Moscow’s promise to pay “European” prices for central Asian natural gas marks out the direction of sweeping changes in the international trade and in Russia’s domestic market.
The plan will further strengthen Russia’s hand in international gas markets. It makes schemes to export central Asian gas to Europe by non-Russian routes that much more difficult; it puts Ukraine and Belarus on the back foot in negotiations on import prices; and it protects supplies for those western CIS customers so that Russia can keep its own gas to meet ever-rising domestic demand.
Turkmenistan, Uzbekistan and Kazakhstan jointly export about 55-60 billion cubic metres (bcm) of gas per year – equal to about three-quarters of Ukraine’s consumption, or half of Germany’s – almost entirely into the Russian pipeline system. Most of it is sold on to Ukraine.
The principle that from 2009 the gas will trade at “European” prices – that is, roughly, the price charged for Russian gas at the German border, minus transit fees – was laid down in March, at a meeting between Gazprom chief executive Aleksei Miller and his opposite numbers Yagshigeldy Kakaev of Turkmengaz, Nurmmukhamad Akhmedov of Uzbekneftegaz and Uzakbay Karabalin of Kazmunaigaz.
European border prices are currently close to $400 per thousand cubic metres (mcm), while Turkmen gas is sold to Gazprom for $130/mcm at the Turkmen border, and sold to Ukraine at the Russian border for $179.50/mcm. Next year a European netback price could be almost twice that level. The background to these steep price rises is the historically high oil price. In Europe, most natural gas is sold on long-term contracts tied to a basket of oil products and therefore to oil prices.
In the short term, the central Asians’ announcement was bad news for Ukraine, which could be forced to pay European netback prices from 2009 rather than from 2011, as Belarus should. It came just after Ukraine had fought its latest “gas war” with Russia: on March 4-6, Gazprom reduced supplies to Ukraine, and Ukraine retaliated by warning that the transit of gas to Europe could be affected.
A deal struck on March 13, right after the central Asians’ announcement, went some way to meeting Ukrainian prime minister Yulia Timoshenko’s demand that intermediaries be removed from the import arrangements – but also mooted that next year’s import prices will be settled with reference to what the central Asians charge.
On a larger scale, these events signal the end of fixed, low gas prices in the former Soviet Union – a huge step in the transition to the market. European-type gas pricing, pegged against a basket of other fuels and allowing inter-fuel competition, beckons: this, along with the liberalization of the Russian power market, is a quantum leap away from the Soviet legacy.
“We are seeing the harmonization of pricing mechanisms across the former Soviet Union,” Tatiana Mitrova, head of the Centre for International Energy Markets Studies at the Russian Academy of Sciences’ Energy Research Institute, tells Emerging Markets. “First the Baltic states agreed to link natural gas prices to an oil basket, as is done in European contracts.
“The same thing was agreed with Ukraine and Belarus. Then in November 2006 came the Russian government’s decision to bring domestic prices up to European netback levels by 2011. Now we see this same principle moving east.” The central Asian exporters’ announcement had been surprising only because it came “a little faster than many observers expected”.
Not good for Europe
Moscow has not only offered a hefty increase in what it pays for central Asian gas, it is also pressing ahead with building pipelines for it. In December, gas industry heads from Russia, Turkmenistan and Kazakhstan signed an agreement to build the Prikaspiisky pipeline along the east coast of the Caspian, to carry 20 bcm of gas per year north to Russia’s Saratov region.
By tying up central Asian supplies, and promising to pay good money for them, Russia is hoping to ward off competition from both China and Europe for central Asian gas.
Attention from both east and west has been focused in Turkmenistan, where the government talks about raising production from the current 60-odd bcm/year to 160, while experts think 100 bcm is a more realistic figure in the next decade. Gurbanguly Berdymukhammedov, who took over as president early last year, has courted foreign oil companies more convincingly than his erratic predecessor, Saparmurat Niyazov.
In July last year, the Chinese oil and gas company CNPC signed a production sharing agreement with Turkmenistan to produce gas onshore. China also agreed to build a 7,000km pipeline to carry up to 30 bcm/year of Turkmen gas to Shanghai.
But CNPC will struggle to compete with Gazprom on price. When reports appeared in the press that it would pay the equivalent of $140/mcm on the Turkmen border, CNPC denied them: Gazprom is now offering up to twice as much.
The European Union – which is seeking to reduce dependence on Russia for gas, which it fears could rise to as high as 40% of its supply over the next decade – has fallen even further behind in the competition for central Asian supplies. Europe has for many years endeavoured to find ways of importing gas from central Asia, avoiding Russia. But although foreign oil majors working in Azerbaijan could commit some gas to such projects, without some volumes from Turkmenistan they will be very difficult to do.
