The Wall Street Journal-20080128-Gazprom Drills Deeper Into Europe- U-K- Becomes Foothold in Entry to Consumer Market- Mistrust Lingers

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Gazprom Drills Deeper Into Europe; U.K. Becomes Foothold in Entry to Consumer Market; Mistrust Lingers

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London -- Russian energy giant OAO Gazprom is moving aggressively into retail natural-gas markets in Europe, with plans to sell gas and power directly to consumers, a top company official says.

The United Kingdom has emerged as a beachhead in its strategy.

Vitaly Vasiliev, head of Gazprom Marketing and Trading, the Russian giant's U.K. arm, predicts Gazprom will have 14% of Britain's commercial and industrial market in gas within three years, up from 1.5% today. "Gazprom wants to be an energy company, not just a supplier of gas," he says in an interview. "We want to participate in the whole value chain."

It might be hard to square such aspirations with GM&T's 140 employees and modest office in a London suburb. Experts say its goals are overambitious.

Yet the push by Gazprom, which already supplies a quarter of Europe's gas at the wholesale level, comes at an auspicious time. The European Union is moving to open up energy markets to give electricity and gas consumers more choice. That means easing conditions for new entrants and granting them access to transmission networks.

But there is concern about state-controlled energy giants like Gazprom taking advantage of market liberalization. Gazprom embodies everything the EU is trying to change -- a vertically integrated national champion with a monopoly on exports and that owns gas fields and pipelines. In a pre-emptive move against Gazprom, the EU is mulling a plan to stop such companies from controlling EU distribution networks.

Because many EU countries are still dominated by powerful incumbents that don't tolerate outsiders, Gazprom's distribution strategy may be doomed. "As long as this system of monopolies remains, it will be very hard for Gazprom to expand," says Vladimir Milov, a former Russian deputy energy minister and now head of the Institute of Energy Policy in Moscow. "Their friends don't really want to let them in."

Underlying the mistrust of Gazprom are memories of two years ago, when it closed the taps to Ukraine during a pricing dispute, triggering supply disruptions in Europe. Gazprom was accused in Western capitals of being a tool of Kremlin foreign policy, which the company denied.

Its entry into Britain has coincided with a cooling in U.K.-Russian relations, triggered by the fatal radioactive poisoning in London in 2006 of Alexander Litvinenko, a former KGB officer. Russia's refusal to extradite Andrei Lugovoi, the man British prosecutors accuse of the murder, prompted tit-for-tat diplomatic expulsions last year.

GM&T's Mr. Vasiliev, a 35-year-old graduate of Stanford University's business school, says the chill hasn't harmed his company's prospects in Britain. "If customers come and choose us, despite all the negative coverage, it shows they trust that we're a good supplier," he says.

Gazprom's biggest push within Europe came in late 2006 when it signed a landmark deal with Eni SpA, the Italian energy group, allowing Gazprom to sell 3 billion cubic meters of gas a year directly to Italian consumers.

Gazprom that year also expressed an interest in buying Centrica PLC, the U.K.'s largest gas utility. British politicians, worried about Kremlin interference in U.K. energy supplies, called on the government to block the deal.

Instead, Gazprom moved cautiously. Its first retail acquisition outside of Russia was Pennine Natural Gas, a small U.K. gas-supply business that focuses on small and midsize enterprises. Gazprom later bought another smaller company, Natural Gas Shipping Services. Gazprom now has about 5,000 U.K. customers, among them venerable British institutions like the Manchester United soccer club.

U.K. brokers who buy gas from GM&T have been impressed. "Gazprom is new to the market, so they're fleet of foot and innovative," says Michael Abbott, deputy managing director of Inenco, an energy consulting firm and a GM&T customer.

Analysts say the company has grown aggressively. "Gazprom is small, but they're acquiring new customers every month at increasing speed," says Binoy Dharsi, an analyst at Datamonitor.

Addressing fears that the expansion will increase Europe's overreliance on Russian gas, Mr. Vasiliev counters that most of the gas it sells doesn't come from Russia. Of the 16 billion cubic meters of gas GM&T traded in Western Europe last year, 10 billion was acquired on the basis of long-term "swap" agreements with other European groups such as DONG Energy A/S of Denmark, or from third parties.

Such deals slashed transportation costs. "Our Siberian fields are 7,000 kilometers [about 4,300 miles] away from our customers in the U.K.," Mr. Vasiliev says. "If you physically move this gas to Britain it takes seven days."

GM&T is moving into the French market. Mr. Vasiliev says it sold 500 million cubic meters directly to industrial consumers last year, and wants to increase that to 2.5 billion to three billion cubic meters by 2011. It also wants to expand into supplying small businesses, as in the U.K.

But France is much tougher than Britain. "It will be trickier for them, as customers don't like switching from the incumbent," says Mr. Dharsi. France is less liberalized than the U.K., meaning it will be harder for GM&T to acquire a local supplier like Pennine.

Breaking into Germany's downstream sector also has been difficult. Gazprom has signed asset-swap agreements with Wintershall, the gas division of German chemicals giant BASF AG, and energy giant E.On AG that give both companies a stake in its huge Yuzhno-Russkoye gas field in Siberia in exchange for stakes in their downstream operations. But Gazprom and E.On have so far failed to agree on terms for the swap.

"E.On doesn't want to give up real assets in return for access to who knows what," says Mr. Milov.

GM&T accounts for only a tiny part of Gazprom's results. Gazprom in December reported second-quarter profit of 102.87 billion ($4.2 billion) on revenue of 532.37 billion. GM&T reported 2006 revenue of 1.5 billion ($2.97 billion).

As well as running Gazprom's trading operation, Mr. Vasiliev spends a lot of his time trying to counter Gazprom's negative image. In 2006, he appeared before the British House of Commons' trade and industry committee, trying to persuade members of Parliament that Gazprom wasn't an arm of the Russian state.

For Gazprom, working in the U.K. is first and foremost a learning experience. "It's an opportunity to get into the market, try to understand how it works and learn how to operate in it," he says. "We're doing things that Gazprom has never done before. It'll take some time."

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Gregory L. White in Moscow contributed to this article.