Gazprom and the EU test energy ties that bind

On the day in October 1973 when Soviet gas started flowing to West Germany diplomats from the two countries gathered in Nuremberg's Kaiserburg castle to celebrate. "Two peoples dared to integrate, in the long term, their national economies with each other," declared Anton Jaumann, the Bavarian economy minister.

Four decades later, both Europe and Gazprom are chafing at the legacy of that collaboration - a mutual dependence welded in place by thousands of miles of steel pipe. The deterioration in their relations culminated on Wednesday in the European Commission formally accusing the Russian state-controlled company of illegally abusing its dominant market position in eastern Europe.

The stakes are high for both sides: Gazprom accounts for nearly 30 per cent of the EU's gas consumption; the continent, meanwhile, represents more than 60 per cent the Russian company's gas revenues.

Even though the antitrust case may not be decided for several years - Gazprom said on Wednesday that the accusations were "unfounded" and will have an opportunity to contest them - the growing strains have already triggered a reappraisal of the relationship in both Brussels and Moscow that is likely to reshape the global gas market in the coming decades.

Gazprom is "turning its back to the EU", says Thierry Bros, gas analyst at Societe Generale in Paris. "The winds are changing. Russia is trying to move further east and Europe is trying to move further west."

The chill has been apparent for years. Gazprom came under intense criticism from Europe during supply disruptions in 2006 and 2009.

But the past year has brought a sea change as the Ukraine crisis sent relations between Moscow and Europe to a post-cold war low, and Brussels all but froze co-operation with Gazprom on energy issues.

The most dramatic example of the Russian company's changed stance was the cancellation in December of the $40bn South Stream project, which had been designed to deliver Russian gas to southern Europe but had met objections in Brussels.

Since then, Gazprom has stepped back from Europe investments in a move that people close to the company say betrays a lack of belief that it will receive fair treatment from European regulators.

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At the same time, the Russian company is courting China: it signed an enormous 30-year deal with Beijing last May and is in talks for an additional supply contract via a different route.

Together, the moves represent "a fundamental reorientation of Russian gas export policy", says Jonathan Stern, chairman of gas research at the Oxford Institute for Energy Studies at Oxford university.

For its own part, the EU is attempting to pull away from Russia, launching a new push to import gas from the Caspian, the Middle East and North America.

Nonetheless, neither Gazprom nor Europe can end their mutual dependence in the near future. Europe's own natural gas production is declining, and Gazprom's deals with China do not envisage meaningful deliveries until the 2020s. Even then they would represent only a fraction of the volumes currently sold to Europe.

Indeed, Gazprom and the Russian government have indicated that they hope to settle the antitrust case. The Russian energy ministry said on Wednesday it hoped that "mutually acceptable and civil solutions" would be found.

Prof Stern says the commission's charge sheet also appears to go less far than it might have done, limiting allegations of price gouging to just five countries. "It's a score draw between Gazprom and commission," he says.

<>Gazprom has already adjusted its behaviour in Europe, under pressure from both the looming antitrust charges and other legal disputes with its customers, he points out. It has largely disposed of so-called "destination clauses" that restrict resale of its gas, and negotiated lower prices with several countries, including Lithuania, with which it has been feuding for years.

More problematic may be the politics of a settlement. Under EU law, the terms must be legally binding and enforced through a monitor. Given that Moscow refuses to accept the commission's authority over a strategic state-controlled group, this may prove difficult.

"The sensible commercial course is to settle," says Alan Riley, a law professor at City University. "The question is whether a radicalised Kremlin could stomach it."

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