Is Gazprom’s Pipeline Export Monopoly Under Threat?

by Andras Szekely

Gazprom has a reputation of being the ultimate monopolist, the company on which both Siberian babushkas and German industry are dependent. Since Alexey Miller was appointed CEO of the company, Gazprom has played a crucial role both in the domestic Russian market and in the European gas market. For a long time Gazprom’s dominant position was unquestionable in the domestic market, mainly because of two reasons: first, Gazprom owns the pipeline system and was unwilling to provide access for independent gas producers. Second, although regulated gas prices have been growing since the early 2000s (but from a very low base) Gazprom and the independents could barely make any profit in the domestic market (Gazprom became profitable in the Russian market for the first time in 2011). It was its export monopoly – the law on export monopoly was adopted in 2006 – that allowed Gazprom to both finance its giant projects and supply the Russian industry with cheap gas and Russian households with even cheaper gas.

From the point of view of the Kremlin, Gazprom missed two things in the last decade: it wasn’t able to reach a deal with China and it also failed to enter the growing LNG market –with the exception of its Sakhalin II project.

There are three arguments for Gazprom’s export monopoly: first, for the sake of profit maximization (from the point of view of the state) Russia should avoid a situation in which Russian companies would compete for the same markets; second, it is in the Russian people’s interest to export their national resources through state owned companies (or the state has to control this strategic industry); third, Gazprom needs extra money to be able to supply Russian consumers with cheap natural gas. However, under the surface one could observe slow shifts that eventually challenged these arguments. First, after the Yukos affair, Rosneft became the biggest oil company in Russia (a state owned company!) with a growing gas production capacity. Second, Gazprom itself was lobbying for higher domestic prices – the company needed money for its domestic and international pipeline projects as well as for developing new green fields – that not only questioned the legitimacy of the export monopoly, but also helped independents to increase their market share year by year. In the meantime, the financial crisis, the growing share of LNG in international natural gas trade and the shale gas revolution in the US (and its consequences) pointed at Gazprom’s inability to preserve its market share in Europe, entering the Asian market both through LNG and pipeline gas.

From the point of view of the Kremlin, Gazprom missed two things in the last decade: it wasn’t able to reach a deal with China and it also failed to enter the growing LNG market –with the exception of its Sakhalin II project. At the same time, independent gas producers have been increasing their market share in Russia steadily. In the mid-2000s the decreasing market share for Gazprom was arguably even beneficial; the company was able to export more to the more lucrative and growing European market (Gazprom even bought Turkmen gas in order to be able to supply both the European and its domestic market). However, Gazprom continued to lose its domestic market share even after the 2008 crisis, when both consumption and prices began to decline in the European market.

On the 25th of February, Vice PM Dvorkovich instructed both governmental agencies and natural gas producers to work out their own proposal for exporting gas through pipelines.

Here, it is important to understand that independents increased their share not because they successfully competed with Gazprom (although arguably it could be a factor) but because of the regulation. The market share of independents and Gazprom in Russia is formed by the delicate balance between transport tariffs (which are lower for Gazprom than for independents), discounts from the regulated prices (that until recently made independents more attractive, as for Gazprom it was illegal) and the obligation to sell gas for households (that is an unprofitable business, except for three regions where Gazprom is the only supplier). Thus, it was the more successful lobbying of independent gas producers in different governmental agencies rather than market competition that has decreased Gazprom’s domestic market share from almost 90% in the 2000s to 72% in 2013. In other words, the independents’ share (and production) increased not in spite of but, rather thanks to state regulation.

Open Challenge From Independents

A reason for that, or at least partly, is that Gazprom’s challengers have become bigger not only by higher production but, also by acquisitions. Most importantly, Rosneft bought TNK-BP and Itera, tripling Rosneft’s gas production. With Rosneft headed by Igor Sechin, who is also the secretary of the Presidential Commission of Energy Affairs, independent gas producers got a major lobbyist. Novatek, too, was a success story. The company managed to conclude a deal and launch the first LNG project of Russia (Rosneft, a partner of Exxon, played a very minor role in the Sakhalin project) in a consortium with Total and CNPC – Yamal LNG project. Another potential player in the future can be Lukoil. The company has had a very conservative strategy – supposedly to avoid any conflicts – Lukoil sells more than half of its natural gas at the wellhead to Gazprom (thus, Lukoil does not supply industrial or residential consumers at all). However, Lukoil has lately been making joint statements together with Rosneft and Novatek on reforming the natural gas industry.

The independents’ share (and production) increased not in spite of but, rather thanks to state regulation.

