Rising Gas Exports, Demand for New Supply Guarantees Future of Russia's Indepent Gas Producers on the Russian Gas Market

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Every year, volume of Russian gas export by Gasprom is increasing. To be able to fulfill its growing obligations, the industry leader has to take care of gas production buildup, but if new markets appear, such as China and other countries of the South-East Asia, it would be difficult for the export monopolist alone to handle the situation. In these conditions, the role of independent gas producers is growing even with the problems of restricted access to the pipeline network. Victor Baranov, President of the Union of Independent Gas Producers, is talking about the problems of independent gas producers in the developing market.

Oil & Gas Eurasia: It is often said that there is no natural gas market in Russia. Can you prove the opposite?
Viktor Baranov: The natural gas market started forming in 1998–1999 when independent gas producers, companies set up in the early 1990s, get developed sufficiently. These companies were small, the share of gas they produced at the moment was insignificant.
In 2001, independent companies decided to establish the Union of Independent Natural Gas Producers – (Soyuzgaz) to represent them in the political field. Soyuzgaz’ primary objective was to create a lasting understanding within the government and society that both the state and Gazprom needed the independent private natural gas business, and could benefit from it. During 2001–2005, there were disputes regarding access to the market. In 2002, some instruments of the market were created, for instance, the Interregional Oil and Gas Complex Exchange (MNBK) and Mezhregiongaz’ trading site. By 2005, the market shaped up and the goals were achieved: NOVATEK and ITERA became the biggest independent natural gas producers; ТNK-BP, Rosneft, LUKOIL had steady operation. However, the Russian market system has its specifics. It isn’t a free buy and sell system, as market is supposed to be. Gas is mostly sold at a price set by the state, it is the gas sold by Gazprom to both residential and industrial consumers. Today, efforts are made to develop the gas market, and a pilot project has been launched at Mezhregiongaz’ trading site to sell gas at free price. The necessity to transfer industrial users to free market prices is currently considered. Real steps aimed at launching the exchange trade are being worked out.

OGE: The trading site started operating later, didn’t it?
Baranov: It was launched in 2002, but the site seemed to run in a testing mode: there were no clear and transparent rules of operation, and also serious software problems. The business could not come to an agreement on the point whether it needed both the exchange and the trading site. And only now these tools started operating in accordance with market laws. Late in 2005, the Ministry of Industry and Energy of the Russian Federation (Minpromenergo) decided on what to do with the “5+5 experiment” (as it was later called) and they started online trading. By 2008, the online trading became a 7.5+7.5 project. Its participants understood that the site and the exchange have different objectives, they don’t compete, but rather  supplement each other. The point is that in the West, e.g. in England and in the U.S., both trading sites and exchanges do exist, and there enough room for everyone – so, they figured, the same could be done in Russia. That is how in 2006 the “Schedule Plan for Exchange Trading of Gas in the Russian Federation for the Period of 2006–2008” appeared.

OGE: It seems, the trading site has been a successful experiment. What about the exchange?
Baranov: The exchange is not trading yet. Unfortunately, there did exist certain difficulties pertaining to organizational issues. However, we overcame them, and now we have a clear view with regard to how a gas exchange should be arranged. So, it will be able to work with financial instruments, which are used worldwide and which are more complex than a trading site.

OGE: What is the current share of independent producers, what will it be in the future? What is their annual output?
Baranov: The independent producers make up their share of 100 bcm of gas (together with associated gas) or 15 percent of the market, which is quite substantial. Their main consumer is the industrial sector. Besides, in Sverdlovsk region, for example, all social demands are satisfied by ITERA that supplies natural gas. The independent companies plan to produce an estimated volume of 200 bcm by 2015, which will account for 20-25 percent of the market, as LUKOIL, TNK-BP and Rosneft will increase their production. In particular, TNK-BP, which used to sell 1.2 bcm annually, expects to sell 3.4 bcm this year after they sort out the issue with connecting Rospan to the main pipeline.
OGE: Do you think Rospan will be one of the most important assets in the much-spoken-of joint venture between Gazprom and TNK-BP?
Baranov: There are speculations on the issue, but it has not happened yet. If Gazprom gets more than 20 percent share in Rospan then the Rospan’s gas will be affiliated and will become a subject to state regulation. It is not to the advantage of Rospan shareholders who currently sell gas at unregulated prices. However, the recent Government Decree No. 851 of 10/12/2007 “On Extending the Pilot Program for Selling Gas at the Trading Site in 2008” makes it possible to sell gas, which belongs on a PSA basis to a shareholder independent of Gazprom, at a trading site for unregulated price even in case this gas has been produced by a Gazprom affiliate. This opens up a wide venue for cooperation between independent companies and Gazprom. Such an expansion of unregulated market sector was among the Souyuzgaz’s proposals to Minpromenergo.

OGE: Could you name independent producers that achieved the best results?
Baranov: ТNК-ВР, which is to increase gas production by 200 percent from 1.2 bcm to 3.4 bcm. Last year, all independent companies came very close to the point where they could enter the market. For instance, LUKOIL couldn’t enter the market because it gave all its gas to Gazprom. Yet, first of all, parity must be observed as far as the online trading is concerned; secondly, Gazprom has to ensure supply of 15 bcm of gas, and one of the ways to achieve this is to allow independent companies sell more gas at the trading site. Gazprom lets them increase production provided the gas will be traded at the site – in any case, the price will be higher then that fixed by Federal Tariff Service. On average, the price is 1.5 times higher, which is to the advantage of independent companies.

