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RUSSIA AND THE GLOBAL NATURAL GAS MARKET
Russia is the world’s largest reserves-holder, producer and exporter of natural gas and is playing a significant role in development of the European gas market and as an important player in gas deliveries to Former Soviet Union countries. Russia has the world’s largest natural gas reserve base. The estimates for the country’s proved natural gas reserves by the International Gas Union and Gazprom are identical and stand at 47.85 trillion cubic meters (compared to the Cedigaz estimate of 47.65 tcm), which constitutes 26.3% of total world reserves. Presently, most proved reserves are located in the western parts of Russia. However, as will be discussed in further detail in this report, the producing reserves in West Siberia and the southern regions of Russia’s European part are now in decline and need to be replaced by reserves further to the country’s east and north. The continental shelf of the Barents and Caspian seas should become an important factor of Russian gas industry development during the next The best prospects for major new discoveries of natural gas in Russia, according to estimates by Gazprom and the RF Ministry of Natural Resources, are in the eastern part of the country as well as in offshore zones along the Arctic and Pacific coastlines. However, these are very challenging regions due to their remoteness and very harsh climatic conditions. While most of such challenges can be met with engineering and technical solutions, the costs per cubic meter of natural gas produced will be significantly higher than that from the gas fields currently onstream. As discussed in this report, this new level of costs will be one of the key problems facing Russian natural gas exports in the medium-term future. International markets are becoming increasingly global due to the growth of liquefied natural gas (LNG) as an international commodity business. The worldwide interdependence of gas markets puts downward pressure on prices, which is something Gazprom will have to cope with. Increasing gas prices, on the other hand, would stimulate development of new gas reserves and originate new gas flows to the market. The current situation with high energy prices puts on additional pressure to start production at new upstream projects in Russia. In December 2007, Gazprom launched production at the Yuzhno-Russkoye field, where production in its stable phase will be 25 billion cubic meters (bcm) of gas per year. Russia is the world’s largest producer of natural gas, producing 612.1 bcm of free gas, according to BP Statistical Review of World Energy, and total gas production (including associated gas) at 656 bcm, according to the Russian Ministry of Industry and Energy. The most interesting comparison is with gas producers in Europe – the main destination of gas exports from Russia. Currently, Russian gas production significantly exceeds combined production of the three main European gas producers, Norway, UK, and the The essential factors affecting Russian gas production are depletion of the currrently producing gas fields in the Nadym-Pur-Taz region and the huge capex requirements for development of the new gas provinces in terms of both production and transportation. Production of the natural gas industry in Russia is dominated by Gazprom, though there is also a significant role to be played by independent companies. Gazprom accounts for 84.7% of all production, with the balance split between the oil companies and the independent gas producers. The Russian economy heavily depends on consumption of natural gas, a heritage of the Soviet era and the first decade of economic reforms, when gas prices were frozen while coal and oil prices were set free. During this period, gas consumption increased further and now about 52% of Russia’s primary energy needs are met with natural gas, which is double other countries’ average level of dependency on natural gas. Recent statements from the government indicate a willingness to reduce this dependency, including by increased use of coal as a source of primary energy. However, the recent decision to join the Kyoto Protocol may make such a shift difficult to accomplish. Another proposed way to address the problem of the shrinking share of natural gas in Russia’s energy balance is to develop the nuclear power stations network. Yet the most realistic method to reduce the inefficient use of gas will be the energy-saving technologies. According to various estimates, they will be able to generate an economy of 10 bcm to 15 bcm to the current consumption level. Gazprom is characterized above all by giant proven gas reserves, legal and factual control over all gas exports from Russia, and extremely strong dependence of market capitalization on global energy prices. Gazprom’s ambitious goal is to develop into a world-class energy company. In 2005, the liberalization of trading company shares was making it the focus of