Gazprom: how the world's biggest gas producer lost its swagger

Gone are the days of Gazprom’s powerful swagger and threats to diversify its business away from Europe to Asia. The world’s biggest gas producer is now a diminished figure, struggling to adapt to dramatic changes in global gas markets and a breakdown in relations between Europe and Russia.

Displacement of LNG from Asia to Europe spurred by the dramatic development of shale gas production in the US is creating new supply options for several European countries. This is affecting Gazprom’s traditional business model in Europe based on long-term contracts that underpin its upstream investments.

For Gazprom, these new pressures have coincided with a determined effort by the EU to develop competition in energy markets by ensuring the better flow of electricity and gas. The EU has introduced legislation that prevents energy suppliers from owning transportation infrastructure and excluding non-owners from using it. These “unbundling” measures have forced Gazprom to abandon its long-standing attempts to minimise commercial risks by buying distribution assets in EU markets.

The regulators’ pressure has gone further: in 2012, EU competition authorities launched an anti-trust investigation into Gazprom’s business in several EU countries. It has formally accused Gazprom of several violations of EU law related to anti-competitive behaviour. Gazprom has proposed an out of court settlement. It has every reason to avoid a fine that would open the door to other companies pursuing their own claims against Gazprom.

After Russia’s annexation of Crimea in 2014, the EU has finally started to think geopolitically about the security of energy supplies and the challenge of managing its high level of dependency on Russian gas. Around a third of the gas consumed in Europe comes from Russia. The erosion of trust between European countries and Moscow after Russia’s decision to tear up the defence and security arrangements agreed at the end of the Cold War has accelerated the EU’s efforts to diversify gas supplies.

Eight member states are still fully or predominantly dependent on Russian gas, including Lithuania and Poland. Lithuania has moved to reduce its dependence by establishing an offshore LNG terminal and has negotiated a lower price for Russian gas supplies as a result. Poland is about to open its first LNG facility.

In addition, the EU has been able to provide political and financial support to deliver gas to Ukraine through reverse flows, mainly from Slovakia. This has allowed Ukraine to minimise the quantity of gas its buys from Russia. In 2011, Gazprom sold 45 billion cubic metres of gas (bcm) to Ukraine. In 2014, the amount dropped to 14.5 bcm. The loss of a 30bcm market (more than Gazprom sells to its second biggest customer, Turkey) is significant.

Gazprom’s export strategy appears to be in disarray in both Europe and Asia. As part of a long-term policy to avoid transiting gas through Ukraine (about 40% of deliveries to Europe pass through Ukraine), Gazprom and its European partners built the Nord Stream pipeline that brings gas directly to Germany under the Baltic Sea. Gazprom then invested nearly $5bn in the South Stream pipeline to transport gas to southern Europe under the Black Sea only to abandon it in late 2014 in the face of pressure from EU competition authorities that raised questions about the legality of the project.

Gazprom then announced that it would run the pipeline to Turkey instead and deliver gas to the Greek border only to say later that it would reduce its capacity by half and double the capacity of the Nord Stream pipeline.

These rapid changes have left analysts confused about Gazprom’s intentions. Expansion of Nord Stream appears problematic because of unresolved regulatory risks related to access to two pipelines in Germany. In addition, several EU countries are now lobbying against the project because of its effects on their transit revenues. Finally, Brussels policy makers are concerned about the impact of depriving Ukraine of its transit role.

Moscow’s much-vaunted “pivot to the East” in 2014 was supposed to demonstrate Russia’s credentials as a global economic power starting with large-scale exports of pipeline gas to China in 2019. Signed while Moscow was at war in Ukraine, the Chinese drove a hard bargain that now looks even more disadvantageous to Gazprom because of falling oil prices.

The planned 4,000 km “Power of Siberia” pipeline linking East Siberia to northeast China is facing delays and may not even be built. An accompanying project to establish a liquefied natural gas terminal in the Pacific port of Vladivostok has been shelved indefinitely because of financing difficulties created in part by western sanctions against Russia over Ukraine.

In 2008 at the height of its power, Gazprom had hubristic visions of becoming the world’s first trillion dollar company. Its bravado reinforced by powerful business and political connections across much of Europe was an indication that the gas relationship of mutual dependence between Russia and Europe had become unbalanced to Europe’s disadvantage.

With a market capitalisation today of under $50bn, Gazprom is a different animal in a much-changed world. The challenge for Europe is to use its new found influence to re-balance the relationship to mutual advantage.

For the foreseeable future, Europe will continue to need Russian gas and Europe will remain Gazprom’s most important market.