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2015-05-29 18:20:00

RUSSIA STRENGTHENS POSITION

RUSSIA STRENGTHENS POSITION

Just two years ago, Gazprom spent a reported $1bn on its 20th birthday celebrations, with Sting and the Bolshoi ballet entertaining President Putin and company executives in a lavish gala dinner hosted at the Kremlin.

And there was much to celebrate. Russia was the undisputed king of gas - the world's biggest producer with the biggest reserves and the biggest exports.

But the party has since fallen rather flat.

Weaker demand in Europe and plunging natural gas prices have hit revenues, while US and EU sanctions over the country's actions in Ukraine are targeting Russia's energy sector.

Add an EU charge of monopoly abuse, increased competition from Qatar and a potential glut of US liquefied natural gas (LNG) flooding the market next year - not to mention the possible unleashing of Iran's vast gas resources if sanctions are lifted following a nuclear deal with Tehran - and the threats are both numerous and real.

With state-controlled Gazprom, which dominates Russia's gas industry, one of Moscow's primary foreign policy levers, the stakes could not be higher.

As the biggest single supplier of gas into Europe, will Russia's influence on the continent begin to wane, and will she flirt ever more with China to compensate?

Plunging profits

Most gas contracts are indexed to the price of oil, which has slumped more than 40% since last summer, dragging natural gas prices down with it. Mild weather and cutting off supply to Ukraine following a contract dispute compounded the problem - Gazprom saw profits plunge almost 90% last year, from more than $20bn to $3bn.

GLOBAL GAS PRICES

And with the oil price likely to remain relatively weak for the foreseeable future, revenues will remain under pressure. As Michael Moynihan at energy consultants Wood Mackenzie says, "the gas price is low and it's not going back to the highs of two years ago".

But low prices are hitting all gas producers. In fact, Mr Moynihan says, a weak rouble is helping to make Russian gas companies, which also include big producers such as Rosneft and Novatek, more competitive - allowing them to make the same profit margins despite falling prices.

The question for Gazprom now is whether to cut exports to combat oversupply, thereby supporting prices, or to keep volumes high to protect its market share. Rather like Saudi Arabia in the oil market, the company is perfectly able to withstand a prolonged period of low prices.

Huge potential

And there are many other reasons why the outlook for Russia's gas industry is far brighter than at first it may seem.

For a start, Russia's gas fields are running well below capacity, according to Irina Gaida from Boston Consulting Group. "Russia's gas industry has better production potential [than its oil industry] as the gas fields are much younger and are in the early stages of development".

There is, then, plenty of potential to ramp up production when new contracts are signed, as they will be.

GAZPROM GAS EXPORT TO EUROPE

GAZPROM GAS SUPPLIES TO EUROPE

The US and EU sanctions are primarily targeted at the country's oil industry, for very obvious reasons. Russia provides about 30% of Europe's gas, so it's simply not in the EU's interests to compromise Gazprom's ability to produce and export gas.

This month's deal with the UK's Centrica to increase gas supplies by 70% to more than 4 billion cubic metres (bcm) a year provides ample proof of this.

Equally, the sanctions are designed to hamper financing and stop Russian companies importing new technologies. But Russia's vast resources of conventional natural gas mean it does not need to develop new techniques to frack shale rocks, and it already knows well enough how to extract gas and build pipelines.

If sanctions remain in place over the long term, raising finance may become an issue, but right now they are having little impact on Russian gas producers.

The European Commission's charge last month that Gazprom has abused its dominant market position in Central and Eastern European gas markets is also unlikely to undermine the company's stranglehold on European gas imports.

As John Lough, of the Chatham House think-tank says: "The Commission hesitated over whether to pursue this as it was concerned about damaging its gas relationship [with Russia].

"Gazprom will make a robust defence and then try to seek some kind of settlement."

The likelihood is that a financial penalty will be agreed before business returns to normal.

Rising pressure

But while Europe's actions are having little direct impact on Russia's gas industry, their indirect repercussions are profound, not least pushing Moscow towards closer ties with Beijing.

"Russia has been talking to China for 10 years about exporting gas, but for various reasons they couldn't find alignment," says Mr Lough. "It has not been prepared to go the last mile, but the pressure to sidle up to China has now increased."

Feeling ever more isolated in Europe and suffering from wider economic sanctions, Russia signed two significant gas deals with China last year. The first, worth $400bn at the time, provides for 38bcm a year from 2018. Construction of the pipeline to transport the gas from East Siberia began in September.

A provisional deal for a further 30bcm was signed a month later, with gas potentially being delivered from West Siberia through the Altai region in southern Russia. Some of this gas could, Mr Moynihan says, come from fields that currently export to Europe.

The combined 68bcm is half the 140bcm Russia currently delivers to Europe, but when the pipelines are in place, that number could grow significantly.

China's demand for energy to satisfy its rapidly expanding economy and increasingly wealthy population is growing fast, while environmental concerns - mainly pollution and water shortages - mean the country needs to reduce its dependency on coal.

As Ms Gaida says: "The share of gas in China's overall fuel mix will rise rapidly. The potential of China far exceeds that of Europe". And Russia's resources are such that it would have no problem supplying both.

There is also the tantalising possibility of a deal with India, another potentially gargantuan market for Russian gas. Any such agreement, however, appears a long way off with no easy route for a pipeline between the two countries.

Frosty relations

Russia's gas industry, then, dominated by state-controlled Gazprom and with its vast resources and ideal location, seems perfectly placed to overcome the numerous obstacles laid before it.

As Mr Lough says, "I wouldn't underestimate Gazprom - it's a very capable company".

Despite frosty relations with Europe, it will continue to supply gas to a continent that, for now, has little viable alternative, while at the same time helping to satisfy China's voracious appetite for a cleaner alternative to coal.

With serious questions about whether Europe can develop a viable shale gas industry at all, let alone in the foreseeable future, and the slow adoption of genuinely clean, renewable energy technologies in many countries, Gazprom, and by proxy Moscow, will continue to hold the trump cards in any negotiations with the EU.

US and Iranian gas may offer another way out, but until European countries are able to wean themselves off Russian gas, this will remain the case.

bbc.com

Tags: RUSSIA, EUROPE, GAZPROM, GAS, LNG, US, SANCTIONS