March 18, 2011
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№ 2 (February 2011)

Gazprom Gains Ground on the Spot Market The giant also intends to retain its long-term contracts

   Low spot prices during the global economic crisis did not help the Russian gas giant, whose long-term contract prices were too high for consumers. However, in the fourth quarter of 2010, European exchanges provided Gazprom with what was Christmas and New Year’s present in one.

By Maria Akulich

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   In late November – early December spot prices soared, for the first time since the crisis topping both the average annual price of the monopoly’s long-term contracts ($308 per 1,000 cubic meter) and the end-year spot price of $327 per 1,000 cubic meter. Spot price component in the customized contracts for E.On, GDFSuez and ENI has also increased. GM&T, Gazprom’s international trader at the NBP, TTF and Zee, has visibly improved its trading flow. In fact, the long-term contracts have once again demonstrated its business stability, too – even in such changing environment as the reforming EU energy market. And though by early 2011 this winter fairytale was beginning to look increasingly dull – the prices on the trading floors started falling again – the aftertaste remained there, just like after a sip of good champagne on the New Year’s Eve.

Destructive Fluctuations:  Export Earnings Plummet

   Global financial and economic crisis, the one that broke out in the second quarter of 2008, resulted in significant layoffs Europe-wide. As a result, 2009 natural gas consumption in the region fell by 7 percent. European market also felt the impact of growing LNG supplies (15 percent up on 2008 volumes); initially LNG was earmarked for the U.S., but had to go elsewhere due to high levels of U.S. shale gas production. As a result, Gazprom exports to non-CIS countries in 2009 fell 12 percent compared to the year earlier.

   During that period, prices on the European spot markets were usually significantly below the Gazprom’s long-term contract prices. According to BP statistics, the average 2009 price at U.K.-based NBP exchange was approximately $174.6 per 1,000 cubic meter (a 55-percent drop on 2008). At the same time, the average selling price of Gazprom gas for non-CIS long-term contracts in 2009 was pinned at some $302, informs Gazprom export. “The particular feature of our last year’s exports has been the pressure exerted by tumbling spot prices. At the time, the gap between spot and contract prices was over $100,” summed up Alexander Medvedev, deputy chairman of Gazprom and general director of Gazprom Export, at the conference “Export and Reliability of Gas Supplies to Europe” in June 2010. Sergei Komlev, head of the department of contract monitoring and price forming at Gazprom Export, calls the movement of European spot prices “destructive fluctuations”, boom-and-bust type.

   According to the expert, in some point in 2009, the price gap was over $150.
Still, other major suppliers of natural gas to Europe also tried to take advantage, both on the crisis and fluctuating exchange prices. For example, in 2009 Norwegian contracts included up 40 percent of spot price supplies, which resulted in growing share of Norway exports to the EU (from 18 percent in 2008 to 20 percent in 2009); the strategy also enabled the country to launch LNG production, gaining 3 percent of the market in 2009 (from zero a year earlier). Qatar has also boosted LNG export to the EU, from 15 percent in 2008 to 25 percent in 2009 (Eurogas data). It was precisely the “flooding” of the European market with Qatar LNG that resulted in such a plunge on the spot market, holds Alexander Nazarov, senior analyst at Metropol company.

   As for Gazprom, its 2009 revenue from gas sales to non-CIS countries fell 12.5 percent on the year, while the share in total imports of natural gas by Western Europe edged down to 26.3 percent (compared to 28.4 percent in 2008). “The monopoly even agreed on tailoring the contracts with some key partners, providing the opportunity to buy small quantities of gas at spot prices. This erased about 7 percent of Gazprom export earnings. But if the gas giant were inflexible, the losses would have been more significant, as well as the fall of supply volume,” Nazarov says.

The Silver Lining

   According to the IEA, from January through September 2010 natural gas consumption by OECD countries grew 6.1 percent compared to same period of 2009, natural gas imports – by 8.1 percent. Following the rebound of the European market, Gazprom began to regain its position. For the nine months of 2010 the monopoly supplied European markets with 99.09 billion cubic meters of gas (compared to 97.43 billion cubic meters for the same period a year before). Gazprom’s revenue grew 10.87 percent to 1,988 billion rubles, contributing to optimistic stance the company demonstrated already in summer. What’s more, another price fluctuation on the stock exchange (already upwards) added to their optimism. “In May this year, although we already faced summer, spot prices in Europe hiked up significantly. It was not just a small increase – by $3-4, the prices had grown by $30-40. So, LNG had to travel back to the States – over a million tons of extra LNG, compared to 2009,” said Alexander Medvedev, predicting 2010 exports at 145 billion cubic meters and revenue at $45 billion. “If we forecast something in June, these forecasts come true, almost like a dream,” assured the head of Gazprom Export.

