This post was written in 2012–2013 and reflects thinking at the time. For current views and topical discussions, please see recent articles.
As every fool knows, vertically integrated energy companies tend to have an easier time coping with the vagaries of market conditions. For that reason Centrica, having inherited the supply business of British Gas, has felt somewhat naked without upstream assets to underpin it. The company has bought or built several power plants and entered the North Sea E&P arena. That, however, has taken it only part of the way from dangerous dependence on wholesale energy markets. Among other sources, the company buys piped gas from Norway's Statoil and LNG from Qatar (mostly the state-owned Qatargas), under long-term gas supply contracts. Just a few days ago Centrica signed yet another one of those, this time with Russia's Gazprom. This is Centrica's way of limiting its exposure to the UK's notoriously volatile spot market.
Incidentally, Gazprom has the opposite problem. While it is a quasi-monopoly in Russia, the company lacks a sufficient downstream hedge, which it felt very sharply in 2008 when the international oil and gas prices nose-dived. So far, apart from some asset swaps giving it exposure to the distribution and supply business in Germany, the company has failed to gain a foothold in Western Europe's retail markets, which it would love to do.
It is therefore not surprising that Cordi O'Hara, one of Centrica's directors, sees in the Gazprom tie-in "a natural fit with one of the world's largest gas producers and exporters". Why then not take it a step further? What about a formal JV or a full-on merger? Indeed, rumours to that effect have been circulating for a couple of weeks now. With the Nord Steam pipeline from Russia into Germany seemingly on track, and a spur pipeline expected into the UK, this would make even more sense.
The commercial logic is obvious. In the energy business, however, politics often trumps economics. It was almost exactly seven years ago that BBC Business News called me for a comment on the "imminent" Gazprom bid for Centrica. My response then was "this isn't going to happen". There are too many vested interest opposed to a closer business relationship between the UK and Russia. Nothing since then has made me change my mind. We've had the "Litvinenko affair" in London, the "spy stone" in a Moscow park, vehement disagreements over Libya and Syria, and so on. However, I am now becoming to feel cautiously optimistic that the political opposition may be weakening. There are two words that explain this: Deepwater Horizon.
Why should BP's misfortune in the Gulf of Mexico have any bearing on this? In a nutshell, BP's struggle for survival since the blow-out has shown in stark relief the importance for key UK businesses of cooperating with Russia on energy issues. Bob Dudley, BP's CEO who took over in the aftermath of the disaster, has built the entire recovery strategy around opportunities in Russia as well as JVs with Russian partners. Last year BP's 50% holding in TNK-BP provided 90% of BP group's dividend. Even bigger potential prizes are at stake in the Russian sector of the Arctic. BP's Eastern strategy deserves a separate blog post (watch this space!), but the main point is clear. If "British Petroleum" (as president Obama kept calling the company) is allowed to take piece of the action in the Russian upstream, why should Gazprom not be allowed to take a piece of the action in the UK retail market?
One shouldn't expect a plain sailing, obviously. The European Commission's recently launched anti-monopoly investigation into Gazprom will not help matters in the short term. However, the EC is clearly concerned with the bigger picture - the commercial basis on which the EU cooperates with out-of-region energy suppliers. The investigation may also serve to soften Gazprom into accepting a more limited deal than a full take-over.
