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1 | Dr. Jonas Grätz | 20. September 2013

The impact of EU law on Gazprom and its implications

Platts 7th European Gas Summit, Vienna

Dr. Jonas Grätz

Center for Security Studies (CSS)


1. The EU’s key goal is to lower the economic and political costs of gas

supply.

2. The EU Commission has learned to leverage the buying power of

the internal market. Regulations and their enforcement are being

used as a bargaining tool to assert the EU’s political and economic

interests.

3. EU policy is creating greater uncertainty, but this is partly intended.

It does not necessarily jeopardize security of supply.

4. Gazprom is fighting a rearguard battle. A change of Gazprom’s

strategy is likely after a management change.

5. Ukraine will stay the major transit corridor.

Theses


EU:

Interest: uninterrupted,

affordable supply at a low

political cost

Tools: large demand base, rules

and regulation

Russia:

Interest: maximize the product of

resource rents and political

control

Tools: resources, state monopoly

capitalism

The strategic setting

mutual dependence


Leveraging domestic demand by setting rules for suppliers is the only

way to lower political and economic costs in current strategic setting.

Backward vertical integration would be ideal, but is politically impossible.

Traditional “bilateral monopoly” faded away (Gazprom made inroads into

German market, already captive markets in CEE).

due to lack of reciprocity, the consequence would have been forward

vertical integration by suppliers. This is especially problematic in the gas

industry due to high entry barriers. CEE / Baltics as a showcase.

Organising a market by way of regulation is ideal to fend off growing

supplier power and diversify supply.

Attractiveness of the EU market and rigidity of gas supply-demand

relationships are a plus.

Substitutability of gas as a fuel is a further case in point.

The rationale of the EU’s marketisation agenda


Traditional Gazprom supply

monopoly

Baltics accepted Gazprom as

shareholder in their utilities in return

for long-term supply contracts and

reduced price.

But: Prices are among the highest in

EU, for Lithuania the highest

This was major trigger for EU

antitrust case

Arena I: Unbundling in the Baltics (I)

Source: EU Quarterly Report on European Gas Markets Q 2 2013


Lithuania and Estonia went for full ownership unbundling and were

supported by Commission.

Spin-off of TSOs from gas utilities realised in August 2013, Gazprom

voted for spin-off amid protests about “robbery” and “expropriation” from

Gazprom.

Gazprom still owns part of the TSOs.

Sell-off of TSO to be completed in 2014 in Lithuania, 2015 in Estonia.

BIT with Lithuania may protect Gazprom, currently challenges

Lithuania before UNCITRAL tribunal.

EU jurisdiction over common market is being leveraged jointly by

small Baltic States and the EU Commission.

Implementation of EU rules may run counter to legal obligations

towards third countries (but BITs often allow for compensated

nationalisation).

Arena I: Unbundling in the Baltics (II)


Exemptions from unbundling and

TPA are possible for new

pipelines, but must meet a range

of criteria, inter alia that risk

would be prohibitive without

exemption.

Gazprom and its partners applied

for exemptions for OPAL and

NEL pipelines.

OPAL: 35 bcma capacity

NEL: 20 bcma capacity

Arena II: Third Party Access for Nord Stream

Source: Wingas


NEL was not exempted, as it is not a cross-border pipeline. 65% of

capacity are allowed for long-term capacity booking. No upper bound

for bookings from Gazprom under shorter-term contracts.

OPAL was granted a conditional exemption (legally shaky)

Gazprom is allowed to use full capacity if it organizes annual gas release

programme of 3 bcm. Otherwise 50% of capacity have to be auctioned off

to third parties.

Gazprom shunned gas release, currently uses only 50% of the pipeline.

Hence, Nord Stream goes underutilised (mostly 40% of capacity).

Gazprom has been in negotiations with the Commission to amend

the decision, purported breakthrough in last week

As investment has been sunk before exemption decision, Gazprom is

in weak position. EU tried to further its interests in this context.

Conditional exemption from TPA may actually be worse than TPA.

Arena II: TPA for OPAL and NEL


Russia advanced US-$ 39

billion project to thwart

Nabucco, circumvent

Ukraine, and enhance

influence in the Balkans

So far, it is not more than

a project – no financing

for offshore section

Pipeline has value as

strategic investment only

with exemption from TPA,

but legal preconditions

may not be present

Arena III: TPA for South Stream onshore (I)

Source: South Stream


Legal preconditions for exemption not present

It is a new route for “old” gas – no diversification

It does not enhance security of supply – lack of Ukrainian storage

facilities, new non-EU transit country, technological risk of subsea pipeline

But: It may be a promising project for concerned EU member states.

