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18 August 2015

There Is Method in Gazprom’s Madness

Russia’s gas companies as tools of Russian foreign policy

Can politics cause economists from Europe and Russia speak different languages? Yes, and this can be witnessed with Gazprom. If the West wants to understand the Russian gas game, it needs to learn its logic first. It is a far cry from the business models of the stock exchange noted companies from Europe.

Is Gazprom insane? Russia wants to build Turkish Stream with a capacity of 63 bcm a year at a cost of 55 billion dollars. Another planned project is two new Nord Stream lines with a capacity of 55 bcm, the costs of which are still unknown. Gazprom also plans to build two lines to China – Power of Siberia and Altai pipeline. Both will cost more than 50 billion each. Sanctions have made it difficult to acquire capital, causing Gazprom to freeze those projects. One after another, each declaration about new gas mega-projects hurts the fragile viability of Gazprom. Fitch downgraded Gazprom’s long-term credit rating to BBB- with a negative outlook.

So why does Russia speak so much about new, expensive pipelines? Because Russia’s gas companies are tools of Russian foreign policy. Their CEO’s are more like clerks, officers or statesmen than managers. They are professional in what they do, but what they do differs from merely looking at stock all day. Market conditions are of secondary importance to them when it comes to assuring the influence in Western companies, infrastructure and keeping hydrocarbons sales high. Russia risks a lot by playing for more. Moscow’s game is about retaining economic influence on Central and Eastern Europe despite the dissolution of the USSR. This is why, while European economists look at one-year cycles, Russia counts in decades. The goal is clear, however the plan is fluid. The Kremlin assumes its position according to the situation at hand, reacting simultaneously. Analysts quarrel as to whether there is a purpose in the deception or whether it is simply evidence of accidental policy.

Turkish Stream is a mere bluff until Europeans start to believe in it. The official goal of Turkish Stream is to quit Ukraine gas transit in favour of the Turkish route, decreasing the risk connected with sending gas through this country. This is contrary to what Ukraine and the European Commission (EC) would do. Ukraine needs between 17 and 19 bcm of gas in its storage to stabilize the transit to Europe but it has no money to buy it all. To stabilize the transit through Ukraine, the EC mulls investment in gas transit system (GTS) and underground gas storage system. A middle ground would be found with Gazprom helping in Ukraine’s GTS modernization. This is a real scenario, positive from Russia’s perspective which is why Kyiv, in a dedicated act, forbid Gazprom to acquire any stake in its gas sector infrastructure.

Taking into consideration developments in their environment, Russia will act in one of two ways. In the middle ground scenario above, Gazprom gets some concessions for Turkish Stream or Ukrainian GTS. The first option is that the Kremlin destabilizes Ukraine by quitting gas transit through its territory until the change of government for some pro-Russian crew, at which point Russia forces Ukraine to give away its control over the pipelines to Moscow. The second option is that Russia gets concessions directly from the European Union. If the economic situation in Ukraine goes the way of Greece, it is quite possible pro-Russian forces could take over power and agree to Ukraine’s Finlandization. Kyiv would give up its pipelines to Gazprom to find money and technical support needed to stabilize the transit. The Normandy Four would agree to such an agreement if Ukraine becomes another South Sudan (which is what Russia is aiming at). In these circumstances, building Turkish Stream in full will not be necessary. It would remain important for competition with Caspian gas supplies, but not with respect to Ukraine. This way, the primary objective is achieved, and Ukraine stays in the Kremlin’s orbit. This is why it is so important that the EU maintains its help for Ukrainian gas sector in terms of money, expertise and integration into European market. This winter could be decisive in this respect. Ukraine needs gas to stabilize the transit to Europe. The European Commission is considering buying some volume of gas to help.

The Turkish Stream bluff is a useful tool to make the European Union act like Russians want. It matters not whether Western economists believe the bluff. It already works. The fruits of this bluff are a revived Nabucco-West and Eastring which would serve well as Turkish Stream extensions. An additional benefit for Moscow is the division between countries in the Visegrad Group and EU in general on their positions about Russian gas: the end justifies the means.

The only answer is not to submit to Kremlin rhetoric and bluffs. Europe needs to finish the Transadriatic Pipeline, new LNG terminals and new interconnectors between the countries. An antimonopoly survey led by the European Commission needs to provide real tools that lead to change in Gazprom activity for good. Russia wants to lure Europe off the diversification path, so the steps on it must be even firmer. If the diversification plan fails, the cost of dreams of mega-projects like Turkish Stream will be returned to Kremlin, and the insane-looking policy of Gazprom will show to be rational, though not rooted in market-driven logic.

Russia uses its companies to make policy. Some Western companies treat Gazprom like any another stock company – looking for quick returns and low risk. Russian companies can sacrifice a lot to serve their country. Russia uses this Western misunderstanding and misperception which has persisted even well after annexing Crimea. Western policy is not a monolith, providing Russia with the opportunity to play on the differences between EU countries’ gas sectors.

Russia does not necessarily need to actually build any new pipeline. Simply talking about new projects serves Gazprom’s interests. Lately, Gazprom, Austrian OMV, German E.on and Dutch-British Shell signed a protocol about two new Nord Stream lines which would double the annual pipeline capacity from 55 to 110 bcm. The proposition worked on European partners even though Nord Stream is currently not used to full capacity. In fact, enlargement would provide it with further overcapacity and would undermine its economic feasibility. But perhaps the European Commission would exempt Nord Stream from EU full capacity rules? Maybe Great Britain would agree to build an extension to its borders? Involvement of Western partners make such scenarios more viable. Gazprom makes Europeans act the way the Kremlin seeks, even when mainly speaking about new initiatives. Utilizing Sun Tzu’s philosophy, this is how Russia can win a war without fighting a single military battle.

Gazprom’s biggest obstacle now is not money, which Gazprom lacks. It is the European Commission which uses politics to forces European companies to stick with transit through Ukraine. Brussels wants to invest in Ukrainian GTS and, in fact, understands the Kremlin’s logic. Companies looking for fast earnings do not. This is how the EC catches up with the Kremlin gas game. The diversification plan, Energy Union postulates, along with the integration of European energy sectors, is the real answer in overcoming the political limitations of pure market logic. There is a method in Gazprom’s “madness”. We must use the countermeasure which appear at first glance appear mad from a market perspective, but are ultimately deadly rational. Russian managers are still tools of Kremlin foreign policy. Closing ones eyes to this reality will not make it disappear. In fact, this would be the real madness.

On June 30, the European Commission, Russia and Ukraine failed to agree on a gas discount for another quarter. Kyiv did not agree to Russia’s terms and wants to quit gas supplies from Gazprom starting as of April 1, 2016. Ukraine already has an alternative – reverse gas supplies from European countries. Ukraine chooses to buy (for now) more expensive, but a less policy-dependent resource. This shows that circumstances are increasingly narrowing the space for Russia’s maneuvers described.

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