HAS RUSSIA OVERCOMMITTED ITSELF?
But it is not only a question of whether or not there will continue to be such a strong demand for Russian gas. Several skeptics have also warned that Russia has overcommitted itself and has not invested enough in the development of new fields within Russia.16 Among others, German Gref, formerly the minister of economic development, has complained that Gazprom has not only failed to expand productive capacity and maintain its existing infrastructure but it has also neglected commitments to re-equip and expand gas pipelines and other essential facilities, 30 percent of which he says needs replacement.17 Furthermore, while neglecting essential producing facilities, Gazprom, he complained, has squandered capital on frivolous pursuits such as TV stations and newspapers. A report in the November 9, 2007, Financial Times warns that Gazprom is now spending more in expanding into other sectors of the economy than on developing new fields.18
A recent example is Gazprom’s commitment to allocate $375 million to build a ski resort with three hotels, a covered parking lot for 1,000 cars, and a ski lift for the 2014 Sochi Winter Olympics. That comes with being a national champion. (Vladimir Potanin with his Norilsk Nickel and Oleg Deripaska with his aluminum company, Rusal, both national champions, are also diverting similarly large sums to Sochi.) But in the case of Gazprom, it is money that will not be going to the development of new gas reserves.19
Leslie Dienes of Kansas University has also pointed out that as long as domestic energy prices for both petroleum and gas in Russia are prevented from reaching market levels, those below-market prices not only subsidize excess consumption but they also discourage investment in the development of new reserves.20 Prices are kept low for fear of a political backlash from the public if this benefit is eliminated. Dienes also points out that not only does the subsidized price for natural gas result in the misallocation of resources, but for the same political reasons, electricity rates are similarly controlled. Since natural gas is used to fuel almost half of the country’s electrical generators, limiting electricity rates means that the electrical industry, along with the public at large, also has a strong interest in preventing any increase in natural gas prices.
Indicative of the problem, the Russian electrical industry has estimated that it will consume 186 billion cubic meters of gas by 2010. However, Gazprom predicts that electricity generation will need only 168 billion cubic meters, a difference and possible shortfall of 18 billion cubic meters.21
In an effort to use market prices to restrain demand and increase supply, the government has decided to “liberalize” domestic gas prices—at least those that are paid by industrial users. To force nonindustrial consumers to pay much more was still deemed too risky. Nonetheless, by 2011, it is estimated that prices for industrial users will be double those of 2006.22 Jonathan Stern, director of natural gas research at the Oxford Institute of Energy Studies, argues that if Russia increased natural gas prices as much as they were increased in Ukraine and Belarus, less would be consumed and there would be no problem supplying both the domestic and foreign markets.23 John Grace agrees in principle but expresses it somewhat differently. “If domestic gas prices were at parity with the European market, there would be enough to supply both [markets]. . . . Even so it must be done at a very measured pace.”
After widespread criticism that Gazprom had not invested enough to guarantee future production, on May 31, 2007, the government released a draft investment program spelling out what was needed to “Develop a Unified System of Gas Production, Transportation and Supply in East Siberia and the Far East.” While the details made public are a little sketchy, this seemed to be an updated version of an energy development plan (whose details were also sketchy) covering both petroleum and natural gas that was first issued by the Putin government in 2003. If implemented, this latest version should forestall possible shortfalls. According to Alexander Ananenkov, acting CEO of Gazprom, by 2020 Gazprom should produce 670 billion cubic meters, a 14 percent increase in production.24
If production depended on Gazprom’s investing enough in the development of future reserves, there could well be a shortfall in supply. But there are other possible sources of supply: independent gas producers in Russia, of which there are at least two, and gas produced as a byproduct by the country’s several petroleum producers. In addition, Gazprom has also been able to count on reselling substantial quantities of gas from the Central Asian producers.
Admittedly, the gas production of Novatek and ITERA, both of which are independent of Gazprom (at least officially; in fact, Gazprom owns almost 20 percent of Novatek’s stock), amounted to only 40 billion cubic meters. Byproduct gas produced by the country’s petroleum producers equals another 40 billion cubic meters or so, which when added to that produced by Novatek and ITERA, equals about 15 percent of what Gazprom produces, which is a substantial amount. However, unless Gazprom allows Novatek and ITERA access to Gazprom’s pipeline, these non-Gazprom producers are limited to supplying consumers within a short radius of their operations. Similarly, in most cases the petroleum companies can produce more natural gas but refuse to do so, because if they want to sell it to customers farther afield or in foreign countries, they too have to gain access to Gazprom’s monopolized pipeline and Gazprom typically refuses access to any gas not produced by Gazprom itself. This exclusion is a legacy from the Soviet period.
