September 5th, 2012
Via STRATFOR (subscription required), a very interesting two-part analysis of the challenges building up against Gazprom both internally in Russia and externally as well:
State-owned Gazprom currently accounts for more than 80 percent of Russia’s natural gas production. Moreover, the company has a monopoly on natural gas distribution (via pipeline or liquefied natural gas) and exports to consumers in the former Soviet states, in Europe and beyond. Gazprom’s domination of the massive natural gas sector in Russia has allowed the firm to act unilaterally and guide how natural gas is used in Russia and abroad, politicizing the sector and the firm.
Russia’s natural gas sector operates very differently from the country’s other major energy sector, oil. Russia’s oil giant Rosneft does not hold the same kind of monopoly on its sector that Gazprom does on natural gas. Rosneft produces less than a quarter of Russia’s 10 million-barrel-per-day output. Russia has a slew of other oil companies that give Rosneft some competition, such as TNK-BP, LUKoil and Gazprom’s oil branch GazpromNeft. Moreover, Rosneft does not run the oil pipeline infrastructure in Russia; there is a state oil pipeline operator, Transneft. This has limited Rosneft’s power in the country compared to Gazprom. It also does not allow Rosneft to act as politically in the oil sector as Gazprom does in the natural gas sector.
The Gazprom-Rosneft Rivalry
There are no warm feelings between Gazprom and Rosneft. Each firm was set up during the state’s consolidation of the energy sector. In 2005, the state tried to merge the two companies to create one giant state energy firm, but politics got in the way. Both Gazprom and Rosneft are fiercely guarded by opposing clans in the Kremlin. Gazprom is run by the civiliki — Prime Minister Dmitri Medvedev was once its chairman — and Rosneft is run by the siloviki, with Deputy Prime Minister and head of the Union of Industrialists in Russia Igor Sechin as its champion.
Competition between Rosneft and Gazprom grew in the mid- to late-2000s as the companies began dabbling in each other’s sector. GazpromNeft has taken a 10 percent market share in the oil sector, producing 1 million bpd. But Rosneft’s natural gas arm, RosneftGaz, has only a 2 percent market share of the natural gas sector, producing a little more than 12 billion cubic meters annually.
There have been constant rumors that Rosneft wants to become Gazprom’s major competitor in the natural gas sector, breaking the firm’s near monopoly. But Rosneft has done little to achieve this, mainly for technical reasons (such as little access to natural gas infrastructure, be it fields or pipelines) and because of a lack of political will inside Russia or among its natural gas customers to pressure Gazprom to loosen its hold. This could be changing, however, because pressure from several directions — competitors, the Kremlin and Gazprom’s European customers — could fracture its control over the natural gas sector.
Competitors’ Power Plays
Rosneft appears to be trying to gain a greater presence in the natural gas sector. Thus far, Rosneft’s plan seems to have three parts: increase the company’s power in the natural gas sector, increase its natural gas production and loosen Gazprom’s grip on natural gas exports.
In order to gain influence in the natural gas sector, Rosneft is working to gain control of large pieces of Russia’s electricity network. The country’s electricity sector is disjointed and chaotic. Starting in 2007, Russia had a clear plan to break up the state power monopoly, the Unified Energy Co., into three sectors: generators, distribution grids and the Federal Grid Co. The goal was to privatize the new firms in order to gain private investment in the aging electricity networks. These plans were interrupted in 2008 by the financial crisis, and the state still owns 70 percent of the electricity sector through a number of fragmented firms.
Rosneft’s champion, Sechin, has proposed merging the power grid firm Interregional Distribution Grid Co. with the Federal Grid Co. to create Russia’s largest electricity network. The catch is that Sechin wants to make Rosneftgaz the new entity’s operator, ending the privatization plans. This could put Rosneft in the position to make decisions or moves in the natural gas sector, since 48 percent of Russia’s electricity comes from natural gas. Sechin’s plan has already felt a backlash — Deputy Prime Minister Arkady Dvorkovich, who holds the energy portfolio under the prime minister’s office, sent a public letter to Russian President Vladimir Putin openly criticizing Sechin’s plan. Dvorkovich is close to Medvedev and thus linked to Gazprom and its supporters, and he is known to be hostile toward Sechin’s circle.
Sechin has other plans to raise Rosneft’s profile. Rosneft is in talks to merge with several other Russian natural gas companies. In July, Rosneft acquired a 6 percent stake in the independent natural gas company Itera and has applied to raise that stake to 51 percent. Itera produces 20 billion cubic meters of natural gas annually, which, if coupled with Rosneft’s production, would give the firms a combined 5 percent market share — something of a feat considering Gazprom’s dominance. Itera also has strong ties to and shares in Central Asia’s natural gas sector (particularly in Turkmenistan), which Gazprom has been trying to move in on for years.
Stratfor sources have also indicated that Rosneft would like to strike a deal or merger with Russia’s second-largest natural gas firm, Novatek. Novatek currently produces 10 percent of Russia’s natural gas and holds some of the most attractive fields for future production on the Yamal Peninsula. Gazprom holds 10 percent of Novatek (and another 9.4 percent via GazpromBank, though these shares can be repatriated by the other shareholders). But the relationship between the two firms is not friendly. Novatek is trying to gain a foothold in Russia’s natural gas export market and made a deal in July with Germany to start supplying natural gas. But in order to do this, Novatek has to send the natural gas via Gazprom, since Gazprom owns the export infrastructure.