The project that has moved furthest ahead, the Nabucco pipeline – that would run from Turkey to Austria via Bulgaria, Romania and Hungary – received a boost in February when RWE, one of Germany’s largest energy companies, joined the consortium.
But at the same time Austria, Bulgaria and Hungary signed up to a rival Russian project, the South Stream pipeline. OMV, the Russian company that runs the key gas terminal at Baumgarten, says it will be open for gas from both pipelines – but industry observers reckon South Stream has the edge.
The biggest losers of all are the US administration, which has raised the stakes in its geopolitical battle with Moscow by supporting Nato membership for Ukraine and Georgia, and plans to site missile bases in central Europe – and has been the strongest supporter of European diversification away from Russia.
When US secretary of state Condoleezza Rice appeared at the Senate foreign relations committee in February, once again to denounce Moscow’s “reprehensible rhetoric” about targeting nuclear missiles on Ukraine, she added with reference to central Asia that “some of the politics of energy is warping diplomacy.” Asked about Russia’s progress in tying up central Asian gas supplies, she assured the committee that she hopes to appoint a “special energy coordinator” to recover lost diplomatic ground in the area.
Expensive for Ukraine
While Europe worries about diversifying gas supply away from Russia, other former Soviet republics worry about paying for the large volumes of gas they receive – none more so than Ukraine, which consumes as much as the whole African continent, or as Japan. Per head, it consumes even more than Russia.
Ukrainian import prices have risen from $50/mcm in 2005, to $95/mcm in 2006, $130/mcm in 2007 and $179.50 this year. The first step up coincided with the first “gas war” of January 2006, when Russia reduced throughput for three days. Then, economists at the World Bank – not to mention Ukrainian politicians – warned of the dire consequences of price rises. But industry managed to swallow them, while residential supplies were subsidized.
It appears that high prices for Ukraine’s main exports – steel, steel products and fertilizers – sheltered the economy from much of the impact that economists had expected. The strength of its biggest export market, Russia’s, helped.
Whether the Ukrainian economy will hold up so well this year and next is an open question. So far, industry seems to be able to pay higher prices, but others are struggling. In mid February, when President Yushchenko went to Moscow to haggle over import arrangements with President Putin, he wrote to the government and municipalities, complaining that only 35% of residential and municipal sector gas bills due in January had been paid – suggesting the return of the non-payment problem which had dogged former Soviet economies in the 1990s but has largely disappeared in recent years.
Another depressing statistic for Ukraine is that its own gas production – each increase in which means less dependence on Russian and central Asian imports – fell slightly in 2007, despite plans to raise it substantially. Valentin Zemlyansky, spokesman for Naftogaz Ukrainy, the Ukrainian national oil and gas company, tells Emerging Markets that, over the longer term, the key to the problem lies in energy-saving programmes. “But for now, we have to set prices with Russia for next year through negotiation.”
He acknowledges that by agreeing higher prices with the central Asian exporters, “Russia has killed two birds with one stone. It has made things difficult for the European and American governments, who would like to have access to cheap central Asian gas, and it has put pressure on Ukraine.”
Payment for Russian industry
If European netback prices are a challenge for Ukraine, they should be even more of a challenge for Russia, whose domestic consumption is 340–360 bcm/year, about three-quarters of the EU’s.
In November 2006, the Russian government set out a plan for prices to rise to European netback levels by 2011 – and so far everyone is sticking to the timetable. A prime mover in shifting both gas and power prices upwards has been Anatoly Chubais, head of the national power company United Energy Systems, which has sold off almost all its assets, prepared the way for market liberalization, and is due to be dissolved this year. Since the power industry is the single largest customer, this has helped.
Government officials started publishing a nominal European netback price in November at around $168/mcm. This year, industry is paying 25% more than last year – $63/mcm, with customers in most big industrial areas paying $10–40 extra to cover transport.
Customers who want extra volumes have to purchase them on a gas exchange at much higher levels, or even pay penalties – and the extent to which they are doing so is surprising, Mitrova of the Russian Academy of Sciences says. “We do not see any reduction of demand caused by price increases. On the contrary, industrial consumption is increasing continuously, due to the all-round strength of the economy.”
Indeed, most experts are so bullish on Russian demand that the question over the next 10 years is whether Russia will have sufficient gas supply, in advance of gigantic projects such as the Shtokman field in the Barents Sea and the Yamal peninsula coming on stream.
Mitrova is sanguine on this, too. She believes that sufficient extra volumes will be available in western Siberia, using technology, and that a plan being worked on by government and the oil companies to reduce flaring of associated gas will also help.
Natural gas will remain a constant in former Soviet economies for a long time to come. But the days of cheap fixed prices are drawing to a close.