The EU may soon have Gazprom and Vladimir Putin running on fumes

May 1, 2015
Russian President Vladimir Putin chairs a meeting on recent wildfires issues in Abakan

Russian President Vladimir Putin chairs a meeting in Abakan, the Republic of Khakassia, April 21, 2015. REUTERS/Alexei Druzhinin/RIA Novosti/Kremlin

For all of President Vladimir Putin’s rhetoric about Russian nationalism and economic self-reliance, he finds himself surprisingly constrained in his ability to respond to the European Commission’s action against Gazprom.

The European Commission’s decision to bring antitrust charges against the Russian energy giant sparked an immediate complaint from Russian Foreign Minister Sergei Lavrov. He loudly protested that the European Union was changing the rules in midstream. The European Union, however, was trying to send a different message to Russia: institutions matter, and Gazprom does not get a free pass around its rules.

The commission charged Gazprom with abusing its dominant market position and overcharging customers in several countries. As a state-owned firm with geo-strategic implications, Gazprom is no ordinary company. In addition, because the potential fines are significant — up to 10 percent of the company’s global revenues — these antitrust allegations cannot go unanswered.

An engineer checks the gas distribution system in Beregdaroc

An engineer checks the gas distribution system in Beregdaroc, one of several points where Russian gas crosses into the European Union, February 10, 2015. REUTERS/Laszlo Balogh

Yet Putin will have to respond at a time when the country’s energy and economic options are limited. He also has to swallow the European Union’s reminder that even after Ukraine, Russia is not an international rule maker.

The commission’s “statement of objections” focused on Gazprom’s use of market partitioning, which demands that gas only be used in the purchasing country and prohibits its re-selling. Such territorial restrictions violate the European Union’s competition requirements, according to the commission, and have directly resulted in higher prices in five EU states — Bulgaria, Estonia, Latvia, Lithuania and Poland.

Russia insists, however, that because Gazprom is a state-owned enterprise, Europe’s competition rules should not apply. Instead, as a “strategic” company (as designated by the Russian government), the European Union and Russia should resolve these charges on an inter-governmental level — not through the normal regulatory process.

Gazprom’s designation as a strategic company has existed under Russian law for several years. The classification  was created to make it more difficult for foreign investors to buy controlling interests in dozens of domestic Russian industries, including energy, technology and natural resources. Yet this term has no legal meaning outside Russia and is unlikely to persuade the commission to drop the charges.

It turns out that Gazprom has been seeking special status in Europe for years. To no avail. The EU Third Energy Package of 2009 calls for the separation of European energy suppliers and distributors. This requirement would undermine Gazprom’s business model for Europe. For the energy monolith does not want to share its pipelines with other companies. Moscow ultimately refused to ratify the energy charter treaty and, in 2014, filed a request for consultations at the World Trade Organization, but with no evident change in policy.

Judging by the European Union’s previous actions, the commission appears unwilling to grant any special exemption to Gazprom.

The charges against Gazprom confirm what has become increasingly apparent during the Ukraine crisis — Russia is far more integrated into the global economy than originally believed. These relationships can only be disentangled at a significant financial cost.

In reality, Putin’s options on the energy front are limited. He could, of course, threaten the European Union with gas cut-offs, as he has done in the past. But that would deprive Russia — and Gazprom — of crucial hard currency earnings at a time when Russia finds itself in dire financial straits. Gazprom’s net profits are already down 70 percent this year. With Russia facing major budget deficits and domestic workers grumbling about not being paid, Putin can’t afford to lose even more money.

Putin could also pursue alternative markets for Russia’s gas. Much fanfare accompanied the $400 billion Russia-China gas supply deal in May 2014. The ultimate profitability of this agreement, however, remains in doubt, primarily because the parties failed to divulge any price terms.

The pipeline’s construction is years away from completion in any case, and there are already suggestions that, due to inflation and the decline in the ruble, significant cost overruns will occur. In the near-term, China cannot replace Europe as the major energy market for Russian gas.

Similar constraints exist in the financial markets. Putin, for example, wants to encourage Russian individuals and companies that have their money located in offshore accounts, to return it to Russia under a proposed amnesty. Such a repatriation of funds — without proper checks of the non-criminal origins of the money — runs afoul of the Financial Action Task Force anti-money-laundering recommendations. Russia does not want to be identified as a non-compliant jurisdiction by the task force, though, so the amnesty remains in draft form. And the Russian money stays overseas.

The lesson is clear. Russia is an integral part of the global energy and financial markets. Until such time that Putin can persuade other countries that Russia has a better rules-based system, he will have to abide by the present one.

