Gazprom Reviews Marketing Strategy, Forecasts Higher Gas Exports to Europe in 2010

Optimistic Forecasts Perhaps…

Coming off a year in which Gazprom not only saw its gas exports to Europe fall but also lost market share in the continent to competitors, the Russian gas giant held its first board of directors meeting yesterday in the capital, Moscow. The year 2009 was not kind to Gazprom, beginning with a commercial price dispute with Naftogaz Ukrainy that mushroomed into a two-week gas supply halt to 18 countries, and ending with the Russian company negotiating with its major European import partners on the delicate matter of "take-or-pay" penalties for their reduced offtakes below minimum annual levels. In between, Gazprom saw the bubble burst on rising European gas prices (although a recovery is already under way) and was forced to shut in some gas production, as well as push back timetables for several major new fields, including the Bovanenkovskoye field in the Yamal Peninsula.

This year has already got off to a better start, if only because the company managed to avoid a New Year's gas dispute with Ukraine. A political deal reached in November 2009 by Russian and Ukrainian politicians to reduce Ukraine's gas import obligations in 2009 and 2010 (in the context of that country's sharp economic contraction and subsequent weaker gas demand) has helped reduce the risks of a new confrontation. Indeed, Gazprom has expressed confidence that Naftogaz will in fact pay its January gas bill by the 7 February deadline, avoiding triggering a potential politically tinged dispute between the two firms on the same day that a new Ukrainian president will be elected. In an effort to put the past behind it, Gazprom has reportedly written off the 4.5 bcm of gas (worth approximately US$1 billion) that it was not able to deliver to Europe via Ukraine last year as a result of the January dispute, according to The Moscow Times.

Gazprom said that its declaration of force majeure during the January 2009 dispute with Ukraine absolved it of having to deliver this gas to Europe, which—in the overall context of Europe's weaker total gas demand last year—actually allowed the Russian firm's import partners to reduce the size of their fines under take-or-pay principles. Preliminary operational results for Gazprom showed that the company supplied Europe with 140.2 bcm of gas in aggregate, down 12.3% year-on-year, with European importers together taking approximately 8 bcm of Russian gas below minimum required levels under take-or-pay. Germany's E.ON has reportedly agreed to pay Gazprom around US$140 million for its own unused gas last year.

For the past few months, Gazprom has been touting the signs of a recovery in European gas demand, and the Russian gas firm's own production has picked up as a result. A cold winter heating season in Europe has provided Gazprom with a needed shot in the arm in terms of increased demand for its gas, but more forecasts still point to the overall weakness of European consumption for the next few years as economic growth remains largely flat. Gazprom, however, is still somewhat optimistic that the demand situation in Europe is not that bad, with the company revealing its 2010–12 European export plan yesterday. Gazprom is forecasting gas exports to Europe will increase to 160.8 bcm this year, followed by additional increases to 163.5 bcm in 2011 and to 170.9 bcm in 2012.

…But Realistic Assessment

Gazprom's optimism on the recovery in European gas demand is tempered somewhat by the sobering realisation that the U.S. gas market is perhaps no longer in play. Even as the Russian firm has launched a gas trading subsidiary in the United States and set about securing regasification capacity in North America in order to deliver LNG supplies, Gazprom is coming to the realisation that its ambitious plans to secure 10% of the U.S. gas market are no longer feasible in the context of the ongoing shale gas "revolution" in the United States. The boom in shale gas and unconventional gas production in the United States over the past few years has caught most of the industry, including Gazprom, off-guard, as what only recently appeared to be a gold opportunity for the Russian gas firm has all but evaporated.

Indeed, as the United States has quickly gone from being a potential major market for LNG imports to self-sufficiency, those LNG supplies are increasingly finding their way to Europe. Thus, the shale gas boom in the United States has the effect of a double whammy on Gazprom, not only curtailing its marketing options in the United States but also affecting the company's business in Europe. Weaker demand in Europe and increased LNG supplies in the Atlantic basin translated to a gas glut and a major arbitrage last year between spot gas prices in Europe and Gazprom's oil-indexed gas prices in its long-term contracts with its import partners. European firms took advantage of this arbitrage, reducing their offtakes of Russian gas and causing Gazprom to lose market share.

Outlook and Implications

Gazprom's solace in losing market share in Europe last year was in insisting on penalties under take-or-pay principles, but the Russian company's board of directors is well aware that this money is merely a sticking plaster on a wound that may require a tourniquet. Already, Gazprom is being forced to the negotiating table by its import partners seeking lower overall gas prices in their long-term contracts, and the Russian company's cherished oil-indexation pricing formula is under attack as a result. Gazprom deputy CEO Alexander Medvedev last week acknowledged that the firm has made several "modifications" to long-term contracts in consultation with its European partners, but it seems unlikely that those will be the last.