1. © Copyright Giacomo Luciani The Politics and Economics of International Energy (Spring 2009- E657) Lecture 7 part 2 Geopolitics of Natural Gas Trade Prof. Giacomo Luciani

2. © Copyright Giacomo Luciani Gazprom’s Counter Strategy  Gazprom is seeking to acquire control of export pipelines and major importing/distribution companies to increase its market power  With backing from the Kremlin, uses prices, volumes and access to upstream as pressure tools  Openly attacks the EU gas policy  Gazprom’s bargain: security=monopoly

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4. Five Myths about Gazprom Five Most Popular Myths About Gazprom #1 Gazprom is an energy weapon of the Kremlin #2 Gazprom is involved in pipeline wars in Europe to exert political influence #3 Gazprom is a threat to competition in the gas market in Europe #4 Gazprom is an unreliable supplier #5 Gazprom is managed by kleptocrats, not professional managers 3

5. Five Myths about Gazprom Myth #1 “Gazprom is an Energy Weapon of the Kremlin”  Assertion 1.1: “Gazprom exerts political pressure on neighboring countries by shutting off gas supply in the middle of the winter”.  Assertion 1.2: “Gazprom’s pricing policy is politically driven”.  Assertion 1.3: “Russia’s key political leaders – Mr. Medvedev, Mr. Putin and Mr. Zubkov – control Gazprom and use it as a political instrument”. 4

6. Five Myths about Gazprom 5 GAZPROM’S VIEW  The fundamental question in examining these assertions is to decide whether Gazprom is a business entity operating under normal business consideration; or, a quasi-business, quasi-political organization that carries out the political programs of the Russian government?  The answer to this question underlies all of the assertions that I will discuss today with you. I hope to show you clearly that Gazprom is a normal business organization with understandable business goals and objectives. I hope that the open-minded members of this audience will give a fair hearing to my arguments today that will show that Gazprom operates on business principals, not on political or geo-political considerations.

7. Five Myths about Gazprom Assertion 1.1: “Gazprom exerts political pressure on neighboring countries by shutting off the supply of gas in the middle of the winter”  From the time of the break-up of the Soviet Union and until now, Russia has subsidized the countries of the former Soviet Union through below market prices for gas and other commodities. The amount of this subsidy consists of the difference between European gas price and the below-market price that Gazprom has charged its customers in these countries. Chart 1 shows that these subsidies were very substantial.  Gazprom finalized its transition to a full-fledged joint stock company in 2003 and began the process of ending these subsidies to countries of the former Soviet Union. Maintaining Soviet-era subsidies is incompatible with protecting the interests of company shareholders in a normal business operating company. Gazprom informed all of the countries that were then receiving subsidies that Gazprom planned to enter into new agreements that would eventually bring them to world prices.  Not all the countries were willing to accept this transition to world prices. At that point Ukraine refused to discuss any changes to the price policy. As a result, the contract to provide gas to Ukraine expired on December 31, 2005 and Gazprom stopped shipments of gas to Ukraine for three days in January 2006. This stoppage was the result of a commercial dispute and of Ukraine’s intransigence in the face of losing its subsidy from Gazprom. This was an economic dispute, not a political one.  How can anyone claim that we “brutally” treat our neighbors if we subsidize their industry with billions of dollars? 6

8. Five Myths about Gazprom Gazprom Price Subsidies to Neighboring Countries* 7 * Only European FSU Countries **Belarus and Moldova Source: Gazprom Export

9. © Copyright Giacomo Luciani No longer funny prices?

10. © Copyright Giacomo Luciani Narrowing the price gaps  Lower prices to other FSU countries are increasingly anachronistic  Domestic price increases are obviously more difficult, but are also taking place  If the process continues, the root causes of many conflicts will be eliminated

11. © Copyright Giacomo Luciani Are price increases politically motivated?  Discounts are politically motivated. The end of discounts is a commercial move; its timing is politically motivated  Russia is a complex country, the President does not decide alone  Different groups have opposing agendas – the balance determines the final attitude  Changing political circumstances affect the balance, may cause shifts in attitudes  However, systematic political use of energy supplies is not in the cards

12. © Copyright Giacomo Luciani Russia and gas market liberalisation  Gazprom is very conscious that gas exports to Europe generate rents  The Commission wants to eliminate the rents, Gazprom wants to capture more of them  Also, gas market liberalization shifts more of the risk to the producer  OPEC takes similar positions: taxation of oil products, security of demand…

13. © Copyright Giacomo Luciani Is Gazprom threatening European energy security?  By supporting new pipelines, Gazprom enhances European energy security  Can we say that it prevents diversification?  Should it rather invest more in the upstream?  My conclusion: Gazprom/Russia is behaving as rational economic actor

