Who Are You, Mr. Gazprom?
The freezing air temperatures in the beginning of this year made the Europeans wonder again if Gazprom actually is a reliable source of natural gas. After a few clumsy attempts of accusing either Ukraine or the EU’s market liberalization policy of causing delivery disruptions, the management of the Russian giant had to admit a simple fact: there just was not enough gas in the pipes to cover the peak demand.
For observers who have been watching Gazprom since the beginning of its operations it was not a revelation. The first noticeable failure of the same sort occurred in February 2004 when the company shut down the pipelines leading to Belarus, Lithuania, Poland and Germany. Top officials of the company acknowledged at that time that all producing wells in Russia were fully operational; gas was recovered at the maximum rate from underground storage facilities; imports from Central Asia were going on; but the supply was not sufficient to satisfy all domestic and foreign consumers.
Some industry watchers even suggested that the wintertime ‘pricing wars’ of Gazprom with Belarus and Ukraine were just cover-up operations to avoid the humiliating disclosure of the Russian exporter’s inability to maintain a steady flow of gas supply when consumption is at its peak.
Several factors have contributed to the distressing shape of Gazprom’s export capacity—and most of them have to be ascribed to the poor quality of corporate governance.
Production at the huge and relatively shallow gas fields filled with almost pure methane Gazprom has inherited from the Soviet era is falling at the annual rate of about 25 bcm a year and new projects can barely compensate the decline. New developments, such as fields on the Yamal Peninsula or offshore ventures, are technically complex, extremely costly, and will take many years to show their full potential.
The influx of gas from Central Asia has dwindled from 50 bcm a year to less than 15 bcm after Gazprom broke its contract with Turkmenistan in 2008 and failed to carry out its promises to upgrade the pipelines leading from that area to Russia. The Turkmens and their neighbors in Uzbekistan and Kazakhstan redirected their gas export plans to China, foiling the Russian company’s expectations of selling gas to the Chinese.
A plan of expanding Russia’s underground storage capacity, adopted by Gazprom in 2004, was abandoned in favor of pipeline projects, and in January 2012 the facilities were unable to cope with demand.
To make the situation even worse, Gazprom kept postponing new upstream projects and continued wasting the bulk of its investment funds to build long, and often redundant, pipelines with blatantly exaggerated budgets. Russian government officials and managers of Gazprom insist that the security of gas supply to Europe depends on new pipeline routes. Don’t they already have more transportation capacity than they need?
By the fall of this year, when the second thread of the Nord Stream pipeline becomes operational, the overall capacity of Russian gas pipelines that reach the EU will roughly total 250 bcm a year, and it is worth recalling that these pipes transported across the borders of West European nations just 107 bcm of Russian gas in 2010 and 112 bcm in 2011. There is plenty of room in the existing pipelines but Moscow wants to build another one, South Stream, with the annual capacity of 63 bcm. If the purpose is to punish Ukraine politically by stopping gas transit across its territory, the price of the bypass ‘streams’ in the Baltic Sea and Black Sea is too high. An amicable agreement with the neighbors would have been a much cheaper option.
The attitude of Gazprom to prices appears to be another example of miscalculation. During the last general shareholders’ meeting in June 2011 the CEO of Gazprom Export Alexander Medvedev told journalists that the company had made a strategic choice in favor of increasing immediate export revenues instead of maintaining its market niche in Europe. ‘The export policy of the Gazprom Group guarantees stability, sustainable growth, predictability, and high rates of return,’ he claimed. And Gazprom Chairman Alexei Miller proudly reported to Vladimir Putin that his company had achieved success by remaining ‘adamant’ in negotiations on price policies.
It had been Putin himself who had allowed Gazprom to make this strategic choice. In September 2010 he told the Valdai discussion club: ‘What is more profitable for a company—to be more flexible and retain the market volume, or assume a firm attitude, refuse to retreat, and reconcile itself with a partial loss of this market? There are no enemies of Gazprom inside Gazprom. They believe that it is better to firmly insist on obligations under signed long-term contracts. I will not say now what I believe. They follow this policy and they bear responsibility for it. They must be given the opportunity to go this way.’
In fact, Gazprom has opted for the policy of maximizing immediate gains from keeping its prices inflexibly high and disregards the need to maintain its existing market niches and cultivate new ones. The choice was wrong, the market niches of Russian gas started shrinking rapidly, and Gazprom had to make significant concessions to its clients in Europe. During the past two years, at least 19 cases of amended contracts have been reported, and some buyers—such as GDF Suez or Austria’s Econgas—have even managed to get not one but several reductions of the price. New revisions of contractual terms are expected soon.
Instead of winning the sympathies of its traditional clients with a flexible pricing policy, the Russian gas monopoly makes awkward attempts at bluffing its way into the EU market.
Speaking in Munich in October 2006, Putin said that the Europeans’ ‘incessant talk about excessive dependence’ on Russia ‘make us search for other markets, and we’ll find those markets.’ ‘If we go there, Europe will be undersupplied with non-renewable energy resources,’ he added. In August 2008, Putin warned Europe again that Russia's energy reserves will flow to the Far East if the continent's leaders seek to punish his country for invading Georgia.
In November 2008, he threatened to scrap the Nord Stream project. ‘Europe must decide whether it needs this pipeline or not,’ Putin told Finland's prime minister. ‘If you don't, we will build liquefaction plants and send gas to world markets, including to European markets. But it will be simply more expensive for you,’ he added.
When the Russian officials learned that North America was not a promising market for Russian gas, they started blackmailing the Europeans with promises to reverse the export flow of gas eastward, to China and other potential consumers in the Asian Pacific area. ‘If Europe doesn’t like the prices of Russian gas, Gazprom will supply gas to China,’ Miller declared in an interview to the Süddeutsche Zeitung in June 2011.
Russian attempts to sell gas to China have been going on since 2001, and every year Gazprom declared that the negotiations were in either ‘final’ or ‘active’ phase. A series of documents have been signed but they all stopped short of a real contract with a mutually acceptable price formula in it. Putin keeps saying that China is eager to buy 68 bcm of Russian gas a year. The talks are still in a blind alley.
Even though the threats are manifestly unrealistic, they do erode the reputation of Russia as a reliable energy supplier. Insisting on a special status of Gazprom on the European market makes Europe replace its gas contracts with any alternative that appears on the horizon. It is the energy security of the Old World that is at stake.
Mikhail Krutikhin is a Partner, RusEnergy, an independent privately-run company established in 2000 by a group of Russian experts with a long experience in consulting and publishing business. Based in Moscow, it specializes in monitoring, analysis and consulting on oil and gas industry of Russia, Central Asia, Azerbaijan and Ukraine.