The 3 Week Diet System

Sunday, May 24, 2015


May 24:

At the CSIS event on Ukrainian Energy Reforms and European Gas Supply, Alan Riley delved deeply into the EU's antitrust case against Gazprom, breaking down the allegations against the Russian gas company, and describing the repercussions of not settling the matter before a ruling by the European Commission.
He recalled that the European Commission's antitrust allegations against Gazprom, which resurfaced in April, were originally launched in September 2011 with a series of “dawn raids” at Gazprom's offices in Berlin and Prague.
“The Commission can take enormous amounts of documentation, copy corporation servers – they're able to obtain a vast amount of information and they can ask questions under the threat of financial penalty to those answering the questions.”
This, said Prof. Riley, resulted in a Commission investigation the following year.
According to him, in the Commission’s statement at the time they announced they were focusing on three principle issues: destination clauses, denial of third party access to pipelines/markets, and indexation.
Of the destination clauses, he said: “This is essentially a clause in long-term supply contract which says 'you, Poland, can have our gas – here is your contract; however, you are not allowed to sell it to, say, Germany.'”
While initially there was no problem doing that, said Prof. Riley, considering increasing single market integration and equalization prices in much of the region it was not a problem. “Now the issue might be somewhat more complex in the sense that it's not actually about formal clauses in long-term supply contracts; it's about practices which try and divide up the market and allow you to impose different prices across the system.”
Secondly, Gazprom is alleged to have stopped competitors getting to market for the last decade.
He explained, “Gazprom classically owns one-third of a pipeline network in a particular member state and it's commercial allies own the other two-thirds, and it is able then to stop anybody, effectively, accessing the pipeline network.”
Alternatively, he said, Gazprom can impose pressure on host governments or corporations in a state to stop the building of LNG terminals, pipelines or interconnectors. “Effectively stopping any competitors from entering the market,” he added.
The indexation issue, said Prof. Riley, is tricky. Initially, he recalled, the Commission said it was seeking to challenge the indexation of gas prices to oil prices. The original linking of gas prices to oil prices had occurred in 1967, when the Dutch were trying to figure out how to price and sell gas from the Groningen field. “And as, at that time, we had oil-fired power stations and were going to also use the gas for generating electricity, it seemed reasonable enough to link the oil and gas price.”
Today, he said, oil-fired stations are the last resort.
“The actually practical link no longer exists,” he explained. “Today, if there's no transactional, commercial basis for the link, if a dominant company uses that, relies upon indexed-based, is that sufficient to constitute abusive dominance? I would have thought no, but there may be a lot more to it.”
The price discrimination across the Union angle, according to Prof. Riley, has greater potential as a legal route of investigation. He explained: “If you go to the UK market – the most liberalized, liquid gas market in Europe – you're paying around $300/tcm, whereas substantially closer to Moscow – in Lithuania before they got their LNG terminal in place - they were paying close to $500/tcm. And under no ordinary commercial rationale, beyond the fact that the Baltic states were a gas island that were 100% dependent, could you easily justify that.”
He said that a series of meetings were held between Alexander Medvedev and Directive Group (DG) Competition officials at the end of 2013 to settle the case, with the major issue being overpricing, but no agreement reached.
Professor Riley offered that the Commission could fine up to 10% of Gazprom's turnover of the preceding business year, which could amount to $15 billion. “However, the Commission would not actually pose a fine of that size – I reckon between half a billion and $3 billion if you look at previous practice.”
The bigger threat for Gazprom, said Prof. Riley, would be if the Commission imposed remedies, like if the company was forced to sell pipelines, infrastructure or storage facilities in order to reduce Gazprom's market power in Europe.
He added that a monitoring trustee could also be appointed to oversee the operations of Gazprom in the European market. Further fines could also be imposed, investigations could be undertaken, etc.
A “prohibition decision”, he explained, would be problematic in that a document would exist, which would be published in 18 languages and include all of the official details of what Gazprom had done in the last decade – real reputational issues for the company.
“There's also the problem that, almost immediately, you would trigger a series of arbitration claims in Western Europe, to challenge the existing pricing structure. Because if the Commission rules that indexation is unlawful, then one of the difficulties for Gazprom is that the case only deals with Eastern Europe, not Western Europe, but the Western Europeans will be affected by any decision in the Gazprom case for Eastern Europe – this is increasingly a single market – so they will be able to trigger the price review clauses in all of their arbitration contracts, to argue downward the price of gas they're currently importing from Russia on the basis of the Commission's prohibition decision,” said Prof. Riley, who called it a “cascade effect.”
That decision, he said, could be used all over the world, for example by China.
Finally, the most potential damaging effect, according to him, is the prospect of damages claims on the basis of illegal pricing being brought by countries, state utility companies, energy intensive private corporations right across the whole of the European Union.
If, for example, Poland pays about $10 billion/year for gas and the overcharge is roughly 10%, tacking on compound interest. “You do the math,” quipped Prof. Riley. “That's one member state. The numbers could get very big indeed.”
He said that his advice to Gazprom has been, “Whatever you do, settle the case. You cannot allow a prohibition decision to be published – it will be very bad news indeed.”
The fact that charges have been filed, he said, does not mean there won't be a settlement.
With the oil price as low as it has been, Prof. Riley asked if it is worthwhile for Gazprom to fight on this front.
“Equally, the European market is being put together, the Energy Union is on the way, physical interconnections are being strengthened, the Third Energy Package is being employed across the market – so all the points that Gazprom is trying to fight on are actually, practically and commercially, difficult to sustain, so why try to defend what is increasingly indefensible and commercially impractical? Why not just do a deal?”
Prof. Riley opined that, given that Russia has become radicalized in the last 18 months, it may be quite difficult for the leadership of Gazprom and the Kremlin to take that decision.
Meanwhile, he observed that Gazprom has already been conducting a selling off of energy assets in Europe, like the sale of Wintershall, or the company's trading operation moving from London to St. Petersburg, and an alternative strategy is apparent.
He said that Russia had captured Turkey, explaining, “One of the real reasons for the Turk Stream decision on 1 December was that in October and November the Russians reduced the supply of gas to Turkey by 50%, causing panic in Ankara and providing an extra incentive to do the deal that the Turks did – they're already 60% dependent on Russian gas and they're paying higher prices than Ukraine.”
Also, he said Russia has a strategy to buy a number of energy assets in Turkey, so while it is losing Ukraine and they European Union, Russia is trying to hold on to the one remaining country with growing gas demand.
Aside from the antitrust case, Prof. Riley said Europe should complete the single market and put the interconnections in place, and dealing with “weak links” like Bulgaria.
Editor's note: Reuters reported on 7 May that Gazprom has 3 months to respond to the EU antitrust charges. For it's part, the company says it might be willing to make price concessions.


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