On the rare occasion in the post-Soviet era when Gazprom has agreed to buy gas from a petroleum-oriented company like Yuganskneftegaz, it paid almost nothing for it. For example, in 2006, Gazprom paid less than $11 per 1,000 cubic meters for gas it grudgingly agreed to buy from Yuganskneftegaz.25 That contrasted sharply with the $100 per 1,000 cubic meters that even Belarus was paying at the time.26
Since access to Gazprom’s pipeline is not always possible nor profitable, the easiest way for the petroleum companies to dispose of their byproduct gas (associated gas)—and what for them is often a bothersome nuisance—is to flare it. According to an estimate by the French energy specialist, Pierre Terzian, Russian companies flare anywhere from 15 to 16 billion cubic meters of gas, an enormous waste. In fact a study prepared for the World Bank concludes that Russia flared more gas than any other country, twice as much as Nigeria, which was second only to Russia.27 This also contributes needlessly to earth warming.28 In part this was also due to the fact that until 2005, when Gazprom moved to absorb Sibneft, Gazprom did not seriously concern itself with petroleum production. It was almost completely absorbed in producing natural gas, so it had no interest in utilizing the associated gas produced as a byproduct by the country’s petroleum producers.
When the petroleum companies spun off from Rosneft became privatized, their quest for profit led them to sell both gas and petroleum for the first time. Yet with a few exceptions, they profited little from their natural gas production because Gazprom continued to deny them access to the Gazprom monopoly pipeline. The attitude of what the Russians refer to as Gazoviki was “You, the petroleum producing companies, have no business impinging on our natural gas production activities.”29
For those addicted to conspiracy theories, there seemed to be another reason for Gazprom’s refusal to allow pipeline access. In several cases, refusal to allow some of the petroleum companies access to the gas pipeline was a part of the continuing effort by Putin and his Kremlin associates to regain control of properties given away during the privatization era. Gazprom’s refusal to allow petroleum producers access to its pipeline was a way of preventing nonstate oil producers from following their contractual commitments to deliver gas and thereby forcing them to return ownership of potential gas fields to the country’s national champions. In other words, this was just another form of renationalization designed to look like an initiative undertaken by the private producer, not the state.
GAZPROM: A STATE UNTO ITSELF
As an example, Gazprom refused to allow TNK-BP to build a pipeline so it could transport the gas it was producing in its Kovykta field in East Siberia to eith
er large domestic or foreign markets. This was important because according to the terms of their license, TNK-BP promised that by April 2007 they would be producing 9 billion cubic meters of gas a year.30 But as the time approached and Gazprom refused pipeline access, TNKBP found that they could find a market for their gas only in Zhigalovo, a nearby logging town, and only for slightly less than 1 billion cubic meters. This was despite the fact that TNK-BP was charging a bargain $30 per 1,000 cubic meters when Gazprom was exporting gas at an average of $190 per 1,000 cubic meters.31 Of course, transportation costs and market conditions in Western Europe and East Siberia are not the same, so there should be some difference in price, but this still seems to be inordinate. Beyond that, the only way TNK-BP could reach other customers would be for Gazprom to let them build their own pipeline network to the border. Potentially, Gazprom could build a pipeline network that could serve larger foreign customers throughout Asia. TNK-BP even offered to build their own pipeline for that purpose but were denied permission to do so.
Since TNK-BP could not reach any large customers if they were to produce gas, they would have had to burn it off—not only a waste but against the law and harmful for the atmosphere.32 Alleged violations of other production commitments and charges of pollution forced Royal Dutch Shell and their Japanese partners to sell more than half of their holdings in Sakhalin II to Gazprom. It did not do anything for Russia’s reputation when Shell and the Japanese agreed to sell Gazprom a half interest (plus one share of stock) for $7.45 billion. Most estimates set the value considerably higher.
While such wasteful and narrow-minded behavior has benefited Gazprom economically in the past, if it should be unable to fulfill contracts with gas from its own fields, there is the possibility that it can always seek to supplement its deliveries with gas from the petroleum companies. This may result in only a relatively small percentage of what Gazprom delivers, but we don’t know. Until now, because of Gazprom’s determination to maintain its monopoly, independent gas producers as well as the petroleum companies have been pressured to curb, not expand, gas production. If instead they were to be rewarded for increasing their gas output, output would undoubtedly be considerably higher than it is now.
There have already been hints of a change in policy. After the government agreed to raise the price for domestic industrial users of gas, Gazprom assumed that this would stimulate so much production by others that by 2020 Gazprom would be producing only 65 percent of the country’s gas, considerably less than the 87 percent it produced in 2004.33
Gazprom’s acquisition of the petroleum producer Sibneft has also led to a change in Gazprom’s thinking. Now that a Gazprom subsidiary, renamed Gazprom Neft, is also drilling for petroleum, Gazprom finds itself producing the associated gas that comes up with the crude oil from the well. Gazprom now realizes that flaring much of that byproduct is a lost profit opportunity. Consequently, in August 2007, Gazprom announced that it had set itself the goal of utilizing 95 percent of what is called the “associated petroleum gas” (APG) by 2012. They extracted and used 14 billion cubic meters of APG in 2006 but expect to increase that to 22 billion cubic meters by 2011.34
Along the same lines, there is a growing governmental awareness of how much potential wealth is simply going up in flames. Even Putin has expressed his concern. In August 2007, he held a meeting with the heads of Transneft, Rosneft, and Gazprom, his favorite national champions, and warned them that if they burn off more than 5 percent of the APG they release into the atmosphere they will be fined. According to an estimate of the Ministry of Natural Resources, that could mean that the country’s petroleum companies (both state and private) will have to pay $580 million a year because, according to Putin, Russian oil companies burn off more than 20 billion cubic meters of APG a year.35
Gazprom has been able to count on one other source of supplemental natural gas. Until they can find some alternative routing, Central Asian producers such as Turkmenistan, Kazakhstan, and Uzbekistan will have to continue shipping their gas to Europe through Russia via Gazprom’s pipeline. As we saw when Gazprom cut off the flow of gas to Ukraine, much of that gas actually had been coming from Turkmenistan. Undoubtedly, the Central Asian producers will in time find some way to reach European markets by bypassing Gazprom pipelines, but for the near future most of their exports will continue to flow through Russia and at least some of this gas will continue to be resold by Gazprom as part of Gazprom’s contractual commitments.
