Gazprom's EU partners anxious for price cuts

Published on NewsOK Modified: January 14, 2013 at 7:57 am •  Published: January 14, 2013

U.S. natural gas production rose to a record 1.78 billion cubic meters (63 billion cubic feet) per day on average in 2012, according to the U.S. Energy Information Administration. That's up 24 percent since 2007, when drillers were first beginning to tap enormous reserves of gas trapped in shale formations under several U.S. states. The U.S., once thought to be in need of additional natural gas imports, is now expected to become an exporter within a few years.

That's a big turnaround from five years ago when Gazprom was working on supplying liquefied natural gas to the U.S. market. The International Energy Agency expects U.S. gas production to rise to overtake Russia in 2017.

"The shale gas boom in North America and the U.S. in particular has a double-sided impact for Gazprom," said Andrew Neff, a senior energy analyst at IHS Energy. Not only does the company lose a customer, it also has to find somewhere to sell the gas it had set aside the U.S.

On top of this, Neff warns that "North American LNG exports could potentially compete with Russian gas."

Gazprom's South Stream pipeline is being built to secure Russia's gas supply to Europe following a series of clashes with Ukraine, to whom Gazprom currently pays about $2 billion a year in transit fees. In 2006, Russia cut off its supplies to the Ukraine after the two countries clashed over the price of gas and the transit fees. Russia kept shipping gas to the EU through Ukraine. However, to cope with a spell of severe cold weather, Ukrainians siphoned off some of that supply. European customers started reporting a drop-off in supplies as a result.

The dispute escalated in the winter of 2009 when Gazprom again cut off supplies to Ukraine after talks over a new gas contract failed. Again, Europe started experiencing a fall in supplies. In spite of Ukraine denying this time that it had siphoned off Russian gas, tens of millions of Europeans were left without gas for three weeks in the depths of winter.

Going through the Balkans, Austria and Italy, South Stream will avoid Ukraine, which will still get its supplies from the existing pipeline but won't get the extra transit fees.

However, analysts are concerned that Gazprom could be overreaching with its pipelines. On top of the South Stream project, the company in October opened Nord Stream, a new pipeline under the Baltic Sea, directly linking Germany with Siberia's vast natural gas reserves with the capacity of 55 billion cubic meters. The construction of South Stream and expansion of Nord Stream will mean Gazprom's capacity will exceed expected demand by between 50 billion to 100 billion cubic meters, according to analyst estimates.

Alexei Kokin, an oil and gas analyst at Moscow-based UralSib investment bank, is skeptical of the reasoning behind the South Stream, adding that for Gazprom and the other investors, the project "is pretty much a waste" of capital expenditure.

"The timing of South Stream looks bad for Gazprom," said IHS Energy's Neff.

Gazprom officials, however, defend the Balkans-bound pipeline despite its estimated cost of €16 billion ($20.6 billion).

"If that wasn't profitable for our partners, we would not go ahead with this project," Gazprom's CEO Alexei Miller said in December.

Miller explained that Gazprom would be saving a lot of money by not having to pay the $2 billion in transit fees to Ukraine: "With South Stream, we will be paying these transit fees to ourselves," he said jokingly.

As well as battling to maintain its clout in Europe, Gazprom is also fighting on the political front in the region. European officials have warned Gazprom that it would have to allow third-party gas producers to use South Stream to comply with European laws that ban suppliers from owning transit facilities such as pipelines. Gazprom and its European partners in the project are lobbying for South Stream to be exempted from the law.

The company is also facing an EU probe to determine whether it violated competition rules by linking gas prices with prices for oil.

Putin strongly criticized the EU energy regulations as he sat down for talks with European leaders in Brussels last December. "It creates confusion and undermines confidence in our mutual work," he said.