Gazprom: Keeping the taps open

First came the stake-out. On foot and by car they took the measure of the buildings, the entrances and the layout, plotting the fastest way to seal off corridors, shut servers and seize computers. With the morning came the synchronised raids, launched against almost two dozen offices spread across 10 countries, a series of commercial outposts stretching from Bulgaria in the south to Estonia in the north, tracing an arc of Gazprom’s affiliates and customers across Europe’s eastern flank.

The date was September 27 2011 and Europe’s biggest ever antitrust raid had just begun. It was Brussels’ opening salvo in an attempt to overturn — through force of law — the 40-year-old business model of the region’s gas overlord. EU investigators took away in backpacks slung over their shoulders the secrets of a Russian export monopoly that supplies almost 30 per cent of Europe’s gas. The central allegation (although no formal charges have been brought) is that Gazprom exploited its pricing power to charge countries such as Lithuania at least a third more than Germany.

In a sign of the political tension that surrounds the case, Vladimir Putin, Russia’s then prime minister, reacted to news that offices of Gazprom’s customers and affiliates had been ransacked for corporate secrets. “I hope nobody has been arrested or jailed,” he fumed while being briefed on the “dawn raids”. “Not yet,” replied Alexei Miller, the Gazprom chairman. “Thank God,” said Mr Putin.

He need not have worried. The EU’s competition authorities cannot issue arrest warrants. Indeed they even abide by Brussels’ unusually civil working hour requirements: “dawn raids” are conducted no earlier than 9am.

After that dramatic opening gambit, and an inconclusive attempt at settlement talks last year, the case has drifted. Formal charges against Gazprom, which, according to EU sources, were largely ready at the end of 2013, were delayed through fears of further antagonising Russia, while a worsening conflict ripped Ukraine apart.

Russian retaliation

Brussels’ antitrust enforcers are proudly independent and the pause was starting to look very political. But the arrival of a new commission in November has given the Gazprom case fresh impetus. Last month Maroš Šefčovič, the commission vice-president in charge of energy, said the case was only “weeks away”.

Margrethe Vestager, the competition commissioner, is more circumspect, admitting that she will offer only “oracle-like” utterances on the timing of any charges and the options for offering Gazprom a chance to settle. Still, eastern European diplomats say that they have been assured by the commission that action is imminent, although they expect charges to take months rather than weeks.

If and when she selects her moment, Ms Vestager will be firing an incendiary legal weapon, with repercussions well beyond the business of gas supply. Alan Riley, law professor at City University in London, argues the Gazprom clash is likely to be the defining antitrust case of the decade — a worthy successor to the epic regulatory battle that embroiled Microsoft, concluding in 2007 and ultimately costing the company more than €2bn in fines. “The commission needs its pound of flesh and the Russians need to protect their pride. That makes it very difficult indeed,” he says.

The stakes are raised by the danger that Russia could turn off the taps in retaliation: in parts of southeastern Europe, the dependence on Gazprom is almost 100 per cent. The crisis in Ukraine has laid bare Moscow’s increasing animosity towards the EU and a landmark trade accord between Brussels and Kiev proved to be a trigger point for the conflict that has engulfed the eastern Donbass region.

Ms Vestager is at pains to insist that she will not co-ordinate with national capitals about the timing of any charge sheet, despite the potential backlash from Moscow. “The minute you do that, you would politicise the case,” she says.

The threat of a large fine against Gazprom — theoretically as much as 10 per cent of annual revenue — will only add to the list of Moscow’s grievances against Brussels. As Gazprom posted sales of more than $150bn in 2013, one Baltic diplomat notes that Russia would view any potential penalty as a strategic threat to its rapidly deteriorating economy, even though Brussels would almost certainly never push for anything near the possible maximum.

Gazprom declines to comment on the case but the company, which suffered a 60 per cent plunge in profit in the third quarter of last year, is signalling that it is interested in a truce. Forthcoming gas contracts with Lithuania and Estonia present an opportunity for detente in the Baltic. Elena Burmistrova, director of Gazprom Export, says that the company believes “the political environment in Europe will be restored to a situation in which we feel welcome again”.

Paying a heavy price

Although the threat of a fine is an obvious red rag to Moscow, the case’s deeper significance lies in pushing Gazprom, one of Russia’s most strategically important groups, to overhaul the way it conducts business in Europe. Eastern European countries are bitter about what they see as Gazprom’s ability to set political prices — high for Nato members in the Baltic but low for an autocrat such as Ukraine’s former president Viktor Yanukovich. The wide price disparities across Europe rile policy makers in Brussels because they argue that Russia can use its gas to play a game of “divide and rule” among its former satellites, undermining consensus for tighter economic sanctions against Moscow.