attention of strategic and equity investors worldwide. At the same time, Gazprom remains a largely enigmatic company, with little consensus on its future development among interested parties, as apparent from numerous analytical reports The extent to which Gazprom will be able to successfully manage opportunities on a global scale is of extreme importance to the gas market players, including political figures. The Russian government elite treats Gazprom not just as a corporation, but also as the vehicle for promoting Russia’s political interests, similar to the approach towards most national or quasi-national energy companies worldwide. In this respect, 2005 became a landmark year for Gazprom when the government finally consolidated in its hands 50%-plus shares of the company. On the international stage, Gazprom is a major source of gas supply to Europe. In the last five years, Gazprom’s long-term contracts have satisfied between 25% and 30% of European gas demand, which makes the stability of Gazprom’s gas deliveries to Europe critical for the company’s key business partners in Europe, as their market position strongly depends on retailing Gazprom’s gas to final consumers. In this context, Gazprom’s intent to further globalize its operations and to get more involved down the supply chain forebodes substantial change in many markets. However, Gazprom is continuing to be highly dependent on the international gas markets. The policy under which Gazprom has to supply the less attractive domestic gas market in priority order, as well as the way Gazprom finances selected projects of ‘national importance,’ makes the European market critically important for the company. In 2004, over 73% of Gazprom’s total income came from gas sales outside Russia, mainly (but not completely) through Gazexport (Gazprom export, since 2006) the company’s international trading arm. Gazprom management supposed that the situation can start to change with phased grow of gas prices in Russia, which makes the internal trading operations more convenient from an economic point of view. But the growth of international gas prices demonstrated gas sales to Europe and to FSU countries share in Gazprom trading balance remained the important factor. In 2006, over 79% of total Gazprom revenues came from international sales. The Russian domestic market is in fact still subsidized by exports, which has negative implications for production. Gazprom’s investment capability will be directly dependent on its exports dynamics, which in turn will be strongly affected by developments in the domestic market. The situation is changing but very slowly, according to the social factor of gas prices increasing in Russia. Meanwhile, Russia is becoming a major importer of natural gas. As mentioned above, the depletion of traditional areas of production is leading to development of higher-cost domestic resources. The economics of producing natural gas in Central Asia, especially Turkmenistan, are stimulating imports. It is more economically effective to produce natural gas in Central Asia and to further transport it through Gazprom’s pipeline system, than to transport it from the more challenging production zones of Russia. For reasons of security of supply, as well as economics, future gas supplies for the Russian market will be a combination of imports and domestic production, with imports growing. The 2003 contract with Turkmenistan provides for supplying natural gas in the range of 70-80 bcm per year for a period of 25 years. Similar gas delivery contracts, though for much smaller volumes, have been signed with Uzbekistan and Kazakhstan. As of today, Gazprom’s long-term balance assumes that 70 bcm of gas will be imported from Central Asia. We believe this assumption to be very questionable. In the future, Russia could be importing over 100 bcm per year in that time frame, making it one of the world’s largest importers of natural gas along with being the world’s largest exporter of natural gas. The natural gas of Central Asia is being used and could be used in the near future to strengthen the biggest Russian gas company’s position. At the same time, it’s clear that Central Asian countries wish to be independent with their gas on Euro-Asian gas markets and will seek an opportunity to attain this independence. The current study aims to examine the key strengths and weaknesses affecting and shaping Gazprom’s global position. It looks at the company’s gas reserves, production, and transportation, as well as its current and anticipated marketing operations in Europe, Asia-Pacific and the United States. Based on an analysis of the main factors influencing Gazprom’s future exports and on the company’s strategic decision-making practices, a study develops three scenarios for development of Gazprom’s future exports that show an expected impact on global gas markets over the next twelve Whether and how Gazprom would be able to achieve sustainable growth in the future depends on how successfully it