Having acknowledged that Gazprom itself is not capable of realizing the Kremlin’s plan – supplying both Europe and China while at the same time reaching other countries through LNG – the government decided to liberalize the LNG market at the end of 2013. The new law opened the door to ship LNG abroad only for private companies that received gas extraction licenses of national importance before January of 2013 and for operations of state groups from offshore fields – that is Novatek and Rosneft. The logic of this limited liberalisation was the same as in the case of the Yamal LNG project. Novatek’s LNG does not threaten a possible Gazprom-China pipeline deal, though CNPC contracted 3 million tons from the project’s annual production, such volumes clearly leave room for Gazprom’s gas in China. Also, Novatek’s owners – Michelson and Timchenko – have close personal ties to President Putin, which indicates that the Kremlin does not have to fear gradually losing control.

The liberalization was a big success for the independents – and for the Ministry of Energy – but they did not stop here. In January of 2014 the CEO of Lukoil proposed a plan that would allow independent gas producers to export natural gas through pipelines. On the 25th of February, at a governmental commission on energy meeting, vice prime-minister Dvorkovich instructed both governmental agencies (Federal Tariff Service, Federal Anti-Monopoly Agency and the Ministry of Economics) and natural gas producers to work out their own proposal for exporting gas through pipelines. Whatever will be the result, it is a matter of fact that Gazprom’s (pipeline) export monopoly is under serious threat. Just a few months earlier it would have been unimaginable that CEOs of independents would openly question Gazprom’s export monopoly and even call for its elimination.

It seems that decision makers understood that for the sake of huge (international) projects, such as the Nord Stream, South Stream and the Power of Siberia pipelines or development of green fields, the domestic burden on Gazprom has to be limited.

If we have a look at the three arguments for Gazprom’s export monopoly we will see that although they have altered since 2006, they have not changed fundamentally. The Kremlin (and other governmental bodies too) do not want Russian gas to compete for the same markets. Also, there is no reason to believe that control over natural gas export has become less important for Moscow. Rather, the Kremlin is just ready to make some concessions and change the means of its control. What really changed it is Gazprom’s role in the domestic market, the perception that Gazprom should gasify remote areas, and conduct unprofitable business for the sake of the people (remember the Russian government’s plan to introduce European netback prices by 2020). It seems that decision makers understood that for the sake of huge (international) projects – such as the Nord Stream, South Stream and the Power of Siberia pipelines or development of green fields – domestic burden on Gazprom has to be limited.

A Future Without a Monopoly?

As a consequence, what we could see in the future is limited export via pipeline by independents. The CEOs of both Novatek and Lukoil suggested at the Gastech-2014 conference held in Seoul, that independents could be allowed to export an amount of gas via pipeline proportional to their share in Russia’s natural gas production. That means if Novatek produced approximately 10% of Russia’s natural gas, the company would be allowed to export 10% of its production. Surely if the government decides to change the law on natural gas export, the regulation will be very specific – more than likely there will be conditions which only some exact companies can fulfill. A possible solution can be a law that clearly defines which companies are allowed to export their products – as is the case of the law on Arctic oil and gas fields.

However, there is another important aspect, geography. It is unlikely that independents will be allowed to export pipeline gas to Europe. Gazprom has built up its infrastructure to Europe for decades; the company has no problem with supplying its customers from its major West-Siberian fields (also a new Russian supplier would challenge Gazprom’s long-term contracts in Europe). What provides a real option for natural gas pipeline export by independents in the near future is a possible deal with China. Gazprom has been trying to sign a deal since the early 2000’s and the two parties have agreed on everything but the price. If the deal is made, Gazprom will face a need for huge investments – construction of the Power of Siberia pipeline (61 bcm) plus the development of Chayanda and Kovykta fields that are to supply China. Seeing Gazprom’s inability to make a deal and the growing demand for new giant investments in the stagnating Russian economy, Rosneft is trying to get access to the Power of Siberia pipeline. Rosneft has a reputation as a company that can make deals with the Chinese; also, the company has reserves near the route of the future pipeline. The Yurubcheno-Tochomskoe and Srednebotuobinskoe fields have reserves of 387 and 115 bcm, respectively, with the second field to be developed together with CNPC – a fact that probably makes the deal more attractive for China.

As a solution, Michelson (CEO of Novatek) suggested that Gazprom pay the netback price for an independent’s gas.

Yet another question is whether independents will be allowed to sign contracts with foreign partners directly. In the Chinese case (the only case that could be realized in the near future) it is unlikely. Russia faces a monopsony in China – that is probably the main reason why Gazprom has not been able to reach an agreement so far – direct deals of independent gas producers with China would even further decrease Russia’s bargaining power. As a solution, Michelson (CEO of Novatek) suggested that Gazprom pay the netback price for an independent’s gas. Such a scheme seems favorable from the point of view of the Kremlin since it could retain its control over the country’s natural gas exports while also avoiding competition between Russian gas in foreign markets.

To sum up, what we could see in the future is limited natural gas export by independent gas producers via Gazprom’s pipeline system with geographical restrictions, and Gazprom as an intermediary between independents and foreign consumers. A true liberalization – elimination of the export law and deregulation of the domestic market – is very unlikely under the current political regime.

Andras Szekely is an MA student in the ENERPO program at the European University at St. Petersburg.

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