The fact that German energy company RWE is contemplating a downstream merger with Russia's Gazprom on the back of Berlin's decision to phase out nuclear power is bad news for Europe on three levels. The first is that oil-indexed gas prices will be reinforced in favour of wholesale spot prices. The second is that European diversification efforts will be undermined given that RWE was the leading utility behind the EU inspired Nabucco pipeline. The third is that once Gazprom gets a foothold in the German downstream scene, the EU's dream of ‘unbundling' production, transmission and distribution will be dead. Europe will be tied to Russia's hip at a time when Moscow is increasingly looking towards Asia for lucrative new markets and additional political leverage.
Weak fundamentals have masked deep policy flaws in European energy provision, nowhere more so than on gas. Europe has not only taken its eye off the Asian ball where demand is tightening, but more specifically, from its structural dependence on Russia. The EU's hapless handling of the Arab spring has made alternative upstream supplies a tougher nut to crack, but the real policy ‘no brainers' fall within the EU itself. Most notably in Berlin, where the post-Fukushima decision to accelerate the nuclear phase out is set to give Gazprom a significant downstream German stake - at least if RWE's recent Memorandum of Understanding with Gazprom is much to go by.
Obviously a degree of brinkmanship is involved in the RWE-Gazprom deal, both from RWE to try and force a nuclear rethink in Berlin and from Gazprom to underpin its European market share in terms of volume and price. Whether both sides follow through towards a fully-fledged joint venture remains to be seen, but the stakes are too high to simply sit back and wait: Gazprom isn't just trying to consolidate its European position on the back of nuclear closures, it is looking to sign a 68bcm/y deal with China and rapidly ramp up its LNG capacities in Eastern Siberia.
No need to worry? Perhaps. Gazprom and Chinese energy company CNPC struck a similar MoU in 2006, only to see it founder on pricing problems. But China has moved the debate on by offering advanced payments of $US25-40bn in return for 30bcm/y of discounted gas. Prospective target prices expectations are reportedly honing in around the $300/mcm mark, and Gazprom believes exports to Asia could grow by around 150%. Even if the numbers change, Europe has be slow to catch on to the fact that Moscow is trying to put itself in a position where it can reroute LNG or pipeline exports between East and West at will. Although the geographic, logistical and financial hurdles for an integrated export network will ensure that Russia continues to humour its richest consumer for some time to come, Europe needs to understand that as the gravitational pull of Russian supplies shifts eastwards, Moscow's strategic focus will be on arbitrage not compromise.
Europe has thus made a number of bad moves during in the midst of a of a lax gas market. Investment in storage has been low and liberalisation to reduce pricing pressures weak. All while European upstream diversification has been debunked by its failure to project military power. Germany's U-turn on the speed of the nuclear phase out has made matters inexorably worse. Decommissioning existing generation capacity to appease voter fears is anathema to strategic foresight, at least in terms of supply security. It ignores rising Asian demand, the energy requirements of economic recovery in Europe, creeping supply side constraints, or indeed the possibility that unconventional gas will prove too unpopular to develop.
By breaking the energy covenant with its utilities, Germany has offered Gazprom an opportunity to move into the European value chain at the very moment Russia is set to curb its dependency on European imports. If Gazprom manages to cement its supply routes to Asia, the prospects for European energy will incredibly bleak, and not just if markets are tightening. Who knows, we might one day be grateful to retain oil-indexed price links to keep Russian supplies online. But going long on gas means going long on Russia, we better hope that Germany re-evaluates the price of energy populism.
Matthew Hulbert, Senior Research Fellow, Clingendael International Energy Programme, The Hague & Christian Brutsch, Senior Lecturer, University of Zurich. Please note these are the views of the individual authors, not necessarily those of CIEP.