Russian gas giant Gazprom has for many years shown interest in the European electric power market and the news about the possible creation of a power plant joint venture with German energy company RWE indicates that it is taking the first real steps to entering this market. Analysts say Gazprom will get a new gas sales channel by setting up the joint venture and will also be able to build a complete technological chain from gas production to power sales. They also say Gazprom mainly plans to strengthen its positions in Western Europe and could also expand to Eastern Europe in the future, but is still unlikely to have a significant share on the European power market even in the long-term.
In recent years, Gazprom has held talks on cooperation with a number of European companies, including Germany’s E.ON, the largest buyer of Russian gas, and Italy’s Enel, but has had no success, and currently only has the Kaunas thermal power plant in Lithuania, which has already been generating losses for several years.
In mid-July, Gazprom and RWE signed a memorandum of understanding for strategic partnership in power generation in Europe, under which they plan to consider setting up a joint venture consisting of existing or newly-built gas and coal power plants in Germany, the U.K. and the Benelux countries (Belgium, the Netherlands, and Luxembourg). Analysts believe the move could be considered Gazprom’s first real step to entering the European electric power market.
“The power industry is one of Gazprom’s priorities in Europe. In light of recent decisions by the German government to reduce their nuclear power programs, we see good prospects for the construction of new modern gas-fired power plants in Germany,” Gazprom CEO Alexei Miller said after signing the memorandum.
Shortly after explosions at Japan’s Fukushima-1 nuclear plant in March, Germany made a decision to shut down its nuclear facilities by 2022. As of early 2011, nuclear plants generated 23% of the total power produced in Germany, and experts said earlier that shutting down nuclear plants would lead to a higher demand for gas in Germany. Gazprom said then it was ready to invest in European power assets operating on gas, including in Germany, and estimated that Germany’s decision to shut down nuclear plants would create demand for an additional 15 billion–20 billion cubic meters of gas per year.
The signed memorandum could also be profitable for RWE. It could secure safe and competitive gas supplies for RWE, the company’s CEO Jurgen Grossman said after signing the document. Grossman also recently said in an interview with German magazine Der Spiegel that the company was considering selling a strategic stake to Gazprom.
The surveyed analysts reacted positively to Gazprom’s plans to enter the European electric power market by possibly setting up a joint venture with RWE.
“Gazprom is seeking to diversify its assets and revenue flows and is also expected to get an international image by carrying out projects in Europe,” said Konstantin Reyli, a senior analyst covering power utilities at investment company Metropol. Moreover, Gazprom is interested in creating a complete technological chain starting from gas exploration and ending with production of power, the final product, he said. Gazprom will also be able to find an additional sales channel for its products, Reyli said.
The analyst said it was difficult to forecast Gazprom’s revenue from entering the European market, noting that power prices in Europe were very volatile, and Gazprom’s investments could bring no return.
“It is logical for Gazprom to enter the European power market, as Gazprom is a large gas supplier and is interested in building a complete technological chain from production and transportation of gas to sales of electric power to consumers,” said Sergei Pikin, director of the Energy Development Fund.
Moreover, the proposed deal gives Gazprom diversification of business and an increase in the added value and margin on the European market, Pikin said.
“For Gazprom, this proposal offers additional market opportunities for gas sales as well as achieving its stated objective of increasing its direct exposure to power generation in Europe,” analysts at VTB Capital said commenting on Gazprom signing the deal with RWE.
The deal is in line with Gazprom’s long-term strategy implying expansion on the European power market, analysts at UralSib Capital said, adding that Gazprom would be able to insist on guaranteed gas purchases both by existing and future thermal power plants. Moreover, RWE holds a 17% stake in the Nabucco gas pipeline project and is the only German company participating in the project. So, being a partner of RWE, Gazprom will be able to have some influence on the implementation of the pipeline project, the analysts said. Gazprom holds 50% in the South Stream project, a rival of Nabucco encompassing construction of a pipeline for the transportation of Russian and Central Asian gas to Europe.
The creation of a joint venture is also expected to allow Gazprom to gain a presence on the European power market and increase its market share in Germany after the shutdown of nuclear facilities, the analysts at UralSib Capital said.
Gazprom is interested in implementing electric power projects mainly in Germany and was aiming precisely for this market, said Reyli from Metropol. It plans mainly to strengthen its positions in Western Europe and could also be interested in building power facilities in Eastern Europe, but that is of secondary importance, the analyst said. “Concluding cooperation agreements with other European electric power utilities could not be ruled out in the near future, but at the moment Gazprom plans to focus on cooperation with RWE,” Reyli said.
Analysts also do not expect Gazprom to gain a big share on the European power market after setting up a joint venture with RWE. The volume of the European electric power market is quite large and Gazprom is now expected to implement only separate projects and is not expected to have a big share, said Reyli from Metropol. “Gazprom is expected to gradually increase its share on the European electric power market, will be doing it cautiously and won’t obtain a significant share even in the mid- and long-term,” the analyst said.
Commenting on Gazprom possibly expanding its presence on the European power market, Reyli said he believed it would be difficult for Gazprom to further develop on the market if the financial state of European power companies improves, as in this case there won’t be any companies willing to sell their assets or the price of the assets will be too high. If the condition of European power companies remains unchanged, then Gazprom could make some more acquisitions, the analyst said.
Analysts also believe that Gazprom is unlikely to pose strong competition to European power companies. “The European power system is highly regulated, and Gazprom is not expected to carry out an aggressive policy of expanding its presence on the market,” Reyli said.
No details about the proposed joint venture are known yet, but analysts believe the joint venture will be established on a parity basis and will focus on building power facilities operating on gas, as Gazprom is interested in expanding gas sales.
“Gazprom will likely be ready to agree on setting up the joint venture on a parity basis, but with RWE having an advantage in making decisions,” said Reyli from Metropol. In any case, the sides are expected to sign a shareholder agreement, which would define principles of making decisions, he said.
Pikin from the Energy Development Fund also believes that the companies will set up the joint venture on a parity basis. Gazprom has repeatedly said that it would not like to be a minority shareholder in a joint venture with European companies and is seeking to have a controlling stake or a stake close to controlling, the expert said.
Gazprom may inject either funds or long-term liabilities for gas supplies into the joint venture, Reyli from Metropol said.
Gazprom could provide more flexible conditions of gas supplies as part of the deal, Pikin from the Energy Development Fund said.
The creation of the joint venture is still subject to antitrust approval, and the German antimonopoly service has already announced plans to examine the deal. Gazprom is expected to act simultaneously as a fuel supplier and a seller of the final product, and the antitrust body could impose some conditions on the proposed deal, said Reyli from Metropol. The deal does not contradict European legislation, Pikin from the Energy Development Fund said.
Reyli from Metropol also noted that the sides only had plans to study setting up a joint venture. Gazprom’s talks with Italy’s Enel and Germany’s E.ON led to no certain projects, the analyst reiterated, adding that RWE may not be satisfied with conditions that could be offered by Gazprom, and in this case cooperation with RWE will bring no results. However, RWE has a large debt and will be forced to search for a strategic partner, the analyst said. RWE’s current debt is estimated at 27.5 billion euros, its net profit is falling, while power prices do not compensate growing expenditures on fuel. RWE will also get more predictable fuel supplies by cooperating with Gazprom, Reyli said.