Gazprom Gas Export Pricing Under Attack at Home and Abroad

Pricing Strategy Under Fire

The shifting dynamics of the European gas market—or rather, the growing inter-connectedness of the global gas market, together with the economic downturn and the shale gas revolution in the United States—have put Gazprom on the defensive over the past six months over its pricing strategy. The Russian gas giant's insistence on maintaining its oil-indexation pricing formula for long-term supply deals with European customers has led to a loss of market share in Europe in 2009, as importers with a choice opted to buy more gas supplies on the spot market, where prices have remained well below the time-lagged, oil-indexed gas prices offered by Gazprom. As a result, European importers took on aggregate approximately 142 bcm of Russian gas last year, 8 bcm overall below the minimum "take-or-pay" (ToP) volumes obligated in Gazprom's aggregate supply contracts.

Gazprom has resolved several ToP settlements with its major European trading partners such as Germany's E.ON and Italy's Eni. Nevertheless, with gas demand still weak in Europe and a fickle economic recovery only barely under way, the company faces the prospect of another difficult year in selling gas into Europe. Although it is optimistic for a recovery in European demand, the increasing global gas glut—due to the commissioning of various LNG projects and the transformation of the U.S. gas market with the boom in domestic unconventional gas production—means that suppliers other than Gazprom appear poised to meet more of Europe's import needs, particularly as the gas giant stands firm in defending its oil-indexation gas pricing formula. In the face of growing competition, until now, Gazprom has been content to sacrifice volumes and market share for higher prices (particularly to the former Soviet states), allowing its gas sales in monetary terms to remain relatively stable (see Russia: 2 February 2010: Gazprom Posts Higher Q3 2009 Net Profits Despite Lower Sales Volumes).

Nevertheless, over the past few weeks the cracks in Gazprom's armour have begun to appear, with various company officials signalling that it will introduce more flexibility in its pricing formula. Last week, the company said that it would take European spot prices into account in its pricing formula in its long-term supply contracts, followed by a more precise statement by Alexander Medvedev, head of its export arm, that the company would allow some customers up to 15% of sales linked to gas prices on the spot market, albeit only for a three-year period, including 2010. Yesterday, Sergei Komlev, head of Gazprom's contract structuring, appeared to go a step further still, telling participants at the FLAME gas conference in Amsterdam (the Netherlands) that Gazprom is willing to amend its pricing to offer spot indexation as a temporary measure. Noting the ongoing divergence between spot prices and prices under the company's oil-indexed contracts, Komlev said, "In order to stimulate offtake...we offered some of our clients spot indexation for small portions over take-or-pay obligations."

Gazprom (Says It) Knows Best

At the same time that the firm is responding to pressure from its European customers, Gazprom is facing ongoing pressure from Russia's own Federal Customs Service (FCS) over its export pricing. Although last month it successfully fended off an attempt by the FCS to change the method and location at which it pays duties on gas exports from Russia, the FCS is not completely backing down just yet (see Russia: 17 February 2010: Gazprom Secures Victory in Dispute with Russian Customs Service over Export Duties). The Moscow Times reported last week that the FCS is now pushing a proposed change that would base Gazprom's duties on gas exports on the volumes delivered rather than the prices declared by the company.

The FCS argues that a volume-based export duty would make Gazprom's pricing more transparent. The gas giant currently pays a 30% duty on the sale price for each of its individual gas export contracts, but these prices are confidential and they differ for each of its customers. The FCS is saying, essentially, that this is the reason for changing to a volume-based duty, which would make duty payments easier to verify. Gazprom, however, has countered that the FCS proposal would decrease its revenue and thereby lower its overall duty payments. It has also argued that a volume-based duty would create confusion for commercial settlements, since different importing countries measure gas at different reference temperatures, raising doubts about the FCS stance that calculating the duty by volume would be easier to gauge than calculating it based on the declared price.

Outlook and Implications

Not surprisingly, the FCS proposal is facing resistance from Gazprom, but just because it would add new complications in calculating gas export duty payments does not mean that the agency will back down. Indeed, simply proposing the change after being defeated on the earlier proposal indicates that the FCS is willing to take a stand against the Russian gas firm, which is also under attack by the government over the company's operation of the domestic pipeline network. The Federal Anti-Monopoly Service (FAS) is slated to hold a hearing later this month on loosening Gazprom's restrictions on third-party access (TPA) to the domestic pipeline system. Russian oil firms and independent gas producers have long argued that Gazprom falls well shy of its commitment to ensure "open access" to the network.