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Business Analysis & Features

Gazprom and the struggle for power

Gazprom is now so powerful that it is capable of freezing much of Europe. Sarah Arnott reports

The Ukrainian gas crisis, which escalated further yesterday and put Europe's energy supplies into greater jeopardy, is a prime illustration of the unusual status of Russia's state-backed energy giant.

According to Gazprom, not only has Ukraine "stolen" 65 million cubic metres (mcm) of gas destined for Europe since New Year's Day, when Ukraine's non-payment of a $615m (£414m) bill saw Russia turn off supply. But, by refusing to exchange the necessary technical information, Naftogaz, the Ukrainian state utility, is now making it impossible for Gazprom to pump much gas into the transit system at all.

Who is to blame depends very much on whom you talk to. Naftogaz says the tap has been turned off at the Russian end of the pipeline, and that it is shoring up European deliveries with more than 10mcm of its own gas. Gazprom is vehement in its condemnation of Ukraine's behaviour. Alexander Medvedev, the deputy chief executive of the company, told a press conference in London yesterday: "We have become a hostage of the irresponsible behaviour of a transit country through which 80 per cent of our export gas to the EU runs."

Not only does the Russian side profess itself "shocked" at Ukraine's behaviour, but it insistently characterises the dispute as purely commercial and rejects the suggestion that representatives from Brussels might help broker a deal. "We don't need intermediaries in commercial negotiations," Mr Medvedev said. "There are certain rules in this business and if the Ukrainian side will come with a professional delegation, not a political one, it would be easy to find a compromise solution. But to do that, it is necessary that Ukraine behave normally, as accepted in an international setting."

For all its protestations, Gazprom is simply not a normal commercial entity. Nor is it as non-political as it claims. Not only is the Kremlin Gazprom's largest shareholder, but both the board and the management committee are peppered with political figures – including the current First Deputy Prime Minister, the Minister for Industry and Energy, and the Minister for Economic Development and Trade. Until recently, Gazprom was chaired by Dmitry Medvedev, the Russian President (and no relation of the deputy chief executive).

Gazprom was privatised from the old Soviet utility group in the 1990s, hit by string of corruption scandals, and then taken back under Kremlin control in 2005 when the government simultaneously bought itself a controlling stake and lifted the restrictions on foreign ownership of shares. It is both Russia's largest company, and the world's biggest gas group, with nearly 29,000 cubic kilometres of reserves, or 16 per cent of the global total. By virtue of its size, and the growing political importance of energy resources, Gazprom is the darling of Russian industry – a vital source of income and the route to a seat at the top geopolitical table. Alex Pravda, from Chatham House, the foreign policy think-tank, said: "Gazprom is a state champion par excellence, and the Russian government makes no secret of that."

Russia says that it is simply behind the curve, that its promotion of Gazprom is no different from the behaviour of Western state corporations in the past. But the country has a major image problem when it comes to energy. The first row with Ukraine followed hot on the heels of the Orange Revolution, which brought in a pro-Western government – prompting the mistrustful to claim Moscow was using energy as a political club to beat down pretensions to freedom in its former satellite states. When Russian oil supplies to the Czech Republic were disrupted within days of the government's agreement to host a US radar station, the chorus grew louder. And last year's conflict with Georgia was viewed by sceptics through the prism of Georgia's role in the Baku-Tbilisi-Ceyhan pipeline which supplies oil to Europe from the Caspian Sea without reference to Russia.

"A matter of degree turns into a matter of kind, and the degree of state involvement in Gazprom is considerable because energy is Russia's major resource," Mr Pravda said. "The Kremlin is trying to balance it – militarily and economically – but it is still largely reliant on energy for its foreign policy."

As far as western Europe is concerned, Gazprom is a reliable supplier. The company's record in former Soviet states is more varied, but its relationship with such states is more complicated. On the one hand Gazprom is a commercial entity, expected to pursue commercial goals. On the other, as a hangover from the USSR's rock-bottom gas prices, it is bound to provide massive discounts to former Soviet states. The repeated arguments with Ukraine, Belarus and Georgia are over the speed at which it can raise prices to nearer the European level. Professor Jonathan Stern, from the Oxford Institute of Energy Studies, said: "Despite the perception, what has not happened is Russia saying that, unless a country do such-and-such political thing, it will cut off the gas."

Neither is all Gazprom's vilification of Naftogaz unearned. Ukraine does steal gas, and its officials are notoriously difficult to deal with, according to experts on the region. "The trouble is when the West puts too much of a Cold War gloss on the situation," Professor Alan Riley at London's City University said.

Bypassing Russia: A Polish alternative

Even before the 2008-9 version of Ukraine's annual battle with Russia over gas, the governments of other former Soviet states were looking for foreign energy companies to helpexploit local resources and avoid reliance on Gazprom.

Aurelian Oil & Gas, which listedon London's Alternative Investment Market and has a former Conservative politician as its chairman, Lord Sainsbury as a shareholder and a Polish billionaire backer, is aiming to capitalise on opportunities in central and eastern Europe.

The company champions the low tax and royalty rates, transparent licensing and minimalpolitical risks for energy companies in the region. There are not only significant new fields to be found, but modern technology also enables existing, uneconomic state-held sites to be brought into production. Aurelian's major field in Posnan in Poland, forexample, could account for as much as 15 per cent of the country's gas demand if it delivers on its promise.

David Prior, Aurelian's chairman, said: "In most Central European economies very littledevelopment has taken placebecause everything was done in Russia. Local governments areextremely supportive – the fiscal regime for the development of gas in Poland, for example, is about as good as it gets anywhere in the world."