Gazprom: Moving in a Liberalized Market

December 01, 2006 18 21  GMT

Summary

The Kremlin announced Nov. 29 that Russia’s domestic natural gas market will be fully liberalized by 2011, giving Russia — and more specifically, the state-controlled natural gas giant Gazprom — a long-term energy strategy that might actually work. The plan is to increase domestic natural gas prices to beyond what the average Russian can afford, thereby driving down demand and freeing up more reserves to be exported for a higher profit. Gazprom also just acquired a new jewel of an asset to replace its currently decreasing resources.

Analysis

Russian Energy Minister Viktor Khristenko announced Nov. 29 that Russia’s natural gas market will be fully liberalized by 2011, giving Russia a more viable long-term energy strategy. Raising — and eventually doubling — domestic natural gas prices over the next five years will allow Russia to begin cutting back on its mammoth domestic consumption and free up more supplies for export. In 2007, the domestic price will increase by 15 percent, which will put the cost of natural gas above the cost of production for the first time. This means Russian state-controlled energy monopoly Gazprom will no longer be supplying the domestic market at a loss. Additionally, Gazprom just acquired 100 percent of Yamal LNG, the company that holds the license for the vast Yuzhno-Tambeyskoe field. This solidifies Gazprom’s hold on new natural gas reserves to replace the monopoly’s increasingly depleted fields.

Currently, Russia domestically consumes approximately 70 percent of its natural gas production; in 2006, it produced 643 billion cubic meters (bcm) of natural gas, 433 bcm of which were for domestic consumption. Khristenko has said that at the current consumption rate, natural gas supplies to domestic industrial consumers would increase between 30 percent and 50 percent by 2010, and could exceed 50 percent by 2015. The Kremlin has been forcing Gazprom to supply the domestic market at the sharply subsidized rate of $45 per thousand cubic meters, leaving the monopoly to depend solely on its exports to Western Europe and Turkey for profit.

Khristenko said future contracts for domestic natural gas will be for longer terms and be based more on the average export price for natural gas — though the cost will still be at least 40 percent below what he calls the “global” market rate. The domestic rates will increase to $50.60 per thousand cubic meters for the first half of 2007 and to $63.30 by 2008. By 2011, the Kremlin will reach its target price of $125 per thousand cubic meters. The plan is to put natural gas prices beyond the reach of the average Russian consumer so that domestic demand will plummet, freeing up supplies for more profitable exports.

But domestic prices and demand are not Gazprom’s only problems. Nearly all of the company’s infrastructure and production assets are more than 30 years old. Beyond that, only one significant field — the Zapolyarnoye field — has been brought online in the last 15 years. More than 70 percent of Gazprom’s total natural gas production comes from three major fields: Urengoy, Yamburg and Medvezhye. The “Big Three,” as they are called, are in serious decline, and Gazprom’s natural gas production forecast only calls for growth of around 1 percent by 2008. If Gazprom wants to be a mid- to long-term producer, it needs a new jewel for its crown — and it might have just found one.

Through Gazprom-affiliated companies, the monopoly acquired 100 percent of Yamal LNG. Yamal’s Yuzhno-Tambeyskoe field, on the Yamal Peninsula, is estimated to hold 1.2 trillion cubic meters (tcm) of natural gas reserves — enough to supply Europe for three years. The Yuzhno-Tambeyskoe field and the Yamal region are must-haves for Gazprom. It has been wrestling to gain assets on the Yamal Peninsula, and the acquisition of Yamal LNG not only gives Gazprom reserves to replace its current supplies, but also cuts out the foreign competitors who were looking to develop the region.

Gazprom’s acquisition of Yamal LNG is a bit of a tangled web. Yamal LNG was set up by Nikolai Bogachev, CEO of Russian energy company Tambeyneftegaz, after Gazprom bought 25 percent of the Tambeyneftegaz. Bogachev transferred the Yuzhno-Tambeyskoe field to the newer company, presumably to keep it out of Gazprom’s grasp; he then began looking for foreign energy companies — such as Spain’s Repsol YPF, U.S.-based Anadarko Petroleum Corp., Petro Canada and supermajor Royal Dutch/Shell — to develop the field.

In 2003, Gazprom filed suit against Yamal LNG and Bogachev in Moscow courts, saying the Yuzhno-Tambeyskoe license transfer was illegal. Since then, Gazprom has kept Bogachev, Yamal and the future of their natural gas fields locked in a legal battle. Originally, Gazprom intended to have the license simply transferred back to Tambeyneftegaz, but Bogachev decided Nov. 22 to sell full control of it to Gazprom — for an undisclosed amount.

With this new asset, Gazprom now controls the majority of the natural gas in Yamal Peninsula, which is estimated to hold approximately 10 tcm in its onshore fields. Gazprom already controls the Bovanenkovskoye, Kharasaveyskoye and Novoportovskoye fields, with reserves estimated at 5.8 tcm. With the rights to the Yuzhno-Tambeyskoe field, Gazprom now has 7 tcm of untapped natural gas reserves — enough to supply Europe’s 540-bcm-a-year demand for more than the next decade.

Gazprom has been trying to figure out how to get all this natural gas wealth to market for decades. Bogachev’s Yamal LNG had proposed to Western companies that the peninsula be a liquefied natural gas (LNG) export location — a fantasy, since the peninsula is surrounded by ice 10 months out of the year. In the early 1990s, Gazprom began building a six-trunk line system — the Yamal-Europe pipeline — stretching from the peninsula to Poland and Germany via Belarus, and it is expected to be finished around 2010. The current line (which does not hit the peninsula yet) carries 33 bcm annually, and considerations for a second set of trunk lines — the Yamal-Europe II pipeline — are already being drafted.

Though a second Yamal-Europe pipeline sounds like a logical plan for getting the large reserves to Europe, this is, after all, the cash-shy Gazprom. The cost of developing each of its natural gas fields in Yamal, on top of building the Yamal-Europe II pipeline, would cost Gazprom tens of billions of dollars. Gazprom is also not the most reliable when it comes to keeping good relations with foreign investors on their turf. One of these things must change for Gazprom to survive long term in the energy game. Until then, Gazprom can only move forward by driving domestic demand down, and it can only survive by acquiring new assets.