Streetwise Professor

September 26, 2014

Gazprom: Price Discriminating, Monopolist Thugs. What’s Not to Love?

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 8:48 am

Russia is mounting a full-spectrum offensive to grind Ukraine into the dust. Military, paramilitary, diplomatic, political, and economic.

The centerpiece of the economic campaign is, of course, gas. Today Russia’s energy minister threatened a gas cutoff to any country that resold gas to Ukraine, in violation of Gazprom’s sales contracts. Hungary immediately knuckled under.

Energy Minister Alexander Novak asserted that the re-export to Ukraine of gas Europe buys from Russia was illegal and could see some of its nations go without fuel shipments from state energy giant Gazprom for the first time since 2009.

“We hope that our European partners will stick to the agreements. That is the only way to ensure there are no interruptions in gas deliveries to European consumers,” Novak told Friday’s edition of Germany’s Handelsblatt business daily.

Novak’s comments were published only hours after Ukraine’s state energy firm Naftogaz reported an interruption of gas supplies it receives through Hungary.

Naftogaz noted that the apparent cut “came only a few days after a visit to Hungary by representatives from (Russian state gas firm) Gazprom”.

Hungarian Prime Minister Viktor Orban conceded that his country could not risk losing access to Russian gas — responsible for about 60 percent of the country’s supplies — over Ukraine.

“Hungary can not get into a situation in which, due to the Russian-Ukrainian conflict, it cannot access its required supply of energy,” Orban said on state radio.

For its part, the EU disputes Russia’s interpretation of contracts:

The European Union rapped Hungary over the supply interruption.

“There is nothing preventing EU companies to dispose freely of gas they have purchased from Gazprom, and this includes selling this gas to customers both within the EU as well as to third countries such as Ukraine,” Commission spokeswoman Helene Banner said in Brussels.

Any such contractual terms would be, literally, agreements in restraint of trade. They restrain trade between first buyers of Russian gas and others.

Sometimes  restraints enhance efficiency. That is definitely not the case here. The restrictions have one purpose, and one purpose only. To facilitate price discrimination (and hence the exercise of market power) by Gazprom and Russia. This map provides a fascinating visual demonstration of how Gazprom discriminates by price. Adjacent countries can pay dramatically different prices. More distant countries pay lower prices than ones nearer to Russia.

Much of the discrimination is purely economic. Countries with access to few alternative suppliers or few alternative energy sources pay higher prices. But much of the discrimination is political. Note that Belarus and Armenia, reliable Russian clients, pay very low prices, but Ukraine and Lithuania, which bracket Belarus, pay very high ones.

Destination clauses are necessary to maintain these big price differentials. Hence eliminating them would reduce Gazprom’s market power and profitability (though the welfare effects of 3d degree price discrimination are ambiguous) and also reduce Russia’s political leverage. With the ability to resell, those buying at a favored price could resell to those whom Gazprom wants to charge a high price. Gazprom would have to charge pretty much the same price to everyone (though since diversions are not costless it would retain some ability to discriminate, but not nearly as much, especially in the longer run as new infrastructure could be created).

Which makes it all the more bizarre that Europe, and Germany in particular, hyperventilate over far more dubious and abstract theories of market abuse by Google and Microsoft, but meekly let Gazprom run roughshod with textbook monopolist tactics. The lack of a unified energy policy, and unified energy purchasing (Europe could act as a monopsonist) allows Gazprom to play its usual divide and conquer games, of which price discrimination is one obvious result. Expediting the antitrust action against Gazprom would be another way of combating Gazprom’s malign influence.

In the current dispute the stakes are both economic and political/geopolitical. Despite the high stakes, Europe will doubtless limit its response to theoretical objections like those delivered by Helene Banner.

One (bitterly) amusing sidelight to this is despite its market power (the result of Russian law which gives it a monopoly over gas exports and of European acquiescence) Gazprom is still a horrible performer by all conventional metrics. It’s price-earnings ratio is about 3. Contrast that to Shell, Chevron, and Exxon, which have ratios of 10, 11, and 12, respectively. Performance metrics, such as value added per employee or earnings as related to reserves, are horrible.

This is a testament in large part to appalling corporate governance and the insecurity of profits and property in Russia. Speaking of which, there were several developments in the Yevtushenkov/Sistema/Bashneft story today. Yevtushenkov’s house arrest was confirmed and extended, and the Russian government seized Sistema’s Bashneft shares.

I’m never going to run out of material. Never.

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  1. Hello Mr.Pirrong

    New markets forces will ” put a sanction” on Ural pricing. CANADA:

    Canada could beat Russia in its own backyard, a Synthetic Ural “made in Canada” for Europe.

    With the introduction of competition from Alberta streams, the odds are that Russian blends will have to be discounted further in Europe.