handles six major sets of priorities: • control over key domestic reserves • efficient management of the world’s largest gas-production operations • stable operation of the gas transportation system and its development • greater efficiency of domestic gas sales, with increasing gas prices for • higher returns from exports to current markets and penetration of new • control over Central Asian gas that could potentially compete with Gazprom’s Throughout the 1990s, Gazprom’s management had to face serious challenges related to all of the above priorities. The economic reforms in Russia, government regulation of gas prices, and weak international gas prices resulted in severe under-investment for Gazprom. On top of this, the largest Russian gas fields entered into their depletion stage, while the transportation system – the largest owned by any single company in the world – required sizable capital expenditures to operate stably. It was the period when gradual liberalization of the gas market began in Europe, and diversification of gas supplies became an important issue for the EU. This brought Gazprom under the impression that it was in real danger of losing part of its export income and of facing worsened economics of remaining contracts. The period of low prices was over by the late 1990s, which coincided with Vladimir Putin becoming Russia’s president in the elections of the year 2000. The new Russian leader started strengthening control over Gazprom by appointing new management that initiated a program of ‘emergency’ measures, including in respect to export markets. Fortunately for Gazprom, both gas demand and prices in Europe were growing, despite the liberalization process, which helped Gazprom raise capital for further development. Gazprom’s total gas sales grew consistently over the period 2000-2004 and reached $34.2 billion in 2004, which allowed the stabilization of gas production and expansion of the capacity of the gas-transportation infrastructure. Further sales growth was also fueled by gas price growth that followed oil price growth. Gazprom’s gas supplies to Europe reached 161.5 bcm in 2006, with 101 bcm more exported to the former Soviet Union countries – an outstanding level for Gazprom. The company signed agreements with the Central Asian countries and started selling its gas to Europe through Gazprom Export’s contracts. However, even with all these impressive successes, certain fundamental problems in Gazprom’s operations remained unresolved. In 2006, Gazprom’s gas sales reached $64.9 billion. It’s possible to note that approximately 10 bcm, which was included in Gazprom statistics, has non-FSU origin and was resold in European market, especially in Belgium and UK. At the end of 2005 Gazprom announced the decision to increase gas prices for all FSU countries to the “real market level,” a step explained by the necessity to mobilize financial resources from sales to these markets. In 2004-2005, Gazprom restored control over total gas deliveries to FSU countries. During 2006 and 2007, Gazprom realized this strategy to increase the profitability of gas sales, with the reduction of non- The period from 2006 to 2010 is going to be a time of important decisions for Gazprom’s management and the country’s government, and it will shape the role of the gas giant on the global gas market for at least the next two decades. Gas production has stabilized, but with unclear prospects since Gazprom has been limiting upstream activity in its main giant gas fields of the Nadym-Pur-Taz region (NPTR). The company needs to develop new gas provinces in order to meet the goals inside and outside Russia. Development of these new provinces – Yamal, Eastern Siberia and Far East – requires billions of dollars of capital expenditures. Yamal Peninsula has been named a priority investment project, and the Bovanenkovskoye field will produce its first gas as early as in 2011. At the same time, Gazprom attracted foreign partners French Total and Norwegian StatoilHydro to develop the Shtokmanovskoye field, complete with an export-oriented LNG plant and construction of new pipeline to support gas deliveries by Nord Stream. However, pursuing development of all the priority projects simultaneously is likely to be overly expensive and risky, despite several declarations of Gazprom’s management to the contrary. The company will thus need to make choices that will largely depend on the Russian government’s position in respect to reform of the domestic gas market, which in turn may allow Gazprom to secure the financial resources required for its major investment programs. Profitability of gas sales to the domestic market would also mean Gazprom’s dependence on the European market is reduced. In the medium and long term, Gazprom has no real alternative but to develop Yamal as its new core gas- production region. The Shtokmanovskoye project, in order to go ahead, will have to find solutions to the serious challenges of investment, market opportunities, and Table 1.1 Forecast of Gazprom’s investments in new upstream and transportation
