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    A Perfect Storm of Trouble for Russian Gas



Russia, which previously has been the dominant supplier of gas to much of Europe—especially the Commonwealth of Independent States (CIS)—is now having to diversify to Asia to take back some of its market share.

by: Erica Mills

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Top Stories, News By Country, Russia

A Perfect Storm of Trouble for Russian Gas

Russia in a “perfect storm” of a mess that nobody could have predicted just a few years ago, Dr. Tatiana Mitrova, Head of the Oil and Gas Department at the Energy Research Institute of the Russian Academy of Sciences, has said.

Dr. Mitrova said that a number of factors have come together that have caused serious issues for both Russian gas producers and for the Russian economy. 

On the home front, the expert explained, a stagnant economy is having a knock-effect for producers, customers, and for investment into the sector. 

With that slowdown, inefficiencies in the institutional framework of the energy sector, which is more and more concentrated on the oil sector, are becoming more pronounced. Combined with falling demand on the global market, the country is feeling the pinch. 

“There has been some sort of competition in the gas sector but definitely that is not enough for a purely competitive and efficient market,” she said. “Now we are facing a stagnant demand both for oil and gas globally. These two commodities are providing 70% of Russian export and 50% of Russian federal budget revenues, so you can imagine how painful that is.”

Russia, which previously has been the dominant supplier of gas to much of Europe—especially the Commonwealth of Independent States (CIS)—is now having to diversify to Asia to take back some of its market share. Even so, the prognosis is not especially positive currently for Russian suppliers there.

“We have some minor growth in Asia but Asia is not the market where we [Russia] are installed,” Dr. Mitrova explained. “There’s no infrastructure; there’s no experience. Everything has to be built. 

And that entry into the Asian market will be no quick fix for the country’s waning fortunes in gas, she warned. 

Though the Russian government has declared exports to Asia a priority, the lack of infrastructure will stymy any quick growth. 

“Asian exports will start to expand only after the Power of Siberia pipeline is completed in five years starting from now,” the expert said.

“After that, it will take another five years to reach its projected capacity of 38bcm. Only by 2025 will the expected capacity of 38bcm start to flow to China, providing Russia with some diversification. Until then, Russia is dependent on the European supplies. Right now, Russia has a choice of CIS, domestic market, or Europe—nothing else is left.”

With the increased competition on all markets—particularly thanks to liquefied natural gas (LNG)—diversification is a necessity for Russia. With competitors from the U.S., from Iran potentially, from Brazil, Australia, East Africa, Dr. Mitrova says competition will change dramatically in the next five to seven years. 

But increased competition is just one in a list of challenges the country is facing. As it has been with other suppliers and countries, the decline in oil and gas prices is a top concern for Russia. 

“The oil and gas price decline is a complete disaster,” she says. “Again, if you remember 50% of the federal budget is provided by oil and gas, that explains a lot why Russia is so nervous about the oil price and gas price.”

That nervousness is compounded by the geopolitical tensions the country is facing, which have been frustrated by the Crimea conflict with Ukraine. 

Those tensions and difficulties have led to CEO of Gazprom, Alexey Miller, saying that Gazprom is not willing to invest in the European downstream any longer or in European infrastructure. That decision could drastically affect European-Russian relations.

“It could mark this real move of Russian supplies to the EU-Russian border, really going back to the Soviet concept where the gas is supplied just to the border and then no other interactions,” Dr. Mitrova said. “I’m not thinking it’s a good idea in terms of cooperation and partnership, but in the current geopolitical environment, unfortunately it seems to me to make a lot of sense.”

The impact of sanctions has not been ignored by the Russian government either.

In a CNBC exclusive interview in January this year, Russian Finance Minister Anton Siluanov estimated that external shocks to the economy from oil and gas has totalled $200 billion. 

“Mainly this comes from the oil price shock but about $40 to $50 billion of that comes from the sanctions,” he said at the time.

Those shocks’ effect is sharply felt at a time when production has radically increased in Russia while at the same time domestic demand has not grown.

“With such a weak economic outlook, domestic gas demand is flat at best or it could even decrease slightly,” Dr. Mitrova said. “We do not see any perspective of the domestic gas growth. The domestic market is not able to absorb additional gas production.” 

That poor economic outlook has meant that the steady growth of gas prices that Russia had been seeing has been halted.   

Previously, Russian domestic gas prices had been frozen from 1991 until they were lifted. Dr. Mitrova says the country saw gas price growth after that of 15-25% per annum.

“But when facing the economic slowdown and the negative growth of manufacturing, the government had to make a decision to freeze domestic gas prices at the level of inflation,” she said.

“For domestic gas producers, the domestic market is not looking very attractive compared to any export market.”

Any producers hoping to find a comfortable or easy market opportunity in Europe could be disappointed.

“If you look at the export market, you see that during the last five years, Russia export opportunities to both Europe and the CIS did not increase (to put it in a soft way),” Dr. Mitrova said. “And, actually, in the CIS, we are absorbing huge decline in volumes—especially because of Lithuanian supplies.”

To an outside perspective, it might seem as if Russia is stubbornly sticking to its old routines in how it deals with its customers, but Dr. Mitrova says that there has been a change in the approach despite the well-worn rhetoric in favour of traditional oil indexation used officially. 

“If you look in more details at the renegotiations Gazprom has had, the price which Gazprom is in fact receiving from the customers, Gazprom is adopting (flexibility_ very, very slowly (flexibility) even though the rhetoric remains from the old days.” 

Between 2009 to mid-2014, the company has reviewed with 58 contracts with 39 clients, providing price discounts, easing of take-or-pay obligations and a certain introduction of a spot component. 

This is a far cry from where Russia and Gazprom was just a few years ago.

“The old strategy—it was about expansion in the European market,” Dr. Mitrova said. “Currently no one is talking about expansion. Currently it’s about protecting the market niche; it’s about protecting this 30% of the European market, or at least protecting the current volumes. That’s the aim—not to conquer the European market.”

But the outlook is not all grim for Russia if one is to look objectively at Russia and Gazprom’s place in the European energy mix, there’s one major advantage, Dr. Mitrova says. 

“Despite all the political perspectives, despite all the warnings of being too dependent on Russian gas, at the end of the day, if we are looking at the economics, Russian gas is still the cheapest. In terms of supply cost, it has a huge competitive advantage.”

 Erica Mills