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№ 9 (September 2009)

European Energy Firms Fall Short in Gazprom Purchases

European energy companies, faced with weakening demand and plentiful lower-cost fuel supplies, have bought far less natural gas from Russia's OAO Gazprom this year than they are obliged to under long-term contracts -- setting the scene for a potentially damaging showdown with Moscow.

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European Energy Firms Fall Short in Gazprom Purchases

European energy companies, faced with weakening demand and plentiful lower-cost fuel supplies, have bought far less natural gas from Russia's OAO Gazprom this year than they are obliged to under long-term contracts -- setting the scene for a potentially damaging showdown with Moscow.

A person close to Gazprom's export arm said purchases by the company's largest European customers had fallen short of the minimum specified in their "take-or-pay" contracts by about 10 billion cubic meters, or about 7%. A worker stands by a Gazprom pipeline in Lithuania last month. European companies are buying less gas from the Russian energy giant than they agreed to in long-term contracts, setting the stage for friction with Moscow.

 The undelivered gas is valued at roughly $2.5 billion, and the person said Gazprom will insist its European customers pay for it. The issue was of "great concern" to Gazprom, he said.

The financial crisis and ensuing recession have depressed demand for natural gas in Europe. At the same time, supply has surged thanks to new shale gas fields in North America and a slew of new liquefied natural-gas projects.The supply glut has pushed down the spot price of gas in active markets such as Britain's National Balancing Point, or NBP, and Zeebrugge in Belgium.

 In August, the U.K. forward gas price for delivery this winter was around 40 pence (64 cents) a therm, down from more than 100 pence a therm in June 2008.But European companies that buy gas from big producers such as Gazprom, Sonatrach of Algeria and StatoilHydro ASA of Norway haven't benefited from the price drop.

That is because long-term European gas-supply contracts are linked to the price of oil, which has stayed stubbornly high. Crude has recovered from its lows of $35 a barrel at the end of last year and is now trading around $80 a barrel.Some industry experts are now calling for a radical rethinking of the way gas contracts are priced, saying they should be linked to spot market prices for gas rather than oil products.

"The oil-linked price and minimum-purchase commitments in long-term gas contracts may become increasingly unmanageable as buyers are forced to take volumes at much higher prices than their competitors," Antonio Brufau, the chief executive of Spanish oil company Repsol-YPF SA, told an industry conference in Buenos Aires this month.Gazprom has defended oil indexation, saying there aren't trading hubs with sufficient volume to provide better pricing signals than oil products.

"The NBP handles 15 billion cubic meters of gas a year while Gazprom sold 160 billion cubic meters to Europe last year," said Sergei Komlev, head of price formation at Gazprom Export. "If we used the NBP it would be like the tail wagging the dog."Gazprom's customers, such as E.On Ruhrgas AG of Germany, GDF Suez of France and ENI SpA of Italy, have responded to the discrepancy in prices by scaling back purchases of Russian gas and buying on the spot market instead.

But under their "take-or-pay" contracts with the Russians, they are required to take delivery of minimum annual volumes and pay up if they take less.Take-or-pay contracts are a vestige of the early days of the gas industry when liquid spot markets didn't exist and producers needed long-term deals with stable prices to underpin vast investments in new gas fields.

The system has endured even as some markets, such as the U.K., have moved to spot gas market pricing. The person close to Gazprom said the minimum its customers were contractually obliged to take this year was about 150 billion cubic meters of gas, when in fact they would be taking only around 140 billion cubic meters.

But he stressed the shortfall can also be credited to the cmopanies if they end up buying more gas the following year than they are contracted for.Analysts say it is unprecedented for the European take-or-pay buyers to be in default to Gazprom. "We're in uncharted territory here," said Jonathan Stern, director of gas research at the Oxford Institute for Energy Studies.

 "This is billions of dollars that Gazprom hasn't had."Part of the problem for Gazprom is that it has already made an exception on take-or-pay, laying itself open to the charge of double standards. In September, Russia agreed to let its cash-strapped neighbor Ukraine buy much less gas from Gazprom than stipulated in a supply contract signed in January.

"The Europeans are now saying -- you didn't penalize Ukraine, why are you penalizing us?" said a person close to Gazprom Export.ENI and E.On Ruhrgas said they "do not comment on contractual matters." GDF Suez said only that it will "respect all of its contracts."  

 -   Copyright 2009, Wall Street Journal. All rights reserved.  

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