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The Attack on Gazprom (Part II)

by | published June 12th, 2014

As I write this, we are facing a far worse development elsewhere in the world: Iraq is now in a full-blown crisis and oil prices are on the rise worldwide.

This morning, oil futures in both New York and London are reaching levels not seen in a year.

This is serious business. In fact, I’ll be discussing the troublesome implications of this crisis on Fox Business today at about 4:40 p.m. Eastern and later this evening live on Chinese national television, ahead of the open on the Asian markets.

And don’t worry. I’ll be sure to address the rising instability from the events in Iraq in the next regular issue of OEI. So stay tuned.

But first, I’d like to finish our discussion of the Western attack on Gazprom…

Gazprom is in the Crosshairs

As you know, I introduced the problem facing Russian natural gas major Gazprom (OTC:OGZPY) in the last issue of OEI. As noted on Tuesday, it has to do with Bulgaria’s decision to suspend work on the South Stream pipeline.

That suspension came only after some concerted pressure from both the European Union and Washington. And by placing this roadblock to a very expensive and essential piece of Russia’s export infrastructure, the West had begun its most concerted economic retort on the Ukrainian crisis.

Then right on cue yesterday, Kiev rejected Gazprom’s offer of $385 per 1,000 cubic meters (about $10.90 per 1,000 cubic feet). The price is the base for current contracts with Europe and that is disconcerting at EU headquarters in Brussels. That’s because it means the price is going up for throughput gas across Ukraine to Western Europe.

Now given how it is calculated, that price would have been going up anyway. The long-term contract between Gazprom and European end users dictates that the price is periodically reviewed and set based on a basket of crude oil and oil product prices. As oil goes up (as it has been doing), natural gas necessarily follows suit.

But the wider policy area is now providing some additional pressure on Gazprom.

Recall from the previous discussion that the company and the Russian central budget require an expansion of natural gas sales or financial problems will emerge. And remember, the Chinese agreement is still without specifics and, even if it results in a favorable price for Russia, it must be combined with improving exports to Gazprom’s main end user-Europe.

After the emergence of the Ukrainian mess, that is becoming unlikely.

Both the European Union and the U.S. now blame Moscow for the Russian annexation of Crimea and the resulting ethnic unrest in a wider area of Eastern Ukraine. Initial economic sanctions have merely set the stage for the real target.

Gazprom.

Of course, the Russian argument for years has been a consistent refrain. Moscow is a trusted energy partner, this mantra goes. The problem has been the actions of transit states.

For instance, former Soviet state and now independent Belarus had created uncertainty over the pricing and volume on the Yamal pipeline crossing its territory into Poland.

Gazprom solved that issue by moving to control Belarusneft and the Belarusian pipeline system.

But the Ukrainian situation was something else again. Even with a pro-Russian president in Kiev, Russian attempts to control the domestic Ukrainian pipeline system were rebuffed. Disputes over gas debts and Russian charges that Ukraine had been siphoning off throughput intended for Europe later resulted in two “gas wars.”

One of these resulted in Gazprom cutting off supplies moving into Ukraine during a bitterly cold January in 2009. The EU responded by immediately looking for ways to diversify its energy supplies.

For its part, Moscow claimed Kiev had created the problems and began building bypass pipelines from Russia directly to Europe. The first – Nord Stream – is now moving gas from Northern Russia to Northern Germany. The second is South Stream.

Without both of these pipelines, the Russian attempt to balance the east-west exports of gas between China and Europe will fail. And that translates into significant revenue loss for both Gazprom and the central government dependent upon its sales abroad.

That’s why the West’s current moves against the Kremlin center on South Stream. As noted on Tuesday, this is already the most expensive pipeline project ever attempted, one that has required Moscow to redirect much of its domestic gas transport network.
Bulgaria’s decision to suspend work on its onshore connector line for South Stream into Southeastern Europe is a major blow to Gazprom.

But it is not the only one coming…

Turning Up the Heat on the Russians

There are limited options for the Russians to get around this bottleneck. At present, Romania is the most likely alternative. Unfortunately, Bucharest is earmarking its efforts for a liquefied natural gas (LNG) project through the port of Constanta (the Azerbaijan-Georgia-Romania Interconnector, or AGRI).

But there is also another way that Romania upsets South Stream plans. With the annexation of Crimea, Russia no longer has to worry about Ukrainian offshore Black Sea permissions for the underwater portion of South Stream. Yet it still must contend with two other countries for those rights or the gas will never make a European onshore connection (even, after the Bulgarian decision).
One is Romania and the other is Turkey. Russia cannot move gas via South Stream without at least one of these countries providing offshore water zone access.

Unfortunately for Russia, Romania is a member of the EU. And both Romania and Turkey are members of NATO.

For the first time, there is a general consensus that the billions of dollars already spent on South Stream may have been for naught. Until an accord is reached with the West, the project at best is now delayed for years.

As a result, Gazprom’s bottom line will surely suffer.

So what should the real object be in this exercise of global politics?

The truth is that Brussels (the headquarters for both the EU and NATO) as well as Washington need to be careful here. Given its major contracts and business relations with principal utilities and end users in Europe, any attempt to cripple Gazprom would be counterproductive.

The goal is to inflict economic pain, not create a fatality.

That, in turn, reminds me of the wise counsel given almost five centuries ago by the Italian strategist Niccolo Machiavelli. In his Discourses (…on the First Ten Books of Titus Livius’ History of Rome), the great thinker poses the question of what makes for a good general.

He concludes that an able commander positions his troops so they cannot retreat but always allows his opponent a way to withdraw. As Machiavelli notes, “You win more battles by allowing the adversary a way to withdraw rather than pushing him against a mountain and forcing him to fight.”

So the task now is to drive home the point using South Stream as the focus, and bring the Kremlin to compromise – not to destroy Gazprom.

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  1. G. Goss
    June 12th, 2014 at 21:53 | #1

    Dear Dr. Kent Moors, 12th June 2014
    With the ongoing Ukraine crisis amongst others in the World, How safe is it for Americans to invest in Montenegro. It is a small beautiful country, that seems to have many lucrative projects to invest in. However, I am concerned about rapidly changing events in the World and How that may affect Americans investing in South Eastern Europe. I enjoy your takes and insight as You paraphrase current ongoing events around the World.
    With kind regards, Mr. G Goss (gG)

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