Russia: Winning A Battle, Losing the Gas War
On the face of it, the failure of the Nabucco pipeline is a humiliating blow for the European Union (EU) and a triumph for the Kremlin. Nabucco — named after Verdi’s great opera about freedom from enslavement — was a flagship project, hatched in 2004, to bring gas from the Caspian and Central Asia to Europe, via the Caucasus, Turkey and the Balkans. Nabucco exemplified the EU’s desire to create a “Southern Corridor” for gas, matching the one successfully created for oil with the Baku–Tbilisi–Ceyhan (BTC) pipeline in 2005. The aim in both cases was a fine one, to break the Kremlin’s grip on East-West energy supplies. Now Azerbaijan says it will not supply gas to Nabucco. Russia is pushing ahead with its rival South Stream pipeline to take Russian gas to Europe. Game over?
Not a bit of it. For a start, Nabucco was never as important, or as good as its fans maintained. With a planned annual capacity of 10 bcm (billion cubic metres) initially and 20 bcm eventually, it was too small to make a real difference: Europe’s annual gas consumption is around 500 bcm, of which Russia provides about a quarter. Nabucco was too expensive to succeed without strong political backing. But that was not forthcoming. Governments hard-hit by the recession had other priorities. Changes in the gas market undermined the pipeline’s economics further. It was unclear where its gas would come from, or who would buy it. In short, Nabucco was a nice line on the map, but not a serious energy project. It mattered mainly as a symbolic challenge to the Kremlin’s plans.
Though Nabucco may be dead, the Southern Corridor is not. The shorter, cheaper, Trans-Adriatic Pipeline (TAP), which runs through Greece to Italy, rather than through the Balkans to Austria, is now the favored recipient for Azeri gas. Since Greece sold its gas grid DESFA to the Azeri state oil company in June, the case for TAP has been overwhelming.
But that sale illustrates a second and much more important point. Until recently, a large energy privatization in Greece would have been an irresistible target for Gazprom. Russia has excellent links with Greece, and has been trying hard to strengthen its position in the Balkans. But the European Commission has put Gazprom on the back foot. It has launched a major investigation against the Russian gas giant for market-rigging. It has also created a far tougher legal environment for its business model. Gazprom complains, for example, that it cannot use its Nord Stream pipeline in the Baltic Sea to its full potential because EU competition rules prevent it from using the Opal onshore pipeline to the Czech Republic. Constructed at vast expense in 2009, Nord Stream is now running half empty.
This highlights the way that Gazprom has hugely underestimated the power of the EU Commission. It assumed that Russia’s close political ties with Germany and other countries made its business model invulnerable. In fact, it presented an irresistible target to the zealous officials of the Energy and Competition directorates in Brussels. A bundle of measures known as the Third Energy Package prohibits gas companies from operating both distribution and long-distance transport networks. It also makes it illegal to charge different prices to different countries.
Unfortunately for Gazprom, this approach is the basis of its business. It charges high prices to countries that have no alternatives (like Lithuania) and much lower ones to those that have alternatives (like the Netherlands). The initial EU investigation is thought to have attracted complaints and other information from energy companies that have been victims of Gazprom’s monopolistic and market-abusive practices in past years, but were too timid to speak. This will help beef up the Commission’s formidable “statement of objections” (in effect a writ) against Gazprom, due to be issued later this year.
Another political miscalculation on part of Gazprom was on the way that the EU would react to the unreliability (political and technical) of Russia’s gas deliveries. A series of rows with Ukraine, coupled with high domestic demand during harsh winters, led to several supply interruptions — most notably in 2009 — which hurt households and businesses severely.
This shock forced the EU to take energy security more seriously. The fruits of that shift in policy are new gas interconnectors — between Poland and Slovakia, Slovakia and Hungary, Hungary and Romania, and so on. When completed, these will form a North-South gas grid between the Baltic Sea and the Adriatic.It will make it hard for Russia to cut off individual countries and much easier for the countries of the region to trade gas with each other. In effect, these interconnectors demolish one of the last remaining physical legacies of the Soviet empire in Europe.
Gazprom’s woes are also compounded by its misreading of the gas market. It believed that the future lay in pipeline-delivered gas from conventional gas fields. It completely underestimated the effect of America’s development of shale gas. Though the United States does not export natural gas (if it does so from 2016 onwards, Gazprom will be in even greater trouble) the new abundance of domestic gas supplies means that America does not need to import any. This shift came just as large amounts of natural gas have come on stream in places like Qatar.
As a result, the price of liquefied natural gas (LNG) has plummeted. So too has the cost of the infrastructure needed to obtain it. LNG terminals used to cost billions. Now they start at around $200 million. A gasification ship, which can be hooked up to the domestic network to turn liquid gas into usable supplies, can be rented for $50 million annually. This puts LNG within the reach of even the smallest countries.
Even worse for Gazprom, Europe is facing its own shale gas revolution too. This could, perhaps within a decade, turn Europe into a gas exporter. Looming new gas suppliers include Kurdistan (technically part of Iraq, but increasingly close to Turkey) and the gas fields of the eastern Mediterranean.
In the face of this gloomy outlook, Russia’s strategy has been to press ahead with new pipelines. But these look increasingly like irrelevant and costly boondoggles. Why spend billions of dollars building South Stream (or doubling the capacity of Nord Stream) in order to deliver costly pipeline gas which cannot compete with LNG (and, increasingly, with European shale gas)? One answer is the weakness of Gazprom’s top management, and the illogical political constraints under which they operate. But a more plausible explanation is corruption. New pipelines may not be a very good way of getting gas to customers, but even before they are built they can be an excellent way of putting money in the hands of officials, politicians, regulators and others. Russia may be bad for Gazprom’s business. But Gazprom can be quite good for Russia’s.
Belatedly, Russia may now be waking up to the importance of shale gas. It also hopes for a tighter gas market eventually, perhaps from big increases in demand in China (or even in Saudi Arabia, if the Kingdom decides to stop burning oil to generate electricity). But it is perilously late for Gazprom, which has already seen its share price and market share plunge. Its market capitalization is below $100 billion for the first time since the disasters of 2009. The Kremlin is now playing a defensive game in energy, reduced to trying to shore up its hold in places like the Baltic States or the Balkan Peninsula, rather than using its mighty energy weapon to determine the future of the European continent.
Edward Lucas
This article first appeared in the July edition of Central Europe Digest, a monthly periodical published by the Center for European Policy Analysis (CEPA)
CEPA Senior Fellow, Edward Lucas, makes a compelling case for why Gazprom is losing its footing in Europe. Failure to foresee the EC’s response to the unreliability of Russian gas supplies and a misreading of the ongoing shifts in the gas market have forced the Kremlin to play a defensive game in energy, Lucas concludes.