Gazprom billboard near the Russian Parliament building in Moscow
In recent months the Western media has taken notice of Russia's tightening domestic market for natural gas and electricity. First the International Herald Tribune, then the UK Independent and Financial Times newspapers published articles questioning whether Russia can continue to expand energy exports while providing enough energy at home. Last week Gazprom executive Alexander Medvedev responded to these claims by reassuring Western investors that his company will invest more than enough to meet rising demand at home and abroad. Gazprom plans on investing $40 billion in the next few years to develop huge Arctic gas fields in the Barents Sea and Yamal region of northwest Siberia.
Even so, some analysts doubt that Gazprom can overcome the political constraints imposed by Russia's upcoming 2008 elections, and begin encouraging conservation by raising gas rates. The need for more energy conservation is highlighted by the fact that Russia consumes more than 2/3rds as much gas as the U.S. - in spite of only having half the population.
Russia does have immense coal reserves and stockpiles of nuclear fuel leftover from the Cold War to substitute for gas in electric power generation. However, neither conservation nor substitution is likely to take off until natural gas prices rise. Many powerful Russian industries have profited from Gazprom's legal obligation to sell them gas for less than half of the European market price ($250 per million cubic meter), and are not likely to allow rate increases without a fight.
Gazprom does not have to raise rates to Western European prices overnight to meet its export obligations. But it will probably need to accelerate the liberalization of the Russian gas and power market to meet its ambitious goals.
Click on the extended post to read Energy Biz Insider Editor in Chief Ken Silverstein's article on this topic.
Most Gazprom production goes to Russia's domestic market, where prices are fixed by law
by Ken Silverstein
Editor-in-Chief, EnergyBiz Insider
Russia's image is that of a chameleon. A few weeks ago, key leaders there were meeting with the representatives of the Western world to finalize an agreement to enter the World Trade Organization. Now, many of the same folks are center stage again -- trying to ward off accusations that they poisoned a former spy in London.
That inconsistency -- or lack of trust -- is what has driven a wedge between Russia and some of its trading partners, namely those in the former Soviet Union. Recall that last winter Russia cut off natural gas supplies to Ukraine in an effort to collect closer-to-market prices. And while the dispute was legitimate, it put into question whether Russia could be trusted to fulfill its contractual obligations.
Many Europeans say that Russia needs the revenues from selling its natural gas as much as they need those supplies. They maintain that the former Communist state is as reliable of a partner as the nations of the Middle East or Northern Africa. Other nations made up of mostly the former Soviet Bloc argue that Russia leverages its natural gas domination as a way to earn economic clout.
There's no disagreement that Russia holds vast natural gas reserves. According to the U.S. Energy Information Administration, it possesses 27.5 percent of the world's gas supply. About half of its own needs are met with natural gas while it provides about 23 percent of Europe's demand. The United States, meantime, wants to import a lot more liquefied natural gas from Russia.
Russia's dilemma is real: It currently consumes more than 15.3 trillion cubic feet of natural gas a year, second only to the United States. But, its economy is growing and it needs greater resources to grow internally. Through its state-owned enterprise Gazprom, it still subsidizes prices not only to its own citizens but to other Eastern nations as well. Somehow, it needs to obtain market rates for this valuable fuel.
"The issue is not about Russia's reputation as a reliable supplier of gas to Europe," says Jonathan Stern, director of gas research at the Oxford Institute for Energy Studies, in an interview with the International Herald Tribune. "The fact is that there is a limit over how much gas Russia can sell to Europe. I don't think Europe realizes it, but we are reaching the limit of Russian exports. Russia needs the gas for themselves."
Russia produced 19.3 trillion cubic feet last year, the story reports. Of that, about 10.6 trillion cubic feet went to domestic customers at subsidized prices while 5.3 trillion cubic feet was supplied to European customers at market rates. The cushion will gradually erode as demand in the once Soviet-dominated countries rises to meet the needs of their growing economies. While Russia says that it has plans to increase production to 19.8 trillion cubic feet by 2010, there's a big question as to whether it can attract the needed investment to achieve that goal.
Clearly, Russia has been investing in its natural gas sector. But, it does not have the know-how or the capital to vastly increase its production. For that, it has been in talks with some Western enterprises that consist of ConocoPhilips and Norsk Hydro of Norway to develop the gas-rich Shtokman fields in the Barents Sea. To become an energy leader, the U.S. Energy Information Administration says that between $173 billion and $203 billion must be invested in Russia's gas sector by 2020.
Russia's government has said that Gazprom ought to functionally separate its production and transportation units in an effort to become financially transparent. Along those lines, lawmakers there have debated how to give foreigners more latitude when it comes to owning shares of Gazprom. While shares are freely traded in Moscow, foreigners pay a huge premium when compared to local shares.
That may change but it is highly unlikely that Gazprom would become a private entity. The state controls the entire natural gas pipeline infrastructure along with every compressing station. The monopoly is also the largest producer of gas in Russia. Specifically, Gazprom controls nearly all of Russia's natural gas while it owns a quarter of the world's gas reserves.
Gazprom is an outgrowth of the old Soviet Union and today, the Russian government owns 51 percent of the conglomerate. As such, the natural gas sector is stunted - a function of aging fields, state regulation and monopolistic control, experts say. But, many Russians want it to remain a national enterprise and note that they sold off key industries on the cheap in the 1990s -- and are paying the price for those decisions now.
In Russia, "Private enterprise will be tolerated and private capital can play a role in the oil and gas industry, but oligarchs are not going to dictate government policies," says Zach Allen, president of PanEurasian Enterprises. "President Putin has made it clear that he wants to make sure that oil and gas policy remain under government control because that is how Russia's modernization will be financed."
Westerners must continue to engage Russia. Investment there would not just bring together businesses' capital resources but it would also harness their technological expertise and create goodwill among nations. The increased capital would have a positive effect over time because it would enhance U.S. energy security and bring the former Soviet nations into the international fold.
Russia needs the West too. It plans to increase production to meet growing demand both domestically and abroad and must win foreign investment to do so. The Catch 22 is that complex trading agreements and strict ownership rules give pause to investors.
A more cohesive international community would go a long way towards shoring up Russia's image and in particular its reputation as a reliable provider of natural gas. It would appear that increased liberalization of the Russian economy would be the most effective way to win investment, end price subsidies and honor its commitments.