At the end of 2013 and early in 2014, the parties were at least still talking to each other about the EU’s three main grievances. Negotiations did not start well. Anatoly Yanovsky, Russia’s deputy energy minister, said bluntly that he did not acknowledge the EU’s authority and declared the probe illegitimate. But after that shot across the bows, the mood changed and he explained Gazprom wanted to find a solution. He passed responsibility for the negotiations to Alexander Medvedev, Gazprom’s deputy chairman.

So began three months of inconclusive talks. Unusually large delegations of 25 Gazprom executives would squeeze into a charmless room in the Madou Tower in Brussels, to face off against officials from the commission.

One negotiator describes Mr Medvedev as a steely opponent — an ice hockey fanatic who delights in flattening opponents. “If I was on the ice with Medvedev, I would definitely want to be on his side,” he says.

On two of the EU’s concerns, there are high hopes of an eventual settlement. Early last year, Gazprom signalled a willingness to give ground on destination clauses, which prevent the resale of gas. Lawyers argue these are incompatible with EU law and will not be accepted in future contracts. However, over 2014, this thorny question of resales leapt back to prominence, with Russia insisting that Poland and Slovakia should not throw an energy lifeline to Kiev by pumping Gazprom’s gas back eastward in so-called “reverse flows”.

Brussels has also been closing the gap with Moscow on practices perceived as excluding rival suppliers. Eastern European states argue that Gazprom has linked its own pipeline projects to supply deals and has threatened price increases if customers seek to build infrastructure to buy from competitors. Since Russia cancelled its landmark South Stream pipeline across the Black Sea at the end of last year, EU lawyers expect Gazprom to be more open to resolving this question of third-party access.

Cinderella man

But the EU’s third complaint is set to be the most contentious. Nothing divides the two parties more than the allegations of exploitative pricing. At stake is Gazprom’s very modus operandi, indexing gas prices to oil in long term contracts, a Dutch practice called the Groningen formula, which began in the 1960s. Since the investigation began, Norway’s Statoil has largely stopped using the practice of oil indexation and the commission is pushing Gazprom to take a new approach, setting prices in a transparent, open market.

This is the most difficult territory. According to people familiar with the talks, the commission’s flinty energy expert Céline Gauer told Mr Medvedev that Germany would make an appropriate price benchmark from which Gazprom should not widely deviate. Her message was clear: ditch oil indexation and cut prices.

An irritated Mr Medvedev warned that a shift to spot pricing on illiquid European gas hubs could increase prices. “Would you not want that?” countered one of the investigators. Gazprom was no Cinderella [to vanish at midnight], Mr Medvedev replied, it was in Europe for the long haul.

The difficulty for the commission is that there is very little legal framework for agreeing on what constitutes overpricing. According to Mario Mariniello, a former EU competition official, now at the Bruegel think-tank, it is far more complex for the commission to “identify a fair price” than to tackle the other concerns, over gas resales and market discrimination.

There is no sign Moscow will abandon oil indexation and Vladimir Chizhov, influential Russian ambassador to Brussels, regularly defends the methodology.

Strategy

A shift in Gazprom’s relations with Europe

For all its reputation as a monolith, Gazprom has not sat still since the EU investigation started. The Russian company has renegotiated many of its major European contracts to lower prices and give greater weighting to spot pricing

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“The talk about the unfair Groningen formula that links gas prices to the price of oil has vanished into thin air now that the oil prices have taken a hit,” he said in an interview with Itar-Tass, Russia’s state news service. “No one in Europe has any complaints now.”

But Professor Riley argues that those falling prices could also lessen the attraction of the oil index for Moscow. “As Lithuanian and Polish liquefied natural gas terminals come on stream, and more gas is being reverse flowed across the continent . . . how far can Gazprom realistically price discriminate between its customers?”

Even so the appetite to revive the dormant antitrust case is high. One eastern European diplomat argues that the credibility of the EU hinges on its ability to extract a meaningful fine. After decades of cleaning up western European markets, the Gazprom case is seen as a litmus test of whether the authorities will throw equal weight behind market forces in the new eastern members. “Settling without a fine would be a scandal,” argues the diplomat.

One of the great unknowns of the case is the extent to which Russia will co-operate if Gazprom is found guilty. If it does not pay a fine, the commission has powers to deduct money from payments owed to Gazprom by its customers in the EU.

Václav Bartuška, the Czech energy ambassador and a former negotiator in deals with Gazprom, says Prague’s gas problems have reduced in recent years as it diversified supply but he still sees the case as a critical moment.

“We spoke about the need for a serious inquiry into Gazprom’s practices even when many Europeans wanted to see Russia through rose-tinted spectacles. That need is clearly more pressing now. We believe everybody that wants to have access to the EU market has to adhere to the EU rules. Want to play differently? Go somewhere else.”