Following the revolution in Ukraine, the ousting of ex-President Viktor Yanukovich and Russia’s annexation of Crimea, Gazprom, Russia’s sole natural gas exporter, has almost doubled Ukraine’s natural gas price. According to the state-run gas giant, the price was raised due to the cancellation of two major discounts.
One of the discounts was granted to Ukraine for permitting the Russian fleet to use Crimea’s city of Sevastopol as its base. When Crimea became part of Russia, the agreement and the discount were canceled by Russian President Vladimir Putin in early April. The second discount, for timely payments, was canceled a few days later because Ukraine failed to fulfill its obligations to get a discount. Western political leaders have accused Russia of energy bullying and threatened it with sanctions.
In May, Russia signed a 30-year deal, worth $400 billion, to deliver gas to China. The media speculated on the reasons why, after 10 years of unsuccessful negotiations, the two countries managed to come to an agreement. One of the assumptions was that the deal was Putin’s reaction to the potential threat of European sanctions against Russia following the Crimean crisis.
During the St. Petersburg International Economic Forum in May, Alexey Miller, CEO of Gazprom,said the recent contract between Russia and China will likely influence gas pricing in the European market. With many details to discuss and hundreds of kilometers of pipelines to build, it is unclear what the selling price for China will be, or in what ways the contract can affect Europe.
According to Dr. Mikhail Korchemkin, managing director of East European Gas Analysis, a consulting company, the agreement between Gazprom and the China National Petroleum Corp. will not affect the price of Russian gas sold to Europe. “First, European prices are set by existing contracts,” Korchemkin said. “Second, East Siberian gas fields are not connected to Europe, so this gas cannot be sold to Europe.”
However, the setting of gas prices for European countries raises a lot of questions. The price varies from country to country. Gazprom is secret about commercial transactions, and the terms of agreements for long-term gas contracts are generally not disclosed. In Europe there is no market price for natural gas, as such. Also, there is no standard formula that would define gas prices for wholesale customers.
In the late 1960s, Gazprom introduced the contract model, in which gas prices were tied to oil prices. In 2012, the European Parliament called for liberalization of the gas market. The new model implies the development of an integrated European system of gas indexation, which would allow European gas companies to trade with gas providers on a more predictable basis. Instead of being dependent on oil price dynamics, gas prices would be set in gas hubs (centers of market trading).
Due to the secrecy around the terms of the agreements, it is difficult to estimate to what extent the new model has been introduced in practice. Korchemkin said the share of spot-indexed gas sales is growing. “For instance, this year Italian Eni and Gazprom signed a contract fully indexed to the spot price of gas. Norwegian Statoil has shifted from oil to gas indexation in all contracts.”
Based on data accumulated from gas supply companies and energy consultancies, Reuters published a report in March 2013 showing that only about 35 to 38 percent of all major European gas supplies are now priced off traded hubs. American research company PIRA Energy Group came to the same conclusion in its 2013 study, which estimated that roughly two-thirds of European gas consumption is still oil-indexed.
Putin voiced an official position during the Second Summit of the Forum of Gas Exporting Countries in July 2013. “Tying gas prices to oil prices is the most relevant, fair and tradable,” he said.
For Gazprom, that solvency of gas market auctions is so far insufficient for shifting to a new model of pricing. For example, one of the indexes of solvency is the correlation between the volume of gas trading in the hub and the volume of real shipping (the so-called churn ratio). The hub is considered to be marketable if the churn ratio is at least on the 10-15 level. So far, this applies only to the British market. In the rest of the European markets, the churn ratio is still significantly lower.
As a result, Gazprom developed the system of discounts. Because of it, the Russian monopoly’s average European price is close to the market price. At the same time, the dependence of gas pricing on oil prices remains.
Exported natural gas is significantly more expensive than the gas sold to Russian customers. In 2012, prices for Russian gas were on average three to four times higher for Western Europe, and more than 3.1 times higher for the members of the Commonwealth of Independent States and the Baltic states, than for Russian customers.
Gazprom has never officially disclosed prices for Europe. The European Commission tried to make European Union countries disclose the terms and conditions of agreements with Gazprom but didn’t succeed. Sale prices from Gazprom to 21 other European countries were revealed for the first time, in February 2013, by the daily newspaper Izvestia, which claimed the information was obtained from the company’s executives. No names were revealed, however.
Data show that one price does not fit all for Russia’s European gas consumers. West European countries pay less to Gazprom than do the poorer Central and Eastern European countries. Poland and the Czech Republic pay over $500 per thousand cubic meters of gas, while across the border, Germany pays less than $400.
“Contract price depends on many factors, such as the seasonal curve, take-or-pay level [the minimum volume the buyer has to purchase, even if it uses less gas], interfuel and gas-to-gas competition [competition among different fuel types and gas sources],” Korchemkin said. “Moreover, a company may buy Russian gas at two or more contracts with different prices,” depending on the contract terms.
In an interview with Radio Free Europe James Henderson, a Russian oil and gas industry expert at the Oxford Institute for Energy Studies, said that Gazprom sets its prices “according to what the alternatives in those countries are.”
“It essentially acts as a discriminating monopolist,” Henderson noted. “If it has a significant market share in a country, or if it can see that a country has limited alternatives, then it prices accordingly.”
EU member states have always found it difficult to find consensus when it comes to natural gas diplomacy. On April 29, Gazprom and OMV, an Austrian energy company, signed an agreement on the development of the South Stream pipeline. The proposed 2,500-kilometer route would stretch from Russia under the Black Sea through Bulgaria, Serbia and Hungary and into the Austrian Baumgarten gas transport hub. The new pipeline would bypass Ukraine, providing Europe with an alternative route of gas imports totaling around 32 billion cubic meters annually, starting in 2017.
Moscow successfully circumvented the EU’s “third energy package” regulations in the South Stream project as it started signing bilateral deals. It is even more difficult now to talk about joint purchases of Russian gas and a uniform price for European countries.