ANAPA, Russia (AP) — Russian energy giant Gazprom is spending billions to expand its already massive footprint in Europe. But it will have to tread carefully at a time when global natural gas supplies are surging and prices are falling, giving European utilities and businesses more leverage in negotiating supply contracts.
At a lavish ceremony in December to mark the start of construction of a new pipeline to Europe, Gazprom put on a show of its industrial might to match the project's €1 billion ($20.92 billion) price tag. On the Black Sea coast, 600 miles south of Moscow, the company built a eight massive steel-framed marquees to house Russia's President Vladimir Putin, Gazprom's executives and various European partners — all for a two-hour ceremony in which two short sections of the new South Stream pipeline were welded together.
In spite of all the public praise heaped on Gazprom at the event, there was recognition behind the scenes that the company is losing some of the clout it holds over Europe. While the region will remain heavily dependent on natural gas piped from Russia for decades to come, its ability to demand better prices is improving. That's because Gazprom is facing competitive pressures around the globe as gas production grows in the U.S., Australia, the Middle East and Africa. In other words, it needs Europe more than ever before.
Born out of the Soviet gas ministry in the rush of Russian privatizations in the late 1980s and '90s, Gazprom is effectively the country's gas industry, accounting for about 80 percent of the country's natural gas output. The company, which posted some $5 billion in net profit in the second quarter of 2012, holds a monopoly on Russia's gas export market and has first choice of which fields to operate. Gazprom exported some 238 billion cubic meters of natural gas around the world last year.
The vast majority of those exports arrive in Europe. The company supplies a quarter of the 27-country European Union's gas needs, some 124 billion cubic meters, according to Eurostat, the EU's official data service. Europe still tethers itself to Gazprom because, at the moment, it is almost impossible to find enough gas from other sources to replace the sheer amount the company exports.
The South Stream pipeline — jointly funded by Gazprom, Italy's Eni, France's EdF and Germany's Wintershall — was conceived in 2007. South Stream is due to start operating in 2015 and will bring up to 63 billion cubic meters of Russian gas a year to the Balkans, Austria and Italy.
However, the market for natural gas has changed dramatically since South Stream was first thought of. Natural gas reserves and export facilities are springing up around the world. European energy groups have already started importing gas from Qatar and will have more and more suppliers to choose from as more facilities come online.
Over the past few years, Gazprom has been locked in disputes with its European clients over its pricing policies. The big European energy companies — such as Germany's E.ON, France's GdF Suez or Poland's PGNiG — are unhappy with what they believe are rigid contract terms: High tariffs linked to oil prices and the take-or-pay clause which leaves energy firms locked with the volumes they may not need.
In 2012, Gazprom exported gas to Europe at an average price of $381 per 1,000 cubic meters — or $10.88 per 1,000 cubic feet. That is higher than the two most important European benchmarks for gas prices, the U.K. and Amsterdam, which had average prices for gas of $9.47 per 1,000 cubic feet and $9.42 per 1,000 cubic feet respectively, according to Platts, a global energy information provider.
In the first half of 2012, Gazprom has paid some 133 billion rubles ($4.3 billion) in "retroactive discounts" to settle these contract disputes with its clients, according to its earnings report. And the Europeans are hungry for more.
Paolo Scaroni, chief executive of Italy's Eni which owns 20 percent in South Stream, said his company would not need as much gas from Gazprom this year as it is bound to buy under the take-or-pay obligations because of weak market conditions.
Eni managed to get a lower price from Gazprom last year, and Scaroni told the AP that he does not see "any reasons why they should not be changing the prices in the future and adapt them to market conditions."
"Russian gas should be extremely cheap to produce, so it's going to be competitive with any gas in the world," he said.
One of the biggest long-term threats to Gazprom comes from the U.S., where the country's natural gas industry has grown rapidly thanks to recently perfected drilling techniques known as "fracking" — that have allowed drillers to extract from underground shale deposits.