Integration, it must be stressed, should not be equated with deterrence. As Putin has shown throughout the Ukrainian crisis, he is willing to act in open defiance of international norms no matter what the economic consequences. Putin’s primary leverage remains his control over the level of violence in Ukraine — the world listens when fighting is threatened or ongoing.

Putin cannot truly triumph, however, until he gets to re-write the rules of the game — whether on security, energy, trade or finance. Otherwise, he constantly will have to react to prevailing laws that Russia had no role in drafting.

The European Commission has reminded Putin that such a victory is a long way off.

15 comments

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But the Russians are right. The EU changed the game midstream. The last time they changed the rules midstream, the EU lost South Stream which will now no longer go to the EU but will go to Turkey, a non-EU member. Brilliant EU. And you’re about to shoot yourself in the foot again by changing the rules midstream. Mr. Putin has pointed out to the EU that, while they get to make their own rules, that rule making doesn’t come without a price.

Posted by majkmushrm | Report as abusive

I think Elon Musk may have a better way to handle Putin:
http://www.reuters.com/article/2015/05/0 1/tesla-batteries-tesla-motors-idUSL1N0X S03L20150501

Posted by UauS | Report as abusive

At least Russia are being honest for once. “Hey this is important. There’s no way we’re going to obey the laws”. That’s today’s Russia in a nutshell.

Kick a Putinbot, for democracy! Hard, in the ‘nads…

Posted by SigmaTheta | Report as abusive

Putin is caving to the sanctions. But too little too late. He has already set the Russian economy into a downward long-term movement. Investors are pulling out, and new ones are going elsewhere. Incompetent statesmen, petty border skirmishes, more interested in image than global business results.

Posted by AlkalineState | Report as abusive

In any business price depend on seller especially in seller’s market.Buyers have to be aware.It seems EU is getting desperate to bow down Putin.But his strength is his people of the country who are willing to sacrifice for him.

Posted by gentalman | Report as abusive

Good. Take the gas to turkey and grease. You know why those countries are getting kicked out and excluded from the EU? Because they don’t have any money. And they never will. The people there barely work. Good luck in your rich new markets, Russia :)

Posted by AlkalineState | Report as abusive

Wait till the coming winter and this EU will be one more in line for Russian gas contracts – the dependence is too-great to overcome in a short time.

Posted by Mottjr | Report as abusive

Turkey should be a hub to which all gas pipelines from all gas suppliers will arrive and then a common pipe line to Europe. That way Europe will be able purchase gas from whoever they want.

Posted by Macedonian | Report as abusive

Brilliant.

Posted by FUD312 | Report as abusive

This article highlights one of the key differences between Russia and the European Union, which is the absence of the Rule of Law in Russia. And the Eu does well to impose sanctions based on its laws to foreign companies who want to operate on its territory. Much rather Greece than Chechnya…

http://www.reuters.com/article/2015/04/2 3/us-russia-chechnya-idUSKBN0NE28O201504 23

Posted by FUD312 | Report as abusive

is desperate in finding ways to force Russia to kneel to them, but in vain. There are many.countries in Eu, which have different priorities and interests, Russia is a single nation. Eu countries don’t have single stance even in much easier achievable goals as to combat with the illegal immigration.Russia is producer of gas, most of the European countries are importers. There is no any serious alternative to the Russian gas, and relations with Russia aren’t confined only to gas and oil. One day Putin will go, but whoever replaces him will defend interests of Russia. It’s a very small probability that RuSsia will be ruled for a long by person putting priorities of his country behind those of foreign countries or personal ones. Putin is a strong politician defending interests of his country, whichever methods he uses. Finally, Russia is a nation with strong imperial traditions, not a puppet state as Saudi Arabia or Bahrain

Posted by Levko | Report as abusive

Financial Action Task Force closes blind eye on money laundering capital:SINGAPORE

Posted by Jingan | Report as abusive

Here is my prediction of what Putin will do. It will be winter, possibly a very hard freeze or blizzard in Europe, or just after such weather conditions. Putin will cause gas supplies to be interrupted to Europe, perhaps just for a short time. That will, in his mind, give him the price leverage he needs because Europe will be begging him for the gas at that moment. But smart Europeans better be investing hard *subito* in both a bolstered military preparedness and seriousness, as well as energy independence from Russia, otherwise Putin will rightly smell weakness and he will attack.

Posted by AgentG | Report as abusive

It’s easier to pick a fight with Google than with Putin. Putin wins at home when he fights abroad.

Posted by Hipster_Dufus | Report as abusive

EU lapdog members including Poland and the Baltics should be turned off Russian gas.

No international law is in place to allow regional customers to resell gas intended for them alone.

This is yet another reminder that the true motive behind the Ukrainian mess is to find a way to make Russia into an obedient raw materials supplier to the EU.

Just say no.

Posted by Forkbeard | Report as abusive