US-Ukraine Security Dialogue IV
Is Gazprom On the Ropes?
Keynote presentation by US Army War College Professor Stephen Blank, delivered at “US-Ukraine Security Dialogue IV”, American Chamber of Commerce in Ukraine, Kyiv, July 17, 2013.
Draft: not for citation or quotation without consent of the author. The views expressed here do not represent those of the US Army, Defense Department, or the US Government. [In consultation with Dr. Ariel Cohen of the Heritage Foundation]
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. (1)
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 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 Moscow”s and Gazprom”s efforts to concentrate power in Moscow has triggered growing 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 $1 Billion 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. (2) This is hardly Gazprom”s only challenge in Europe. The European Commission is investigating it for multiple and diverse violations of EU antitrust laws. (3) 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. (4)
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. (5) This multiplier effect may or many 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. (6) It also is seeking indigenous sources of shale gas and wants European energy companies to store gas in its underground facilities. (7) 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. Typically, on June 28, 2013, one day after Ukraine announced that it was requesting this underground storage form European firms Gazprom chief, Alexei Miller, announced that Gazprom saw very serious risks for the transit of Russian gas through Ukraine to Europe” if Ukraine does not take proper steps to speed up pumping (Russian) gas into underground storage facilities. He also warned European suppliers not to store gas in Ukraine”s underground facilities, citing Gazprom”s purely negative experience of doing so. (8) But Miller neglected to add that during the third quarter of this year Russian gas costs Naftohaz $400/TCM whereas European gas is some $30/TCM cheaper. (9)
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. (10) Indeed, Lithuania and the other Baltic States have been resisting Gazprom”s prices and practices for several years. (11) And Lithuania”s President, Dalia Grybauskaite openly believes that Gazprom”s plans to raise gas prices to Lithuania by 24% represent a form of political pressure to prevent Lithuania”s energy independence. Therefore Lithuania”s plan to build its own LNG terminal is a justified response. (12) German companies like RWE and EON and Italy”s ENI, and Bulgaria have successfully forced Gazprom to reduce its prices to them. (13) Other governments will emulate them if they have not already started doing so.
In the Caucasus as well Gazprom”s tactics have aroused suspicion and bitterness. Azerbaijan”s June 28 decision to connect to the TAP pipeline might be the least detrimental to Russia of the alternatives that were presented to Baku, but it still opens the way to a dedicated alternative source of gas for Central and Europe and the Balkans. EU Energy Commissioner Guenther Oettinger emphasizes that this decision is a victory for the EU for the key question is not whether gas reaches Europe through Nabucco ending in Vienna or TAP ending in Italy but rather diversifying supplies since there are no border controls for gas and Europe has a single market for gas. Indeed, the EU has helped Azerbaijan deliver gas to it directly despite Russian pressure. Meanwhile other Balkan pipeline projects to ensure deliveries to Balkan states are already in progress. (14) Nevertheless, apparently fearing Russian intervention in the October 2013 presidential elections Azerbaijan made unbelievable promises” to Rosneft (clearly Baku reads the tea leaves as to who in Russia is moving up) about exploring for oil in both Azerbaijan and Russia and on land and in the Caspian Sea. (15) When Moscow hosted a summit for countries exporting gas and did not invite Baku it thus sent an unmistakable signal that was understood along with its ability and past willingness to interfere in Azerbaijan”s domestic politics at a sensitive time. (16) Baku”s moves show the power residing in Russian energy firms that goes beyond the Russian Federation”s borders. But perhaps the most egregious recent case of Gazprom “s interference in another state occurs in Armenia.
Armenia has recently announced that drawing closer to the EU and signing an Association Agreement with Brussels are its main priorities and once that happened Moscow drew up its artillery. Even though EU Commissioner for Enlargement and the European Neighborhood, Stefan Fule, stated that this Association Agreement would in no way affect Armenia”s deep cooperation with Russia, who has a military base in Armenia and controls its energy policy, Moscow announced its opposition to that integration” with Europe. (17) Vyacheslav Kovalenko, Russia”s former Ambassador to Armenia, warned that Armenia would get few tangible benefits from the agreement with the EU while risking alienating Russia because the Association Agreement would preclude Armenia”s entry into Russia”s pet project the Eurasian Economic Community and its Customs Union. Signing the agreement with Brussels would place boundaries between Russia and Armenia and lead to the withering of the current allied relations. (18)
Meanwhile Gazprom seeks to acquire all the shares in the majority-owned Armenian natural gas distribution company and extinguish any leverage Armenia might have as a result. Moscow is demanding Armenia entry into the Customs Union and announced plans for a 60% gas price rise. It settled for an 18% rise but even that might become excessively onerous for Armenia. Yet Russia”s support is crucial if Armenia wants to hold onto Nagorno-Karabakh, where Russia has also, through arms sales to both Armenia and Azerbaijan, demonstrated that it plays both sides against the middle to perpetuate that conflict and its ensuing leverage in the Caucasus. (19) Not surprisingly Armenia”s political opposition party has already denounced Russia”s pressure on Armenia and the potential giveaway of Armenia”s remaining stake in its gas distribution network. (20) It should also be clear to outside observers that Moscow has sought to bring similar pressures upon Kyiv to give up control of its distribution network to Russia in return for membership in the Customs Union and that such a deal, even if briefly led to lower gas prices (and experience shows that this does not, in fact, happen) would also mean the effective renunciation of Ukraine”s ( and Armenia”s) independence. Such tactics clearly explain these states” resistance to Russia and Gazprom, albeit with varying degrees of success.
