Russian gas-market liberalisation crawls ahead
Gazprom's grip on Russia's gas market is loosening, but liberalisation will be a slow process, writes Tom Nicholls
THINK of Russian gas and you think of Gazprom. But perhaps not for much longer: pressure is growing on the government to liberalise the gas sector and let other producers compete more freely in the domestic market.
Liberalisation would make obvious business sense for Gazprom's rivals, by providing them with another revenue stream. But it would also create a significant environmental benefit, making it easier for oil producers to sell associated gas – reducing flaring, which prime minister Vladimir Putin has admitted is a "disgrace".
The World Bank estimates that Russia flares almost 50bn cubic metres a year (cm/y), a substantial volume in the context of the country's exports to the EU, which range from 120bn cm/y to 150bn cm/y (see Figure 1). A 2008 study by the Bank, based on satellite images, estimated that Russian oil producers flare 38bn cm/y – or 45% – of the country's associated gas production; a further 10bn cm/y is flared from gas-condensate production. The same study also estimated that it could be economically viable to use up to 80% of the flared gas in Russia and eliminate up to 80m tonnes of carbon dioxide emissions a year.
Russia responded, last November, by ordering oil companies to use "up to 95%" of the gases associated with petroleum extraction. Flaring, said President Dmitry Medvedev, "pollutes the environment and sends tens of billions of roubles up in smoke".
Competition in the gas sector would also improve energy efficiency in a country where too much energy is wasted. According to the International Energy Agency (IEA), Russia's energy intensity is about twice that of the OECD. The World Bank, meanwhile, estimates that the country – the third-largest emitter of greenhouse gases, after China and the US – has a gas-saving potential of 240bn cm/y, twice its annual exports to the EU. The bank also estimates that Russia could save 45% of its total primary energy consumption and that its energy inefficiency is equal to the annual primary energy consumption of France.
The government has been trying to boost efficiency. In 2009, it established its first target for reducing energy intensity: a 20% improvement by 2020. That marked a shift from the mindset of the mid-1990s, when cheap resources seemed abundant, companies were focused on rushing oil to market, natural gas was an inconvenience and policy documents made no mention of efficiency.
The drive for greater efficiency in energy use and efforts to reduce gas-flaring have coincided with a growing interest among oil producers in marketing their gas resources; with oil production stagnating, they are eager to find other sources of revenue. The government envisages a steady rise in the gas produced and sold in Russia by companies other than Gazprom. Independent producers accounted for just 17% of Russian gas production in 2008, but this share will rise to 27% in two decades' time, according to the government's Energy Strategy to 2030. The same document forecasts that independent producers will account for most of the growth in the domestic gas market over the next two decades, with almost half of the volumes delivered in 2030 in Russia coming from producers other than Gazprom (it is extremely unlikely, however, that the government would tamper with Gazprom's export monopoly).
But opening up the market to competition, which would complement efforts to liberalise Russia's electricity sector (PE 8/09 p18), will not be straightforward and the government's informal target date for a new market structure – 2014 – is ambitious. The government's commitment to reducing gas flaring obliges it to design market mechanisms to incentivise flaring cuts; at present, the economics of selling gas are undermined by low end-user gas prices and by difficulties faced by rival producers in gaining access to Gazprom's transmission infrastructure.
But the new market model remains at an embryonic stage of development. A proposal exists to split Russia's gasfields into two categories: old fields and new fields. But this has not been formalised in any policy documents.
Old fields would be mainly Gazprom's and would remain under its ownership, preserving long-term contracts, making it unnecessary for the state-controlled company to unbundle its assets and protecting a national champion. The Yamal Peninsula fields – where natural gas, condensate and oil reserves amount to 10.4 trillion cm, 228.3m tonnes and 291.8m tonnes, respectively – would almost certainly be categorised as old, for example, and retained by Gazprom. However, as old fields gradually deplete, the liberalised market – increasingly fed by production from new fields – would grow.
Yet even after a market structure has been defined, which will take time, putting it into effect will have to occur gradually. Gazprom has, for several years, been incentivising consumers to switch to gas from other power-generation sources, such as diesel and biomass; sanctioning sudden price rises as a means of attracting new investment to the upstream and midstream segments of the gas chain would be unpopular at the consumer end.
At present, tariffs for industrial customers – despite a 15% rise last year and another similar increase this year – are around half what they would be in Europe; the prevailing government view is that gas tariffs would be comparable with European tariffs, on a netback basis, by 2014. But it will probably take longer for Russian prices to catch up, especially if economic recovery is slow: rising energy costs will compromise the competitiveness of Russian industry.
Increasing prices to industrial consumers will be politically easier than to domestic consumers. But a badly planned two-speed liberalisation might have the effect of encouraging Gazprom's rivals to target the more lucrative end of the market – factories and other industrial plants – leaving Gazprom with the less profitable, but more politically sensitive consumer market, something that Gazprom would resist.
