Part II: Gazprom Case.
This is a continuation of a previous post. The foregoing post reviews recent cases initiated by the European Commission that were aimed to reform European energy sector. In this post, I describe the investigation of the case of Gazprom and discuss possible outcomes and consequences for both parties.
General information about the company
Gazprom is a world largest extractor of natural gas (14% of global output) and is one of the world largest companies (TOP 10 in Oil & Gas Industry according to Forbes). Company’s headcount is over 390 thousand employees. In 2011, Gazprom produced 8% of Russian Gross Domestic Product, while the Russian government controls more than half of all company’s shares. Gazprom controls the largest part of natural gas production in Russia. It produced 75 % of total Russian production of 600 bcm. Total exports have been constant during 2000s, estimating around 200 bcm/a, 60 % of which went to non-CIS countries in 2013. The Russian Energy Strategy 2030, adopted by the Russian Government Decree in 2009, forecasts a further increase in production of natural gas (up to 1000 bcm), its domestic consumption (650 bcm) and exports (350 bcm) (Energy Strategy of Russia 2030). In 2014 Gazprom managed to have 29,7% of market share of the European Union. Gazprom managers forecast a further increase of Gazprom’s market share in the EU (Gazprom strategy, 2015).
Instituting the investigation
The European Commission initiated the case under 39816 “Upstream gas supplies in Central and Eastern Europe”. So what were the claims of the European Commission?
The Commission claimed the following:
(1) According to the Commission, Gazprom created the obstacles to the network access by hindering free flow of gas across the Member States and partitioning some of the EU markets along the national lines. The Commission states that Gazprom prevented any exports of gas in its supply agreements for Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland and Slovakia using export bans, clauses destination, and providing requirements for exports approval.
In other words, Russian gas cannot compete with Russian gas (European Commission Report)
(2) Another claim of the Commission was that Gazprom used unfair pricing (that is gas price linked to oil price) in five Central and Eastern European countries (Bulgaria, Estonia, Latvia, Lithuania and Poland). Especially, Commission was concerned about increasing prevalence of hub-based pricing in the more liquid spot and derivative markets as well as concluding the long-term agreements (up to 2035).
(3) The Commission also had concerns regarding the gas transport infrastructure.It suspected Gazprom in leveraging its market dominance in Bulgaria and Poland by making gas supplies conditional upon obtaining certain infrastructure-related commitments from the wholesalers. The Commission argued that in Bulgaria, Gazprom linked gas supplies to the acceptance of some obligations by the buyer, namely, for construction of the pipeline infrastructure (Bulgarian section of the gas pipeline “South stream”), and in Poland – with preservation of its control over the Polish section of the gas pipeline “Yamal-Europe”.
In this section I will shortly cover how the story unfolded.
2007-2010: Series of antitrust investigations against several gas incumbents in Western Europe (boosting competition in the markets of Germany, Belgium, Italy and France).
2011: Series of unannounced inspections in the natural gas sector.
2012, September: Commission opens proceedings against Gazprom suspected in hindering competition in Central and Eastern European gas markets.
2015, April: Statement of Objections to Gazprom for alleged abuse of dominance on Central and Eastern European gas supply markets.
2015, September: Gazprom submits its official response to the Commission’s “Statement of Objections” and proposes formal talks with Brussels to settle the case. Gazprom did not admit guilt, however the negotiations on the draft proposal for commitments has started.
The Legal Background of Gazprom Case is built on ‘the abuse of a dominant position which may affect trade between Member States’ (Article 102 TFEU) and regulated by Antitrust Regulation (Council Regulation No 1/2003) – Article 11(6), Article 16(1).
European Gas Market and Market Concentration Overview
Given the market shares of Gazprom in the Central and East European countries (See Figure 1, grey lines stand for Russian companies share in each country), the dominance of the Gazprom seems indisputable. Therefore, the Commission defined Gazprom as explicitly dominant player in the markets of Central and Eastern Europe (CEE): “Gazprom is the dominant natural gas supplier in all Central and Eastern European countries, with market shares well above 50% in most, and in some countries up to 100%” (European Commission).
