Gazprom is capable of single-handedly pulling Europe out of any energy crisis

At the same time, the German Bundestag denied Russia's involvement in the rise in gas prices.

“Everyone was speculating that gas prices would fall and were waiting for this to happen in order to continue buying gas. It certainly didn't work. But the situation is not connected with the Russians, but with those who shape the gas policy here in Germany, ”said Klaus Ernst, head of the Bundestag's Committee on Economics and Energy.

Russian analyst Sergei Kapitonov asks questions on the Carnegie Moscow Center website:

What are the reasons for this crisis? And how can the situation be corrected?

Historically, Europe has built its own gas industry and gas imports from the USSR, Norway and North Africa according to the Groningen model. This model rightly assumed that gas producers needed some sort of payback guarantee after they attracted multibillion-dollar investments in field development and pipeline construction. Therefore, a system of long-term 20-30-year contracts was born in the industry, guaranteeing product sales for decades to come.

These gigantic contracts required a clear pricing mechanism. It was the price of oil or a basket of petroleum products, to which the cost of a cubic meter of gas was tied with a certain coefficient, taking into account the calorific value of energy carriers. At that time, this was not only a commercial, but also a technological sense - in Europe, power generation based on fuel oil and diesel fuel was still actively used, which was gradually replaced by coal and gas only after the oil crisis of the 1970s.

In the gas industry, there has traditionally been a very deep integration of the interests of suppliers and buyers, rather than a simple sale of gas on the market at the moment. As a result of this commercial diffusion, European companies received guaranteed volumes of gas from the north of Siberia, Austrian and German companies started gas production in the holy of holies near Novy Urengoy, and Gazprom became a partner in intra-European gas pipeline systems and entered the final European market through its traders ...

However, already in the 2000s, discussions about Moscow's gas weapons resounded in European capitals against the backdrop of rising oil prices and the first gas crises with Belarus and Ukraine.

When in 2008 oil prices rose to an unprecedented $ 140 per barrel, raising the price of Russian gas to $ 500 per thousand cubic meters, Europe moved to concrete actions. First, since the beginning of the 2000s, exchange gas trading began to actively develop there (it was launched in the UK back in the mid-1990s). In the early years, little gas was sold in this way, and therefore spot prices were generally lower than on long-term contracts.

Over the next ten years, the Europeans managed to largely remove the oil tie from Russian gas contracts. If in 2010 only 10-15% of Gazprom's contracts had some spot component, at the end of 2020 there were already 87% of such contracts.

Another Rubicon was the EU's Third Energy Package, adopted in 2009 and subsequently repeatedly modified. It divided gas producers, pipeline operators and end distributors. Gazprom has lost the opportunity to own European gas pipelines, creating an integrated supply chain from fields in Siberia to a domestic gas boiler, for example, in Berlin. Due to the new legislation, Russia had to abandon the South Stream gas pipeline project, get problems with loading the OPAL gas pipeline (the continuation of Nord Stream in Germany), and now Nord Stream 2.

Finally, the last area of pressure on Gazprom was its long-term contracts. A six-year antitrust investigation by the European Commission, together with general market trends, forced Gazprom to remove from its contracts the ban on re-exporting gas to third countries (although such provisions still apply in many LNG contracts around the world).

All these years, Gazprom has not always blindly followed the changing European approach. There were both gas crises with closest neighbors and crises of shortages (for example, in 2014–2015, when the concern unsuccessfully fought against gas reversal to Ukraine, reducing supplies to European customers). At the turn of the 2000s and 2010s, gas prices for Eastern Europe and Western countries could differ by tens of percent, which led to an antitrust investigation. The explanation that this is how the contractual formula works did not suit the European Commission.

As a result, everything came to the conclusion that the export block of Gazprom today and ten years ago are two different companies. Oil indexation contracts that were once the basis of business are now called legacy contracts even in the presentations of the concern itself. In Western Europe, Gazprom trades on almost the same principles as Norway. With the difference that Norwegian gas is sold mainly through deals here and now, while Gazprom's gas is sold under longer forward contracts (price with delivery one month, one quarter ahead).

Despite all the difficulties in relations with Europe over the past decade, Gazprom has invested heavily in the development of fields and the development of gas transportation infrastructure in the north of Russia, as well as the construction of export gas pipelines. In 2012, production began at the giant Yamal Bovanenkovskoye field and the Bovanenkovo-Ukhta gas pipeline was launched. In 2017, the Bovanenkovo - Ukhta - 2 gas transmission system was launched specifically for Nord Stream 2. In 2021, Bovanenkovo reached its design production level of 115 billion cubic meters per year, and Gazprom is moving further north, developing the Kharasaveyskoye field in Yamal, which at its peak should give 32 billion cubic meters of annual production.

Against this background, Gazprom actively promoted the thesis that it has a huge surplus of production capacity over actual demand. In the mid-2010s, it was 200 billion cubic meters, and today, according to the head of Gazprom, Alexei Miller, it is about 150 billion cubic meters. This is a fantastic amount - more than the entire annual production of Norway (the # 2 gas supplier to the European market) or Australia (the # 1 LNG supplier to the world markets). Thus, if such a reserve of production capacity does exist (and there are other opinions), then Gazprom is capable of pulling Europe out of any energy crisis on its own.

However, “capable” does not equal “should”. For example, Norway uses a seller's option in its spot contracts - that is, it may not supply gas without any sanctions in the event of, for example, an inappropriate price environment. Likewise, Gazprom is not legally obliged to put its spot volumes (anything above long-term contracts) on the market for any of the reasons (the needs of the domestic market, problems with production, or no explanation at all). This is how market liberalization works, which Europe has been intensively pursuing all these years.

However, there is one flaw in this commercially fair logic. It does not take into account the very magic of Gazprom that the old and loyal partners of the concern are used to. The magic that allowed Gazprom in the winter of 2018 to update daily records for supplies to Europe for two weeks in a row, when the Beast from the East frost front hit it. There were other cases when Gazprom came to the rescue and supplied more than it should have under the contracts.

Thanks to this, in the eyes of many partners, Gazprom has become something more than just another supplier certified according to European rules. In recent years, Europe has not only put a lot of pressure on Gazprom, but has also allowed it a lot. Even after the Ukrainian crisis in 2014, Europe did not equate Gazprom with Russia's foreign policy. Gazprom continued to receive $ 30–40 billion of foreign exchange earnings annually in Europe, avoiding sanctions and completing the construction of new gas pipelines to Europe.

But this magic can be dispelled if in the current crisis it is not Gazprom that comes to the aid of Europe, but, for example, Norway or suppliers of liquefied gas, capable of quickly redirecting cargo to the shores of Europe when the price situation changes. And then, having calculated how much the gas crisis of 2021 cost them, the Europeans can begin to invest even more actively in the energy transition and the gradual phase-out of gas - not from Russian, but in general. Therefore, the soonest stabilization of the gas market in Europe is beneficial not only to bankrupt European enterprises, but also to Gazprom.

Paradoxically, Europe found itself hostage to its own energy policy - in calm periods it limited and reformed interaction with Gazprom, and in times of crisis calls on it to increase supplies. But Gazprom also did not become just one of the gas traders in Europe - the concern is still expected to make powerful steps affecting the market. Still, Gazprom dominates gas imports to the European Union with a share of more than 40%, and this imposes a colossal responsibility. And how Gazprom manages its unique position now will determine the future of all Russian pipeline gas in Europe.