Another big sticking point is the cost of maintaining infrastructure. In exchange for third-party access to its network, Gazprom will require permission to charge higher transit fees, yet that will be difficult to foist on third parties unless end-user prices are allowed to rise in proportion. It would also lead to a requirement for greater transparency on Gazprom's part; companies paying high transit fees and contributing to the upkeep of the gas-pipeline network will want to know how their money is being spent.
There are numerous other barriers to liberalisation. Gazprom is not legally bound to disclose spare capacity – a necessary step in establishing market opportunities for third parties. The government must also establish the terms for third-party access; until it does, sellers will not be able to sign up buyers under long-term sales contracts. In turn, that will prevent them from making the necessary upstream investments. Gazprom has also pointed out that the quality of the gas supplied by third parties may be inferior to gas already in its system, which would require a price-adjustment mechanism and could raise technical problems.
However, numerous though the impediments may be, there are strong reasons for encouraging liberalisation, beyond improving efficiency and reducing flaring. In view of the uncertain outlook for European natural gas demand, it is in the interest of Gazprom, whose Arctic Shtokman project has been delayed (see p4), to push more exploration risk onto other companies.
And while Russia's existing market structure encourages the development of large fields, a competitive, market-based system may also encourage the development of small fields and unconventional gas sources, such as shale gas.
In addition, powerful though Gazprom is, there are influential companies and individuals outside the company that would like to see a more open gas market. Gazprom will need to cede some ground, says Andrei Bely, a lecturer at the Higher School of Economics in Moscow.
Indeed, it already has. At the end of last year, Novatek, Russia's largest independent gas producer and the second-largest natural-gas producer (see p14), replaced Gazprom as gas supplier to OGK-1, a power plant owned by Inter Rao. It will sell up to 64.7bn cm of gas to Inter Rao between 2010 and 2015 under more "advantageous and flexible conditions" – in the words of the buyer – than it had previously. Igor Sechin, an influential political figure with strong links to the oil lobby, is chairman of Inter Rao. Novatek, meanwhile, is controlled by Luxembourg-based investment fund Volga Resources. Gennady Timchenko, who also owns oil trader Gunvor, owns Volga.
A good chance that it will
"Companies such as Novatek are keen to see this market functioning, so there's a good chance that it will work," says Bely. Gazprom's rivals are optimistic about the prospects for growth in gas sales and production, and give gas a prominent place in their growth strategies. Despite uncertainties in the economic outlook caused by the recession, Novatek expects steady growth in gas demand and says it will expand its productive capacity from 45bn cm/y in 2010 to 65bn cm/y in 2015.
Lukoil, Russia's largest privately owned oil company, which has proved gas reserves of 0.65 trillion cm, describes gas as a "new and rapidly developing" business segment. Gas sales in Russia amounted to 10.947bn cm in 2009, of which 7.584bn cm was sold to Gazprom and 3.363bn cm to other consumers – a fragment of the overall market, which consumed 390bn cm in 2009, according to Cedigaz.
Rosneft, among the largest gas producers in Russia, owns 0.816 trillion cm of proved gas reserves, mainly in western Siberia, but less than a quarter of them are being developed. The state-controlled oil company is similarly enthusiastic about this area of its business; it says it has "excellent prospects" to build on its significant undeveloped gas reserves and claims it could produce over 55bn cm/y given freer access to Gazprom's pipeline transmission system. "Things are clearly changing," says Simon Pirani, senior research fellow at the Oxford Institute for Energy Studies.
Increasing private-sector involvement further upstream is another sign of a freer market in Russia. Gazprom and the government remain highly selective about which foreign companies – if any – co-operate in its big-ticket gas projects.
But with no legal impediment to the participation of foreign companies in upstream ventures, several companies, such as Gazprom's long-standing German partners, are already working in mutually beneficial upstream partnerships with the Russian company, providing exploration and production technology and expertise in exchange for access to the world's biggest gas resource.
Western Siberia's Yuzhno Russkoe field, which produces 75m cm/d, groups together Gazprom, Wintershall and E.On Ruhrgas. The Achimgaz joint venture, which is now operating and is expected to produce up to 7.5bn cm/y, involves Gazprom and Wintershall. If and when the Shtokman field is developed, it will involve foreign co-operation (although with the Atlantic basin oversupplied with liquefied natural gas, it could be years before substantial progress is made).
There is even talk within the energy ministry of a revival of production-sharing agreements (PSAs), although a formula that is attractive both to the government and to private-sector investors is yet to be defined. That idea would have seemed impossible four years ago, when the Kremlin, emboldened by high commodity prices, helped Gazprom force its way into the Sakhalin Energy consortium, which had been working under a PSA that the government considered overly generous to the consortium's foreign investors. But things change quickly in Russia; perhaps Gazprom's traditional dominance of the domestic gas market will be next.