Streetwise Professor

May 11, 2015

Gazprom Agonistes

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 12:26 pm

It has been a hellish few months for Gazprom. It’s profits were down 86 percent on lower prices and volumes and the weak ruble. Although the ruble has rebounded, the bad price news will persist for several months at least, given the lagged relationship between the price oil and the price of gas in the company’s oil-linked contracts. The company has been a die-hard defender of the link: another example of be careful what you ask for.

Moreover, the EU finally moved against the firm, filing antitrust charges. Although many of the European Commission’s antitrust actions, especially against US tech firms, are a travesty, the Gazprom brief is actually well-grounded. At the core of the case is Gazprom’s pervasive price discrimination, which is made possible by its vertical integration into transportation and contractual terms preventing resale of gas. Absent these measures, a buyer in a low-price country could resell to a higher price country, thereby undercutting Gazprom’s price discrimination strategy.

It is interesting to note that the main rationale for Gazprom’s vertical integration is one which was identified long ago, based on basic price theory, rather than more elaborate transactions cost economics or property rights economics theories of integration. Back in the 1930s  economists identified price discrimination as a rationale for Alcoa’s vertical integration. There was some formal work on this in the 70s.

Gazprom is attempting to argue that as an arm of the Russian state, it is not subject to European competition rules. Good luck with that. There is therefore a decent chance that by negotiation or adverse decision that Gazprom will essentially become a common carrier/have to unbundle gas sales and transportation, and forego destination clauses that limit resale. This will reduce its ability to engage in price discrimination, either for economic or political reasons.

The company is also having problems closer to home, where it is engaged in a battle with an old enemy (Sechin/Rosneft) and some new ones (Timchenko/Novatek), and it is not faring well.

Gazprom and Putin have always held out China as the answer to all its problems. There were new gas “deals” between Russia and China signed during Xi’s visit to the 70th Victory Day celebration. (Somehow I missed the role China, let alone the Chinese Communists, played in defeating the Nazis.) But the word “deal” always has to be in quotes, because they never seem to be finalized. Remember the “deal” closed with such fanfare last May? I expressed skepticism about its firmness, with good reason. There is a dispute over the interest rate on the $25 billion loan that was part of the plan. Minor detail, surely.

Further, Gazprom doesn’t like the eastern route agreed to last year. It involves massive new greenfield investments in gas fields as well as transportation. It has therefore been pushing for a western route (the Altai route) that would take gas from where Gazprom already has it (in western Siberia) to where China doesn’t want it (its western provinces, rather than the more vibrant and populous east). The “deal” agreed to in Moscow relates to this western route, but as is almost always the case, price is still to be determined.

If you don’t have a price, you don’t have a deal. And the Chinese realize they have the whip hand. Further, they are less than enamored with Russia as a negotiating partner. Who could have ever predicted this? I’m shocked! Shocked!:

Chinese and Russian executives and advisers said that in addition to the challenge of negotiating prices acceptable to both sides, energy deals between the countries have also been hampered by mutual distrust and Chinese concerns about antagonising the US.

“The Russians are unreliable. They are always flipping things around for their own interest,” said one Chinese oil executive.

Who knew?

Putin is evidently losing patience with the company, and its boss Alexei Miller, is far less powerful than Sechin and Timchenko. When it was a strategic asset in Europe, and offered real possibilities in Asia, it could defend itself. Now that leverage is diminishing, its future is much cloudier.

The impending new supplies of LNG coming online in the US and Australia dim its future prospects further.

In sum, Gazprom is beset by many agonies. Couldn’t happen to a better company.

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6 Comments »

  1. Gazprom, what an apt parable for Russia. Mindless integration, Western lobbysts expensive fluff about the ‘first trillion dollar company’ and now continued slide into irrelevance as alternative routes are developed because people dont like having ungrateful, inept semi-savages control their heating bills. The only real downside is as Russia grinds down further into irrelevance the small circle of elderly ‘military men’ will be tempted to gamble on another foreign adventure.

    Comment by d — May 11, 2015 @ 3:30 pm

  2. Although the ruble has rebounded

    I’m wondering what is driving this recovery. Are the Russians squandering their foreign reserves by buying roubles, or is there a glimmer of hope that the oil price and Russia’s economy will pick up any time soon?

    Comment by Tim Newman — May 12, 2015 @ 1:35 am

  3. […] The trouble with Gazprom. (streetwiseprofessor) […]

    Pingback by 05/12/15 - Tuesday Interest-ing Reads -Compound Interest Rocks — May 12, 2015 @ 12:18 pm

  4. Nitpick. Agonistes doesn’t mean ‘in agony’, it means, strictly, ‘contenduh’.

    Comment by Green as Grass — May 13, 2015 @ 8:55 am

  5. @Green. I know. I think of it as mean “struggler,” and I think that fits.

    The ProfessorComment by The Professor — May 13, 2015 @ 4:22 pm

  6. Hi, Prof.

    Gazprom is managed by Putin itself and Miller contract was just extended for the next 5 years. Gazprom’s managment main task is to tunnel money from the company, mainly through pipeline related CapEx directly to Putins friends Rotenbergs (these guys just recieved 60% of the main Russia airport literally for free). All the rest is correct.

    KR,
    Alex

    Comment by Alex — February 19, 2016 @ 6:00 am

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