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Home / Issue Archive / 2008 / February #2 / Gazprom, Europe Sing Harmony on Energy Security

№ 2 (February 2008)

Gazprom, Europe Sing Harmony on Energy Security

In their never ending search for stable employment, Russians dream of working for a safe state-owned company

By Elena Zhuk

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Here, Gazprom is undoubtedly the leading contender. Under the leadership of Dmitry Medvedev, Chairman of Gazprom’s Board of Directors and First Deputy Prime Minister of RF, who in December was declared Putin’s official successor, Gazprom became the company of choice for nearly 44 percent of the 1,600 Russians interviewed by the All Russia Public Opinion Research Center.

The rapid growth of the Russian gas monopoly, which in December boasted a $300 billion capitalization, has propelled Gazprom to the top tier of anybody’s list of the world’s wealthiest companies. It is now nipping at the heels of such transnational giants as Microsoft, ExxonMobil and General Electric. And it is not out of the question that Gazprom might actually overtake some of its rivals. How so? Like any other company, Russia’s state-owned gas monopoly is pragmatically seeking out all opportunities to maximize its profits in a competitive market. It is no longer in the mood to satisfy the demands of ex-Soviet partner states for subsidized gas supply.

“Today and in the nearest future Europe remains our main export market, just as it was in the past,” another Medvedev in Gazprom’s leadership told an elite audience at last autumn’s “Russian Gas 2007” forum held annually at Gazprom headquarters in southern Moscow. Expanding on his point, Alexander Medvedev, Deputy Chairman of Gazprom’s Management Committee and no relation to likely presidential successor Dmitry Medvedev, continued:  “Today, Europe is the center of our economic interests. Our interests are interdependent since Europe cannot do without Russian gas, just as Russia cannot do without European customers.” Last year, Gazprom celebrated 40 years of supplying gas to the Czech Republic and Slovakia, and next year the company will celebrate the same anniversary marking the start of gas supplies to Western Europe.

And Gazprom didn’t wait too long after the New Year to launch yet more pipeline projects to keep European supplies flowing. With the German-Russian North European Gas Pipeline (North Stream) now crossing the Baltic seabed on its way to Germany, Gazprom in January announced new initiatives to guarantee supply to southern Europe.

Italy’s Eni which laid Gazprom’s Blue Stream pipeline across the Black Sea to Turkey, will now undertake an east-west crossing from Russian shores on the Black Sea to Bulgaria. After traversing Bulgaria, this South Stream will snake in two directions via Serbia and Greece – to Vienna where it would connect into Gazprom’s existing hub outside of Vienna, or to Italy. A final decision will be made after various feasibility studies are completed. Recently Gazprom purchased 51 percent of Serbian national oil company, NIS Serbia, and intends to build a 400-km part of South Stream with 10 bcm per year through capacity and capitalize the Banatsky Dvor underground storage facility.

The message from Gazprom as 2007 rolled into 2008 was in sharp contrast to what it was the last two winters when it took steps to rid itself of arrangements to supply gas at below market prices to former Soviet states, particularly Ukraine (in 2006) and Belarus (in 2007). Though Gazprom had to behave as it did to drive home the importance of market discipline, it handled the PR badly. Europe reacted with Cold War apprehension and the Western press unfairly branded Russia as an unreliable energy supplier. Considering Europe’s new love fest with Gazprom, it seems that Russia’s image is now turned around and Europe views its neighbor to the east as a reliable business partner.   

Germans Rush to Develop Yuzhno-Russkoye Field to Satisfy Demand

With so many new pipelines headed Europe’s way, Gazprom has no choice but to turn its attention to developing new fields from which to source supply. On December 18, at Gazprom’s South Moscow headquarters on Namyotkina Street Chairman of the Board Dmitry Medvedev and German Foreign Minister Frank-Walter Steinmeier signed an agreement to bring into production the Yuzno-Russkoye field, located in the Krasnoselkupsky area of the Yamal-Nenets Autonomous District. The Yuzhno-Russkoye gas condensate field reserves are as follows: 825.2 bcm of gas ABC1 category, 208.9 bcm of gas C2 category, 5.7 million tons of oil. Gazprom sold its block of shares in the field development project to Germany’s BASF in exchange for shares in Wingas, a German gas distributor.

