EU calls time on the old gas model

In light of EU competition commissioner Margrethe Vestager’s litany of charges against Gazprom today, chief executive Alexei Miller’s speech to the Valdai Club in Berlin on 13 April looks like a last-ditch defence of a business model that has run its course.

Vestager charged Gazprom with imposing destination and anti-resale clauses in its gas contracts, preventing recipient firms from selling the gas outside their home markets. She also accused the firm of charging unfairly high prices in central and eastern Europe, given its production costs or the costs of supply in the market. And Gazprom had used its market dominance to extract promises from some of its customers regarding gas infrastructure, she said.

Miller had claimed that Gazprom charged its German customers the least of all its European counterparties because these German firms were more willing to share the burden of supply security. His implication was clear — central and eastern European buyers paid higher prices because they bore less of the burden. Seen in these terms, linking prices and supply to infrastructure projects is only logical.

Such an argument may have held more water in the early days of the European gas industry, when markets were small and illiquid, and when much of the continent was divided up into a cluster of regional gas monopolies.

But with the development and integration of the European gas market — thanks in no small part to the commission’s efforts to break monopolies’ hold — this logic has looked increasingly shaky.

Since early 2013, Gazprom’s pricing chief Sergei Komlev has argued that the higher prices reflect the value of supply security and flexibility in the firm’s long-term contracts.

But even by that measure, the price Gazprom charged for the service looked high compared with the cost of securing flexibility in the market by other means, particularly given Europe’s surfeit of storage capacity.

And the destination and anti-resale clauses that the commission says Gazprom imposed in the region could have prevented customers from accessing alternatives in the market. Such clauses have historically been used to protect differential pricing. But they also prevent firms from restructuring their supply portfolio in the market. And it is hard to finance new import routes and interconnections with neighbouring markets if restrictive contracts mean that the capacity will not be used.

The commission’s charges against Gazprom are unlikely to provoke its retreat from the European market. Despite EU gas demand falling over the last four years, dwindling domestic production means that its need for imports will grow. Russia is well-placed to provide a substantial part of that supply.

But Gazprom’s sales strategy looks like it will have to change. Komlev has already mooted breaking the link with oil in long-term gas contracts, in return for removing buyers’ flexibility to nominate varying supplies. Norway’s Statoil and Dutch firm Gasterra have already linked most of their contracts to gas hubs.

And, like Statoil, the Russian firm could opt to reduce its exposure to the European downstream — in particular, dealing with pipeline access — by delivering gas to the EU’s borders and leaving its buyers to ship it to their customers.

Such a strategy would be a reversal of its previous plans, in which it pursued a presence at every level of the value chain, with a particular focus on storage and pipeline capacity.

But it would be consistent with Gazprom’s new Turkish Stream project, which will deliver gas through Turkey to Europe’s borders. Gazprom is still obliged to deliver gas to points within Europe, but its customers may be willing to negotiate different delivery points in return for a price cut or spot indexation.

And the strategy would still leave Gazprom with significant market power. Freed of the responsibility to honour varying customer orders, Gazprom would be able to use its substantial storage capacity — both within Europe and in Russia — to withhold gas from the market when prices are too low for its liking. Statoil already explicitly pursues a “value over volume” strategy, with no complaint from EU competition authorities.

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