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By John Helmer in Moscow

The Russian and Azeri governments have taken the air out of a scheme to provide Europe with an alternative source of gas supply to Gazprom, which signed an agreement on Monday with the State Oil Company of the Azerbaijan Republic (SOCAR). When it comes to putting the gas into high-priority political schemes for Europe’s energy needs, the Kremlin proves once again that it is prepared to put money where its mouth is, while the European Union raises hot air in think-tanks and editorial columns.

The new deal, signed in Baku during a visit by President Dmitry Medvedev, provides for Gazprom to begin purchasing gas from Azerbaijan from the start of next year. The initial volumes are very small — just 500 million cubic metres per annum. But they give Gazprom the option to increase them, as Azeri production from the Shah Deniz field, in the Caspian, ramps up. “All things being equal among potential buyers, priority will be given to Gazprom,” Gazprom CEO Alexei Miller said at the signing ceremony. “Other buyers would have to offer conditions that are more financially attractive.”

According to unidentified sources cited in the press, Gazprom is going to pay some $350 per thousand cubic metres, a substantial premium to the current market price, and roughly in line with the $340 price paid by Gazprom to Turkmenistan in the first quarter of this year. From the point of western brokerages and western shareholders, this is costly for the company’s bottom-line, and thus for its dividends and share price. So long as gas prices remain low on low demand, there is the potential, argues a report from Unicredit Securities, “to force Gazprom to cut its own production while replacing it with virtually zero-margin Central Asian gas.”

These terms directly threaten the supply of Azeri gas for the Nabucco pipeline, the European Union-backed rival for Russia’s South Stream pipeline to export gas to southern and central Europe. Both pipelines are being designed to cross the seabed of the Black Sea. By offering Azerbaijan the same price premium as already agreed with Turkmenistan, Gazprom gets a priority buy-option for gas on both sides of the Caspian. The extra cost on Gazprom’s balance-sheet will earn a political dividend, if the scheme can reduce the gas available to Nabucco below the level required for pipeline profitability.

In the feasibility and bankability stage of the Nabucco pipeline, western investors and governments have now to worry that they cannot afford a bidding contest with the Kremlin over the price of Shah Deniz gas. And if Nabucco is deflated before it starts, the political dividend earned by the Kremlin can be translated into more flexible pricing later on, when South Stream starts delivering. As Medvedev explained in Baku, the agreement has been devised “absolutely not on political motives but on mutual benefits.” Nabucco, Miller implied, has been a political “fetish”.

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