Gazprom board reluctant to continue subsidizing Russian economy

April 23, 2014

The Gazprom Board of Directors took notice of the information about the future pricing in the domestic market, including cross-subsidization among different regions and consumer groups, Gazprom’s press office said on April 22.

It was noted that Gazprom, the biggest gas supplier to the domestic market, sold gas at regulated prices that remained below the economically viable level, thereby supporting the domestic economy.

The regulated prices are undervalued and Gazprom is not able to generate revenues enough for creating its own source of financing to be invested in constructing new production, transmission and storage facilities and maintaining the existing ones for the benefit of Russian consumers. For instance, between 2000 and 2008 Gazprom made no profit from domestic gas supplies, and only the year 2009 saw the slight profitability growth. During the following years revenues grew steadily, but were still low and currently are also delayed.

In recent years the Company is making efforts to gradually adjust the wholesale prices for industrial consumers to bring them closer to the level of profitability equal to export supplies. Industrial consumers anticipated to see a 15 per cent rise in regulated wholesale prices annually between 2013 and 2015. However, in 2013 the Russian Government made a decision to slow the process – in 2014 the wholesale prices for industrial consumers are expected to be the same as in the second half of 2013; from July 1, 2015 prices will go up by 4.8 per cent, from July 1, 2016 – by 4.9 per cent. This trend will get Gazprom's return on sales to the level of 2009. The Company anticipates this index to vary between 1.5 and 3.5 per cent by 2016.

The abovementioned factors cause delays in solving the issue of setting fair gas prices and achieving the equal profitability of domestic and export gas supplies. In addition, the undervalued prices negatively affect the domestic economy, because there is no favorable environment for promoting gas- and energy-savings as well as for developing high-tech industries.

In addition, the profitability of gas sales varies in Russia's regions and has a bad impact on domestic gas supplies. So far, according to the current tariff policy, Gazprom should compensate for losses caused by gas supplies to the remote Russian regions (distantly located from the main production areas) through higher return on gas sold to consumers located close to gas fields. But in reality, independent gas producers dominate in these high-yield regions and enjoy advantages over Gazprom. In particular, they can sell gas at open prices and pay less taxes with zero maintenance costs; so they are able to offer more flexible sales terms to regular customers.

In order to eliminate cross-subsidization, it is necessary that variations from an average gas price dynamics should be greater in some Russian constituent entities. At the same time, gas tariffs for a short-distance transmission should rise quicker. All these measures will help gradually eliminate cross-subsidization and achieve the relevant profitability of regional gas supplies.

Overall, since the establishment of fair