A Necessary Deterrent to Gazprom

Op-ed in European Energy Review

January 1, 2008

Former German Chancellor Gerhard Schröder travels around Europe, saying that the continent has no alternative to Russian natural gas. That is true, but not quite the issue. The question is not whether European countries should buy Russian gas but under what conditions. There are concerns about predictability of supply in the short and long term.

Thanks to the sharp dispute in the 1980s between the United States and the European Union over the construction of gas pipelines from Western Siberia to Europe, Gazprom felt compelled to be a reliable supplier. Its deliveries to post-Soviet countries, however, have frequently been interrupted because of commercial disputes, and Europe has been hit by Gazprom's sudden sanctions against Ukraine and Belarus.

The long-term specter is that Gazprom neglects investment in development and production, while squeezing out independent producers. It takes over their assets through administrative fiat, or forces them to sell gas to Gazprom at artificially low prices. In short, Gazprom behaves like a crude profit-maximizing monopolist, who wants to control production and transport. It is expansive and wants to manage gas trade in the whole region. For a monopolist, it often makes sense to produce less to be able to charge higher prices, which may explain why Gazprom buys noncore assets rather than expands production. Russia's gas production has actually fallen by more than 1 percent in 2007. Russia's known reserves are immense, but large new supplies from the Shtokman or Yamal fields are not likely to come on line for a decade.

The challenge for the European Union is to form a policy on Russian gas. The Union badly needs a common energy policy. In principle, such a policy exists, but it should be implemented and further elaborated.

The foundation of EU energy policy is deregulation of markets and unbundling. If European energy companies are forced to unbundle, neither they nor Gazprom can form distortional monopolies. German energy companies have persistently colluded with Gazprom, intimidating EU energy security. To impose market conditions within Russia is a greater challenge. Fortunately, Gazprom is the foremost lobbyist for the deregulation of gas prices within Russia, wanting to boost its profits. An additional market obstacle is the large Russian export tariffs for natural gas. In 2004 Russia committed itself to abolish them in its bilateral protocol with the European Union on Russia's accession to the World Trade Organization. The European Union can and should insist on their abolition.

A greater concern is access to Russian pipelines. It is unrealistic to expect Russia to ratify the European Energy Charter, which would grant third party access. Independent gas producers in Russia are becoming ever weaker and can do little to break Gazprom's monopoly.

Thus, the European Union has to find alternatives. Priority should be to build a Transcaspian gas pipeline to tap Central Asian supplies. This will take time and tenacity, but the Baku-Ceyhan oil pipeline, which was also slow in coming, has proved a success. The European Union should welcome the Russian-German Baltic Sea pipeline, because more pipelines breed more efficient markets.

In the shorter term, the European Union needs to build up buffer storage for gas. Since this is hardly commercially viable, such investment needs to be public. The European Union should also expand the role of LNG (liquefied natural gas) as an alternative to the Russian pipeline gas.

Fundamentally, the European Union has a very strong negotiating position. Because of missing infrastructure and excessive transportation costs, Russia cannot possibly sell its natural gas in Western Siberia to Asia, and it has no LNG facilities. Therefore, it has little choice but to sell to Europe, which is a monopolist in relation to Gazprom, while Gazprom is no monopolist in Europe.

Posted with permission from European Energy Review.