Jobs and future transit revenues, while financing provided by Russia

Slightly lower border price as a carrot

Russia concluded IGAs with Bulgaria and Hungary that promise

exemption from TPA and unbundling to South Stream.

In reply, EU Commission threatened to sue member states.

Information exchange mechanism on energy IGAs (Decision 994/2012)

On Russia’s request, all partners except Slovenia have declared the

project to be a national priority.

Exemption might be granted against concession, f.ex. new Russian

suppliers or transit of Central Asian gas

Arena III: TPA for South Stream onshore (II)


Long-term contracts require long-term capacity booking at several

border points

MECO-S gas target model proposes bundling of capacities at

different border points

Market coupling to further remove edge of the problem

CAM NC allows for bookings of up to 15 years, for up to 90% (or

more) of capacity

Bundling of capacities not just exit-entry, but at different BP can be offered

PRISMA seems to be heading into that direction

Hence, congestion rules to bear the brunt of ensuring market access

UIOLI for long-term capacity bookings comes into effect on 1 Oct. 2013

Day ahead UIOLI only from 1 July 2016

Gazproms LTC concerns have been accommodated in CAM NC

EU Commission caved in to resistance from ENTSOG

Arena IV: Capacity allocation under TPA


Although LNG volumes decline, gap between hub prices and long-

term contracts continues to decline, at least in NWE

This is inter alia due to Statoil’s embrace of the hub

As a result, Gazprom had to backtrack on oil-linked pricing

Arena V: Pricing (I)

Source: EU Quarterly Report on European Gas Markets Q 2 2013


Gazprom’s pricing concessions (selected, public sources)

Arena V: Pricing (II)

10-15% spot

indexation

10-15% off

base price

other

ENI 2010 2012*† 2013 7% off base price

E.ON 2010 2012*†

GdF Suez 2010 2013 increased spot

RWE 2013†† increased spot, less t-o-p

WIEH/

Wingas

2010 2012 (amount of reductions unclear;

Gazprom JV)

Econgas, SPP 2012

GasTerra 2010: spot indexation raised to

45%, 2012: further spot increase

PGNiG 2012*†

Bulgargaz 2012 20% off base price (in

return for South Stream support)

* retroactive | † arbitration cancelled | †† arbitration ruling


Less revenue from export because of significant price concessions

Domestic market cannot compensate for this. End-user prices for 2014

have been frozen, netback parity is way off, increased competition

Lower sales to EU, but the trough for Gazprom might have been

reached – Gazprom gas getting more competitive

Implications for Gazprom (I)

0

20

40

60

80

100

120

140

160

180

2005 2006 2007 2008 2009 2010 2011 2012

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

netsalesRussia

netsalesFSU

netsalesEU

Source: CBR, Rosstat Source: Gazprom

Russian gas exports to EU and Turkey, bcm Share of domestic vs. export revenues


Rising CAPEX and OPEX

South Stream, Nord Stream and “Gold Stream” to the Pacific mean very

high CAPEX (Gold Stream and Pacific LNG estimated at $ 65 bn by

Sberbank analysts)

OPEX rise rapidly as well, severance tax increase is only a small part of

the increase

This raises pressure to maintain high gas price and is out of sync

with gas market developments

Rising domestic discontent with Gazprom (esp. among “patriots”)

Channel 1 news anchor Leont’ev called Gazprom-head Miller a

“dangerous lunatic” and “direct threat to our national interests” for ignoring

shale gas revolution. Miller should be sent to psychiatric ward.

Scholar and leader of party “Homeland – common sense” Delyagin says

Gazprom’s strategy resembles “energy-feudalism”, as it ignores economic

development of customers. Deems rearguard actions as unsustainable.

Russia should rather train traders to manipulate spot markets.

Implications for Gazprom (II)


Gazprom is between a rock and a hard place at home and on foreign

markets

Rising taxes and a freeze on energy prices at home, while political

mission continues (Sochi 2014, South Stream, “Gold Stream”)

EU market is to stay most important, home market not so promising

South Stream has lost momentum. It is likely to be downsized,

delayed, or shelved completely.

Possibility of stranded investments in Balkans

Main remaining rationale is jobs in steel / construction

Ukraine will remain the main corridor, also because of storage flexibility

The EU Commission has leveraged the EU’s market power skilfully

Contested regulations and decisions have increased uncertainty

Exemptions are negotiable – a larger agreement is in the cards

We have to think about the consequences of Gazprom embracing

hub-based pricing

Conclusions

Thank you for your attention!

Contact [email protected]

www.css.ethz.ch

Questions?

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