The prompt stabilization of the European gas market is not only in the interests of collapsing European companies, but of Gazprom, too.

With gas prices in Europe exceeding $1,000 per 1,000 cubic meters, and European fertilizer and steel manufacturers stopping production and reducing exports because of the soaring costs, what has led to the crisis, and how can it be resolved?

The current turbulence on the gas market is largely down to Europe itself. Over the last fifteen years, it was the EU countries that built the model of pricing that ensures low prices when demand is low (like last year, due to the pandemic), but means that when demand is high, prices soar.

Historically, Europe had both its own gas industry and imported gas from the Soviet Union, Norway, and North Africa. Since gas producers need some kind of payback guarantee after investing millions in developing deposits and building pipelines, a system was established of long-term, twenty-to-thirty-year contracts that would guarantee sales of gas for decades ahead.

For a long time, the price-setting mechanism was the price of oil, or a basket of petrochemical products. When oil prices reached a record high of $140 a barrel in 2008, causing Russian gas prices to rise to $500 per 1,000 cubic meters, Europe took action. Starting in 2009, Gazprom faced a wave of arbitration proceedings from its clients, mainly aimed at changing the pricing formula to favor gas hub–based pricing over oil indexation.

Over the next ten years, EU countries managed to bring about significant changes in the price-setting mechanisms used in Russian gas contracts. In 2010, only 10–15 percent of Gazprom contracts included a spot price element (allowing for rapid delivery and payment). By the end of 2020, that figure had risen to 87 percent.

Another Rubicon was the EU’s Third Energy Package adopted in 2009, which meant Gazprom could effectively no longer own the pipelines it uses to transport gas to Europe. The new legislation prompted Russia to abandon its South Stream pipeline project, and caused problems with both OPAL (the extension of Nord Stream 1) and now with Nord Stream 2.

Gazprom’s long-term contracts also came under pressure. A six-year antitrust investigation by the European Commission combined with market trends forced Gazprom to remove clauses from its contracts banning the reexport of gas to third-party countries, even though such clauses are still present in many LNG contracts around the world.

During this time, there were also gas wars between Russia and its neighbors, and supply crises, such as in 2014–2015, when Gazprom unsuccessfully fought against reverse flows of gas to Ukraine, which impacted on supplies to its EU clients.

Now, oil-indexed contracts are referred to as legacy contracts, even by Gazprom itself. In Western Europe, Gazprom trades on almost the same principles as Norway does. If European countries had kept oil indexation, they would now be paying $300 or even less per 1,000 cubic meters of gas. Today’s prices are the result of the relentless push to deregulate the market. It makes price shocks possible, and this year’s high prices will go some way to balance out last year, when prices at hubs sometimes fell to the level of Russian domestic prices.

For all the difficulties in its relationship with Europe over the past decade, Gazprom has invested a great deal in developing deposits and gas transportation infrastructure in Russia’s north, as well as in the construction of arterial pipelines for exports. Extraction began at the giant Bovanenkovo field on the Yamal Peninsula in 2012, and in 2021 it reached its full planned capacity of 115 billion cubic meters per year. Gazprom is moving further north, developing another Yamal field, Kharasavey, which should at its peak yield 32 billion cubic meters per year.

Against this backdrop, Gazprom has been actively pushing the narrative that it has a vast surplus of production capacity compared with demand: about 150 billion cubic meters, according to Gazprom CEO Alexei Miller. That’s a truly tremendous volume: more than the entire annual production of Norway (the second biggest supplier on the European market) or Australia (the world’s biggest supplier of LNG). If Gazprom really does have that much additional production capacity (not everyone is convinced that it does), then the Russian company is capable of single-handedly pulling Europe out of any energy crisis.

Being capable, however, is not the same as being obliged to do so. Gazprom is not legally required to put any of its spot volumes (any supplies in excess of the long-term contracts) on the market for any reason. The same is true of transport capacity. Right now, the Russian company is bypassing restrictions on using half of the German OPAL pipeline: it could have cited EU regulations and refrained from bypassing them, thereby creating an even bigger deficit and more turmoil on the market. If a similar gas crisis materializes in the future, when 50 percent of Nord Stream 2’s capacity is blocked, then legally, Gazprom will be entirely within its rights to shrug, decline to increase supplies via alternative gas pipelines, and tell Europe to sort out its problems itself.

That logic may be entirely fair from a commercial point of view, but it doesn’t take into account the “Gazprom magic” to which the company’s long-term and loyal partners have become accustomed. That’s the magic that enabled Gazprom to supply record-breaking daily volumes of gas to Europe for two whole weeks in the winter of 2018, during the “Beast from the East” cold snap. There have also been other occasions when Gazprom came to the rescue and supplied over and above contractual volumes.

As a result, in the eyes of many of its partners, Gazprom has become something more than just another supplier certified on the European market. In recent years, the EU has not just applied strong pressure on Gazprom; it has also made allowances for it. Even after the Ukraine crisis in 2014, the EU never equated Gazprom with Russian foreign policy. The gas giant continued to make annual foreign currency revenues of $30–40 billion in Europe, avoiding sanctions and completing the construction of new gas pipelines to EU countries.

But that aura of magic could disappear in a puff of smoke if it isn’t Gazprom that comes to Europe’s aid in the current crisis, but Norway, for example, or LNG suppliers, who are capable of rapidly redirecting their supplies toward European shores if the price is right. And later, having counted their losses from the 2021 gas crisis, European countries may start more actively investing in energy transition and gradually weaning themselves off not just Russian gas, but all gas. For this reason, the prompt stabilization of the European gas market is not only in the interests of collapsing European companies, but of Gazprom, too.

Paradoxically, the EU has become a hostage of its own energy policy: in calmer times, it limited and reformed its cooperation with Gazprom, but when crisis hits, it appeals to the company to increase supplies. Yet Gazprom is still more than just another gas trader in Europe: the company is expected to wield power over and influence the market. It still dominates EU gas imports—accounting for more than 40 percent of them—and with that comes enormous responsibility. How Gazprom handles its unique position right now will determine the future of all Russian pipeline gas supplies to Europe.

Photo by jotoya shared under a Pixabay license. The opinions expressed herein are solely those of the author.