    This week, WCS was originated by traders at Hardisty, Alberta at near $US 70/bbl. The cost of “railling” the crude to Montreal is fetching $US 12.

    Traders can deliver the WCS cargo to a refinery such Gdańsk, Poland at nearly $US 85/bbl while Urals is currently priced at near 2$ below the Dated Brent, or over $US 96/bbl.

    So yes, it is indeed very big. I let you read and connect the dots between the lines:

    Simon Jacques,
    Commodity Merchant and Shipping Advisor

    Comment by Simon Jacques — September 26, 2014 @ 12:24 pm

  2. What I still don’t understand, after years of watching this sad comedy, is why the EU still tolerates destination clauses when they seem to contradict EU anti-trust legislation, and why the EU has failed to invest in its pipeline network to make sure that regasified LNG from the UK, Belgium and the Netherlands can be pumped through to Poland. If a significant share of gas is bought from other suppliers, how can Gazprom prove that its “own” gas is being re-exported?

    Comment by Alex K. — September 27, 2014 @ 4:17 am

  3. @Alex-I think the only explanations are cowardice and political economy/capture. Google is in the antitrust crosshairs primarily as the result of pressure from European competitors, notably Axel Springer. Gazprom threatens European governments and suborns European companies who in turn pressure their governments. Anti-trust policy is totally politicized, in other words. It’s not based on any reasonable economic theory/analysis.

    You make a very good point at the end. Gas should be largely fungible, and therefore it should impossible for Gazprom to prove that gas it supplied originally was diverted in violation of destination clauses. I don’t know how the legal process would work though. Europeans reverse flows and says that the gas is from Norway or Algeria or Holland. Gazprom cuts supplies claiming a contractual breach. The Euros claim a contractual breach. What then? I presume there are arbitration clauses in the contracts. The arbitration drags on for years. And if Gazprom loses, how does Europe collect? In the meantime Gazprom loses revenue and Europeans freeze. A huge game of chicken.

    The ProfessorComment by The Professor — September 27, 2014 @ 10:37 am

  4. At least three people out there who understand what is going on:

    Comment by Ivan — September 27, 2014 @ 10:38 am

  5. Isn’t the destination clause removed from gas supply agreements ten years ago?
    E.g. Nicolò Sartori, ‘The European Commission vs. Gazprom: An Issue of Fair Competition or a Foreign Policy Quarrel?’, IAI Working Papers 13/03, January 2013, p. 5.

    Comment by Andres Mäe — September 27, 2014 @ 11:19 am

  6. Thanks for the link, Ivan

    It further cements for me the fact that Vladolf Putler is a psycho, being supported by psychos

    Interesting that the country with the second highest number of asylum seekers in the world, after Syria, is — the Rasha.

    Fleeing from Putlerstan to — Estonia – and other places.

    A gang of psychos, headed by Putler, is oppressing 100 million people.

    Comment by elmer — September 27, 2014 @ 12:01 pm

  7. Interesting comparison, also, of the Putler biker show in Simferopol to the Nazi film, “Triumph of the Will,” and the fact that “Triumph of the Will” looks meek and tame in comparison to the biker show.

    Brutal atrocities in Eastern Ukraine by Putler’s “non-army” also brought up.

    Thanks, Ivan, for the link.

    Comment by elmer — September 27, 2014 @ 12:03 pm

  8. Andres, Sartori only says the destination clause was removed from Gazprom-OMV contracts, weakened in Gazprom-Eni contracts and absent from Gazprom-Gasunie agreements. He does not mention Polish, Slovak, or Hungarian importers, whose reverse physical gas flows are crucial for Ukraine.

    My impression from Gazprom’s dispute with Poland earlier this month is that Gazprom has a good idea of its Eastern European customers’ daily demand and plans to supply them with exactly the amount of gas to fill it, leaving no extra for resale to Ukraine. When Poland’s PGNiG asked Gazprom to increase daily supplies because of a cold spell, Gazprom declined, saying it needed to fill its own underground storage. PGNiG had to stop supplying gas to Ukraine to keep domestic users happy. Gazprom did increase the flow a few days later but it could have been a warning: this is how we can stop you from supplying Ukraine at any moment, and you will have no reason to complain because we’re not freezing you.

    Comment by Alex K. — September 28, 2014 @ 9:34 am

  9. @Alex & @Andres. That’s my reading too. Limited one-off removals of destination clauses from a few contracts, rather than an EU-wide proscription.

    The ProfessorComment by The Professor — September 29, 2014 @ 12:19 am

  10. See below. You got a mention…

    Apparently it’s wishful thinking that the Euros will ever get a clue what’s in their best interest and act accordingly. Come to think of it, he might have a point…

    Comment by Pat — October 1, 2014 @ 10:13 am

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