Today, across Europe and Asia, Gazprom, Russia’s flagship gas company and a major instrument of its domestic and foreign policies, confronts serious challenges. Gazprom’s difficulties are inherent in its character as the Russian state’s agent for both domestic and foreign policies. In a patrimonial, even kleptocratic service state like Russia’s, a corporation like Gazprom, by definition cannot react to market changes with sufficient flexibility or rapidity. As a result, it has rashly dismissed the advent of shale gas as a bubble, expanded capacity in its huge South Stream project even as European consumers retrench or gain access to other suppliers, failed to capitalize on the Arctic’s impending boom, and has been late in signing contracts with East Asian states.
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Gazprom’s challenges stem from the confluence of global energy trends with its own inflexible and unresponsive policies regarding those changes in global energy markets, and its domestic structure and purpose that actually drives much of its foreign policies that have been so unresponsive to international trends. Gazprom exists, first of all to satisfy the political needs of the Russian state, not to act as an independent, normal business. Instead it functions as an instrument for raising tax revenues for the government and extending its power abroad and domestically. In many ways, then, Gazprom greatly resembles a medieval or early modern tax farmer, i.e. a servitor at the Tsar’s court who receives a monopoly franchise to sell one or another form of agricultural produce to raise taxes for the Tsar and support itself. Under the circumstances it is not unduly surprising that Gazprom, like these tax farmers, cannot and will not act according to market logic but rather seeks to isolate or itself from or suppress that dynamic market by displays of political power. Neither is it unusual that Gazprom, when it confronts resistance from supposedly weaker players, e.g. Ukraine, employs harsh language, threats, and intimidation, against Kyiv. Nor is it unexpected that in their efforts to concentrate power in Moscow’s hands that both Gazprom and the government face a mounting resistance.
Recently Gazprom has lost several court cases in Europe, most notably to the German firm RWE, and must pay large fines. It can pay the fines but in a display of spite announced that it would no longer advance Kyiv payment for transit of gas or give Naftohaz, Ukraine’s failing gas company, a down payment of USD 1bn to pump gas into underground storages. Clearly this is punishment for Ukraine’s resistance to Gazprom and Moscow’s attempted takeover of Naftohaz and ensuing control of Ukraine’s gas distribution network, and Ukraine’s independence. This is hardly Gazprom’s only challenge in Europe. The European Commission is investigating it for multiple and diverse violations of EU antitrust laws. Similarly, in 2012 Norway overtook Russia as the EU’s biggest gas supplier, a process and trend signifying an overall European decline in gas consumption due to decreasing demand and increased energy efficiency. In fact, even European and global trade in liquefied natural gas (LNG) declined.
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On June 28, 2013 Azerbaijan announced it would ship gas to Europe through the Trans-Adriatic Pipeline (TAP) through Turkey Greece and then Italy. While this decision leaves Bulgaria, Hungary, Romania, and possibly Serbia open to South Stream, Gazprom’s huge Southeast European project, at least some analysts believe that Azerbaijan’s decisions will, over time, not only, provide the only viable alternative to South Stream for Western Balkan states and Central Europe but could also produce a multiplier effect to tilt the Balkan gas balance away from South Stream. This multiplier effect may or may not come about. But there is no doubt that Gazprom is on the ropes as well in Eastern Europe.
Ukraine, fully grasping the danger looming to it from South Stream which cuts it out of European supply networks and leaves it dependent on Moscow with no recourse to outside support, has dramatically cut its imports of Gazprom’s gas since 2012 and has turned to other suppliers who sell it gas at prices substantially lower than what Gazprom offers. It also is seeking indigenous sources of shale gas. Clearly Kyiv has decided to reduce Ukraine’s exposure to Gazprom’s exorbitant price demands and regressive and inflexible take or pay long-term contracts. Ukraine’s increasingly effective resistance to Gazprom is not an isolated event. Rather it is part of a broader European picture. Lithuania too has just acted vigorously to reduce the amount of Russian gas, Gazprom’s political influence, and behind it Moscow’s influence in Lithuania. Indeed, Lithuania and the other Baltic States have been resisting Gazprom’s prices and practices for several years. German companies like RWE and EON and Italy’s ENI, and Bulgaria have successfully forced Gazprom to reduce its prices to them. Other governments will emulate them if they have not already started doing so.
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Gazprom’s troubles also have serious repercussions for Russian policies in Asia and Russia itself and are mutually reinforcing. Domestically Gazprom, with President Vladimir Putin’s support, has lost its export monopoly in gas thanks to Russia’s recent major deals with China. Indeed, Rosneft is buying ITERA, once connected to Gazprom, and seeks to double its natural gas production by 2020. Gazprom’s loss of monopoly standing undermines its ability to advance Russia’s foreign policy and demonstrates its declining domestic power. As these deals with China also show, although Gazprom says it is pivoting to Asia, the new Promised Land for Russian energy and foreign policy, there is still no gas deal with China despite constant earlier announcements that a deal was imminent. While there are offers on the table with Japan; no tangible breakthroughs in gas have occurred and the deals that have been negotiated are with Rosneft. Meanwhile most energy deals with South Korea remain stalled. Gazprom may be establishing a special-purpose company to oversee development of LNG in the Far East with a capacity of 15 million tonnes that will come on steam by 2016; nevertheless Gazprom clearly trails its rivals in the Far East. Indeed, Gazprom’s entire record since 2000 reveals a consistent disinclination to sell gas to the Far East that has allowed its rivals to prevail over it.
