Turkish pipeline a sign of Gazprom getting real with EU partners

Financial Times (USA Ed) February 19, 2015, p. 14

By Neil Buckley in Europe

Vladimir Putin’s announcement in December that Gazprom was scrapping the $50bn South Stream pipeline project, to bring Russian gas under the Black Sea via Bulgaria to the heart of the EU, stunned and puzzled western observers. Was this a sign that sanctions imposed over Ukraine had made the flagship project impossible to fund? Or pique over the regulatory hurdles South Stream had crashed into in Europe?

The Russian president’s assertion that the Russian gas monopoly would instead build a pipeline to Turkey that could also deliver gas to the EU border was seen as face-saving bluster. Two months later, however, plans to build an alternative supply route via Turkey look serious. Ditching South Stream for « Turkish Stream » also seems to reflect a fundamental – and potentially positive – reorientation of Gazprom’s export strategy.

Alexei Miller , Gazprom chief executive, delivered another surprise last month. He told the European Commission’s vice-president for energy union, Maros Sefcovic, that within a few years the group would stop shipping gas via Ukraine – the current transit route for 40 per cent of Russian gas to Europe and Turkey – and use Turkish Stream instead. If Gazprom’s European partners still wanted the gas, he said, they would have to sort out their own pipelines to bring it from the Turkish-Greek border.

South Stream, too, would have enabled Gazprom to circumvent Ukraine, after pricing and debt disputes with Kiev twice saw the Russian group cut off gas to its neighbour in 2006 and 2009 – hitting onward supplies to west European customers. After badly damaging its reputation as a reliable supplier, Gaz-prom decided the Ukrainian route was too problematic.

But the big turnround here is that Gazprom had spent years on what seemed like politically motivated – and wildly expensive – efforts to own the chain from gasfield to consumer, through building or acquiring gas transportation within the EU.

It persisted after Brussels adopted the Third Energy Package, which liberalised the market and said gas suppliers could not own transmission systems – and which Moscow saw as directed largely at Gazprom. It fought hard for an exemption for South Stream from rules that would have required it to allow other suppliers to use the pipeline.

Giving up that fight in December, according to a report from the Oxford Institute for Energy Studies, marked a « sea-change » in export policy. In a further sign of the shift, the supplier late last year gave up efforts to persuade the EU to let it use 100 per cent of its Opal pipeline in Germany.

Days after cancelling South Stream it dropped a planned asset swap with Germany’s BASF that would have given it control of a German gas trading business that includes western Europe’s largest underground storage facility.

Jonathan Stern, head of the gas programme at the OIES and a long-time Gazprom expert, says a pipeline to Turkey and the Greek border makes commercial sense. « Turkey is [Gazprom’s] second-biggest [export] market, » he says. « It is the only major expanding market they have in Europe. »

Finally agreeing with China on a pipeline supply deal last year made similar sense, he says, even if some observers suggest Beijing drove a hard bargain on price.

Delivering only to the Greek border recognises the reality of EU rules and makes Gazprom more like any other European gas supplier, even if it remains by far the biggest.

Prof Stern suggests that shifting transit from Ukraine to Turkey in a few years will require the Russian monopoly to renegotiate long-term transportation contracts that would otherwise have run unchanged well into the 2020s, adapting them to the EU’s new energy rules.

But Gazprom may not need all the capacity it is planning via Turkey – and the Ukraine route could continue. Some customers may decide they do not want to have to arrange to pick up gas from the Greek border, and plump for alternative sources such as liquefied natural gas from elsewhere. Some might insist on continuing to receive gas via Ukraine, but instead take formal delivery of it at the Russia-Ukraine border, shifting the legal responsibility on to Kiev and the EU for getting it across Ukraine.

The dawning of strategic realism at Gazprom ought to inspire a re-rating of one of the world’s most glaringly undervalued companies. Despite sitting on a fifth of the world’s natural gas reserves, it trades at barely three times forward earnings. Given how closely entwined it is with the Russian state, however, a recovery in valuation seems near-impossible unless relations with the west start to normalise. For now, that seems a distant prospect.