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European Burners

But wait, you may argue, isn't Europe's reliance on Russian gas on the wane?

It certainly seems that way if you look only at aggregate figures. In 2002, Russian gas imports met 45 percent of Europe's needs, a number that has receded to near 30 percent today. Much of the difference was picked up by Qatar, Libya, and Nigeria, sources not in the picture earlier.

The decline can be attributed in part to new LNG facilities in the United Kingdom, Netherlands, and Italy, which have increased the number of sources that can sell gas to Europeans. However, the macro numbers don't tell the entire story. LNG is available only to countries with an LNG regasification terminal, and to have a terminal, a country needs to lay out the capital to build it and also must have a workable coastal spot to build it on. Thus the number of LNG-enabled countries is limited.

Those that can't make use of LNG remain near or at total dependency on pipeline gas, and for now that means Russia. Finland and Slovakia get 100 percent of their gas from Russia, with Poland and the Czech Republic near 90 percent. Even Germany still sits at 40 percent. For those countries, Russia's importance as a natural gas supplier is little changed in this century.


And the company keeping gas flowing to Europe? It's Gazprom, the natural gas counterpart to oil giant Rosneft. (See Figure 8.2.) Together they give Putin a solid one-two punch of oil and gas supremacy in Europe.

Like Rosneft, Gazprom was a bit player at the start of the Yeltsin era. Then it was gutted by oligarchs during the shark-bite privatization period of the 1990s. Putin took a chewed-up Gazprom under his protection and transformed it from carcass to global player.

A history of Gazprom reveals a lot about Vladimir Vladimirovich.

When the USSR Ministry of Gas Industry was reorganized in 1989 (the same year the Berlin Wall fell), Gazovaya Promyshlennost ("gas industry" in Russian), or Gazprom for short, was born. But it was a state entity only briefly. A year after the breakup of the Soviet Union in 1991, the government decreed that the company would be privatized.

Gazprom had the advantage of inheriting all of Russia's assets in the former centrally controlled gas industry. It stormed out of the gates in 1993, producing more than twice the combined Russian natural gas of Chevron, British Petroleum (BP), Exxon Mobil, and Royal Dutch Shell. It looked like Gazprom was already in the big leagues.

Reliance on Gazprom as a Percentage of Consumption

Figure 8.2 Reliance on Gazprom as a Percentage of Consumption

Source: Energy Information Administration. © Casey Research 2014.

It wasn't. It was in a big swamp.

Gazprom had trouble collecting bills from hard-up customers, many of them old, Soviet-era utilities unused to competing in the marketplace. In many cases, to make the best of a bad account, Gazprom accepted in-kind payments. Unfortunately, textile factories and vacation excursions for employees couldn't pay for the maintenance and expansion Gazprom really needed.

To make matters worse, several former Soviet republics—most conspicuously Ukraine—had trouble paying for their natural gas imports or just outright refused. Things got so bad that in 1994, despite producing far more gas than Exxon, Gazprom collected only one-eighth as much revenue.

In 1996 Gazprom registered American depositary receipts (ADRs)[1] for its shares, so that they could be traded publicly in the United States. It also obtained a $2.5 billion loan from international investors on market terms. That gave it some breathing room and time to negotiate several lucrative contracts with foreign companies. It survived the 1998 Russian financial crisis, even slightly increasing its production during that year.

However, the company then nearly succumbed to the menace from within—its management.

Gazprom had long been evading taxes, with the occasional help of Prime Minister Viktor Chernomyrdin, a Yeltsin appointee and the longest-serving prime minister in Russian history. When Yeltsin removed him in 1998, Chernomyrdin returned to his old job as head of Gazprom, where he turned to full-on asset stripping. Board members eagerly went about parceling out Gazprom's properties to their buddies and relatives.

In one particularly egregious example, Gazprom sold a 32 percent stake in subsidiary Purgaz, valued at $400 million, for a total consideration of $1,200 (yes, one thousand two hundred dollars). Gazprom also lent $850 million to favored third parties at low rates while borrowing money at market rates. In total, between 1997 and 2000, Gazprom "sold" assets worth nearly $6 billion for just $325 million. After that, there wasn't much production left.

Enter Putin.

