Gazprom’s Asian ambitions no pipedream (AFR Resources Daily 28 September)

What would it be like staying in a hotel run by a monopoly gas supplier: great security but a bit weak on customer service? So it was at Gazprom’s Hotel Vniigaz in the outer suburbs of Moscow, where I recently spent a week attending a meeting of the International Gas Union hosted by Gazprom. Security was excellent. The hotel is surrounded by a tall iron fence with spikes and to enter and leave you have to go through the guard post. However it was not so good on customer service. If you want dinner at the weekends, sorry but you will have to go back to Moscow. Not even coffee-making facilities or anything in the bar fridge. Not even a Gideon Bible or A Day in the Life of Ivan Denisovich to read.

However, while Gazprom is not likely to threaten Hilton or Hyatt in the hotel business, it is the world’s biggest producer of natural gas.

Russia has the world’s largest proven gas reserves (1,046 trillion cubic feet at the end of 2010 according to BP). Gazprom claims to hold 70% of Russia’s reserves and 18% of the world’s reserves. Russia is the world’s second biggest gas producer, just behind the United States, and Gazprom produces 78% of Russian gas, which is 15% of the world’s gas. It supplies almost 30% of the gas consumed in Western Europe and a much higher percentage in Eastern Europe.

In barrels of oil equivalent, its total production is more than twice that of Exxon and it has 400,000 employees. It also owns Russia’s gas transmission pipelines (including export pipelines) and sells gas through Russian regional gas companies and European gas distributors. It is increasing its direct sales to European end-users (notwithstanding the desire by the EU to unbundle the European gas market).

Gazprom is Russia’s largest joint stock company. While 50 per cent is privatised, it has an intimate relationship with the Russian Government. Dmitry Medvedev was Chairman of Gazprom before becoming Russian President. The Chairman, Viktor Zubkov, is First Deputy Prime Minister and the Board also includes the Minister of Economic Development and the Energy Minister. Viktor Zubkov was Deputy Head of the External Relations Committee of the St. Petersburg Mayor’s Office in the early 1990s when Vladimir Putin was Head of the Office. Alexey Miller, the Gazprom Chief Executive, also worked in the External Relations Office at the same time. Gazprom clearly has a lot of clout in government relations and similarly it plays an important role in Russian foreign policy.

The average price of gas sold by Gazprom in Russia in 2010 was A$2.00 per gigajoule (GJ). The price of gas sold to Germany, linked to oil and reflecting higher transport costs was US$13.34 per million British thermal units (A$11.77/GJ) at the border in August according to Argus. Gas prices to countries of the former Soviet Union (such as Ukraine) are being increased to market levels but pricing depends on what Gazprom describes as “the degree of integration with Gazprom’s gas business”. The former Ukrainian Premier, Yulia Tymoshenko, is in gaol in her country for agreeing to buy gas from Russia at prices expected to reach around A$11/GJ next year. If the Ukraine wants to revise this contract, Russia is demanding that it merge its gas company, Naftogaz, into Gazprom and that it join a customs union with Russia. The Ukraine wants to join the EU.

Russia’s leverage has been increased by the recently completed Nord Stream pipeline from Russia direct to Germany, which does not transit other countries.

While Gazprom has long been focussed on Russia and Europe, its activities in the Far East are growing. Russia’s first LNG project, Sakhalin 2 commenced production in early 2009 and is now operating at its full 9.6 million tonne per annum of capacity. Japan is the main customer but LNG has also been sold to Korea, India, Kuwait China and Taiwan. Gazprom is considering expansion to a third train.

Gazprom has also long been interested in supplying pipeline gas in the Far East and on 11 September completed a 1,800 km pipeline from Sakhalin to Vladivostok. The pipeline has been built to meet domestic needs but Russia would like to extend the pipeline through North Korea to South Korea. Kim Jong Il discussed the plan in meetings with Dmitry Medvedev in August. The Weekend AFR (25-26 September) quotes the South Korean President as saying that plans to build such a pipeline were realistic. North Korea would get the benefit of a transit fee and access to gas while South Korea would get an additional source of gas while having the insurance of its substantial LNG contracts and gas storage.

The big prize for Gazprom in the Far East would be supply of pipeline gas to China. In 2010 Gazprom and CNPC agreed on major terms and conditions (except price) to supply China with pipeline gas from 2015. Contracts were due to be signed this year but this did not eventuate, with Gazprom reported to be seeking around A$10/GJ and China only willing to pay around A$6-7. With this gap in price expectations it does not look likely that Gazprom will win this prize in the near future, with China focussed on LNG from Australia and pipeline gas from central Asia.