The West Has Gazprom in its Crosshairs (Part I)
Almost 45 years ago I signed an agreement with Uncle Sam…
The government essentially said it understood my soul may belong to God, but the rest of the anatomy was going to be theirs until further notice.
That was what brought me into a sometimes ill-defined segment of public service. It’s a job you never really have the option of leaving – at least easily and preferably while still drawing a breath.
But over time age takes its toll. That meant I finally got to the point where I could use the memorable Danny Glover line from the Lethal Weapon movies: “I’m too old for this sh – t.”
Eventually, I was shot at less often (as I write this, not since 2003).
But my role in the Great Game was hardly over, because …
My Latest Brush with the Great Game
The most recent geopolitical chess game began with an uprising against one government in Kiev. It then morphed into a statement of Russian nationalism in Crimea, followed by the onslaught of a situation that threatens to descend into a Ukrainian civil war.
Some of the pieces and much of the strategy in this situation have felt very reminiscent of the Cold War.
That, of course, led a number of pundits who had no experience in the contest or who were not of political age at the time to say much that has been both useless and less than serving.
As for me, I found myself all too easily assuming a familiar mantle of a previous age. The Cold War was an unnerving time. Yet at least you got up in the morning knowing what your purpose was going to be that day. The cause and the enemy were well defined.
You also recognized there were folks on the other side doing the same thing. An uneasy balance ensued, making the exercise strangely predictable.
But being brought “back into play” always means that I become aware of – or have a hand in fashioning – aspects of policy development exercised by others.
Of course, this exercise comes with a certain prime directive. Appropriately enough, it is the same one I occasionally must practice when writing OEI.
It’s simple. If I have access to “inside information” on what a company is about to do in the energy sphere, I must wait until it appears in public – any report, newspaper article, or blog post will do. Once that happens, I’m free to talk about it and can fill you in on some of the details.
The same holds true for what may or may not happen shortly in foreign policy. Guys like me need to sit on information and button it until there is an initial release via other means.
That’s exactly what happened yesterday. So here’s some of what I can tell you now…
A Major Attack Against Gazprom is Now Underway
The Bulgarian government has acceded to considerable pressure from Washington and Brussels (the seat of the European Union) to suspend building the South Stream pipeline. From the initial public statements it is clear that officials there are not completely in agreement. Some still hold out hopes that the project can be renewed.
The object is to hit Russian foreign policy where it is weakest, the juncture at which it is most dependent upon the economic actions of others. Moscow cannot sustain its central budget without an expansion of natural gas exports – its largest single component.
And that means, as in all matters relating to Russian energy policy, the West’s target is Gazprom (OTC:OGZPY).
This is Russia’s dominant corporation and the largest natural gas company on the face of the earth. It is always a main cog in national foreign policy. It does not speak on behalf of a Board of Directors, but for the Kremlin itself.
Gazprom is a behemoth, but not a very well-run one. It is bloated, containing far too many unproductive assets having little to do with the gas business (newspapers, a TV station, sports arenas, a food canning enterprise, textiles, an airline, chemicals, timber rights, and on and on).
Even at home, Gazprom has major problems. It has an outmoded domestic infrastructure extending from depleting field drilling, through the largest pipeline network in the world (where there are thousands of leaks daily), to processing and distribution.
It oversees rapidly declining traditional gas fields and has eschewed developing shale gas (but has been moving on another unconventional source, coal bed methane). It also has an increasing problem with budgeting for the huge expenses of moving into Eastern Siberia, above the Arctic Circle, and out onto the continental shelf (which Moscow argues goes all the way to the North Pole) to offset what by 2020 is probably going to be an 8% annual decline in production at maturing fields.
For both politically astute CEO Alexei Miller and his real boss, Russian President Vladimir Putin, expanding Gazprom and balancing the budget can only happen with increased outside sales of gas.
Vladimir Putin’s Dilemma
The most important element here is simple: Without increasing the annual sale of gas abroad, both Gazprom and the Kremlin are in deep trouble.
And while the recent accord with China has been ballyhooed by Russian media (and officials) as a major step in that direction, two things need to fall into place. Otherwise, the agreement will more likely turn into a decades-long millstone around Gazprom’s neck, rather than a lifeline.
First, both parties must conclude essential elements of pricing and volume, take or pay provisions (requiring the end user accept a certain amount each month or pay as if it has), and the basket of crude oil and oil products used to determine pricing adjustments. I recently addressed these issues in this article: The Achilles Heel of the Russian-Chinese Gas Deal
Second, the Chinese contract is not a breakthrough for the Russians unless it leads to a significant increase in overall exports. That, in turn, cannot take place unless Gazprom continues to improve its market position where it currently sells most of its exports.
There, the Ukrainian crisis and Russia’s continuing refusal to follow the provisions of the Energy Charter Treaty (ECT) and the Transport Protocol (TP) have combined to create a major problem for Gazprom.
ECT requires that all signatory nations separate their domestic companies producing gas from those transporting it. Further, TP obliges that each nation make its domestic gas pipeline system open to outside third parties. Despite having signed the treaty, Russia flatly refuses to either break up Gazprom or allow outside access to its pipelines (administered on behalf of the state by Gazprom on a monopoly basis).
Bulgaria is a member of the EU and Brussels (with some very h3 U.S. backing) has played its ECT hand in compelling Sofia to suspend building its South Stream pipeline interconnection. That onshore segment just happens to be the most critical piece in the entire project.
In all, South Stream is the most expensive pipeline ever conceived. Depending on whose figures you accept, it will cost almost $30 billion,or is now way over that total (my own view is it is well above $32 billion and counting). It is designed to move Russian gas beneath the Black Sea into Southeastern Europe and beyond.
Unless it is built, years of work and significant capital resources will have been wasted. Russia will not be able to bypass Ukrainian throughput to Europe (where the failure of Kiev and Moscow to agree on payment of Ukrainian energy debts again raises the prospect of the gas being turned off to Western Europe), and Gazprom will lose its grip on the European market.
In this high-stakes collision, Gazprom’s lack of leverage is showing.
There are now two other countries about to provide additional roadblocks to South Stream, an existing pipeline network into Northern Germany is coming under pressure, and additional sourcing is moving into place. All of this is descending rapidly on Gazprom.
How all of this could unwind a bold Russian initiative, create the risk of a significant budgetary constriction in Moscow, and undermine an entire pipeline strategy, is where we are going in the next issue of OEI. What’s at stake here is about as serious as it gets.
But I’ll give you a little hint upfront…
It has to do with a certain piece of perceptive Italian writing from some four centuries ago. It just might provide us with the way to stop energy from becoming the catalyst for an even bigger global crisis.
History is often like that.