Financial Times

December 5, 2006

Russia: Gazprom holds the keys to the kingdom

By Isabel Gorst

Russia’s natural gas market is the biggest in the world, after the US, and growing.

But Gazprom, the state gas monopoly, says the obligation to supply gas at cheap, regulated prices to domestic consumers is a millstone round its neck, choking off income that could be used to finance new gas field developments and boost its flat production.

Gazprom derives profits from its $22bn-a-year gas exports to Europe and increasingly leans on independent producers to supply gas for the Russian market.

Domestic prices are climbing and are expected to double by the end of the decade. The future looks bright for Russian independent producers, which own over 11,000bn cu m of gas reserves and account for 13 per cent of Russian gas output.

Leonid Mikhelson, the head of Novatek, Russia’s biggest independent gas producer, estimates that independents could boost output to 189bn cu m by 2010, enough to cover 40 per cent of domestic gas demand.

In contrast, Gazprom, experiencing a severe decline at its big west Siberian fields, anticipates near zero production growth in the coming few years.

Being an independent gas producer in Russia means being a producer that is not Gazprom. But it does not mean being independent of Gazprom.

Gazprom’s control over Russia’s long distance gas pipelines enables the monopoly to decide whether an independent sinks or swims.

Independents failing to co-operate with Gazprom on prices, ownership or other matters can end up with no choice but to leave their gas in the ground.

Rospan International, a gas producer owned by TNK-BP, the Russian/British oil major, could double its 1.5 bn cu m a year gas output if Gazprom would allow greater access to pipelines.

Much more is at stake at Kovykta in east Siberia where plans by a TNK-BP-led group to tap 2,000bn cu m of gas reserves for export to China have been blocked by Gazprom.

Analysts say Gazprom’s refusal to co-operate with Rospan on transport signals a wider strategy to persuade Russian shareholders to sell their 50 per cent stake in TNK-BP, now Russia’s third biggest oil producer, leaving room for a state company to move in.

But Mikhail Korchemkin, a consultant at east European Gas Analysis, says: “Gazprom doesn’t have a strategy. That’s the whole point. They just want to grab everything.”

The independent gas sector was conceived in the 1990’s as a means to bring competition into the industry.

But Gazprom has muscled in on independents’ territory since Alexei Miller, a former colleague of President Putin at the St Petersburg mayor’s office, was appointed chief executive in 2001.

Mr Korchemkin says acquisitions, often secured by bullying, have helped mask a decline in Gazprom’s own gas output and strengthen its dominance of the now more prospective Russian gas market.

Gazprom will shortly appoint two directors to the board at Novatek where it acquired a 19.6 per cent stake last July. Novatek, listed on the London Stock Exchange since 2005, has set a 20 per cent ceiling on Gazprom ownership.

Gazprom’s move into Novatek was a bitter pill for Total to swallow. The French oil major offered Novatek $1bn for an equity stake last year.

But the courtship, which brought international recognition to little known Novatek, ended abruptly when the independent announced plans to list.

Northgas, an independent with production in west Siberia, surrendered a 51 per cent stake to Gazprom in 2005 after a series of bitter legal and pipeline disputes.

A Northgas official says: “It’s better to have 49 per cent of an enterprise that works, than 100 per cent of one that doesn’t”.

Itera, Russia’s biggest independent gas producer and trader in the 1990’s, lost most of its assets to Gazprom after Mr Miller took charge.

Former Gazprom managers handed Itera gas reserves at an extremely low cost and assigned the independent with responsibility for supplying then largely insolvent markets in Ukraine, Moldova and the Caucasus.

Regional economies have since recovered. Gazprom has ousted Itera from the market and raised prices sharply.

Russian oil companies are diversifying into the gas business.

Lukoil, Russia’s biggest oil company, plans to be Russia’s second biggest gas producer by 2016, when gas will account for a third of its total hydrocarbons output.

Lukoil’s strategy marks a solid vote of confidence in the future of the Russian gas market and of Russia’s independent gas sector.

But the company is advancing into gas in close co-operation with Gazprom.

Lukoil and Gazprom have formed a strategic partnership to tap gas fields in the north Caspian and west Siberia.

Big new Russian gas field developments will be expensive. Gazprom announced this year that it would embark on a first: a $28bn development on the Yamal peninsular, a gas rich province on the shores of the Kara Sea.

Once Yamal gas begins to flow in 2011, it will be impossible for the government to ignore pressure to at least double domestic gas prices.

Gas prices are rising steadily. But the Kremlin may opt to delay any radical increase until after the presidential election in 2008.