The following article is from our October 2005 issue.

Putin Pumps Up The Volume. Natural gas to run along a controversial German-Russian axis. By Wolfgang Glabus

A new German-Russian pipeline is scheduled to begin transferring natural gas from Siberia to Western Europe under the Baltic Sea in 2010. While Germany hopes the project will give it entrance into the global gas trade, Russia is using it to shut out unwanted transit countries like Poland and Belarus.

Vladimir Putin once again provided support for his friend, Gerhard Schröder. Just 10 days before Germany's parliamentary elections, a Russian industrial delegation headed by the president traveled to Berlin. In a pre-election publicity coup for the German chancellor, the delegation signed contracts for a spectacular project. Russian energy giant Gazprom and the German companies BASF and E.on are going to build a huge pipeline that will deliver natural gas from Siberia to Germany beginning in 2010.

The energy summit had originally been scheduled for October. But Schröder didn't want to risk his potential successor garnering the glory. So German TV screens were once again brimming with images of Schröder, the statesman negotiating with world leaders. The chancellor was effusive in his praise of the project: "It has secured most of Germany's energy needs for decades to come."

But the German-Russian energy alliance, which Putin and Schröder celebrated before the cameras, met with strong opposition from neighboring countries. The 1,000-kilometer-long pipeline will run under the Baltic Sea and cost up to ?12 billion, making it the most expensive underwater pipe in the world.

Despite the price tag, the project is very attractive for Putin. For the first time, Russia will have a gas pipeline to the West that doesn't cross Belarus, Ukraine, Poland and the Baltic States. Those countries feel duped, done out of not only transit fees, but also political influence. They are outraged.

With a sense of historical irony, the Polish magazine Wprost called the project the "Schröder-Putin Pact." The former speaker of Lithuania's parliament, Vytautas Landsbergis, has even warned that the pipeline will change the strategic balance of power in Europe.

So why is Germany risking the wrath of its neighbors and promoting a project that will significantly raise energy prices? European Union officials have consistently pointed out that a conventional overland pipeline would be much cheaper. But the Germans see a chance to finally make up for a missed opportunity in the oil markets and gain direct access to energy sources.

Germany is the third largest industrial power in the world. But unlike the U.S., Britain and France, it has no large energy companies, nothing that could compete with multinational giants Exxon Mobil, Shell, BP or Total. That leaves Germany a concerned spectator instead of a player in the global energy game.

So in 1970 Ruhrgas, today a subsidiary of E.on signed the first contracts for delivery of natural gas from what was then the Soviet Union.

But the Germans weren't content to remain privileged energy buyers. In 1996, they took the first steps toward changing that when Ruhrgas acquired a 2.5 percent interest in Russia's mega energy company Gazprom. The subsequent acquisition of an additional 4 percent made Ruhrgas the largest foreign shareholder in Gazprom.

Ruhrgas Chairman Burckhard Bergmann became a member of Gazprom's supervisory board, and Germans acquired a direct interest in the natural gas extraction business, quite unlike the German position in the oil business.

And Gazprom is an enormous concern. It has 16.4 trillion cubic meters in proven natural gas
reserves, dwarfing Shell (1.5 trillion cubic meters), Exxon (1.4 trillion cubic meters) and BP (1.3 trillion cubic meters).

The Russians used this advantage for clever bargaining. The head of Gazprom, Alexei Miller, is just 43 years old and a close confidant of Putin. Miller used the carrot-and-stick approach with German energy firms. "The German companies are the only ones we will involve in our gas business," said Miller. But it was not pure generosity. In return, Russia wants to get into the lucrative business of gas distribution in Western Europe.

So far, their most obliging German partner has been BASF AG, based in Ludwigshafen. BASF is the largest chemical company in the world and its subsidiary, Wintershall, is a major player on the gas market. Gazprom has already acquired interests in Wintershall's distribution companies
Wintershall Erdgas Handelshaus (50 percent) and Verbundnetzgas (5.3 percent).

And Gazprom has also already rewarded that consideration. In April, Miller awarded Winters­hall an extraction project in the West Siberian gas field Yuzhno Russkoye that had initially been promised to E.on.

The game continues. Miller is keeping all his options open, even after signing the pipeline deal. "There is a passage that allows the joint venture to be opened up to other energy companies," he says. And that's the motive for Germans. Oil giants like BP and Shell have long been trying to get into business with Gazprom.

So if the German companies want to get into the gas business in a big way, they don't have much choice but to start with the pipeline project. Currently, Germany gets 40 percent of its gas from Russia and that percentage will increase. Critics of the project warn that Germany is making itself very dependent on Moscow.

Many other European countries are taking a different tack. They know Moscow has promised gas exports all over the world - China, Japan, India, the United States. And Russia burns a lot of its gas domestically. So French and Italian companies are looking to North Africa, home to almost one-tenth of the world's estimated natural gas reserves.

Others are looking to the Caspian Sea and the Middle East. Austrian energy concern OMV, along with partners from Hungary and Turkey, did a study on building an overland pipeline from Azerbaijan to central Europe that could be in operation by the end of the decade. Britain is looking at liquid natural gas from Qatar on the Persian Gulf.

The expensive new pipeline will keep energy prices in Germany high. Germans already now complain about the high cost of electricity, and most recently there were particularly steep rate hikes for natural gas.

But pressure on the companies for transparency is growing. The Federal Cartel Office is already investigating German natural gas companies. And a judgment by a district court in Hamburg mandates that E.on's North German subsidiary E.on Hanse must disclose how it calculates consumer prices after the company raised its prices by 25 percent over the last year.

- Wolfgang Glabus is a senior editor at the business magazine Capital.