying gas to European consumers: in 2014 Gazprom also dropped the fight to supply 100% of capacity in the OPAL pipeline, connecting Gazprom's Nordstream pipeline to the European network, and abandoned an asset swap with German chemicals giant BASF, which would have given it control of the Wingas joint venture that sells gas to industrial consumers on the European market.

“All of this is consistent with the announcement by Alexey Miller that the company is abandoning its long held strategy of direct sales to European end-users,” the Oxford Energy analysts now write, adding, “[Gazprom] no longer has aspirations to invest further in mid- and downstream energy assets.”

“This firmly closes the door on any possibility of a 'strategic partnership' between Russia and Europe on gas, and places the trade at the level of a `commercial partnership’ ie if Russia has gas to sell and Europe wants to buy, then trade will take place, but there will be no deeper economic or political commitment to facilitate trade,” the authors believe.

Paving the way to the decision was the signing of a mega-deal with China in May 2014 to supply 38 billion cubic meters per year to China, with a second contract waiting to be signed in 2015 for 30 billion cm per year via a 'western' pipeline to transit Russia's Altai region. This would take Russia's total supplies to Asia – including the existing LNG deliveries from the Pacific coast Sakhalin LNG project - to over 80 billion cm/year by the early 2020s - roughly half of Gazprom's total exports - thus putting an end to the EU's hitherto privileged position as main market for Russian gas.

A subsection of the story is Gazprom's self-perceived inability to gain security for its transit to Europe via Ukraine, for which purpose the South Stream project was intended. Now Gazprom plans to build Black Sea pipelines to transit gas to Turkey, where the gas will be sold to the EU at the Turkish-Greece border. “The 'store' [where Europe will buy its gas] is certainly the delivery point on the Turkish-Greek border,” Miller said in December.

This also entails Gazprom boosting supplies to Turkey, currently its second most important market after Germany, but the one with the most growth potential. But the Oxford analysts don't believe Gazprom can currently raise the financing to build the four pipelines to Turkey needed to entirely replace Ukraine's gas pipeline in supplying Southern European customers, along with onwards infrastructure to be built on the EU side - meaning that Ukraine could continue to transit Russian gas beyond the 2020 cutoff point named by Miller.  "A significant Russia-Ukraine transit relationship will need to be maintained,” the authors believe.

The experts see the shift in Russia's gas policy as an economically justified return to Gazprom's roots and core competence – extracting gas under difficult natural conditions and moving it via vast pipelines to neighbouring national markets, without distractions such as upstream and LNG. “An irony of the post-Ukrainian crisis period may be that a combination of western sanctions, EU regulation and the breakdown in EU-Russia relations, may have pushed Russia and Gazprom into a much more logical commercial strategy for gas exports,” the report finds.

And far as international relations go, the shift might also lessen friction between the EU and Russia over Gazprom's unrequited love for the European market – generally seen in Europe as a Russian imperialist design to gain leverage over the EU – and over the Ukraine transit route, but at the cost of lessening mutual interdependence between the two neighbours. 

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