Russia's "Perfect Storm"

Natural Gas Europe had the pleasure to discuss the current situation in  the Russian gas industry and its prospects with Ms. Tatiana Mitrova, Head of Oil and Gas Department, Energy Research Institute, Russian Academy of Sciences. 

NGE:  In your recent paper you came to a conclusion that  the Russian gas market is entering new era. How challenging is it going to be for Russia?

TM: I call the situation the Russian gas industry is facing now “a perfect storm” - a coincidence of number of negative factors: slowing down demand (both at the domestic and export market), lower gas and oil prices, increasing competition, quite unfavorable regulation in Europe. All together is the difficult environment, but adding on top sanctions, which Russia is experiencing now, the situation is really becoming extremely challenging. Though, I want to stress that these challenges demand significant changes in the Russian gas industry itself but they are not leading to its collapse. They are just restricting considerably the rules in which the Russian state and Russian gas companies have to develop their strategies.

NGE: Will we see further liberalization of the Russian gas sector?

TM: I am quite skeptical on this particular topic. I understand the reasoning of people who are talking about the increasing competition.  Indeed, the share of the independent gas producers is increasing and the competition in the domestic market is becoming tougher. At the same time the current geopolitical situation does not favor any sharp decisions and dramatic changes either in the domestic market regulation or in the export access. Speaking about export liberalization, I know there are expectations in Europe that after liberalization of the LNG exports the government could provide pipeline access for the independent companies to the EU market. I think it is very doubtful as the EU is starting to promote the concept of the Energy Union trying to speak in one voice. Gazprom has a huge portfolio of the long-term contracts which secures its position in the European market. If we imagine that, for example, Novatek or Rosneft will try to enter stagnating European market with falling demand, it will be extremely difficult for them to sign new contracts other than providing customers some price discounts which means that they will start to dump and eat Gazprom’s share but total revenues of Russia in this situation will decline. So, there is absolutely no economic rational point for the state to go for liberalization. Moreover, that would mean disparate policy in pricing for the EU which is one of the instruments of the Russian external policy. Export access is discussed only for the Asian market – Rosneft is trying to promote this idea for the “Power of Siberia”, but the outcome of this discussion is still unclear.

Concerning the domestic market, the tensions between companies are increasing.  There are numerous conflict zones and grey areas which are not defined yet, but in the environment of sanctions, the lack of financing, overall economic slowdown and instability I think it is a risky strategy for the government to try to go for the dramatic gas market reform. As you know, gas is providing 53% of total primary Russian energy consumption. In case if something goes wrong with this reform or if there will be any failures in securing gas supplies, it will be a very painful situation for the government. Besides, gas in many cases is utilized as a domestic political tool, so it serves the interests of centralization and influences on difficult regions like Chechnya and socially sensitive groups of consumers in a way of hidden subsidies. If there is no company like Gazprom which takes care of the state interests, who will be a “guarantying supplier” to all these groups? Most likely the government will not take such a risk, at least in this decade.

NGE: How long can Russian gas prices remain oil-indexed in the changing reality?

TM: At the moment it seems that the most of the European customers are waiting for the second and third quarter when Russian oil-indexed prices will go below spot prices.  Currently the oil prices are quite low and the oil- indexation is not a big competitive disadvantage for Gazprom. In addition, there are no alternative sources to the Russian gas supplies in Europe. Though, at the end of the decade the situation could change as we expect oil prices to relatively recover and we expect more LNG at the global market, especially North American LNG, coming on stream. I think that there will be an increasing pressure on Gazprom to move away from oil indexation to spot indexation. We looked at the statistics and found out that since 2009 Gazprom has already provided on the average 20% price discount to the European customers compared to the tradition oil-indexed price. I would expect that after a couple of years of this indexation  Gazprom will start to move more intensively to spot pricing , the question is what exactly will be the hubs it will be indexed at. The announcement of the Turkish Stream and the fact that  Gazprom is overstressing  that gas will be supplied not to the Turkish-European border but  at the Turkish hub, gives an indication at what hubs Gazprom is going to be priced if it changes  its pricing policy.

NGE: Talking about LNG, how competitive is Russian LNG in the global market?

TM: LNG was a very popular story in the Russian gas industry until the sanctions were introduced. Initially, there were seven projects on the discussion. Now most of them are in limbo. First of all, because of the difficulties with the access to the Western financial market. Secondly, because of the fear of the future intensification of the sanctions.  At the moment LNG equipment is not on the sanction list but as all the technologies of liquefaction are 100% controlled by the Western companies, it is quite likely that if the political situation will further deteriorate,  these technologies could become banned. Therefore, the investors become much more cautious. We heard about Vladivostok LNG which could be potentially terminated in favor of pipeline supplies, there are increasing rumors about Sakhalin I being postponed, Yamal LNG is advancing slower than it was planned… So there are significant difficulties  that are 100% driven by the  politics.  Looking purely at economics, Russian LNG is definitely not the cheapest in the world due to the challenging geographical and climate conditions. Nevertheless, in general Russian LNG looks at least similarly competitive as the new LNG projects from Australia, East Africa, Canada or the US. The question mark here is not economic competitiveness but the availability of technologies and financing.  So, our focus for the LNG exports in this study is the major uncertainty.  Given the current status of the Russian LNG  projects and typical completion times for such projects globally – at least 5 years from FID - one can say with high certainty that a significant increase of the Russian LNG exports should not be expected before 2020 in any scenario. In the longer-term the range is huge: by 2025 it could be just current volumes of LNG (Sakhalin II) and some volumes at Yamal LNG and probably Baltic LNG, or, in a favorable situation, more than tripling current capacities. It is all very much politically influenced.

NGE: Should Russia forget about Arctic gas projects in the age of sanctions?

TM:  It depends on what exactly we are regarding as Arctic. If we are talking only about offshore, then probably this would be postponed for  the unclear period of time, like Shtokman project would hardly start  before 2030. As for onshore gas projects, like Yamal development, Bovanenkovo or Yamal LNG, then it is something that is already advancing.  Bovanenkovo was commissioned several years ago and now it is already producing at 40 bcm, though its potential capacity is 120-130 bcm,  so it is huge underutilization of  the capacities. Yamal LNG is the project which has the best chances to be realized because it is at the most advanced stage. Gas sphere is quite different than oil sector. In oil sector the imposed sanctions regarding  implications  for the Arctic production are much more serious.

Marina Zvonareva is a Natural Gas Europe analyst focused on Russia’s international energy relations. Follow her on Twitter: @ZvonarevaMar1na