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. (21) Indeed, Rosneft is buying ITERA, once connected to Gazprom, and seeks to double its natural gas production by 2020. (22) 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. (23) 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 tons that will come on steam by 2016, and create a fundamentally new LNG product; nevertheless Gazprom clearly trails its rivals in the Far East. (24) 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 let them be active in the Arctic, the next great frontier of Russian energy, with China as well as Western companies. (25) Meanwhile Gazprom”s showcase project there, the Shtockman (Stockman) field, has been closed down. (26) Rosneft in particular benefits in many ways. Rosneft and Transneft had already secured $25 billion 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 $6.6 Billion, $15.9 Billion, and $16.2 Billion 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. (27) 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.
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. (28) Indeed, both Putin and Gazprom”s director Alexei Miller claimed that shale gas was essentially a bubble. (29)
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. (30) 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 whom the US does not have free trade agreements. (31) The prospect of US exports and the ensuing creation of a truly global gas market severed from the oil price is 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. (32) 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. (33)
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. (34) 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, 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. (35) In additiion there is an extensive record of linkages between Russian energy firms, orgnaized cirme, 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. (36) 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 dysfunctionality 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 Rusian state”s tax-farmer. Yet its falling profits, stock price, and increasing immobility have led Putin to criticize it and revoke its monopoly. (37) If it is a template than 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 creattures forced to adapt to unpredictable, dynamic, and profound enviornemntal changes, if Gazprom and its sponsors do not adapt, they will be marginalized.
Olga Khvostunova, How Gazprom Snoozed Through the Shale Gas Revolution,” IMR Review, Institute of Modern Russia, May, 2013, pp. 8-9
Pavlo Vuytets, Gazprom vs. Ukraine: New Threats and Consequences,” Kyiv, Glavkom, in Russian, July 2, 2013, Open Source Center, Foreign Broadcast Information Service, (Henceforth FBIS SOV,) July 4, 2013
Nicolo Sartori, The European Commission vs. Gazprom: An issue of Fair Competition or a Foreign Policy quarrel,”? IAI Working Paper, Istituto Affari Internazionali, No. 13/03, January, 2013, www.iai.it;” Alan Riley, Commission vs. Gazprom: The Antitrust Clash of the Decade,”? CEPS Policy Brief, Centre for European Policy Studies, NO, 285, 2012, www.ceps.be
Norway Overtakes Russia as EU”s Biggest Gas Supplier,” www.euractiv.com, June 25, 2013
Idvassiliev, The Choice TAP vs. Nabucco West: Strategic Implications for Central and Eastern Europe,” http://idvassiliev.blog.com/2013/06/22, June 22, 2013, accessed, July 3, 2013
Ukraine to Cut Russian Gas Import Almost Twofold in 2013,” www.rt.com, February 26, 2013; Azarov: Russian Gas From RWE Costs Ukraine $100 Less Than Gas Bought on Border With Russia (UPDATED),” Kyiv post, June 18, 2013, http://www.kyivpost.com/content/business/azarov-russian-gas-from-rwe-costs-ukraine-100-less-than-gas-bought-on-border-with-russia-325
Daniel Bardsley, Region: Ukraine Turns West For Promising Gas Deals,” Prague Post, January 30, 2013, www.praguepost.com; Kyiv, Kommersant-Ukraina, in Russian, July 1, 2013, FBIS SOV, July 1, 2013
Moscow, Interfax, in English, July 3, 2013, FBIS SOV, July 3, 2003
James Kanter, At Anchor Off Lithuania, Its Own Energy Supply,” New York Times,” July 4, 2013, http://www.nytimes.com/2013/07/05/business/energy-environment/lithuania-aims-for-energy-independence.html?ref=gazprom
