The Euro Economy

While Ukraine’s European fate may be dominating the headlines as tens of thousands of pro-European demonstrators flood Kiev’s public spaces, a deeper source of tension looms beneath the surface, largely outside the eye of the non-financial media. At the heart of the tensions are accusations by the EU’s competition authorities that Gazprom has abused its market position. If EU regulators are successful, they could deal a serious blow to the company’s modus operandi in Eastern Europe, a cornerstone of Russia’s geopolitical strategy.

EU authorities have been investigating Gazprom since early last year on suspicion that the Russian oil and gas giant has abused its dominant market position in upstream gas supply markets in Central and Eastern Europe. Regulators have accused Gazprom of hindering the free flow of gas and the diversification of gas supplies through instruments such as destination clauses, which prevent the reselling of gas, as well as imposing unfair prices on customers (cf Lithuania’s €1.4 billion suit).

About 25% of Europe’s natural gas is supplied from Russia and many Eastern European Member States in particular are highly dependent on Russian gas. The Kremlin has very effectively used this dependence to its advantage in its diplomatic relations with these countries, making energy independence a cornerstone of the EU’s security concerns. The current Lithuanian presidency has put energy security at the top of its agenda and is spearheading many innovative diversification projects.

Russia’s aggressive energy diplomacy can have brutally potent effects. After threatening to raise Armenia’s gas prices by 30%, the small Caucasian country renounced its ambitions to negotiate a trade and cooperation deal with the EU and join the Russian-led Eurasian Custom’s Union instead. Russia has sinceannounced that it will keep prices at $187 per 1,000 cubic metres, in exchange for the final 20% stake in the country’s state-owned gas distribution company, ArmRosgazprom, which Gazprom did not already own.

In Ukraine, the government was forced to put its own deal with the EU on hold while it cooled relations with Russian leaders, who threatened to call in outstanding gas debts and raise prices. The country, Gazprom’s largest European customer, already pays about $50 more per 1,000 cubic metres than the average in the EU, where Gazprom faces more competition. When Ukraine took the unprecedented step of re-buying cheaper Russian gas from the German RWE, much of which flowed through Ukrainian pipelines, Gazprom cried foul and threw around its weight to erect obstacles to the deal.

Many see Gazprom’s uncompetitive commercial practices as an extension of Russia’s ‘divide and conquer’ geopolitical strategy. Politically, the ever more assertive Russia has been able to render EU foreign policy impotent by playing on divergent political views across Europe’s capitals, which are torn between two dominant approaches to Russia. In Europe’s gas markets as well, Gazprom knows that it has a lot to lose from a more integrated energy market in the EU. A less dependent and better-integrated Europe would make it more difficult to leverage its market dominance to its advantage.

The EU has rightly recognised that its anti-trust threats can be a powerful weapon against Russia’s geopolitical machinations and abusive dominance in energy markets. Russia has been particularly irritated by Europe’s Third Energy Package, which imposes limits on the ownership of distribution infrastructure by energy suppliers. Under the rules, Gazprom, as well as other EU energy giants, like ENI, RWE and GDF, are being forced to sell off chunks of their vast pipeline network.

When the EU announced it was proceeding to elaborate a formal statement of objections (accusations) in October, a Gazprom official speaking to the BBC responded tersely: “Let them investigate.” With stake so high, however, the company, which could be forced to fork over up to 10% of its global turnover (€109 billion last year), seems to have now adopted a softer line. The chief of Gazprom’s export arm, Alexander Medvedev, told the Financial Times that both sides had agreed to “try to find a mutually acceptable solution.”

It remains unclear what Gazprom may be ready to accept in the deal, but the Russian government is anxious to put the issue to rest. Mr. Medvedev has said the company hopes to conclude negotiations in a, “relatively short time – three to four months.” The breakthrough in the standoff came late last month when Russian Prime Minister Dmitry Medvedev sent a letter to Commission President José Manuel Barroso. The correspondence led to the Russian government, Gazprom’s largest stakeholder, being formally included in the settlement process.

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