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Gazprom: Angel or Demon?

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Message James Stafford

Gazprom faces regular opprobrium for its bullying ways of using energy as a pressure and political tool. Seen by some, mostly Russians, as the symbol of a successful and strong Russia, others see it as a dominating juggernaut, economic right arm of the Kremlin implementing, or should we say, imposing its policies by using energy as a weapon.

Just like Louis XIV used to say "L'Etat c'est moi" (I am the State), Gazprom could say the same in light of its commercial power and the unconditional governmental backing it enjoys. However, just like Monsanto generates passionate debates with its genetically engineered seeds, Gazprom's activities cannot be simply labeled as right or wrong and subject to final judgments.

Though far from being an angel, Gazprom is not necessarily a demon either. It is easy to point fingers and to forget that oil & gas is a merciless sector where every major is trying to position itself for the next 20 to 30 years and secure predictable supply and demand at home and abroad. After all, large Western energy companies were not born nice and proper. It took decades for codes of conduct, tacit or written, to be adopted and enforced. It is also easy to forget that all energy companies have in mind the interests of the country they come from.

Why would it be any different for Gazprom? And why should Gazprom take upon itself to act differently if it can get away with what it does and not be sanctioned by its own government?

The main issue with Gazprom could be summarized by using the famous quote of U.S. Secretary of Defense Donald Rumsfeld who said about Iraq "there are known unknowns. That is to say, there are things that we now know we don't know. But there are also unknown unknowns. These are things we do not know we don't know." Because of all the things we do not know about Gazprom, sensitivity to what Gazprom does is greater because ultimately what it decides to do today and how it does it will impact energy supplies for years to come and how the game is played.

The lack of information on the personal relationships between the business and political world, on its exact ownership structure, on the exact identity and role of business intermediaries, on the flow of money through a labyrinthine network of offshore and shell companies, and on the overall exact modus operandi of Gazprom is what leads Gazprom to be subject to greater scrutiny and interrogations. It efforts to maintain an export monopoly for gas flowing to Europe and Asia at a huge cost, possibly over-committing dwindling resources at a time of lower energy prices and lower needs from consumers is another concern as would happen if Gazprom was to fail?

Gazprom: The Lord of the Rings

Gazprom is a behemoth: it is Russia's largest company, state-controlled and the world's largest gas producer. Engaged in gas exploration, processing, and transportation, it operates an extensive pipeline network stretching thousands of kilometers across Central Asia and Europe. Gazprom ranks #22 in the 2009 annual ranking of the world largest corporations published by Fortune magazine and has 456,000 employees. With close ties to the Kremlin - President Dmitry Medvedev used to be chairman of Gazprom's board of directors - and accounting for about 25% of Russia's federal tax revenues according to pre-crisis data, Gazprom has a unique leverage and has no qualm about flexing its muscles.

Gazprom has an uncanny ability to do things that are morally reprehensible by Western standards and to be oblivious to the critics that ensue. Image building and public relations are concepts that have not sunk in, even more so as Russians have the deep belief to be justified in their actions, be it with its dealings with Chechnya or Georgia, or when cutting gas to Europe in January 2009. Russians also like to push situations to the limits, just like driving without seatbelts and passing cars with incoming traffic on an icy road.


Gazprom and Ukraine: who's bad?

Russians are full of contradictions, and so is Gazprom. One can only be amused to read its mission statement extracted from its Gazprom in Figures 2004 -2008 and 2008 Annual Report that state: "OAO Gazprom mission is to ensure an efficient and balanced gas supply to consumers in the Russian Federation and fulfill its long-term contracts on gas export at a high level of reliability." That did not prevent Gazprom from bluntly cutting the gas supply to Ukraine in January 2009 over non-payment issues and quantities to be supplied, impacting 18 European countries in the mix in the midst of a cold winter.

The image of Russia as a reliable partner has been severely damaged, even more so as this was not the first time gas supply to Ukraine was cut like in January 2006. Even the Soviet Union did not tamper with gas supply, knowing how important the energy cash machine was to its economy and survival. Those cuts prompted (i) end-user countries to find alternative suppliers and (ii) producing countries that rely on the Gazprom pipeline network, to find alternative export routes for their existing clients, in addition to finding new clients.

In this context, the Nabucco Pipeline that bypasses Russia gains momentum while Turkmenistan can sigh with relief with the new Central Asia China Gas Pipeline inaugurated in December 2009 that takes gas from the Caspian Sea via Uzbekistan and Kazakhstan to China.

Russia makes no efforts to work on its international public image but Russia and Gazprom would have benefited from elaborating over the payment mechanisms in place with Ukraine. For many years, Ukraine has enjoyed discounted prices, significantly below world market prices. It also has resisted price adjustments sought by Russia. Those sweet deals have been detrimental to Ukraine and to the competitiveness of its industry. According to the European Bank for Reconstruction and Development (EBRD) "Ukraine is one of the most energy-intensive countries in the world and is only one-third as energy efficient as the average European country."

The following facts would have been good to communicate to show that Russia and Gazprom were sensitive to the challenges that gas price increases represent for Ukraine, both economically and socially. At the end of 2008, Ukraine was enjoying heavily discounted prices and resisted Gazprom's price adjustment efforts, despite a very preferential rate being offered. Gazprom went as far as to lower its price offer from $418 to $250 for 1,000 cubic meters. When the Ukrainians made a counteroffer of $235, Gazprom reverted to if initial offer of $418. The lack of agreement over pricing by December 31, 2008 led to the January crisis. After the crisis, Ukraine still paid 20% less then European prices. Starting in January 1, 2010, a 10-year contract stipulates that Ukraine will switch to market prices.

Needless to say that the door was swung right back at Gazprom by the countries through which Gazprom's gas transit. For instance, Ukraine raised transit fees by almost 60% from $1.70 per 1,000 cubic meters per 100 kilometers of transit to $2.70 in 2010. On top of this, Gazprom accuses countries like Belarus and Ukraine to "siphon" gas out of its pipelines, in other words to take gas out of the pipelines without having agreed to pay higher prices.

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I have an interest in the financial markets, commodities and Geopolitics.
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