Ibid; Nerijus Adomatis and Patrick Lannin, Baltic States, in EU, Fight Reliance on Russia Gas,” Reuters, July 5, 2012, http://in.reuters.com/assets/print?aid=INL6E8ETBGU20120705
Vilnius, BNS, in English, July 10, 2013, FBIS SOV, July 10, 2013
Anna Shiryaevskaya, Gazprom Cuts 2013 Gas Export Price Forecast Amid Contract Talks,” Bloomberg, June 4, 2013, http://www.bloomberg.com/news/2013-06-04/gazprom-cuts-2013-gas-export-price-forecast-amid-contract-talks.html; Walter Mead, US Shale Gas Boom Undermining Putin”s Gazprom,” Via Meadia, May 1, 2013, http://blogs.the-american-interest.com/wrm/2013/05/01/us-shale-gas-boom-undermining-putins-gazprom/
Berlin, Die Welt electronic Edition, in German, Jun e 29, 2013, FBIS SOV, July 3, 2013
Baku, Azadiq, in Azerbaijani, July 8, 2013, FBIS SOV, July 10, 2013
Ibid.: Baku, APA News Agency, in Azerbaijani, July 5, 2013, FBIS SOV, July 9. 2013
Moscow, Interfax, in English, July 4, 2013, FBIS SOV, July 4, 2013; Yerevan, News.am, in Russian and English, July 4, 2013, FBIS SOV, July 8, 2013
Emil Danielyan, Ex-Russian Envoy Warns Armenia Over European Integration Drive,” Radio Free Europe Radio Liberty Newsline, July 9, 2013
Giorgi Lomsadze, Gazprom”s Takeover of Armenia,” Eurasia Insight, June 20, 2013, www.eurasianet.org
Marianna Ghahramanyan, Armenians Protest At Sale of Gas Stake to Gazprom,” Asia times Online, July 11, 2013, www.atimes.com; Yerevan, News.am, in Russian and English, May 18, 2013, FBIS SOV, May 25, 2013
Stephen Blank, Russia”s Energy Deals with East Asia: Who Wins,?” www.thediplomt.com, July 3, 2013
Stanley Reed, Rosneft Takes Over Russian Gas Producer in $2.9 Billion Deal,” New York Times, July 2, 2013, http://dealbook.nytimes.com/2013/07/02/rosneft-takes-over-major-gas-producer-in-russia-in-2-9-billion-deal/?ref=gazprom
James Marson, Russian Energy Deals With Asia Mark Shift Away From Europe,” Wall Street Journal, June 27, 2013, www.wsj.com” Rosneft Inks $270 BN China Oil Deal,” www.upstreamonline.com, June 21, 2013; Moscow, Interfax, in English, June 21, 2013, FBIS SOV, June 21, 2013; Neil Buckley, Inside Business: Russia”s Eastern Energy pivot Has Limits, Financial Times, June 28, 2013, p. 14
Russia”s Gazprom Pivoting to Asia,” www.upi.com, June 28, 2013; Moscow, Interfax, in English, May 23, 2013, FBIS SOV, May 23, 2013
Khvostunova, pp. 8-9
Rosneft Inks $270Bn China Oil Deal,”
Patrice Hill, U.S. Gains Global Competition as Shale Energy Revolution Heats Up,” Washington Times, June 11, 2013, http://www.washingtontimes.com/news/2013/jun/11/us-gains-global-competition-as-shale-energy-revolu/print/
Mead; James Marson and Joe Parkinson, In Reversal, Neighbors Squeeze Russia”s Over Natural Gas Prices,” Wall Street Journal Online, May 1, 2013, http://online.wsj.com/article/SB10001424127887324240804578414912310902382.html
Chris Nelder, “Are Methane Hydrates Really Going to Change Geopolitics,?” http://www.theatlantic.com/technology/archive/2013/05/are-methane-hydrates-really-going-to-change-geopolitics/275275/,
Stanley Reed, 3 Foreign Companies Invest in U.S. Project to Export Liquid Gas,” New York Times, May 17, 2013, www.dealbooknytimes.com/2013/05/17/3-foreign-companies …
Stanley Reed, Shell Makes a Heavy Bet on a Boom in Natural Gas,” New York Times, May 2, 2013, www.nytimes.com
Roman Kupchinsky, Energy and Russia’s National Security Strategy,” The Progressive Realist, May 19, 2009, http://www.progressiverealist.org/blogpost/energy-and-russias-national-security-strategy
Anders Aslund, Gazprom”s Demise could Topple Putin,” Bloomberg, July 9, 2010, http://www.bloomberg.com/news/2013-06-09/gazprom-s-demise-could-topple-putin.html
Anders Aslund, Why Gazprom Resembles a Crime Syndicate,” The Moscow Times, February 27, 2012, FBIS SOV, February 29, 2012
Energeticheskaya Strategiya Rossii Na Period do 2030 Goda, Moscow, 2009; The World Bank, The Future of the Natural Gas Market in Southeast Europe, Washington, D.C.: The World Bank, 2010; Open Source Center, Report: East Europe: Overview of Energy issues, Dependence on Russia, FBIS SOV, May 16, 2007; Open Source Center, Analysis: Russian Oil Companies Expand Influence in Balkans With Kremlin”s Support, FBIS SOV, August 7, 2009, accessed on October 9, 2009; Stephen Blank, )”Russian Energy and Russian Security,” Whitehead Journal of Diplomacy and International Relations, XII, No. 1, Winter-Spring, 2011, pp. 173-188
Marson and Parkinson