14. © Copyright Giacomo Luciani Will Gazprom prevail?  In the immediate, the EC appears powerless – cannot effectively promote new import facilities  However, if Gazprom overplays its hand, the Commission can use its powers under competition policy and force gas sales at the border  The Spanish Government’s decision to limit Sonatrach’s access to the Spanish market is an important precedent  The EC offensive to unbundle networks will continue

15. © Copyright Giacomo Luciani In Conclusion  Russia is not Europe’s privileged energy partner  But neither it is a threat to Europe’s energy security  It is a an oil and gas exporter rationally pursuing rent maximization  Europe’s weakness is Russia’s strength  But Gazprom’s economic empire may be short-lived

16. © Copyright Giacomo Luciani Supplies from the South East

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21. Turkey’s options  Gas can reach Turkey from: Russia The Caspian Iran Iraq Egypt  Intense political competition to saturate Turkish market (and prevent access to others)

22. © Copyright Giacomo Luciani The Russian Hand  Russia was the main supplier of Turkey by way of a pipeline crossing the Ukraine, Moldova, Romania and Bulgaria  The Blue Stream project has been a technological challenge  It aimed at saturating the Turkish market and preventing access to competitors (to Turkey and EU market from the SE)

23. © Copyright Giacomo Luciani The US hand  Promote exports from Turkmenistan but avoiding Iran – hence through Azerbaijan  Promote exports from Egypt possibly serving Israel as well  Prevent Blue Stream  Prevent Iran exports  When Shah Deniz gas field was discovered in Azerbaijan, Turmenistan was dropped as the preferred source

24. © Copyright Giacomo Luciani Iran’s game  Establish pipeline to Turkey as step to access European market  Offer transit to Turkmenistan  Main hurdle: lack of investment funds and partners

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26. Iraq’s game  Under Saddam: entice European companies to weaken sanctions regime  After regime change – no clear direction yet  Recent deal with Shell for use of Southern gas envisages LNG exports – very controversial

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28. Egypt’s game  Onshore pipeline to serve Israel, Jordan, Lebanon, Syria, Turkey.  Offshore pipeline to serve Israel and/or Lebanon and/or Turkey  Two onshore pipelines – one to Israel, another around it (Jordan, Syria, Turkey, maybe Lebanon)  In the meantime: major commitment to LNG projects to Europe

29. Gas Export Projects To Jordan, Syria & then to Lebanon, Cyprus and Europe Through Pipelines: Arab Gas Pipeline: Total Capacity= 10 BCM

30. First Project with Union Fenosa (at Damietta): ntract was signed in July 2000. Contract was signed in July 2000. One train of a total capacity of One train of a total capacity of 7.6 BCM annually (4.8 million 7.6 BCM annually (4.8 million tons LNG). tons LNG). Investment: over US $ 1.3 billion ( ( EGAS 20% & UF 80%) Operation: end of 2004.Operation: end of 2004. Export of the first LNG Cargo: Jan. 20, 2005 LNG: Two Projects

31. The Second Project with BG, Petronas, GDF, EGPC & EGAS (at Idku): Contract was signed in April 2001.Contract was signed in April 2001. Two trains of total capacity 12 BCMTwo trains of total capacity 12 BCM annually (7.2 MM tons). Investment: US $ 1.9 billion Investment: US $ 1.9 billion Investment Shares: Investment Shares: EGPC & EGAS 12% each, BG, Petronas 35.5% each, GDF 5% Operation: mid- 2005. Operation: mid- 2005. Export of the first LNG Cargo: May 2005 Export of the first LNG cargo from train two: Oct. 2005 Export of the first LNG Cargo: May 2005 Export of the first LNG cargo from train two: Oct. 2005 LNG: Two Projects: cont.

32. Egyptian LNG Export Greece

33. Egyptian LNG Exports by Country (2005-2008) Total: 32.3 million tons Otheres: include; Turkey, North Korea, Italy, Norway, China, Belgium and Greece

34. © Copyright Giacomo Luciani In the end  Turkey will receive gas from: Russia, Azerbaijan, Iran and Egypt  Iraq remains a possibility – Turkmenistan is more remote  Turkey will have more gas than it needs  Role as gas gathering platform may influence bid to access the EU  Little storage available

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36. ENI-Gazprom’s South Stream Project

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39. What is at stake?  Even if a pipeline connection from the Southeast is established independently of Russia, the latter will remain Europe’s major provider  LNG supplies from the Southeast are more fungible and can serve different European markets (Western Med, Atlantic, even Baltic)