The Magazine

Pipeline Politics

Is Putin running out of gas?

May 27, 2013, Vol. 18, No. 35 • By ALEX ALEXIEV and STEVEN F. HAYWARD
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The Cold War is now so over that it might as well be grouped with the ancient ice ages, but there is one echo rolling across Europe from East to West: the Russian attempt to dominate the natural gas market on the European continent. As the energy sector accounts for 25 percent of Russia’s economy, any large changes in energy markets present major challenges for Vladimir Putin. Those old enough to recall the Soviet gas pipeline controversy of the early 1980s​—​a high-profile fight of the Reagan administration to deprive Moscow of hard currency​—​are right to have a feeling of déjà vu, as Putin’s motives transcend honest commerce.

Gary Locke

Gary Locke

Despite huge gas reserves waiting to be tapped, most of Europe lags the United States in the shale gas boom for several reasons: a lack of mineral rights on private land, bureaucratic obstacles, the usual intransigent opposition from Europe’s potent green lobby, and, perhaps most important, the lack of adequate pipelines to connect new gas fields to the market. Hence, natural gas prices in Europe are several times higher than U.S. prices. Since natural gas and oil are Russia’s principal export commodities, the prospect of newly abundant oil and cheaper gas outside of Russia is a grave threat to Russia’s economic and political might in the region. Russia can’t do much about global oil trends, but Putin and the state-controlled Gazprom are doing everything they can to throttle new gas development in Eastern Europe, rerunning the same kind of behind-the-scenes propaganda against shale gas that the KGB ran against new NATO missiles back in the Cold War. Propagandists in Russia are promoting every translation possible for the message fracking=bad. The second prong of Putin’s strategy is to control pipeline development as far as possible. But things are not going well for him.

Gazprom is the linchpin of Putin’s political and economic strength. The state-controlled natural gas conglomerate is a huge source of revenues for the Russian budget, but also a slush fund for Putin’s clan—the corrupt network of power-political and economic relationships that rules Russia today. Immediately after coming to power in 2000, Putin moved to put the company under his direct control. In short order, he made his protégé and current prime minister, Dmitry Medvedev, chairman of Gazprom’s board and appointed another protégé, Alexey Miller, as CEO. According to a book by two prominent former Russian politicians, 11 of the 18 executive positions in Gazprom were quickly filled with Putin cronies. He then moved to make the company a “national champion,” giving it an exclusive license for the export of the country’s gigantic gas wealth. It is widely believed that Putin makes all of the key Gazprom decisions himself.

Putin’s energy cronyism is vertically integrated, as he ensures that infrastructure projects such as pipeline construction go to his friends’ firms at lucrative prices. Gazprom pipelines typically cost two to three times more than those built by Western companies, despite the much lower wages paid to Russian labor. While the German portion of the Nord Stream pipeline, for instance, cost $2.8 million per kilometer, the Russian portion built by one of Putin’s handpicked companies cost $6.5 million/km. This is one reason Putin likes pipelines, even if he can’t guarantee they will be fully utilized.

Sitting on 18 percent of the world’s current proven gas reserves (a percentage that shrinks with each new discovery elsewhere), Gazprom became one of the largest companies in the world. At the 2008 peak of the bubble in oil prices, to which Russian gas prices were indexed, Gazprom’s hubris overflowed. With a market valuation of $365 billion at the time, Alexey Miller confidently predicted that his company would become the largest in the world, with a market cap of up to $1 trillion by 2015, and that it would dominate the huge Chinese market as well as 10 percent of the American market with shipments of liquefied natural gas (LNG). Gazprom’s optimists thought it could command 30 percent of the world market.

Only five years later, this radiant vision of Gazprom’s future is just a mirage. Its market cap is $90 billion, neither China nor the United States is buying any of its gas, and its share of the world market has fallen under 20 percent. Moreover, the company is losing market share in its key European market, which accounts for nearly 80 percent of its export revenues. Last year, exports to Europe fell 7 percent to 138 billion cubic meters (bcm), but profits plummeted 23 percent because the company was forced to cut prices to major clients, often retroactively, after losing arbitration court judgments.

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