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   Experts can only guess why Gazprom has not chosen another German company, E.ON, the biggest buyer of Russian gas and Gazprom’s oldest partner, to fulfil the plan. Analysts suspect that by doing so Gazprom is trying to freeze Nabucco pipeline construction that is posing strong competition to Russia’s energy strategy.

E.ON Starts, RWE Picks Up

   After the disaster at Japan’s Fukushima-1 nuclear plant in March and the following decision of the German government to stop using nuclear energy for peaceful purposes, Alexei Miller, the CEO of Gazprom, and Johannes Thiessen, the CEO of E.ON, met nearly every month to discuss “the situation on the gas market and prospects for cooperation”. In June Miller finally disclosed some of the agenda of ongoing negotiations: Gazprom was eager to enter the European energy market. This desire, however, has not been demonstrated for the first time. Previously, Gazprom wanted to enter the European end-user market as part of the deal when E.ON got shares in South-Russian field in Western Siberia. But German company did not go that far and paid back to Gazprom with its own shares.

   Now Gazprom decided to use and possibly take the utmost from the complicated situation in the German energy sector now that companies are being forced to close nuclear plants and bear additional costs of billions of Euros. Things are becoming even more serious as gas prices for European companies are climbing strongly under current long-term contracts which are tied to oil prices with a lag of six to nine months. A year ago, Gazprom agreed with E.ON on adding spot contracts as the German partners insisted. Yet, the German company decided to start a new round of negotiations. People from Gazprom Export are saying that the right to rebid may be used by either parties only once in three years. “It seems to us, that E.ON presumes, that terms and conditions have turned essentially,” one Gazprom Export employee said. Without coming to any agreement on either prices or Gazprom’s participation in the European energy sector, E.ON initiated the arbitration procedure. Meanwhile, the arbitration procedure with RWE’s rebid has been under way since the beginning of 2011.
E.ON and other European companies have not been satisfied with gas prices. Gazprom took this as an argument to obtain energetic assets in Europe. “We are ready to invest into the construction of new gas facilities in Europe and we are ready to buy shares in existing plants and take into consideration the possibility of signing direct contracts on gas delivery to these consumers. Thus we are ready to negotiate gas price policy adjustment as part of the deal, however, in this case our profit will shift from the gas sector to the power sector,” said Miller in the end of July.

   “If one is speaking about Gazprom’s plans and intentions, the German power industry is one of our priorities and we are very serious,” he stressed. He also added that “the latest developments on the global and European energy markets are leading to a situation in which the role of gas may significantly change the rules of the game in the near future, at least for Europe.”
Apparently, E.ON again negotiated firmly – the day after meeting with the president of E.ON, Alexei Miller met RWE’s Jurgen Grossmann, and within a week, the two companies had signed a Memorandum of Understanding on a strategic partnership on energy production in Europe. Gazprom and RWE will consider the possibility of setting up a joint venture, incorporating existing and new power plants operating on natural gas and coal in Germany, United Kingdom and in the Benelux countries.

Nuclear Power Stations Closed, What’s Next?

   It is hardly a coincidence that once the decision to shut down nuclear power stations in the second quarter of 2011 was made, both German companies finished with losses instead of net profits. RWE’s losses totalled 230 million Euro, compared to a profit of 1.6 billion Euros in the first quarter. E.ON got negative results of 380 million Euros. RWE decided to deal with the situation by increasing asset sales from 8 to 11 billion Euros, adding up to power plants the Czech Republic’s main gas lines operator, company Net4Gas, which builds a gas pipeline branch from Nord Stream.

   E.ON took rather unpopular measures. The company decided to make 9,000-11,000 workers redundant under a cost control program as well as to cut down dividend payouts and capital costs. E.ON’s subsidiary Ruhrgas might be among the subdivisions closed due to losses the company suffers as a result of gas resales.

   “E.ON is suffering some serious losses because of high gas prices,” Claudia Kemfert, Professor of German Institute for Economic Research (DIW) in Berlin says, “Unfortunately, the company was unable to cancel Gazprom’s pegging gas prices to oil prices. That is why E.ON’s gas business may simply be unprofitable. It’s clear that it is hard for E.ON to sell the gas at high prices to end-users and be competitive with other suppliers”, she added.

   Gazprom has a different viewpoint. The company is confident that the margin of European gas trade mediators is too high.

   RWE is one of the leading German companies in energy and natural gas production and sale. In 2010, the company sold approximately 38.4 billion cubic meters of gas. RWE’s Czech subsidiary Transgas purchases around 8-9 billion cubic meters of gas from Gazprom every year. RWE is the fifth company in Europe in term of amount of energy production (and No. 1 in Germany) with a total capacity of 52.2 GW. 29 percent of energy is generated from hard coal, 22 percent from gas, 21 percent from lignite coal, 12 percent from nuclear power and 6 percent comes from renewable energy sources. The bulk of this capacity (65 percent) is consumed by Germany, 23 percent by the United Kingdom while the Netherlands and Belgium consumer less (6 percent). In 2010, RWE produced 225.3 billion kWh of electric power.