projects until 2015 including shares in joint projects
Estimated
investment,
Title of the project
Gazprom's share (50%+1 share) in Shtokmanovskoye development (I phase) Bovanenkovo field development and Yamal-Ukhta gas transportation system Gas pipeline to transport Shtokmanovskoye gas to UGSS Total for large projects
74.2-86.2
In order to sustain gas deliveries to international markets, major investment has been planned for maintaining and developing the gas-transportation system. Construction of the Yamal-Europe pipeline and plans for the Nord Stream pipeline signal that the focus of European-bound exports is shifting to North-Western Europe and the Baltic Sea region. The new direct transportation leg from Yamal to Central Russia is another priority for Gazprom, since it would allow the company to make a profit on gas supplied to major domestic industrial consumers, in particular to power generation plants (note that this is true for gas used to generate electric power consequently supplied to industrial end-users; prices for residential consumers will continue to be government regulated). The idea of the South Stream gas pipeline project originated from the need to re-distribute gas streams from Russia to Southeastern Europe. The possibility of supplying gas to China has led to Gazprom’s talks with CNPC over the Altai gas Reconstruction of the Central-Asia-Center gas pipeline system will expand opportunities for Gazprom to include larger Central Asian gas volumes in its supply balance, under long-term inter-governmental agreements with these countries. Further expansion of the transportation system in Ukraine with the Bogorodchany-Uzhgorod pipeline would ensure strengthening of Gazprom’s market position in countries of Central Europe. The pipeline project, however, has little chance of being implemented since Gazprom’s strategy provides that shipments through Ukraine in the future will be reduced. The growth of Russian gas exports on a global scale, combined with integration of Gazprom into downstream gas markets, primarily in Europe, is the key external objective of the company’s management. The reason for this new approach rests with the fundamentally new market opportunities and the importance of taking advantage of them. However, today only the first steps toward creating an international corporate strategy are visible. The core premise of the new strategy toward countries is to secure and grow market share on foreign markets through integration of Russian and Central Asian gas flows under Gazprom’s control, followed by Gazprom/Gazprom Export marketing the gas in Europe and the FSU. Another key element is deeper integration into international downstream markets. Liberalization of the gas market in Europe is opening to Gazprom real opportunities to penetrate new market niches. The company has already taken steps to reach end-users in its traditional markets. Germany and the United Kingdom are prominent examples of markets where Gazprom has started to supply gas to end-users through marketing joint ventures or affiliated companies. Gazprom has started with short-term contracts and spot deals, yet long-term contracts will continue to be a basis of export operations. Consequently, Gazprom is getting ready to face stronger competition in Europe, while also trying to open new gas markets, particularly Asia-Pacific and North America, where LNG is expected to play a major role. At the same time, Gazprom is strengthening its control over the gas markets of the FSU countries and is gradually increasing the efficiency of exports by eliminating earlier practices of low gas prices. In this manner, ‘diversification’ is the key concept explaining Gazprom’s current export efforts, which are underpinned by the base premise of ‘single export channel’, promoted by Gazprom as the way to avoid competition between different Russian gas suppliers on export markets. This idea was incorporated in the relevant gas export law that President V. Putin signed in 2006. But as of now RosUkrEnergo, the company that deals with Gazprom’s gas exports to Ukraine is able to re-sell some of this gas to Europe. This has caused tension between the leaders of Gazpromexport and Gazprom managers, who controlled RosUkrEnergo. The current study presents three scenarios for Gazprom’s future role on international gas markets. All three scenarios see Russian gas exports growing by 2020, but differ in the anticipated pace of growth during this period, and especially in their outlook to 2020. Central Asian gas consistently plays a significant role in all three scenarios, with the divergence largely depending on Gazprom’s ability to develop its own gas reserves. To obtain additional information about the study pl
or contact Vsevolod Prosvirnin by phone: +7 (495) 778-9332 or via email:
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Source: http://www.rpi-inc.ru/pdf/newsletter/rge_2008_e.pdf