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Analysis: Gazprom Russian price increases

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by John C.K. Daly
Washington (UPI) Nov 6, 2008
One of the Bush administration's mantras toward its quavering European allies was to beware of increasing its imports of Russian natural gas, as it would only feed the ravenous coffers of the state monopoly Gazprom, Russia's largest company, which could be wielded in the future as a weapon by the Kremlin.

What a difference a global recession makes. A mere four months ago Gazprom CEO Alexei Miller stated that he intended to transform Gazprom into the world's largest company within seven to 10 years, when its capitalization was projected to reach $1 trillion from its current level of $362 billion. In the last eight years Gazprom's capitalization soared a staggering 4,600 percent.

It was not an idle boast. Gazprom currently has either direct control of or access to nearly 30 trillion cubic meters of hydrocarbon reserves, one-third of the world's natural gas reserves. Gazprom currently extracts 550 billion cubic meters of natural gas annually and exports around 150 billion cubic meters to 28 countries in Europe and the former Soviet Union.

And what a market Gazprom has, supplying about 25 percent of the European Union's natural gas imports, with its tendrils stretching to the English Channel. Among "old" European states, Gazprom supplies 65 percent of Austria's natural gas imports, 36 percent of Germany's, 27 percent of Italy's and 25 percent of France's. The further east an EU member, the greater the dependence on Gazprom. Of the new EU member states that joined in May 2004, Estonia, Latvia, Lithuania and Slovakia import virtually 100 percent of their natural gas via Gazprom. In Central Europe, the figures are nearly as high, with Hungary importing 89 percent, Poland 86 percent and the Czech Republic 74 percent. Finland, a member of the EU since 1995, is also 100 percent dependent on Gazprom, while Bulgaria and Romania, which joined the EU in January 2007, import 97 percent and 39 percent, respectively, of their needs. Other EU members enmeshed in Gazprom's export web include Slovenia, Greece, the Netherlands and Switzerland.

For the Kremlin, Gazprom is the crown jewel in the country's hydrocarbon industry, which in 2007 generated 64 percent of Russia's export revenues, representing 30 percent of all foreign direct investment in Russia, according to International Monetary Fund and World Bank estimates. Gazprom is also Russia's largest earner of hard currency, with its tax payments representing around 25 percent of federal tax revenues.

The term "monopoly" for Gazprom is certainly apt, as it has the exclusive rights of export of Russian oil and natural gas, while it is also the operator of Russia's entire gas and oil infrastructure, used by all other local and independent producers.

But the bad news for Gazprom is that within Russia's borders, Gazprom faces domestic regulation even as it engages in capitalist hardball pricing tactics with its foreign customers. Russia gets more than half of its domestic energy needs from natural gas. Under Russian law Gazprom is required to supply the natural gas used to heat and power Russia's domestic market at government-regulated prices, currently at about $28 per thousand cubic meters. In contrast, current Gazprom prices for the European market are $460 to $525 per tcm.

Enter the global economic slowdown. Rising prices have sharply reduced European imports. Gazprom's solution? Reduce European prices in 2009, to be compensated by raising domestic prices in Russia. In an effort to prevent 2009 becoming an annus horribilis for the mighty monopoly's bottom line, it is the Russian consumer who is shortly to feel the pain of higher natural gas prices.

Andrei Kruglov, Gazprom's deputy CEO and finance and economics chief, told a conference on Russia and the Commonwealth of Independent States, "Unfortunately, according to our forecasts, revenue from gas sales in Europe will start to decline in 2009 as oil prices fall."

Then, in language that would make even a buccaneering Western energy executive blush for its commitment to the "free" market and naked capitalism at its most rapacious, Kruglov unveiled Gazprom's intention to stick it to the Russian consumer, adding, "This reduction, however, will be partially compensated for by growth in prices on the domestic market, where we sell almost twice as much gas as we deliver to Europe. As a result, the negative impact of lowering oil prices will be significantly less. The domestic market will thus be an important factor for us in terms of supporting total sales revenue. Gas prices are to be raised by an average of 20 percent next year."

Starting in January, European consumers can thank Gazprom for prices that will reduce natural gas costs to $350 to $400 per tcm of the blue fuel. Gazprom Deputy Executive Sergei Chelanov cheerily told Russian journalists that for 2008, EU natural gas sales will net around $77 billion, which, added to Gazprom's other fuel exports, will give the company a final bottom line for the year of more than $100 billion.

For a nation that less than two decades ago proudly proclaimed its dedication to socialism, post-Communist Russia has embraced capitalism with a vengeance that would make Karl Marx blanch. In a classic case of "trickle down" economics, the wealthy European countries will get a price break during a global economic slowdown while Ivan Ivanovich in Siberia will dig deeper into his pockets so his increased payments "trickle" into Gazprom's coffers. While Europeans have the options of other natural gas suppliers, ranging from Algeria to Qatar, Ivanovich and his cohorts are effectively stuck since, as Gazprom is a state monopoly, his choice is more limited -- pay up or freeze.

In an attempt to shore up its "total sales revenue," Gazprom with the tacit backing of the Kremlin has decided to fleece Russia's captive consumers, who they correctly reason will cough up the extra cash precisely because they have no other options.

But such a policy may embody some hidden costs for its authors. Russian politicians congratulating themselves on their neat solution to Gazprom's cash-flow problems might recall that their nation is now a democracy, and if they want to understand how rising energy prices can affect national elections, they might call 1600 Pennsylvania Ave. before Jan. 20.

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