Figure 1. European Gas Market Structure (calculations by Saieed and Kiparisov, 2015)
To make the picture clear we together with my colleague Abu Saieed calculated the Herfindahl-Hirschman index (HHI) for 2012. The index measures the market concentration and is widely accepted as a tool for estimating monopolies and mergers. Calculating the HHI, we raised the market share of each firm competing in a market to the second power and summed the resulting numbers (See Figure 2).
The HHI index ranges from 0 to 10,000. The higher the number the closer a market is to being a monopoly. The higher numbers associate with higher market’s concentration and lower competition. Thus, the market that is 100% supplied by a single firm will get the HHI equal 10,000.
Figure 2. Herfindahl-Hirschman Index (calculations by Saieed and Kiparisov, 2015)
One can see that the HHI in Slovakia, Lithuania, Latvia, Finland and Estonia in 2012 was 10,000. Thus, at their markets Gazprom had a monopolistic position. Nearly monopolistic state is also observable in Bulgaria, Romania, Slovenia and Hungary. The imports of gas in Czech, Austria and Poland seem to be more diversified, however the results of 1,800 or greater are assumed to indicate an already highly concentrated marketplace (Investopedia).
Positive changes. There is a trend for positive changes in the activities of Gazprom. The analysis of Gazprom`s official reports demonstrates a much more flexible negotiating position than has commonly been thought to be the case. During the period 2009 – mid-2014 as many as 58 gas supply contracts were reviewed with 39 clients, providing price discounts, easing of take-or-pay obligations and a certain introduction of a spot component. In addition, in September 2015, Gazprom held its first ever auction of gas supplies on the spot market. Financial Times called it “a significant concession after years of arguing in favour of long-term contracts” (Financial Times, 2015).
The Commission has ambitious tasks regarding the transformation of monopolised national energy markets into a competitive single energy market. This process is difficult and long-lasting but the Commission demonstrates a strong will to implement it. In my series of posts on energy market regulation in Europe, I analyse Commission’s Gazprom investigation from the perspective of energy cases since 2007. This allows me to look at the current case in the context of Union’s general competition and energy policies. One can see that Gazprom case fits well into the logic of Commission’s market liberalisation strategy.
There is no doubt that the dominant position of Gazprom in several CEE countries is disturbing for the European Union. Some of the experts argue that huge investments in renewable energy will solve the problem of CEE import dependency. However, this measure may take more than 15-20 years. At the same time, natural gas, given its relatively low ecological harmfulness, is likely to stay a supplementary (and in some regions – main) source of energy during the long-term transitionary stage. Coal has another fate but it is not a subject of the current study.
Gazprom shows some readiness for cooperation and signing an amicable agreement therefore it is not necessarily for the European Union to act rashly.
Lessons Gazprom may have (or have not) learnt from the recent energy cases.
It is unlikely that the Commission will stimulate changes in the already concluded long-term agreements. However, the practice of energy market liberalisation and Distrigaz/EDF case show that Gazprom in the future will not be able to conclude the contracts with the length exceeding five years. It will be also difficult to include supply restriction conditions or conditional commitment statements (e.g. infrastructure development). E.ON and GDF cases are good precedents for market segmentation and network foreclosure that concerns Gazprom as well. A huge fine is very likely to happen. The lessons from the past cases might stimulate company to comply and commit because we saw that the Commission tended not to charge the incumbents if their commitments were well-grounded. However, these precedents might not concern the case since Gazprom is a foreign company. The cases of Microsoft and Google should also be examined. In addition, there is, of course, still might be a room for political, diplomatic and financial issues, therefore there is no clarity about the final decision and its consequences, which is also exaggerated by current political and economic tensions between the EU and Russia.
At least in the next five years the position of Gazprom in the European market is guaranteed by long-term contracts. In the longer run, with the growth of alternative supply, primarily with the coming wave of LNG glut, Russia will have to enter into price competition with the new suppliers, provide additional discounts and introduce an explicit spot price component.
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