Tuesday, 11 September 2012

Gazprom and Russian energy politics

Russian state-owned energy leviathan Gazprom is being seriously challenged for hegemony over Russia’s lucrative natural gas industry, a problem for both the company and Moscow.

To become more competitive, Gazprom is reconsidering its strict pricing policies both domestically and abroad.

Meanwhile, European countries are courting rival Russian energy firms to pressure Gazprom further to weaken their monopoly and secure cheaper LNG prices.

On September 5 the European Commission opened a formal investigation into whether Russian energy giant Gazprom is breaching European Union (EU) antitrust rules by obstructing competition in Central and Eastern European gas markets, according to an EU statement.

Russian Prime Minister Dmitri Medvedev echoed the response from Gazprom calling the EU probe ‘disingenuous’. Mr Medvedev, a member of Gazprom’s board of directors until 2008, plans to meet with EU officials to defend Russia’s policies on energy exports.

Unlike the Russian oil industry, the liquefied natural gas (LNG) industry has been dominated by the Gazprom monopoly for the past decade. Moreover, state-owned Gazprom has been a crucial political tool of the Kremlin both at home and abroad, especially in Eastern and Central Europe.

Gazprom accounts for more than 80 percent of Russia’s natural gas production, and close to 17% of worldwide LNG extraction totals. And like the Russian intelligence agencies, the modern company has remained largely identical to its Soviet-era manifestation no matter how many name-changes are applied. 

Due to its close relationship with the Kremlin, Gazprom secured direct access to the enormous Shtokman gas field in Siberia and the as-yet undeveloped Yamal Peninsula field. More importantly Gazprom has complete ownership of LNG pipelines flowing to Europe from Russia. 

Such complete control over the Russian natural gas sector has benefited Gazprom, and in turn Moscow, financially. But as the economic crisis continues in Europe along with uncharacteristically cold winters, Gazprom’s unique window of high revenue may be closing.

Gazprom has been under increasing pressure from its domestic rival, Rosneft, and from end-user European consumers and also from cheaper natural gas suppliers such as Qatar to increase diversification of the Russian LNG industry.

The competition simmering with Rosneft will expose Gazprom to market prices because it will be unable to use unilateral action to wrest control of mining contracts and pricing.

The Kremlin does anticipate a restructuring of Gazprom if its monopoly weakens.

Any diminishing of Gazprom’s political utility by limiting their energy sector control would be unappreciated in the Kremlin. This is exemplified by Russian Prime Minister Dmitri Medvedev’s decision to intervene on Gazprom’s behalf with the EU.

Russia has struggled to break from a poor economic situation for much of its existence. The country is huge but largely inaccessible and arctic weather drastically limits the spread of human habitation. Tundra and frozen ground create expensive heating needs and costly resource extraction, something the Czarist, Soviet, and the modern state have struggled to overcome.

As the Soviet state collapsed, rolling back conventional Russian influence in Eastern Europe and Central Asia, the Kremlin has leant heavily on its vast resource wealth to gain control over old satellite countries. Aside from the Volga grain belts, Russia’s natural gas reserves are its most important.

Russia has positioned itself as Europe’s primary energy supplier. Russian natural gas supplies total 25 percent of Europe’s total imports and 40% of European Union imports.

Gazprom’s hold on the European energy market allowed it to increase its natural gas prices from the high of NZ$300 per thousand cubic metres (mcm) to between NZ$550 and NZ$700 mcm in recent years. This remarkable rise was achieved by both the subtle manipulation of European energy markets, and the not-so-subtle.

In 2009, Russia displayed an inclination to leverage control over European LNG imports by closing gas supplies to Ukraine over prices disputes and thereby disrupting flow to 17 other European countries.

Ukrainian President Viktor Yanukovich hopes that Russia and Ukraine will change their relationship in the natural gas sector, he said in an Aug. 25 meeting with Russian President Vladimir Putin in Sochi, Russia.

But the bond between Moscow and Kiev has changed. The completed Nord Stream project is viewed by Moscow as a secure pipeline, removing an unpredictable intermediary like Ukraine and assuring Central Europe of steady natural gas supplies from Russia.

The undersea pipeline runs through the cold Baltic Sea from Vyborg near St Petersburg to Greifswald in Germany, is owned by a partner of Gazprom and is a lynchpin in the warming relations between Moscow and Berlin.

Indeed, uninterrupted supply of LNG to Central Europe is a conscious political decision by Moscow calculated to increase reliance and therefore dependence on Russia for European energy.

With German nuclear plants scheduled to close, an increased dependence on natural gas for energy is predicted to bring these two countries closer together.

Yet as foreign sources of LNG begin to take larger bites of the European market away from Russia, and the artificially low domestic natural gas price ceiling is expected to climb, Moscow and Gazprom are facing a dilemma.

On the one hand Russia needs to supply its population with heavily subsidised natural gas (currently charged out at NZ$100mcm), a price-capping legacy from the Soviet era. But on the other hand, Russian LNG exports to Europe can fetch over NZ$650mcm.

Gazprom's exports of natural gas to Europe fell 17 percent year-on-year, to 71.93 billion cubic meters, in the first six months of 2012, according to a statement by Gazprom.

The company's total exports during that period amounted to 104.4 billion cubic meters. So Gazrpom may have to make some tough decisions as European energy supplies clearly continue to diversify.

Gazprom’s European market share may also decrease when the cheaper American LNG super fields come fully online in the next few years.

Coupled with rising domestic demand, shifting European consumer patterns, and a low profit margin due to subsidisation, Gazprom may not be able to continue funding future projects on the Yamal Peninsula and will lose the utility the Kremlin has depended on.

But the energy giant is not without its counters to the forces arraying against it. Gazprom announced September 10 that it would suspend purchases of natural gas from independent producers in Russia. This is important because independent firms have to sell the majority of their extracted LNG to Gazprom because of its monopoly.

In a very Russian way, Gazprom is sending a message to these recalcitrant independent energy firms, reminding them of the real power balance in the Russian natural gas sector. And with a full monopoly on natural gas distribution Gazprom is still a useful leveraging tool for the Kremlin in political relations with Europe.

As foreign gas supplies come online in the European market and Russian gas prices increase domestically, Gazprom and the Kremlin are facing mounting competition.

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