Europe Might Regret Getting Tough With Gazprom

Unlike many EU institutions, the Commissions antitrust body is a pretty serious outfit. It's therefore all the more perplexing that they want to investigate Gazprom for thwarting competition and inflating prices in Central and Eastern Europe. The three exact charges hone in on hindering the free flow of gas across EU member states, preventing countries from diversifying their gas supplies and imposing unfair prices on its customers by insisting on oil index contracts. As the Commission has stated, "Such behaviour, if established, may constitute a restriction of competition and lead to higher prices and deterioration of security of supply." The specific markets in mind are Bulgaria, the Czech Republic, Slovakia, Poland, Estonia, Lithuania, Latvia and Hungary. Mission creep into other EU27 markets is also expected as investigations broaden out.

At the expense of answering the Commissions question for them, of course Gazprom is guilty. It's as guilty as sin. It's doing what any producer worth its salt should try and do. Dominate supplies ­ tick. Maximise rent ­ tick. Insist on destination clauses ­ tick. Do everything it can to stymie European energy package implementation ­ tick. Force small countries to sign up to Russian pipeline projects at the expense of all others ­ tick. Limiting delivery points and consumer access to gas ­ tick. Barge its way into mid / downstream transmission & distribution for vertical integration purposes ­ double tick.  Bluntly put, Moscow wrote the manual for other gas producers to follow on monopolistic behavior, with 'post'-Soviet space as the leading case studies. It would be very hard for the European Commission not to reach such conclusions, even if the investigation will drag on for a number of years to do so.

The question then is to what end?  If the Commission thinks it can force Russia to pay serious fines for sticking to long term (oil indexed) contracts, good luck. No political authority on earth would be able to force payment from the Kremlin short or seizing of assets. Rather, this is more to do with trying to get Gazprom to comply with European liberalization and antitrust rules. Whether it really needed to go down this road to achieve that, is at best, tenuous. Not only will Russia throw its toys out the pram (winter is always the most brutal time to unleash supply cuts in the Balkans), the Kremlin will hire the best energy lawyers money can buy in London to point out some rather inconvenient market truths.

First up is whether CEE states could actually draw on spot markets in the first place? The only hub in that neck of the woods is Baumgarten (Austria), a pretty illiquid market, and not one that acts as a serious price reference point for CEE or South East European states. Renegotiating contracts towards Western European spot prices works for 'West European players', precisely because they can arbitrage NBP over term prices to make Russia shift. That's not a physical (or virtual) luxury CEE or South East European players have. And while it's entirely true that Gazprom has fort hard to prevent Azeri gas from reaching that part of the world, be under no illusions what pricing arrangements are being used to build a 'European' pipeline in Southern Corridor ­ it's oil indexation 101. Both Nabucco West and the Trans-Adriatic Pipleine are predicated on exactly the same oil indexed price points at the competing Russian South Stream pipeline. Presumably the European Commission is building a parallel case to bring against oil indexed supplies from Algeria to Spain and Libyan gas to Italy?

If anything, that's what makes the investigations so dangerous. Spot markets are great, gas prices based on gas fundamentals, even better. But as yet, they don't reflect the underlying reality of regional gas arrangements. Fields are mostly drilled on the basis of long term supply contracts linking producers to consumers, and invariably doing so under oil indexed prices. And let's not forget, it was the European Commission that's been falling over itself over the past decade to grant third party exemption on strategic pipelines for Russia. Nord Stream is a classic example; the Russo-German venture even took great care to totally bypass any CEE territory. Guess what, South Stream was going to be another TPA addition to the European party. Scrub that order please.

More broadly, the fact that spot markets happen to be cheaper than oil right now could also change ­ spot markets have nothing to do with guaranteeing cheap gas, but making sure supplies are cost reflective. Moscow will point out that without Russian gas molecules providing underlying physical liquidity, sport markets wouldn't exist in the first place. They'll also argue that if oil indexed gas happens to becomes cheaper than spot, LNG tankers from the Middle East will be manipulating markets to boot as they dock in European ports. Tricky stuff all round, not to mention the small issue of where OPEC stands in the entire monopoly debate.