Sources have said that Novatek is petitioning the government to repeal the 2005 laws regarding Gazprom’s monopoly on the export infrastructure, which would allow it to export natural gas directly to consumers, such as Germany. For this to happen, a third party would most likely have to be set up to manage the natural gas pipeline systems, much like Transneft does for the oil pipelines. Reportedly, Rosneft fully supports this plan, allying with Novatek for now.
Despite its competitors’ wishes, Gazprom will fiercely fight any changes to the law on its monopoly over exports and against any other natural gas firms encroaching on what Gazprom considers its sector. Ownership of the pipelines and of the majority of supplies has allowed Gazprom to remain powerful inside and outside of Russia. Gazprom does not want to have to compete with other Russian natural gas firms for contracts, because the competition would force Gazprom to negotiate based more on market conditions than on unilateral action.
Gazprom’s Political Usefulness
Many inside the Kremlin also find any weakening of Gazprom’s position unappealing, as it would lessen the company’s political usefulness. However, this sentiment may be changing. For years, former Energy Minister Sergei Shmatko vowed that there would be no changes to the export monopoly law. But in the months leading up to the major government purge in May, Shmatko changed his position and said that a large change was needed in order for non-Gazprom natural gas producers to gain better access to the market and infrastructure. Shmatko was replaced by former Deputy Finance Minister Alexander Novak, who might have been shuffled into the Energy Ministry to start getting the energy firms in order financially. Sources have indicated that this could put Gazprom on the list for possible restructuring, as the company has focused more on political gains than financial stability.
New energy dynamics in Europe — Russia’s largest energy customer — are pressuring Gazprom to behave as a competitive business rather than as a political tool of the Kremlin. Europe has begun consolidating its efforts to import natural gas from non-Russian sources and integrating previously isolated national markets through regional natural gas transport interconnectors. This has forced Gazprom to reconsider its aggressive policies on natural gas pricing. The company has been lowering prices for many European consumers in order to keep them in long-term contracts. But it seems that Europe is interested in taking this a step further by striking deals with other Russian firms, like Novatek, in order to weaken Gazprom’s monopoly on exports and ultimately push for lower natural gas prices.
Gazprom’s Capabilities
Adding to the external pressures against Gazprom are circumstances within the company that are forcing it to reassess its strategy. In taking over the majority of Russia’s natural gas sector, Gazprom has taken on some large, difficult and incredibly expensive projects for the next decade. There are four large projects in particular — Yamal, South Stream, East Siberia and Shtokman — that when put together will test Gazprom’s capabilities financially and as a company.
Gazprom’s projects on the Yamal Peninsula are considered a national security priority for the Kremlin, because natural gas from Yamal is meant to replace natural gas production from the currently declining region of Nadym-Pur-Taz just south of Yamal. However, the project is slow and expensive. The Yamal megaproject is expected to cost between $100 billion and $180 billion through 2035, and Gazprom will take on nearly $70 billion of that cost.
Another project, the South Stream pipeline, will run from Russia to Europe via the Black Sea and bypass politically sensitive Ukraine. Like its sister pipeline Nord Stream, South Stream is meant to diversify Russia’s export routes and allow Russia to shift supplies regionally should political issues arise along the traditional routes. But South Stream is an expensive project, with current estimates at $65 billion by 2014 — and this does not include the cost of developing new fields in southern Russia in order to feed supplies into South Stream.
Part of Russia’s future energy strategy is to develop its natural gas reserves in East Siberia, with the goal of diversifying its exports toward Asian consumers. Many other firms began working in East Siberia before Gazprom did. But in order to ensure that it could continue dominating the natural gas sector, Gazprom aggressively pursued key projects it knew would be at the forefront of efforts to send natural gas supplies to Asia. For example, Gazprom took over the Kovykta field from TNK-BP. Development for all of East Siberia is projected to cost about $90 billion, though Gazprom will not be responsible for all of the cost.
The last major project Gazprom is involved in is the controversial Shtokman Arctic natural gas project. The Shtokman field is estimated to be one of the world’s largest, with 3.8 trillion cubic meters of natural gas. The problem is that it is located in the Barents Sea, 600 kilometers (about 373 miles) offshore in the Arctic, far away from consumers. A consortium of Gazprom, France’s Total and Norway’s Statoil is handling the Shtokman project. Plans for Shtokman stalled, because the three partners have disagreed over the design, export route for the natural gas and the way the Russian government is taxing the project. Costs for Shtokman range from $12 billion to $30 billion depending on design.
It seemed unrealistic for Gazprom to be able to handle so many ambitious and expensive projects to be developed in just the next few years. Unsurprisingly, Gazprom announced Aug. 29 that it will shelve the Shtokman project indefinitely because the development costs are too high. Stratfor sources have also said Gazprom is considering delaying its East Siberia projects at least until 2014 or 2016. Gazprom has realized that it must ensure that it can complete the projects that support its core strategy and strength: being able to produce large amounts of natural gas and leveraging those supplies with European consumers. The Yamal and South Stream projects are more in line with this strategy and will receive priority over Shtokman and East Siberia.
But this shows that the energy giant cannot do it all, leaving openings for others to fill in the gap. Gazprom’s hold on Russia’s natural gas sector does not appear to be close to breaking, but its domination could be eroding because of the confluence of events and pressures affecting the natural gas behemoth. It is up to Gazprom to adapt to these new conditions in order to maintain its position. However, it is clear that the firm will not continue acting unilaterally, as it has for the past decade.
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