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Belgrade's dilemma

Serbia is the latest country to fall under Gazprom's spell. But a new deal raises more questions than it answers, writes Derek Brower

GAZPROM attempted to take control of Serbia's energy sector last month, continuing its ambition to expand its energy influence across southern and eastern Europe. The Russian company has offered to pay an undisclosed sum for a 51% stake in the state-owned Petroleum Industry of Serbia (NIS) – believed to be higher than Gazprom's first offer of €400m ($0.59bn).

In exchange for control of NIS, it is offering to support the country over the status of Kosovo and has held out the prospect of the new South Stream gas pipeline being routed through Serbia. Gazprom also says it will build new gas-storage facilities in the country. A deal was close as Petroleum Economist went to press.

The agreement, if approved in Belgrade, would help entrench Gazprom's position in southeast Europe at the same time as it guaranteed long-term supplies of gas to Serbia. Russia's backing of Belgrade over the status of Kosovo is likely to help Gazprom's attempt to buy NIS. The disputed Serbian province has been under UN administration since 1999.

But last month, the US and Germany announced plans to recognise it as a country if, as expected, Kosovo declares independence after Serbian presidential elections this month. Russia, wary of autonomy-minded dissenters in some of its own disputed territories, has said that it will not recognise Kosovo and will continue to support Serbia's claims over the territory.

Well disposed towards Russia

Serbia is already well disposed towards Russia; its prime minister, Vojislav Kostunica, is known to favour closer economic ties with Moscow and its companies, which have flourished in the country in recent years. Aeroflot, the Russian airline, aims to buy the Serbian national airline JAT and copper mining assets in the country are also attracting Russian interest.

That the Gazprom deal has been prepared at the governmental level is clear: the Russian embassy is understood to have passed on Gazprom's terms to Belgrade and, according to local reports, Kostunica was hoping to have a contract signed by the time he met Russia's President Vladimir Putin at a summit last month.

Within Serbia, meanwhile, Russian diplomatic support has emboldened the country to reject closer co-operation with the European Union (EU), which is likely to follow the US' and Germany's lead in recognising Kosovo's independence. At the end of December, Serbia's parliament adopted a resolution to abandon negotiations about future membership. A warning from the EU to Serbia last month that the sale of NIS must be "open and transparent" could backfire in Belgrade.

Russia is adeptly exploiting this friction between Serbia and the West. The intention to sell a controlling stake in the company to Gazprom is "very clearly a political reward for Russia's support over Kosovo", says Andrew Neff, an analyst at Global Insight, a consultancy. As such, it will make Gazprom once again the beneficiary of Russia's foreign policy.

NIS controls around 60% of Serbia's oil market, operates two refineries and the crude supply pipeline to Croatia. Although its infrastructure was heavily damaged during Nato bombings in 1999, it had hoped to become a regional player in its own right.

But there are other reasons why Gazprom wants control of NIS. The first is the company's interest in beefing up Gazprom Neft, the oil arm formed when Gazprom bought control of Sibneft. The gas company owns 80% of the shares in Gazprom Neft, with an option to buy the remaining stake, which is held by Italy's Eni and Enel, in 2009, for a set price. So Gazprom will do well to increase Gazprom Neft's value now.

Given NIS' domination of Serbia's downstream, Gazprom's acquisition will give Gazprom Neft a solid base for expansion across the Balkans – pre-empting the ambitions of other companies, such as Russia's Lukoil, Hungary's Mol, Austria's OMV and Poland's PKN to do the same.

Gazprom also wants to buy control of NIS simply because it can, say analysts. With cash to spend, the company's options to buy assets elsewhere in Europe are becoming increasingly limited by politics. "Finding a government that is amenable is too good an opportunity to pass up," says Neff.

Increasing value

The prospect of closer integration between Serbia and the EU – which remains the goal of many in Serbia, despite the Kosovo problem – is another motivator, says Jonathan Stern, of Oxford's Institute for Energy Studies. The assets might not be in particularly good condition, says Stern, but their value will only increase. Gazprom will do well to acquire them now, "rather than wait until Serbia is a fully paid-up member of the international community" – and acquisitive Western companies arrive with their chequebooks.

Another reason for Gazprom's interest in NIS is strategic. The proposed agreement between Russia and Belgrade includes Gazprom's offer to ensure the long-term security of gas supplies to the country, with the Russian company and Srbijagas, the state-owned gas-infrastructure firm, to develop storage and distribution assets. By gaining control over the former Yugoslavia's largest energy market and increasing its storage capacity there Gazprom will also be able to target supplies to neighbouring countries, says Neff. And by winning control of the energy sector in a country that is not yet an EU member, Gazprom gives itself a good foothold in southeastern Europe for the day when Serbia does enter the EU.