OGE: Can you give an example of independent gas producers who were successful in Russia?  
Baranov: Last autumn, EuroTEK won a tender for two subsurface areas in the Yamal (Zapadno-Kamennomysskiy and Ladertoiskiy). The company has already started production in Yamal, and, even though it supplies natural gas to only a small settlement, it represents a tentative entering the market, which is usually quite a problem for foreign companies. The company won the tender for production sites that have access to the main pipeline, so it is possible to produce natural gas on a large scale.

OGE: The problem of gas transportation is obvious. How could it be solved? How could the independent producers participate in resolving it?
Baranov: The problem exists, primarily, in the immediate vicinity of the production sites. Independent companies are ready to invest in the transportation system but only with a view of return revenues. Pipeline construction cost is not always returned with gas sales. Since the independent companies do not own the pipeline, there must be some cost-return mechanism. There are quite a few options providing for such a mechanism, but no one in particular has been chosen so far.

OGE: What kind of options?
Baranov: Gazprom can agree to some tariff reductions, or otherwise, the independent producers can cover expenses on a cost-return basis.  
OGE: Could you point out the most essential problems that independent natural gas producers in Russia encounter today?  
Baranov: First of all, it is the problem of financing the natural gas industry, understanding how to do that when 85 percent of gas is sold at a fixed price and another 15 percent – at the unregulated price. The amount of natural gas sold at the price fixed by Federal Tariffing Service keeps pressure on the independent companies, so it’s good to have at least the 1.4-1.5 time price increase at trading sites. There should be development plans for natural gas business, both on federal and regional level. Gazprom has a hard time trying to develop all the fields on its own, it requires a lot of investments. Foreign companies are ready to contribute to the development of Russian fields. If we are talking about Shtokman, for example, it is all clear: gas, which was produced there, will be sold abroad. But what about Yamal fields intended for domestic needs? A program to coordinate such issues as mineral extraction tax, investment in transport and infrastructure, field development should be devised, and there must be certain market rules that are clear to everyone. The government should suggest a program for development of natural gas business. You cannot just say: “Let’s ‘cut-in’ the pipe, boost production, and send the gas somewhere.” Since domestic price for natural gas is relatively low now, power plants prefer a cheap gas to the more expensive residual oil, when deciding on the type of fuel they use. And guess, who are main buyers at the trading site? Power plants. They are ready to pay twice as much when they are in dire need of fuel. So, there is demand for expensive natural gas but we keep on providing our economy with the cheap one. Meanwhile, it is Russia’s strategic resource.

OGE: Are there any independent producers, which are not in the least affected by the problem of access to the main pipe? How do they use the produced gas?  
Baranov: Yakutgazprom in the Republic of Sakha (Yakutia) is a good example. Also, we should mention here Norilskgazprom that belongs to Norilsk Niсkel and supplies natural gas to the city of Norilsk and the Norilsk Plant. The latter doesn’t care about a higher price on gas, because it relies on gas in its operation and uses it to heat the city.

OGE: Can we use the experience of other countries in terms of market orgnization?
Baranov: The British and the U.S. markets are working properly with regard to price formation, exchanges, trade sites. Take power plants, for example: the price for natural gas goes up, the price for coal goes down, and the trader switches the plant from one type of the fuel to another. Such responsiveness determines high performance of the plants. As for Russia, the efficiency of power plants does not exceed 40 percent.
The way the market is arranged can be of interest, too. In the U.S., for example, lines from different producers can be connected to one consumer, which gives him the right of choice. In the U.K. there is a loop gas pipeline and gas can be received from it virtually anywhere throughout the country, so transportation costs are low.

OGE: How can the increase of mineral extraction tax affect independent natural gas producers? Do you believe the extraction tax must be differentiated?
Baranov: The private gas industry developed thanks to shareholder investments. If the tax is raised, the investments are in fact repossessed, which causes problems for the company that can no longer invest into business, transportation and new field development. A formula for a differentiated mineral extraction tax is currently being discussed; it will take into account the production properties of the field, its reserve depletion, the distance to a transportation network, etc.
On one hand, the government underestimates the extent of investment required for the gas transportation system; it is completely worn out, the gas pipelines have been in use since the Soviet times. The new ones are not being built for the lack of financing. But on the other hand, who can guarantee that after the mineral tax is increased, the money will be used on the transportation system development. The tax raising can hit hard the independent companies: problems with investments will start, this will require a search for new sources of financing.

OGE: Is the natural gas market that important for Russia? Maybe, Gazprom’s monopoly is satisfactory for everyone? What problems can be resolved by developing a gas market?
Baranov: In the past, the efficiency of Gazprom’s work was measured by its production, today the company management cares more about profit and feasibility. The market is of interest to both Gazprom and independent producers since it attracts new investments and enables new fields development. RAO UES (RAO United Energy Systems of Russia) has a strong voice and its own opinion on how the natural gas market should develop. These companies  need transparent market mechanisms enabling them to get to the gas resources, as well as clear and established mechanisms defining the gas price.

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