E. ON Ruhrgas intends to follow suit and participate in the project. In exchange, it offered Gazprom assets in the electrical energy sector plus underground gas storage facilities. Delays in the evaluation of these assets prevented the deal from being closed before the field was officially brought into production but the negotiations remain very much alive.

Together with E. ON and Soteg of Luxembourg, Gazprom plans to build two electrical power stations. One with 1 GW capacity will be built in Lubmine on the Baltic Sea, and another gas-powered electrical station will be located in the eastern German city of Eisenhuttenstadt. To power both stations, gas will be shipped through the Nord Stream pipeline.

Despite all the good news coming out of Gazprom this winter, consumers be they European or Russian, will be paying more for gas. In 2008, European consumers will see a 17 percent increase. Chris Weafer, Chief Strategist at Uralsib Financial Corporation predicts that the price of 1,000 cu. m of natural gas will reach $300-400 compared to last year’s $260-270. Gazrpom itself estimates that by the end of 2008, the average price of gas exported to Western Europe will be $354 per 1,000 cu. m.

Reacting to inferences that Gazprom is tampering with gas prices, Alexander Medvedev cited the existing pricing structure: “If we consider the average figure, the share of import price in the end-user price does not exceed 30 percent, regardless of whether we consider industrial, commercial or utility users. All that’s left is the income, which is tied to the market operator’s expenses. Regardless of price level, the average tax level amounts to 40 percent.” In Medvedev’s opinion, “By keeping taxes at such a high level, European governments are trying to solve budget problems.” So, Western Europe does not have much of a choice. At the last autumn’s forum, Eurogas president Domenico Dispenza gave a presentation on the evolution of NG’s share in PE consumption in the EU: 24.1 percent in 2005, and 26 percent and 30.1 percent for 2010 and 2030 respectively.

As for domestic Russian consumers – so long accustomed to seriously subsidized supply – 2008 will be a tough year. In May 2007, the Russian government approved an equal profitability policy on gas supplies to foreign and domestic markets. Despite this policy coming into force only by 2011, in December the Federal Tariffs Service announced the impending price increase.

To achieve “equal profitability” (which is calculated based on discount of custom fees and transport expenses), the wholesale prices for the internal market should be increased gradually. In early December, the Federal Tariffs Service adopted a resolution resulting in a 25-percent increase in wholesale prices for Russian consumers. In accordance with this resolution, in the forthcoming year the average regulated wholesale price for industrial users will amount to 1,690 rubles per 1,000 cu. m of natural gas (without the VAT). For the general public, the price of 1,000 cu. m of natural gas will be 1,290 rubles (VAT excluded). Yet, according Russian First Vice President and Chairman of Gazprom’s BOD Dmitry Medvedev, the general public has no reason to worry: “The increase in the base tariff practically won’t affect residential users; it will be significant for industrial users only.”

Discounts Yes, But No Free Lunch at the Gazprom Cafe

As for gas transportation through trunk pipelines, tariffs were increased by 19 percent. In the case of internal supplies, transporting 1,000 cu. m of gas 100 km via trunk pipeline will cost independent producers 36.13 rubles; for export delivery, 100 km of transportation will cost 40.02 rubles per 1,000 cu. m.

According to the Federal Tariffs Service, “The major factor causing the change in tariffs is the increase in Gazprom’s investment in the trunk pipeline system in accordance with the Complex Program for Reconstruction and Technical Re-Equipment of Gas Transportation Facilities and Booster Stations at Underground Gas Storages for 2007–2010.”