Meanwhile, by proposing the creation of a gas hub in Serbia for exports through the South Stream pipeline, Gazprom might also be seeking better terms from its other potential partners in the project, which it is developing with Italy's Eni. The firms have not yet decided on the final route that the pipeline will follow once it lands in Bulgaria.

A deal between Gazprom and OMV, according to which the companies would jointly own and develop the Baumgarten gas hub in Austria, was to have been signed by the end of 2007. That project has drawn criticism from many in Europe, given that it could kill off the long-planned Nabucco pipeline. Gazprom's offer to develop storage and pipeline facilities in Serbia could be a ploy to force Austria's hand over Baumgarten.

Good for Gazprom, but for Serbia?

The strategy to win control of Serbia's energy sector makes sense for Gazprom. But closer analysis of the proposed deal suggests it might not be such a great one for Serbia. Belgrade, it seems, is paying a hefty premium. The government had planned to privatise NIS by auctioning an initial 25% stake. Several firms, among them Lukoil, OMV and Mol, were thought to be interested. Another 25% stake would have followed.

But the offer from Gazprom will probably result in the termination of those plans, despite complaints from some members of the government that Serbia will sell effective control of its oil sector to Gazprom for a fraction of its value. Analysts say that when it was first considering the privatisation of NIS, Belgrade priced it at up to $2bn.

Economy and privatisation minister Mladjan Dinkic said in the Politika newspaper last month that an international tender could have fetched up to eight times the price Gazprom has offered. The Russian firm's offer was "humiliating", he added. "I am not angry at the Russians; they are great negotiators. I am angry at our [people] ... who are downgrading Serbia's national resources." He has since resigned the committee negotiating the deal with Gazprom.

So what would Serbia receive in exchange for selling control of its energy sector to Gazprom for half of its value? Gazprom's answer is that the company would spend another €0.5bn to rebuild and upgrade NIS' assets. And it promises long-term supplies of gas to Serbia, giving Belgrade and its citizens energy security.

Support over Kosovo aside, the prospect of the South Stream pipeline crossing Serbian territory is another reward for Belgrade's willingness to offload NIS so cheaply. Assuming the transit of 10bn-20bn cubic metres a year (cm/y), the volumes being discussed publicly in Serbia, that would generate transit revenue of some $200m-400m a year, say analysts.

Yes, but ...

That sounds good, except that: Gazprom and Eni still have not decided on the route for South Stream; second, when they do, the likeliest route will not cross Serbia, but will supply the country with a spur line – or a "transit line" – whose final destination is the tiny market of Bosnia-Herzegovina, say analysts; and third, Russia has demanded that if the line does cross Serbia, Belgrade provide transit of the energy for free.

There are other catches. According to the draft 30-year agreement that Gazprom has proposed, the company also wants NIS to be granted a monopoly on oil refining and products marketing for at least five years, with exemption from EU environmental standards over the same period, too.

Furthermore, investment in the gas sector to develop underground storage – a 10bn cm facility in Banatski Dvor – and pipelines would be undertaken by joint ventures involving Gazprom in partnership with Srbijagas. Gazprom, or one of its subsidiaries, would be guaranteed a controlling stake in these ventures and nothing would prevent the Russian company from buying more shares later. Srbijagas would also have to finance projects up to the maximum 49% of its stake in any company, although, according to reports from Belgrade, Gazprom would have access to all capacities of the storage facilities and pipelines.

The Russian company already controls Jugorosgas, which in turn controls the main Pojate-to-Nis pipeline and to which Belgrade has granted the exclusive right to market gas in southern Serbia. Local reports say that it is through Jugorosgas that Gazprom intends to build and operate any new pipeline – transit or spur – in Serbia, meaning that the country's stake in it will remain smaller than Gazprom's.

Russia is confident its proposal is irresistible. "I have no doubts that the agreement will be signed in this or a slightly changed form," its ambassador to Serbia, Alexander Alexeyev, said after the document was passed to Belgrade.

And the Belgrade government seems just as keen, albeit still taking Gazprom's pipeline offer at face value. "That a section of South Stream would go through our country would provide Serbia great proceeds from the transit and also energy security, not just in gas, but also in electricity supply," energy minister Aleksandar Popovic said.

But the proposal will worry the EU. The draft proposal adds up to the kind of deal-making Gazprom has practised in countries such as Armenia, but has rarely dared on the European continent itself: a spurious price for an asset in exchange for control over the energy sector in a country that is strategically important to Gazprom. In truth, the price of the Russian company's financial offer for NIS is irrelevant, even if it appears to be well below market rates. That is because its deal is pure barter.

Forget South Stream, which is unlikely to transit through Serbia. The essence of the pact between Belgrade and Moscow is that Gazprom will guarantee long-term gas supplies to Serbia and Serbia will give Gazprom control of its energy sector, including direct access to customers. For Serbia, where energy shortages are not uncommon and where the dream of EU membership is turning sour, Russia's political support and Gazprom's gas could be hard to resist.


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