Another alternative is for the Central Asian countries to turn east or south and sell to China, Iran, or India. Kazakhstan has done just that with its oil pipeline to China. The Kazakhs have also indicated their support for Turkmenistan, which has signed an agreement with China to build a new natural gas pipeline that begins in Turkmenistan and crosses Kazakhstan and Uzbekistan. It would supply 30 billion cubic meters of natural gas a year for thirty years. Access to gas from any of the three Central Asian suppliers would also allow China to bargain harder with Russia and Gazprom over prices. The Chinese are notorious for their hard bargaining over prices, and negotiations with the Russians have frequently broken down when no agreement could be reached.36 This has not contributed to better relations between the two countries. In 2007, the Chinese refused at first to agree to a price of $100 per 1,000 cubic meters. They reluctantly agreed to go up that high but the Russians wanted at least $125 per thousand cubic meters, pointing out that as of 2011, that would be the price within Russia itself. Even then this would be but half of what the Europeans would be paying.
WHAT ABOUT TOMORROW?
Whether or not the Russians will have enough natural gas to meet their contracts, some Russians for the first time are beginning to question the wisdom of seeking a continuing increase in petroleum and gas output. What is wrong, they ask, about stabilizing output or even discouraging or reducing production? By contrast, those seeking to increase output in the petroleum industry often criticize the tax on petroleum exports that claims most of the revenue collected once the price exceeds $27 a barrel. But proponents of a freeze in production support such a tax because it discourages, temporarily at least, investment in further exploration and development. This postpones such exploration for now and means there will be more set aside for the future.
Yet if production of either natural gas or petroleum should drop or even stabilize, Russia may be unable to meet all of its export commitments. In some cases this might result in a contract violation (something not unprecedented in Russia). But since the rule of law involves a less than fully formed yardstick at best, curbing output and then failing to honor agreed-to contracts would not be regarded by many Russians as a particularly serious crime.
While he did not support any effort to break existing contracts, Sergei Karaganov, deputy director of the Institute of Europe, wondered aloud at a meeting of the Valdai Hills group in Moscow in September 2006 why Russia was so intent on increasing its annual production of petroleum and gas. Rejecting arguments that Russia should take advantage of the moment when prices were at a record high, he asserted that Russia had already collected more revenue from foreign energy sales than it knew how to spend. Look at the $100 billion put aside in the Stabilization Fund as of September 2006 when he spoke, not to mention the more than $300 billion hoard of foreign currencies and gold accumulated in the Russian Central Bank vault. Besides, if their energy reserves were valuable in 2006, given the growing world demand it was more than likely that such deposits would be even more valuable in the future. Further, he noted, the demand for natural gas is fairly inelastic, at least among already existing purchasers. Thus if supplies were reduced, the price for the gas that is being sold would most likely rise so that total revenue might actually increase.
President Putin, however, takes a different stance. At the 2007 Valdai Hills meeting he insisted that Russia should produce as much as it can immediately before someone discovers an energy substitute that leads to a drop in oil and gas prices.
JUST THE FACTS, PLEASE
&
nbsp; Thus while some insist that Russia has not invested enough in new field development and production to assure that it can honor its existing contracts, others argue that Russia should sell its oil and gas as quickly as possible rather than set aside reserves for the future. But what has actually been happening?37 Data taken from BP’s annual statistical survey and used in Table 7.2 suggest that despite warnings that growing consumption within Russia will soon make it impossible to set aside enough oil and gas to meet export obligations, so far Russia seems in no such danger, at least in the short run. In the case of petroleum for example, as of 2006, the amount produced and available above and beyond domestic needs has, if anything, increased each year.
As for natural gas, the trend is not as pronounced. The amount available in 2006 was 10 percent less than it had been in 2005, certainly a worrisome sign. Yet the amount available has fluctuated up and down from year to year. Thus while the export potential was also less in 2006 than in both 1996 and 1999, the amount available for export in 2006 actually was higher than it was in 2000, 2001, and 2002. Russian authorities would do well to discourage wasteful consumption and encourage investment in new fields, but, for the time being at least, there appears to be a comfortable cushion.
Petrostate:Putin, Power, and the New Russia Page 24
