July 3, 2013

The future of Gazprom between international transformations and domestic rivalries

The future of Gazprom between international transformations and domestic rivalries. The largest single producer of natural gas in the world might face serious problems in the near future. Just as it celebrates the twentieth anniversary of its incorporation, Gazprom is back to a low point in both domestic and international achievements. The state-owned company is engaged in a frenetic and grandiose activity, with many titanic new projects in the making, and it occasionally has to publicly defend its business strategies. This behavior may seem untimely at a historical point when the stark reality would need a more mundane and pragmatic approach.

The future of Gazprom between international transformations and domestic rivalries. The largest single producer of natural gas in the world might face serious problems in the near future. Just as it celebrates the twentieth anniversary of its incorporation, Gazprom is back to a low point in both domestic and international achievements. The state-owned company is engaged in a frenetic and grandiose activity, with many titanic new projects in the making, and it occasionally has to publicly defend its business strategies. This behavior may seem untimely at a historical point when the stark reality would need a more mundane and pragmatic approach.

It seems that centuries have passed since the 2008 peak when Gazprom CEO Alexei Miller announced that his company would reach a market capitalization of $1 trillion. That year, Gazprom sold 184.4 billion cubic metres (bcm) of natural gas to “Europe” (which it defines as every country to the west of the former Soviet border, including Turkey and the Balkans). Exports to “CIS and Baltic” market amounted to 96.5 bcm. About of half of Gazprom’s sales were directed abroad. However, the gas row with Ukraine in 2009 dramatically lowered exports, as domestic production began to slow down. “Europe” received 80% of the volumes it imported the year before. Market capitalization sunk from $300 million to $80 million, falling behind most oil and gas majors.

Since this fall, Gazprom has not been able to recover its dominant position in the European market: although traded volumes of natural gas have slightly increased, the share of Russian gas in European imports remains about 25%. Since production within Russia is stagnating for Gazprom, the company’s outlook for the next decade is rather conservative, a sign of the waning bullish attitude typical of just a few years ago. Only sporadically, the “wounded giant”, as The Economist labeled the company, boasts about its necessary role as a supplier in Europe, for example when Miller declared). that last March, Gazprom was able to increase its deliveries by 33.6% on a year-on-year basis.

Aside from the fortunate contingency of a harsh winter in 2012-13, on the export side, Gazprom also faces challenges from the price competitiveness of natural gas hubs. These hubs are selling increasingly larger volumes at spot-market prices that are now lower than those linked to the price of oil. As a tacit acknowledgement of its overpricing in past years, Gazprom recently granted “refunds” to its European customers. This outflow of cash has deflated the management’s confidence on the slowly growing profits, which appeared on the books precisely due to its inflated prices.

On the domestic side, the surge of non-Gazprom producers (NGPs) has washed away some of the company’s share of the Russian market. Last week, Rosneft completed the purchase of ITERA, thereby confirming its inclination to become a key actor on the domestic gas scene. Over the past few years NGPs have conquered more than one quarter of the domestic market, as their lower production costs have made their prices competitive with the capped price that the Kremlin imposes on Gazprom.

Back in 2005, it seemed that Rosneft was about to merge with – and thereby take over – Gazprom. Most commentators were surprised when neither bride nor groom showed up at the altar. Instead, Gazprom purchased Sibneft, strengthening its oil business, and Rosneft became the largest oil producer after the Yukos rebate season. Far from becoming staunch competitors, Rosneft and Gazprom have kept following their respective business models, closely tied to the national energy strategy.

Over the years, Rosneft acquired stakes and fields, sealed agreements and sailed for offshore ventures. Last March it completed the buyout of BP’s share in the TNK-BP joint venture, while during the past few summers it explored the Arctic for recoverable oil. Rosneft has expanded the base of natural gas production through the purchase of ITERA in May, and has now reached new ground in its negotiations with China over eastward oil supply, inking a 25-year contract for a total of 365 million tonnes, worth $270 billion in June.

This stronger Rosneft was quick to reject former-President Dmitri Medvedev’s recent proposal to sell off around a quarter of the government’s shares in the company. Rosneft Chairman Igor Sechin is not willing to see Russia’s shares reduced to 56% while ramping up on investments and new projects. While Rosneft grows, Gazprom shrinks: last March, Putin agreed to consider allowing NGPs to export LNG, although no one in the government has yet officially questioned Gazprom’s monopoly on the pipeline system. In addition, lower prices, lower demand, and more stringent regulations in Europe have not yet triggered the eastward inclination that Putin would like to see. The worry in the Kremlin is that such an imbalance between the two national champions could lead to a new domestic political equilibrium.

Due to the slow reaction pattern that Gazprom has demonstrated to the ongoing “gas revolutions” (shale gas, hub prices, LNG, economic crisis) and given the inertia of the Russian business environment, the gas market is not going to be liberalized in the way that European and American observers would prefer. Instead, the outlook for the near future looks inconvenient for a resurgence of Gazprom as the principal supplier of natural gas to Europe, while Rosneft awaits brighter days ahead through the new partnerships in the East.

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