As for Russia’s neighbors, Ukraine will have to pay $179.5 for 1,000 cu. m of gas compared to last year’s $130. Since Turkmenistan raised the cost of exported gas from $100 to $130 per 1,000 cu. m, Russia had to follow suit. The increase of transit tariffs for transporting Gazprom’s gas across Ukraine was simultaneous with the increase of tariffs for transporting Central Asian gas to Ukraine through Gazprom pipes (up to $1.7 per 1,000 cu. m for each 100 km).

However, the increase of the price of Turkmen gas did not in the least affect deliveries to Belarus based on long-term contracts. Still, most of Belarus was not too happy about Russia’s “Christmas gift” to its potential ally. While getting a long-awaited loan of $1.5 billion, Belarus will pay $119 for 1,000 cu. m of Russian gas. In the opinion of Stanislav Vasilevskiy, First Secretary of Trade at Belarus Embassy in Moscow, for the most part “the loan will fund the upgrading of Belarus’ energy system and introduction of energy-saving technologies.”

The following analysis is taken from the Prospect Investment Company’s website: “In the future, Belarus will be able to buy Russian gas at the internal market price. By then, the market boundaries will be defined, and Belarus may get access to Russia’s internal market under the uniform customs system. This does not mean that Gazprom will subsidize the European economy, as the state budget will bear the burden.” As a result, this year Gazprom will suffer a loss of $3 billion compared to $2 billion the previous year.

New Math – 5 Plus 5 Equals 6.75 

In November, the “5+5” experimental project at Mezhregiongaz’ trading site, which was built to facilitate free gas trade, celebrated its first “birthday.” Under the project, Gazprom and independent producers each had to sell 5 mcm of gas. However, in the course of the tender the parity was distorted in favor of Gazprom, which offered a lower price.

As a result, the company’s share in the total sale volume amounted to 58.9 percent. Among the main customers were electrical power companies representing 55 percent, as well as agrochemical and chemical enterprises. But still, the targeted volume had not been sold. Among factors limiting sales, experts mentioned the unusually warm winter and spring of 2007, as well as the practice of pro gas for which a buyer has not yet been found, and payment of a penalty coefficient.

Other deterrents included parity requirements on gas volumes sold by Gazprom and independent producers at the trading site, and insufficient undistributed resources of independent producers.  In terms of sales, front-runner Gazprom was followed by Rosneft and NOVATEK.

This successful experiment made it possible to trade significant gas volumes at free prices and to sell gas for months and decades ahead. Besides, it enabled purchasing the “blue fuel” without delays. The project will continue this year. Apart from the new 7.5+7.5 formula, it offers an additional “day-ahead” operation mode. Since Russian Prime Minister Viktor Zubkov signed a decree enabling the project to continue, next year the volume of gas sold at free prices cannot exceed the volume of gas sold by independent producers at trading sites by more than 15 percent. The companies trading gas at the sites believe that this experiment is worth converting to a long-term project.

Rumours on the Absence of Russian Gas Market are Highly Exaggerated

“The Russian gas market is continuing to develop, despite claims that it does not exist,” the Vice President of TNK-BP’s Management Board, Alexander Berezikov, told last autumn’s forum at Gazprom. According to Berezikov, “The market is large enough to accommodate big players like Gazprom, as well as smaller companies represented mostly by independent producers. They operate in different market segments and cater to totally different customer groups.” Experts at independent gas producer Itera say independents control a 16 percent share of production. And TNK-BP’s Berezikov cites data that projects annual growth in production by independent companies of 140-180 bcm per year through 2020.

Berezikov added however that to properly assess the market, “the volume that independent companies plan to sell during the year should be listed as a separate item in Russia’s gas balance.” And the biggest barrier to trade is access to pipelines. TNK-BP sold 10 times less gas than projected in 2007 because of access problems and now, Berezikov said, the company will build an 80-km pipeline in the Urengoi area for TNK-BP’s affiliate, Rospan. Access to the uniform gas supply system, introduction of amendments to the mineral extraction tax, construction of facilities for APG processing, amendments to subsoil use legislation, and the possibility of exporting gas are on the list of topical issues for independent producers. And they’re likely to be front and center throughout 2008. Stay tuned for an update.

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