4 min read

Three's Company

Three's Company

So it finally happened. Putin has reportedly kicked it to the cabinet to work out a compromise between Gazprom and Rosneft that would allow Igor Sechin and co. to export 10 bcm of natural gas to European markets via pipeline. Gazprom is deadset against the proposal, naturally, but their argument as to why is peculiar. Per the Interfax reporting, they're effectively arguing that natural gas futures show prices will come down next year. That signals a market expectation that supply tightness and shortfalls are primarily a winter phenomenon and not yet a structural phenomenon year-round. I disagree insofar as the rising share of renewable power generation that's interruptible will change the ebb and flow of natural gas flows to provide relief when it's cloudy, there's no wind, or else some other bottleneck emerges. But it is certainly the case that Rosneft can't claim that it'll be relieving pricing pressures significantly by selling gas utilizing pipeline capacity Gazprom doesn't use since it's set an important precedent during the current crisis – it's not going to ramp up sales to Europe on spot markets as a political favor. If you want more gas, sign longer-term contracts that guarantee it export earnings to subsidize domestic operations, aims, and Russian contractors pilfering the company coffers for personal gain.

Yet Sechin's play here has little to do with the state of the market and everything to do with the certification of Nord Stream 2. The issues at stake reflect the threat that the pipeline will not be certified unless it is compliant with EU third-party access requirements that are meant to prevent the owners of infrastructure from denying its use to other producers, wholesalers, and retailers on energy markets. There's a parallel problem driven by the fiscal consensus in Moscow, not just the political implications of Gazprom refusing to up output for the sake of spot trades at European gas hubs – the Ministry of Finance has a much harder time planning for gas revenues without longer-term export supply contracts that are indexed or relatively fixed in price. Spot trades are a lot more volatile and since the budget still receives large volumes of cash inflows from export duties, there's a self-reinforcing dynamic whereby the appearance of Gazprom's intransigence also fits into a broader foundation of Russian economic policymaking domestically. Greater price stability is greater revenue stability, though it's often suboptimal and inefficiently used to negotiate budgets for investment at the sector level. Rosneft is not likely to try to upset the apple cart. However, since its gas business thus far is entirely domestic it may entertain selling spot volumes rather than long-term contracted volumes. In any case, this would all be worked out through a third-party company ostensibly owned by Rosneft (potentially Gazprom as well in a JV) that books pipeline capacity owned by Gazprom.

I remember flagging this at an event in Washington D.C. back in winter 2017 with a few established Russia hands, one of whom graced us with his presence from Columbia up in New York. I asked what he thought was going in since Gazprom had issued a bond prospectus openly acknowledging it might lose its pipeline export monopoly and be restructured a bit, which suggested growing pressure from Igor Sechin and potentially others. In his words rather dismissively at the time, "from your lips to god's ears." Well, dude, we're here now. Why? Because Putin couldn't be bothered to resolve the impasse and Sechin lacked the adequate external trigger to push a proposal through. EU regulations and the open-ended potential for the Biden administration to impose sanctions while trying to cooperate with European partners as much as possible proved enough. That it dropped around the Putin-Biden call with the US briefing that it would pressure and work with the new German government to leave NS2 dormant can't be ignored.

This episode is a useful reminder that intelligent uses of trade controls, domestic market regulations, and diplomatic uncertainty can exert an effect on the political economy of marketized strategic export sectors for Russia. Put another way, state capitalism is still exposed to market forces and risks. Once Gazprom loses the pipeline monopoly, others are going to smell blood in the water. That doesn't mean the company is going to be swallowed whole or chopped into bits. It'll still be one of the state-owned backbones of the economy and political system. However, failures to make breakthroughs or deliver, including the construction of LNG capacity and massive mismanagement of the Chayanda gas field supplying China, add up politically. What's more relevant is that Putin did not make an effort to protect them from this outcome in the end, and while he's not going to hand just anyone what they want, this may prove as big a deal as Novatek winning the right to export LNG. It also creates more space for price competition between Russian firms and could allow European importers to negotiate between multiple parties. Political operators in the Kremlin and MinEnergo will then have to spend more time adjudicating fights between firms since no one wants to see Moscow's pricing power significantly eroded by competition between Russian exporters.

Using the political economy of Russian rentierism and political management against the regime is a long, slow, arduous process that requires a great deal of domestic coalition building for better economic policies as much as the right foreign policy ideas percolating around executive branches at the right time. However, it's far more sustainable to "talk as you fight, fight as you talk" in the economic sphere where the West possesses considerable advantages when Washington drops the illusion that it can pursue all of domestic and strategic preferences in zero-sum, punitive fashion. That also means more uncomfortable conversations about the efficacy of oil & gas sanctions on Iran, a potential supplier of LNG to European markets with little cause to trust Russian capital and companies and every reason to pursue access to technology and practices via trade to minimize emissions from its oil & gas sector. That's a different conversation, one I'm hoping to try to start with a nascent forthcoming piece that now has to contend with omicron variant and bad news about nuclear talks. But it's still a valid and important avenue. Sechin's latest win reminds us that the economy is a thing to take seriously in Russia, not literally in the hawkish, reductionist discourse of Washington.

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