   Dreaming is OK – that is, if you have a good foundation for the future. “Till 2030, if you count from 2010, we have already sold long-term contracts for a total of 4.3 trillion cubic meters of gas; this gas hasn’t been produced or shipped, but has been already sold out,” said Gazprom head Alexei Miller in Ufa in November. Given the situation, even the December ditching of the monopoly by the Croatia-based INA in favor of Italy’s ENI, though it might look like a fly in the ointment, is in reality a tiny-winy insect since Gazprom Export supplied to Croatia only up to 1.2 billion cubic meters of natural gas per year.

We Wish You а Merry Christmas and a Happy New Year!

   On November 23, 2010 the price of natural gas at the NBP reached $308.16 per 1,000 cubic meters – for the first time since the crisis, spot prices leveled out with Gazprom’s average annual prices for long-term contracts, which the company sustained at about $307-308 per 1,000 cubic meters.

   In general, prices at European exchanges have been rising throughout the fourth quarter, with price amplitudes reaching $164.52. Only this time for Gazprom this price gap was beneficial rather than destructive – the price of gas via long-term contacts proved to be of better value to consumers. Christmas snow drifts and cold weather resulted in growing consumption of natural gas – generally, if winter temperature drops by 1 degree Celsius, Europe’s natural gas consumption will grow on average by 30 billion cubic meters.

   “We believe that the final price lining will not happen before 2012. Also, we should remember that our goal is to sustain the level of revenue rather than to achieve the best price or the best sales volume at any cost. In 2009, the revenue topped $40 billion. If we were to guarantee this revenue by selling half of our gas by spot prices, which existed at the time, we would have to increase the sales by nearly 25 billion cubic meters. Given the crisis, there was no demand for such volumes,” says an OGE source at Gazprom Export.

The 400 Billion Raffle

   Considering the unprecedented situation on the European gas market during the global crisis, Gazprom has shown flexibility by tailoring contracts with some of its partners. The company readjusted its “leftovers” from the crisis period, a total of 15 billion cubic meters, spreading them over three consecutive years (2010–2012). Gazprom has also developed a package of incentives increasing the buyers’ interest in buying Gazprom gas over the minimum volumes. The package also applies to the “crisis leftovers”, spread by Gazprom over three years. GDFSuez, E.On, ENI, Botas wrested out the inclusion of spot component in the pricing formula for existing contracts (10-15 percent). At the same time, contracts include a compensation mechanism to ensure recalculation of the respective volumes from spot prices to oil-linked prices, in case the end-user consumes below the minimum specified in “oil contracts.” Also, if spot prices exceed the price of long-term contracts, the gas is sold at spot prices (as happened in the fourth quarter of 2010). And this principle is still untouchable.
Meanwhile, Gazprom Export explains that after full recovery of gas demand in Europe Russian gas monopoly intends to return to the pre-crisis conditions. In its reasoning Gazprom uses the consensus forecast that was prepared based on expectations of leading international think-tanks. According to this forecast, in 2020 the EU will need to import 380 billion cubic meters, and this figure is set to grow over 400 billion cubic meters in 2030. The question is, who will supply the gas and how will they do it.

   Industry experts also opinionate about the need for further tailoring of Gazprom’s long-term contracts – for example, about linking the price to a wider range of options, or about reducing the time gap between the price conversion in the contracts. However, the first scenario requires specific economic conditions and goodwill of the parties, since every economy has its own “market basket” which includes natural gas alternatives particular for that specific market. In one case it may be crude oil, in another – fuel oil or even coal. It turns out that changing the formula just for the sake of expanding options is economically meaningless. As for the time gap, its main advantage is prices predicted for several months ahead, which enables leveling out the market. “A long-term contract is not like an engraved rigid rule, spelled out to the dot for times to come. It must match the objective development of the market, so when there are significant, objective market shifts it is in our best interest to discuss with partners how we can use these processes in our contracts to our mutual benefit. But so far we have seen a temporary crisis followed by recovery. The market returns to a balanced state. So, what kind of further tailoring are you talking about? How do you tailor a contract if the market gets back to the pre-crisis state? We stick with the ‘take or pay’ principle and with the pricing system linked to oil products prices. The strategic rejection of long-term contracts system is not on our cards in any way,” explains the source in Gazprom Export. It appears that the gas giant keeps its finger on the pulse while hitching its wagon to the stars. Or perhaps this is just a professional bluffing, who knows. In which case a small share of the European spot markets is the extra joker up the sleeve.

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