   By the middle of 2014, RWE plans to bring 12 GW of additional power stations on line. Implementation of this program began in 2006 and overall investments have so far amounted to 12.1 billion Euros.

What if We Add Some More Gas?

   Commenting on RWE’s decision to cooperate with Gazprom, Alexander Rar, the Director of the German Council on Foreign Relations, said that that German chancellor Angela Merkel was rather half-hearted about the idea of building a third line on the “Nord Stream” pipeline when she met Russian President Dmitry Medvedev during their last summit, but “economics seems to have a better idea of challenges being confronted,” Rar said. At the summit held in mid-July, Merkel declared that the closed capacities of nuclear energy would be compensated not only with gas, but also by doubling the use of renewable energy sources and increasing energy efficiency. Still, Rar adds that until Germany reaches an economical and technical breakthrough in the field of renewable energy sources, the country will have to buy more gas. According to preliminary calculations, Germany would have to increase the volume of gas it imports by 20-30 percent (today Germany imports 100 billion cubic meters of gas a year).

   According to Rar, the turn of Germany’s energy policy towards Russia that is obvious after several years of tension will take a toll. First of all, it may place demands on Ukraine which is afraid of losing its strategic position as a gas transit nation. But Ukraine has so far been unable to come to terms on modernization its gas transmission system with either Russia or the EU. In fact, this is one of the main reasons Russia has been building bypass gas-lines.
The Nabucco pipeline, an alternative gas delivery route from the Caspian region bypassing Russia that is heavily lobbied by the EU, will be another victim. RWE is one of the biggest investors and initiators in the Nabucco project and Rar believes  Gazprom will use its cooperation with RWE to stymie the project as it is a major competitor to Gazprom’s plans to increase its own gas supplies to Europe. Comparable to Nabucco (though Nabucco lacks the confirmation of a resource base from either Azerbaijan or Turkmenistan), the South Stream project has the resource base along with facilities and political will.  

Cautious Attitude Remains

   RWE has three months to get the most out of its partnership with Gazprom in terms of gas supply prices as well as to secure the company from further losses. Gazprom has granted the company exclusive rights for three months to handle negotiations on energy sector projects in Germany, United Kingdom and Benelux countries.

   Another proof of Gazprom’s serious intentions on European energy market is its attempt to acquire 50 percent of shares in the Central European Gas Hub (CTGH), the Austrian gas trading platform. But the European Commission barred this attempt by the Russian company. “They proposed unacceptable conditions to us. They asked us to give our eyeteeth to enter that hub,” Gazprom Export director Alexander Medvedev said. He explained that the possible reason for this decision was Europeans’ fear that Gazprom would use gas as a gear to further economically enslave Europe.

   It is highly possible that the same problems may appear with the joint venture between Gazprom and RWE. The European antitrust regulator already announced that if this venture moves forward, it will be reviewed very carefully.

German Energy Market

   On 30 June the German parliament passed several new laws concerning the German energy market, summarized and known under the term “Energiewende” (New Energy Policy). Key elements of this policy change are:
an end to the use of nuclear energy by 2022;
a steadily increasing share of decentralized electricity generation from renewable energy sources, up to 35 percent by 2020;
ambitious targets to improve energy efficiency.

   Due to the “Energiewende” and the general political support for municipalities and smaller energy companies (the so-called “Stadtwerke”), large companies such as E.ON, RWE, Vattenfall and EnBW, are under huge pressure to avoid losing profit and market share to their smaller competitors. The consequences are significant cost-reduction programs, enhancing investments into cleaner technologies and increasing internationalization. By taking aggressive actions, German companies are looking for new growth potential and opportunities to secure energy supply in the medium- to long-term.

   Besides coal, lignite and limited gas resources, Germany is dependent on external energy supplies. Currently, more than 70 percent of Germany’s energy demand is met by imports. Although energy consumption has been slightly decreasing of late, the energy dependency of Germany is going to increase in the future. In collaboration with the EU, German politicians aim to become less dependent on imports in the long run by increasing the share of renewables and reducing the total energy demand.

   In order to meet the political goals, a fundamental transition of the German energy system is required:
New transmission lines have to be built to transport electricity generated in the North Sea or the Baltic Sea to the southern part of Germany where most nuclear power stations will be shut down and where most of the country’s manufacturing facilities are located.

   Decentralized generation capacities should be integrated into the distribution networks and establishing a much more flexible power plant fleet to meet the fluctuating demand.

   New gas-fired power plants should be built to back-up the increasing share of intermittent renewable energy sources like onshore and offshore wind and solar photovoltaic.

   New gas transport lines or LNG stations have to be built to meet the increasing demand for gas.

   Helmut Edelmann, Director, Global Power & Utilities Center, Ernst & Young

German Energy Market

   To fund all the required investments, German energy companies need a lot of money. They also need reliable partners to deliver gas from abroad based on stable long-term, but nevertheless competitive, gas supply contracts. A combination of both – financing the investments via long-term gas supply contracts – could be an interesting idea for German utilities as well as Gazprom.
Victor Borodin, Partner, Ernst & Young

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