The $7bn bill Gazprom has hit Ukraine with for buying less gas than agreed last year might look like the Russian monopoly once again throwing its weight around. In fact, it highlights how much Gazprom’s business model – and with it, Russia’s energy dominance – is under threat.

The bill seemed purposely timed to arrive on the eve of Ukraine signing a groundbreaking deal with Royal Dutch Shell to exploit some of the country’s apparently extensive shale gas reserves. The Shell deal was Kiev’s most determined attempt yet to wriggle free of Gazprom’s grip on its energy supplies.

With Ukraine refusing to pay the bill, the spat seems set for at best an acrimonious arbitration, or at worst a third shut-off of Russian gas to Ukraine since 2006.

But Gazprom’s wrestling match with its biggest foreign customer encapsulates the broader legal and regulatory challenges, as well as the competitive threats, that it faces in Europe – by far its most profitable market. There are distinct overlaps here with the landmark antitrust probe the EU opened last year into Gazprom’s alleged abuses of its dominant position in EU member states from the former Soviet bloc.

Kiev is challenging both the price it pays and the volumes it is committed to under a 10-year, 2009 supply contract with Gazprom. That contract linked Ukraine’s gas price, as for west European countries, to oil prices. But Kiev now pays more than many countries further west.

So ruinous is the price, says Ukraine’s government, that the country has done everything possible to reduce gas imports by diversifying fuel sources and becoming more energy-efficient.

As a result, Gazprom says Ukraine fell far short of the minimum volume it was obliged to import in 2012 under a “take or pay” clause in the contract. The $7bn bill is for the gas it did not take.

In the EU, too, the spotlight is on the link between gas and oil prices, long-term supply contracts, and take-or-pay clauses.

Gazprom says it needs such contracts to ensure that guaranteed cash flows enable it to finance its huge investments in developing new fields. Should EU antitrust authorities – and an arbitration case with Ukraine – deem these practices anti-competitive, the impact could be severe.

Yet these regulatory pressures already result, in part, from an unprecedented competitive challenge to Gazprom.

As this column has noted before, the direct threat to the Russian giant from development of shale gas within Europe itself has yet to emerge. Progress has fallen short of rosy scenarios from a few years back, due to government-imposed moratoria on “fracking”, environmental opposition, and tricky geology.

But Gazprom is being heavily affected indirectly by North America’s decade-old shale boom. Fast-expanding liquefied natural gas supplies transported by ship, once destined for the US, are instead coming to Europe and driving down prices of “spot” or market-traded gas.

A dozen big west European customers and Poland have used this change in the market to extract concessions from Gazprom. These include introducing an element of spot gas pricing alongside the oil link in their contracts, and flexibility on take-or-pay clauses. Ukraine now wants comparable concessions. And one aim of the EU probe is to help eastern European members achieve something similar.

Alan Riley, an energy law expert at London’s City University, argues that the shale gas effect and antitrust probe could spell the end of Gazprom’s European business model. Its network of long-term supply contracts with national energy companies could ultimately be replaced by a “single interconnected European gas market” relying on competition between various gas trading hubs.

An enlightened response by Moscow, says Mr Riley, would be to break up Gazprom, hive off its pipeline network and allow several companies to compete to supply Europe. That would reduce Russia’s ability to use gas as a political tool – but put its gas industry in the best legal and commercial shape to compete in a liberalised European market. Instead, Russia’s reply to the EU probe has been the legal equivalent of turning away and covering its ears. The Kremlin issued a decree attempting to block the probe.

Failing to abide by any future antitrust ruling would, however, almost certainly be self-defeating, provoking a confrontation with the EU. That would only accelerate the EU’s scramble to diversify energy sources that was already sparked by Gazprom’s two previous Ukraine shut-offs.

Sadly for Gazprom’s minority shareholders, however, its leaders and the Kremlin have a history of putting political posturing above commercial sense.

Neil Buckley is the Financial Times’ Eastern Europe editor

neil.buckley@ft.com

www.ft.com/insidebusiness

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