Troubles in the Russian Gas Sector

by Roman Kupchinsky

With demand for natural gas in Europe at new lows, the Russian gas industry is going through a period of decreased profits and dropping production. Russia’s gas giant, Gazprom, the majority of which is owned by the Russian state, has been hit particularly hard.

The International Energy Agency reported on May 15, 2009 that gas consumption in the European Union decreased by 2-3 percent in the first quarter of 2009. Gas imports dropped by 12 percent compared to the first quarter of 2008. During this period, Gazprom’s supplies to Europe fell by 39 percent (and by 50 percent to Germany and Italy) and its share of gas imports to the E.U. decreased from around 30 percent to 18 percent. Despite this, Gazprom remains the largest exporter of gas to the E.U.

According to the Polish Center for Eastern Studies, Gazprom sells gas at the current price of $390-400 per 1,000 cubic meters making it the most expensive gas in Europe. NorskHydro sells gas at $360-370 and Shell at $333. The cheapest gas in Europe is supplied by BP at US$196. BP mainly operates spot supplies, where the price is more flexible than in long-term contracts.

In what might be considered a response to the crisis it faces, Gazprom has begun expanding its LNG sector. The Moscow Times reported on June 1, 2009 that Gazprom was “speeding up its plans to sell more gas by tankers to a wider range of customers as it faces a sharp drop in demand from its traditional consumers in Europe.” “Trends on the global gas markets create conditions for Gazprom to increase the pace of producing and supplying liquefied natural gas,” the company said in a statement late Thursday.

According to the Moscow Times:

“Gazprom’s management board ordered the company’s engineering divisions to work faster in studying options for building an LNG plant in the Far East, the statement said. The board also ordered the engineers to report on the possibility of building a long-discussed LNG plant that would use prospective gas from the Yamal Peninsula, saying for the first time that the plant would take gas from independent producers.“

Gazprom’s main competition in the LNG market would come from Qatar which produces cheaper LNG and has a substantial LNG tanker fleet as compared to Russia’s fledgling few tankers. However, Russia has used gas swaps in the past to export LNG and will presumably do more such deals in the near future.

Gazprom’s aim is to control 25% of the global LNG market by 2030 following the development of a number of key, but highly challenging fields in Eastern Siberia, the Yamal Peninsula and the Barents and Caspian Seas. However, unless the company provides greater strategic focus on developing domestic reserves, while also allowing for greater foreign investment and technical expertise, such a target is likely to remain elusive.

According to the Energy Business Review:

“Gazprom clearly believes that international aspirations can successfully coexist with domestic production in order to achieve such goals. However, the scale of investments and technical expertise required to launch major LNG capabilities, both inside and outside Russia, could be beyond Gazprom’s reach without the help of greater foreign investment and a strategic focus on upstream assets. Even then, Russia will face growing competition from other LNG players in the Middle East, North and West Africa and Asia Pacific in its bid to claim a 25% mantle.”

“According to recent calculations, investment of up to $200 billion in the Russian gas sector will be required by 2020 if it is to meet international demand. The growth of Gazprom’s production rate dropped to a mere 0.5% in 2005 and to almost zero in 2006, underlining the IEA’s forecasts that, without the major development of reserves, Gazprom could be unable to fulfill contracts” the Energy Business Review states.

But Gazprom, despite its vast difficulties does not seem to be in the least bit deterred from achieving its strategic plan to strengthen its monopolistic role in southern Europe. According to the Romanian on-line news portal, on June 1, 2009,

“Romanian gas producer Romgaz and Russian company Gazprom signed a collaboration memorandum as a consequence of the Moscow visit the Economy minister Adriean Videanu and his delegation made two weeks ago. Videanu says that this is the first agreement signed by the two companies since 1989, but he would not reveal its content, as it is confidential…Videanu told the press the access to the agreement was denied, as the memorandum was classified. The minister said that, according to the agreement, this September will see the creation of a Romanian-Russian project between Gazprom and Romgaz, meant to store and use gas. The future depots could store up to 5-6 billion cube metres of gas.”

Videanu also stated that Romgaz will be able to import gas directly from Gazprom, hinting that intermediary companies might be excluded from the deal. However, reported on May 25, 2009, that Gazprom would not exclude the present intermediary companies:

“Gazprom (Export) head Alexander Medvedev said he was pleased with the intermediary companies, in an interview for Radio Romania Actualitati. Romanian authorities believe that if the intermediary companies are eliminated, the prices for imported gas, considered to be some of the highest in Europe, could drop. Medvedev agrees only with the fact that the prices are competitive. The medium price for the second quarter was set to $370 for one thousand cube meters. Markets expect the gas price to drop to $220 by the end of 2009.”

On April 2, 2007, Gazpromexport, Gazprom’s foreign trading subsidiary headed by Medvedev, signed a contract with Conef, a Romanian company owned by the Russian/Israeli businessman Vitaliy Machitsky, to sell Conef up to 2 billion cubic meters of gas annually from 2010 to 2030. Under the contract the aggregate supply volume would reach 42 billion cubic meters. The Romanians were concerned that Machitsky, not only acquired ownership in the country’s aluminum industry but also controlled a substantial percentage of Romania’s gas imports from Russia. At this time Gazprom Export agreed to increase gas deliveries to the Alro Slatina aluminum plant owned by Machitski’s Marco Group. The price Gazprom Export charged Conef for this gas was classified a “commercial secret.”

In April 2007 Gazprom Export signed long term gas supply contracts with three Romanian gas companies – Romgaz, Transgaz and Conef. The contracts provide Gazprom with long-term access to gas shipping facilities in Romania but do not provide any transparency. The blanket use of the term “commercial secret,” currently used by Gazprom to cover up its shady dealings in the countries of the former Warsaw Pact who are now members of the E.U. and N.A.T.O. is very disturbing and the E.U. Commission should conduct an investigation into what is really taking place in Romania. For insuring E.U. energy security it is the right thing to do.