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Under siege, Gazprom’s pricing power begins to crumble

You could almost feel sorry for Gazprom, except that you probably should not. Europe's competition commissioner, Joaquin Almunia, signalled this week that his officials were working on a "statement of objections," the first bureaucratic step in prosecuting Gazprom for anti-competitive behaviour. The commission reckons it has evidence that the Russian gas utility has abused its dominant position in the former Soviet satellite states of central and eastern Europe. In the worst case, Gazprom could be fined 10 per cent of its turnover, some €11-billion ($15.4-billion), based on last year's revenues.

The world's biggest gas company is under siege both abroad and at home, where its status as the Kremlin's spoiled child is being challenged by the oil behemoth Rosneft and rival gas producer Novatek, which both seek to break Gazprom's monopoly on lucrative gas export markets.

The case was sparked off by complaints about overcharging from Lithuania, which is totally reliant on the Russian company for fuel. EU sleuths conducted raids on the offices of natural gas companies in 2011 but the commission's tilt against Gazprom is part of a long-standing quarrel over Russian resistance to allowing competition in its gas export business.

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Russia supplies more than a quarter of Europe's gas and most of the Russian company's profit is generated from selling pipeline gas to Central and Western Europe under long-term contracts with utility companies with prices pegged to oil.

For decades it's been a licence to print money, making Gazprom the Kremlin's biggest taxpayer. Riding high in 2008, its president Alexei Miller boasted that Gazprom would soon be worth $1-trillion (U.S.), the world's most valuable company. It was then worth some $250-billion but the financial crash crippled Gazprom's ambitions as demand for fuel in Europe plummeted.

At the same time, Gazprom discovered that rivals were burrowing into its once-captive European market, bringing cargoes of liquefied gas from as a far afield as the Persian Gulf. Instead of soaring, Gazprom has since deflated to a market value of $100-billion. Forced to refund billions of dollars to European utilities demanding concessions on overpriced gas, the company is now faced with the demand that its contracts be indexed, at least partially, to European spot prices, introducing a huge element of risk to a company that is used to long-term price protection.

It is hardly surprising that Gazprom is slashing capital expenditure. The company was known for throwing money at vast projects, including the $14-billion Nord Stream pipeline linking Russian gas fields directly with Germany through a pipeline on the Baltic seabed. It was intended to avoid the cost, both financial and political, of a transit route through Poland, but weak volumes has raised the cost of Nord Stream and the gas market downturn has forced the Russian company to scrap plans to develop Shtokman, a mammoth offshore gas field in the Arctic.

Meanwhile, it continues to subsidize cheap gas for Russian consumers and struggles to develop an export business that faces eastwards. A recent agreement with China over the terms of gas export failed to set a price. And Gazprom looks anxiously at North America and the prospect of liquefied gas from Canada and the U.S. penetrating markets in North East Asia that Gazprom would like to claim for its own.

Both Rosneft and Novatek have ambitions to export LNG and Russian President Vladmir Putin has said he is minded to allow it.

Indeed, the prospect of a nasty fine from the EU is the least of Gazprom's worries. Sabres will be rattled but Europe doesn't really want to take Gazprom's cash. Counterintuitively, Brussels would much rather the Russian utility invested its money in more gas and instead of fines, the commission is hoping for market-opening concessions.

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Shale gas is a distant prospect in Europe and for the foreseeable future, Russia is the supplier of first and last resort on Europe's eastern fringe. The issue is how it is priced. Both the EU and Gazprom know they are stuck with each other. This antitrust probe is really the beginning of the mother of all trade negotiations.

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About the Author

Carl Mortished is a Canadian financial journalist and freelance consultant based in the U.K. With a career spanning investment banking, journalism and consulting for global companies, he was for many years a financial writer and columnist for The Times of London. More

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