Gazprom and Russian energy politics

Russian state-owned energy leviathan Gazprom is being seriously challenged for hegemony over Russia’s lucrative natural gas industry, a problem for the company and Moscow.

To become more competitive, Gazprom is reconsidering its strict pricing policies both domestically and abroad.

Meanwhile, European countries are courting rival Russian energy firms to pressure Gazprom further to weaken its monopoly and secure cheaper LNG prices.

Earlier this month the European Commission opened a formal investigation into whether Gazprom is breaching European Union anti-trust rules by obstructing competition in central and eastern European gas markets.

Russian Prime Minister Dmitri Medvedev echoed the response from Gazprom, calling the EU probe "disingenuous".

Mr Medvedev, a member of Gazprom’s board of directors until 2008, plans to meet with EU officials to defend Russia’s policies on energy exports.

Unlike the Russian oil industry, the liquefied natural gas industry has been dominated by the Gazprom monopoly for the past decade.

It has been a crucial political tool of the Kremlin at home and abroad, especially in eastern and central Europe.

Gazprom accounts for more than 80% of Russia’s natural gas production and close to 17% of worldwide LNG extraction totals.

And like the Russian intelligence agencies, the modern company has remained largely identical to its Soviet-era manifestation no matter how many name changes are applied. 

Partly because of its close relationship with the Kremlin, Gazprom secured direct access to the enormous Shtokman gas field in Siberia and the as-yet undeveloped Yamal Peninsula field. More importantly, it has complete ownership of LNG pipelines flowing to Europe from Russia. 

Such complete control over the Russian natural gas sector has financially benefited Gazprom, and in turn Moscow. But as the economic crisis continues in Europe, along with uncharacteristically cold winters, Gazprom’s unique window of high revenue may be closing.

Gazprom has been under increasing pressure from its domestic rival, Rosneft, from end-user European consumers and also from cheaper natural gas suppliers such as Qatar to increase diversification of the Russian LNG industry.

The competition simmering with Rosneft will expose Gazprom to market prices because it will be unable to wrest control of mining contracts and pricing.

The Kremlin anticipates a restructuring of Gazprom if its monopoly weakens.

Any diminishing of Gazprom’s political utility by limiting their energy sector control would no be appreciated in the Kremlin. This is exemplified by Mr Medvedev’s decision to intervene on Gazprom’s behalf with the EU.

Russia has positioned itself as Europe’s primary energy supplier. Russian natural gas supplies total 25 percent of Europe’s total imports and 40% of European Union imports.

Gazprom’s hold on the European energy market allowed it to increase its prices from the high of $NZ300 per thousand cubic metres (mcm) to between $550 and $700 mcm in recent years. This remarkable rise was achieved by the subtle – and not so sutble – manipulation of European energy markets.

In 2009, Russia displayed a Machiavellian inclination to leverage European LNG imports by closing gas supplies to Ukraine over prices disputes and disrupting flow to 17 other European countries.

In a meeting with Russian President Vladimir Putin in Sochi, Russia on August 25, Ukrainian President Viktor Yanukovich declared hopes that the two nations will change their relationship in the natural gas sector.

But the bond between Moscow and Kiev has changed. The completed Nord Stream project is viewed by Moscow as a secure pipeline, removing an unpredictable intermediary like Ukraine and assuring Central Europe of steady natural gas supplies from Russia.

The undersea pipeline running through the icy Baltic Sea from Vyborg near St Petersburg to Greifswald in Germany is owned by a partner of Gazprom and is a lynchpin in warming relations between Moscow and Berlin.

Uninterrupted supply of LNG to central Europe is a conscious political decision by Moscow calculated to increase reliance and therefore dependence on Russia.

With German nuclear plants scheduled to close, an increased dependence on natural gas for energy is predicted to bring these two countries closer together.

The Nord Stream pipeline illustrates perfectly how important Moscow considers a strong partnership with Berlin is for its European strategy.

Taken together, Moscow and Gazprom are facing a dilemma as foreign sources of LNG begin to take larger bites of the European market away from Russia and the artificially low domestic natural gas price ceiling is expected to climb.

On the one hand Russia needs to supply its population with heavily subsidised natural gas (currently charged out at $100mcm), a price-capping legacy from the Soviet era. But on the other hand, Russian LNG exports to Europe can fetch over $650mcm.

Gazprom's exports of natural gas to Europe fell 17% year-on-year, to 71.93 billion cubic meters, in the first six months of 2012, according to a statement by Gazprom.

The company's total exports during that period amounted to 104.4 billion cubic meters. So Gazrpom may have to make some tough decisions as European energy supplies clearly continue to diversify.

Its European market share may also decrease when the cheaper American LNG super fields come fully online in the next few years.

Coupled with rising domestic demand, shifting European consumer patterns and a low profit margin due to subsidisation, Gazprom may not be able to continue funding future projects on the Yamal Peninsula, South Stream and Shtokman gas fields and will dilute the political utility the Kremlin has come to depend on.

But the energy giant is not without its counters to the forces arraying against it, announcing on September 10 that it would suspend purchases of natural gas from independent producers in Russia. 

To achieve profitability they must sell the majority of their extracted LNG to Gazprom because of its monopoly on pipelines.

In a very Russian way, Gazprom is sending a message to these recalcitrant companies, reminding them of the real power balance in the Russian natural gas sector.

And with a full monopoly on distribution Gazprom is still at this stage a useful leveraging tool for the Kremlin in political relations with Europe.

As foreign gas supplies come on line in the European market and Russian gas prices increase domestically, Gazprom and the Kremlin will face mounting competition.

The enormous volume of Russian natural gas is too great for one company to develop alone, so other energy companies will be needed to help Gazprom with this massive task.

Nathan Smith has studied international relations and conflict at Massey University. He blogs at INTEL and Analysis