Independent gas firms will be game changer for Russia

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of PLC.

The rise of independent gas producers in Russia marks a paradigm-shift for the domestic market, and could ultimately challenge Gazprom’s dominant position both at home and in the export markets, argues Danila Bochkarev.

Danila Bochkarev is a senior fellow at the EastWest Institute.

"Russian Prime Minister Dmitry Medvedev surprised many energy analysts in Davos this January when he told the Bloomberg news agency that 'Gazprom may lose its monopoly on gas exports from Russia'.

The rise of independent gas producers in Russia marks a paradigm-shift for the domestic market, and could ultimately challenge Gazprom’s dominant position both at home and in the export markets.

Last year, two key Russian independents – Novatek and Rosneft – took important steps to consolidate their position both within Russia and abroad. Both companies have also conducted aggressive merger and acquisition (M&A) policies, focused on the extension of their reserves and client base.

By the end of 2010, Novatek had acquired a 25.5% stake in SeverEnergia and purchased 51% in Sibneftegaz. In August 2011, Novatek received four state licenses to develop new gas fields on the Yamal Peninsula and, in November 2012, the company bought a 49% stake in the independent gas producer Nortgaz.

The company’s direct and indirect expansion has included pipeline and petrochemical companies. Novatek purchased Mezhrigiongaz Chelyabinsk, a gas distribution company.

In 2011, Novatek’s key Russian shareholders took full control over Russia’s largest petrochemical conglomerate, Sibur. In December, Novatek agreed to supply Sibur with light hydrocarbons and liquefied petroleum gas (LPG), for a total value of 510 billion rubles ($17 billion).

Last year also brought important new clients for Novatek. In August 2012, the company concluded two supply contracts with E.ON Russia (€16 billion) and Fortum’s Russian power plants (€3.3 billion), and will provide these two companies with 180 billion cubic metres (bcm) of gas during the period 2013–2027.

In October 2012, Novatek started the implementation of its 10-year supply contract with German utility EnBW, with total volumes expected to reach 20 bcm. Initially, Novatek will be buying this gas on the market via its Swiss-based trader. In most cases, Novatek was replacing old Gazprom’s contracts.

The nomination of Igor Sechin as Rosneft’s chief executive favoured the company’s expansion both in the oil and gas sectors. In August 2012, Rosneft purchased 51% of independent gas producer Itera and the high-profile acquisition of a 100% stake in TNK-BP, which has important gas assets both in Russia (Rospan) and abroad, is planned to be completed in 2013.

Russia’s largest oil company also managed to expand its presence on the domestic market by signing two supply contracts with in November 2012. Rosneft will supply InterRAO with 875 bcm during the period 2016-40. The company also signed a supply contract with Fortum.

The decline of Gazprom’s output, a result of decrease in European gas demand, but also domestic consumption, gave Novatek and Rosneft an even higher profile in 2012.

According to data released by the Russian Ministry of Energy, Gazprom’s production decreased by 5.4% to 478.8 bcm, while virtually all independents producers increased their output. For example, Novatek’s production grew by 7.1% to 57.3 bcm per year.

Novatek and Rosneft also announced their ambitious plans to increase annual gas production to 112 and 100 bcm, respectively, by 2020.

The rise of independents is primarily explained by their ability to secure new supply contracts and to efficiently control lifting costs. Political connections have also played a role.

The ability to lobby for tax breaks and state aid have contributed to the success of energy companies such as Novatek. Yamal LNG would have been unthinkable without important tax incentives.

The favourable tax regime was a key factor in Total’s decision to partner with Novatek in the Arctic liquefied natural gas (LNG) project.

The emergence of the independents has dramatically changed the Russian gas market, creating an oversupply of natural gas in the domestic market, which had possibly reached 30 bcm in 2012.

Inside Russia, the key impact has been that Gazprom, the dominant supplier, has lost market share. The story has been similar to when Qatari LNG first started to compete in Europe: traditional suppliers lost market share because of the competitive pricing policy of the newcomers.

Currently, gas trade in Russia is regulated by the Federal Tariffs Service (FST). While Gazprom has to respect FST’ prices within a 3% margin, independents have the right to sell below the minimum price, allowing them to gain market share.

In an oversupplied gas market, the reintroduction of the spot trading, expected this fall, could boost even more the expansion of the gas independents at the expense of Gazprom.

Independents' ambitions are not limited only to Russia. In November 2012, Novatek requested an exemption from the gas export monopoly enjoyed by Gazprom for its Yamal LNG project in Northern Siberia. If Novatek is successful, Rosneft might follow suit.

So what is behind this change, and what will be its impact on gas exports and domestic gas market?

The emergence of the independents will have an impact on Gazprom’s gas monopoly. While the monopoly may formally remain intact – in particular for the pipeline gas exports – the independents may be allowed to bid for specific export quotas. The future pricing mechanisms to be used by the independents are yet to be determined.

Preliminary analysis on the EnBW contract suggests Novatek is most likely using a mixed pricing system (petroleum indexation plus a spot component, linked to North European gas hubs).

If implemented, such a measure would presumably fit in with EU’s drive towards a competitive internal market and the diversification of gas imports.

It may also improve the image and market positioning of “Russian gas” in Europe. In the long term, Gazprom will still remain Russia’s largest gas company, but it is likely to have to abandon some of its global ambitions and focus on internal reforms.

All these trends will lead to a “smaller” Gazprom, which will have to increase its operational efficiency and will need to review some of its upstream projects. This trend might also result in relatively low domestic gas prices in Russia. 

A longer version of the article was first published in Global Gas Analytics, a new monthly analytical publication by Interfax covering the global gas markets."