Corporate Debt Review

Rosneft Board Move Telegraphs Kremlin Strategy

A Pipeline Pawn

The chess game between Moscow and Washington, D.C. continues. Only this time, it looks like the board has become the European energy market.

Earlier this month, I commented on the real reasons why proposed additional U.S. sanctions have been responded to so forcefully by the Kremlin. In addition to other matters, these have the distinct possibility of attacking a vital revenue flow.

Central to this heavy pushback are the additional American restrictions on access to international banking in general, and the fate of the Nord Stream 2 natural gas pipeline in particular.

As with the initial dual-line Nord Stream, operational for the past five years, Nord Stream 2 is designed to carry natural gas from Vyborg in northwestern Russia (close to the Finnish border), under the Baltic Sea, to Greifswald on the coast of northeastern Germany. Nord Stream 2 will also have a dual-line system and extend some 1,200 km.

Much of the initial work is already underway with negotiations largely completed for access to offshore territory in Finland, Sweden, and Denmark. The Environmental Impact Assessment (EIA) is also in process.

Even before the new U.S. sanctions called for the EU to reject Nord Stream 2, Western Europe had been divided on the project. The primary objection raised by those against the project is energy diversification. That’s a euphemism for the real issue – energy security.

Russia’s Gas Sensitivities

Russia currently provides about 29% of the aggregate EU natural gas needs. However, projections point toward a 50% rise in demand over the next 20 years.

The issue is not whether the imports provided by Nord Stream 2 are necessary (the volume, at least, certainly is), but whether the source of that gas is a good one. Some in Brussels are against making Europe more dependent on Russia for energy.

Gazprom, the Russian natural gas behemoth, is sensitive to this argument. It’s been talking about affordability and sustainability, rather than diversification, every time it defends the project.

The pipeline’s cost is now put at €9.5 billion ($11.2 billion). While proponents note Nord Stream 2 will mirror the operating Nord Stream venue, thereby cutting planning expenses, the pipeline will almost certainly have overruns. Some of these have already been appearing in overages charged by subcontractors in Finland.

And then there is another stumbling block for the project – the Energy Charter Treaty (ECT). The accord specifies that natural gas exporters into the EU must separate transport from distribution. The ECT also requires that providing countries make domestic pipelines available to third parties.

Despite having signed the ECT, Moscow has rejected both provisions. As a result, Gazprom and other Russian energy majors have seen their persistent attempts to acquire assets (such as pipeline networks, terminals, or wholesalers/retailers) inside the EU blocked.

The Kremlin has responded by setting up both Nord Stream pipeline operations with private energy majors in Europe, effectively bypassing their respective governments and, thereby, the ECT provisions.

Both Nord Stream and Nord Stream 2 are administered by boards headquartered at the same address in Zug, Switzerland. Gazprom Marketing & Trading just happens to have an office around the corner.

In the case of each pipeline, Gazprom controls 50% of the project, but the remainder is divided among European energy majors. That way, it is legally a separate entity under EU law and not a foreign project.

Nord Stream 2’s European partners are Anglo-Dutch Royal Dutch Shell, Austrian OMV, French Engie, and German Uniper and Wintershall. Each provides 10% of the working capital.

The second strategic move by the Kremlin to circumvent Brussels was unveiled late last week.

 

Schröder’s Gazplay

It was announced that the Russian government has nominated former German Chancellor Gerhard Schröder to be a member of Rosneft’s board.

Rosneft is the largest state oil company in Russia and itself a major player in the European energy trade. It is also under U.S. sanctions for previous Russian actions.

Schröder, meanwhile, is a close friend of Russian Vladimir Putin, has developed his own private business network in Russia, and has publicly opposed U.S. sanctions against Moscow.

And oh yes, he also happens to be the chairman of the Nord Stream board of directors – a project that, incidentally, received his strong support while he was German Chancellor.

The initial pipeline was signed shortly before he left office in 2005 and he was named to head up the pipeline board shortly thereafter.

Now, Rosneft also has a Swiss trading operation in Geneva. This Swiss connection is important for several reasons.

First, operations located there have direct access to Western Europe without being a member of the EU.

Second, deals can be made with EU member state companies easily from any location in Switzerland.

Third, there’s the ability to utilize Swiss banks (and less transparent Swiss banking regulations) in bypassing foreign (i.e., U.S.) restrictions.

Finally, Swiss law has a different take on what constitutes unacceptable business practices.

Providing all manner of “considerations” to effect agreements are allowed. Many of these would be considered bribes or “corrupt foreign practices” under other countries’ rules (including those on the books in Russia).

But not there.

 

What’s Next for this Energy Chess Game?

Here’s what I expect we’ll see, in short order…

First, intense pressure will be brought on Brussels by the European company members to reject U.S. sanctions and approve the Nord Stream 2 pipeline. In at least one case (Austria’s OMV), the company involved is a state-controlled energy major.

Second, there will be a more concerted joint Gazprom-Rosneft move to acquire European energy assets using the Swiss locations of each company and those of both Nord Stream operations. Gazprom for some time has targeted a position in the huge natural gas hub at Baumgarten in Austria.

A spin off attempt involving the CEGH (Central European Gas Hub) trading platform, a goal Gazprom has energetically sought but one that has been stymied via ECT enforcement by the EU.

With OMV on board with the latest Nord Stream initiative, Gazprom has essentially obtained Austrian government support.

Meanwhile, Rosneft is eyeing greater access to and control over large crude oil and oil product terminals at Rotterdam.

Assuming the joint effort succeeds, I expect there will be more contract swaps, including those involving the exchange of future consignments of oil/oil products and natural gas.

Third, the confluence of energy moves will allow greater flexibility in financing Russian forward export contracts, effectively turning Rosneft/Gazprom/Nord Stream 1 and 2 transfers under Swiss banking as means to circumvent sanctions.

Fourth, in all of these the position of Gerhard Schröder (and his Moscow-based personal business interests) will be pivotal.

 

About the Author

KentMoors

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk management, emerging market economic development, and market risk assessment.

He serves as an advisor to the highest levels of 27 countries, including the U.S., Russian, Kazakh, Chinese, Iraqi, and Kurdish governments, to the governors of several U.S. states, and to the premiers of two Canadian provinces. He’s served as a consultant to private companies, financial institutions and law firms in 29 countries, and has appeared more than 2,300 times as a featured radio-and-television commentator. He appears regularly on ABC, BBC, Bloomberg TV, CBS, CNBC, CNN, NBC, Russian RTV, and the Fox Business Network.

A prolific writer and lecturer, his six books, more than 2,700 professional and market publications, and over 650 private/public sector presentations and workshops have appeared in 47 countries.