Furthermore the deals that China has made with Rosneft and Novatek, Gazprom’s rivals lets them be active in the Arctic, the next great frontier of Russian energy, with China as well as Western companies. Meanwhile Gazprom’s showcase project there, the Shtockman field, has been closed down. Rosneft in particular benefits in many ways. Rosneft and Transneft had already secured USD 25 bn from China in 2009 to build the East Siberian Pacific Ocean oil pipeline (ESPO) and cover their huge indebtedness. Since then by acquiring the TNK-BP energy firm Rosneft had again incurred huge debts that this deal with China will alleviate. Reportedly it faced debt maturities between now and 2015 of USD 6.6bn, USD 15.9bn, and USD 16.2bn annually so this new infusion greatly improves its balance sheet and allows it to show a real cash position and minimize future financing risks even though its working capital will be negative. In addition Rosneft is clearly the primary energy provider and exporter for the Far East and Asia. As this area becomes ever more vital a market for Russia, Rosneft’s political standing vis-à-vis its declining rival Gazprom will probably grow. Certainly, Rosneft’s improved cash position and the politically robust leadership of Igor Sechin, who remains close to Putin, gives it many advantages vis-à-vis Gazprom.
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Gazprom’s woes stem from its unresponsiveness to market signals. The discovery of shale gas and the emergence of LNG, a sector in which Russia is years behind its competitors, have stimulated an abundance of suppliers to Europe who can supply Europe with LNG or ordinary natural gas at much more realistic prices, e.g. Qatar and Algeria. In a few years the United States could join them if it begins to export shale gas in 2016 as is now being discussed and planned. Indeed, the plans to export shale gas from the U.S. are already taking shape. Russia’s government and Gazprom were and are still slow to recognize the significance of LNG and especially of shale. Although Moscow now talks about plans to move more and more exports from the Arctic as LNG and was found to possess huge shale reserves, perhaps the largest in the world, it is n no position to exploit those holdings. Indeed, both Putin and Gazprom’s director Alexei Miller claimed that shale gas was essentially a bubble.
The shale gas revolution and continuing discovery of new sources, e.g. methane hydrate and other forms of methane gas, call Russia’s future ability to export energy at competitive prices and dominate regional or international markets into question. Similarly the recent US decision to allow the export of LNG represents a serious potential threat to other exporters like Russia. Foreign firms are already attracted by the US shale gas boom. Mitsui, Mitsubishi and GDF Suez of France each plan to take a 16.6% stake in an LNG project at Hackberry, LA. And this was before the U.S. government agreed to allow exports from a Texas project to export LNG to countries with which the US does not have free trade agreements. The prospect of US exports and the ensuing creation of a truly global gas market severed from the oil price are also likely to threaten Russia because it could lead to a serious plunge in the price of gas as sold in both Europe and Asia thereby cutting into the profits of Gazprom and Rosneft. But these foreign trends only menace Gazprom’s standing because of the way in which it is organized, constituted, and employed on behalf of Russian policies. There can be no doubting that Gazprom is first of all a political instrument as Russia has repeatedly proclaimed in its energy strategies of 2003 and 2009 that it is energy which is a crucial determinant of its global standing and capability.
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Thus Gazprom’s performance is integral to Russia’s international standing but also to the government’s ability to maintain its budget and fund its programs. Indeed, some analysts now openly speculate about its demise and with it the Putin system’s collapse. Naturally this means that Gazprom is one of the most closely supervised of all Russian state agencies. Arguably its management is a template for other agencies given its centrality to so many aspects of Russian policy. In practice, as Anders Aslund has written, is that Gazprom, perhaps the key foreign and economic policy instrument of the government, is run in a way that either resembles or is that of a organized crime syndicate. In addition there is an extensive record of linkages between Russian energy firms, organized crime, political subversion projects, and influence peddling from the Baltic to the Balkans if not beyond. Indeed, Russia makes no effort to hide the fact that its energy policies are a lever for acquiring enduring positions of political influence in Balkan governments. And as Ukrainians well know (and not only in Ukraine) the same principle holds true there as it does throughout Eastern Europe. But Gazprom’s domestic dysfunctional stems not only from its large-scale criminal-type behavior. Indeed, that behavior is the logical outcome of the structure and purpose of Gazprom as the Russian state’s tax-farmer. Yet its falling profits, stock price, and increasing immobility have led Putin to criticize it and revoke its monopoly. If it is a template, then the entire state is vulnerable to the same challenges. While it is probably far too early to count out Gazprom or Putin, the handwriting may already be on the wall. Like all other creatures forced to adapt to unpredictable, dynamic, and profound environmental changes, if Gazprom and its sponsors do not adapt, they will be marginalized.
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Stephen J. Blank is Senior Fellow at the American Foreign Policy Council (Washington) and expert on global energy security. He is the author of the book Russo-Chinese Energy Relations: Politics in Command published in 2006