Almost immediately, the company's fortunes picked up. As he had in the oil sector, he moved early to rein in the Yeltsin-era oligarchs and disable them politically. Chernomyrdin got the boot in June 2000, 12 weeks after Putin was elected president. He was replaced by Dmitry Medvedev, one of the St. Petersburg boys and the man who would later inherit the presidency from Putin.

The next month, Putin replaced CEO Rem Vyahkirev with the little-known Alexei Miller, another longtime ally. Under Medvedev and Miller, the looting ended and the company set about recovering what it had lost. In one instance, they forced a competitor to sell back a 51 percent stake in Sibneftgaz—at a below-market price—by disconnecting the company from Gazprom's pipeline network.

Slowly, Gazprom regained its strength, and with that came better access to financing from abroad. At home, Gazprom entered the financial sector directly by establishing Gazprombank, now the country's third-largest bank (board chairman: the same Alexei Miller). An improving balance sheet enabled it to acquire more resource assets, modernize old facilities, and build new ones. In 2005, Russian state ownership rose past 50 percent.

In recent years, Gazprom has begun to see more competition within Russia from smaller firms as well as from foreign companies with production-sharing contracts. But Gazprom has made acquisitions of its own and is developing exploration projects in the Arctic that could host tens or perhaps hundreds of trillions of cubic feet of natural gas.

Gazprom has also staked out a position in the LNG market through its involvement with Sakhalin-II (on Sakhalin Island, north of Japan), one of the largest integrated oil and gas projects in the world.

Then there's shale gas. This is the stuff that used to be an uneconomic resource but now can be recovered profitably by fracking horizontal wells. Unconventional recovery has transformed the economies of areas that sit above large shale gas deposits, such as in North Dakota. Shale gas has moved the United States from net importer status to gas self-sufficiency.

And it's another resource in which Russia is rich, or likely so. Because the country has so much oil and gas waiting for conventional drilling, little attention has been given to measuring the unconventionally recoverable shale gas in the gigantic Bazenhov Formation in Siberia (at surface, an area as big as Texas and the Gulf of Mexico put together). A recent drive-by estimate put the recoverable resource at 285 Tcf and 350 million barrels of oil.

Gazprom has remained nearly mum on the subject, and what little the company has to say about the economic viability of shale gas is negative. That has led to criticism that Gazprom is behind the times in the unconventional game.

Or it may be slyly ahead of the game. I take the don't-need-no-shale comments as talk for public consumption, to discourage Europe's development of shale gas while the company quietly explores the opportunities. Like Putin, Gazprom's management and technical teams are far from stupid, and again like Putin, they're capable of a little deception to advance their purposes.

Gazprom is also expanding its delivery system with the South Stream pipeline.

South Stream was conceived in 2007, partly as a response to the European Union's Nabucco pipeline. Nabucco, envisioned back in

2002, would have carried gas from Azerbaijan all the way to Austria. It was intended to lessen Europe's dependence on both Russian gas and Russian pipelines. The plan, however, was abandoned in 2013, for both political and economic reasons.

Something similar may still come to pass, though. The Trans Anatolian Pipeline (TANAP), funded by Azerbaijan and Turkey to move gas to Turkey, should open by 2019. From there, a proposed Trans Adriatic Pipeline (TAP) would continue on through Greece and Albania and under the Adriatic Sea to southern Italy.

Although the TANAP/TAP line would reduce Europe's dependence on Russian gas, its capacity of 570 Bcf per year is only a third of what was planned for Nabucco and only 25 percent of what South Stream will deliver. It would cover just 1 percent of Europe's total consumption. And while Nabucco was a joint European project, TANAP/ TAP would operate at the discretion of Turkey and Azerbaijan .

South Stream is progressing. It will run under the Black Sea and through Bulgaria and should come on line in 2018. Total cost: over $23 billion. It'll immediately be a big factor on the continent, delivering 2.3 Tcf of gas per year, or more than 6 percent of Europe's usage. And it will give Russia another route that bypasses Ukraine. The Russians intend to double its capacity by 2028.

With all that's going on in Europe, and with Russia already a major gas exporter, you might think that Putin would have little to no interest in developing production in Africa. But you'd be wrong.

  • [1] An American depositary receipt (ADR) is a receipt issued by a custodian in the United States to evidence ownership of stock in a foreign company that has not retained a stock transfer agent in the United States.
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