Why Russia’s Grip on Europe’s Gas Markets Is Weakening

    The Wall Street Journal
    By The Wall Street Journal

    Why Russia’s Grip on Europe’s Gas Markets Is Weakening

    Further Losses in Russia’s Pricing Power and Market Share in Europe Appear Inevitable

    Lower gas prices have made it harder for Gazprom to dictate terms to European consumers. Above, Chairman Alexei Miller in June 2014.ENLARGE
    Lower gas prices have made it harder for Gazprom to dictate terms to European consumers. Above, Chairman Alexei Miller in June 2014. PHOTO: EUROPEAN PRESSPHOTO AGENCY



    Jan. 29, 2015 4:57 p.m. ET

    The collapse of oil prices—added to the weight of Western financial sanctions—has hammered Russia’s economy. But Moscow is also suffering from the fall in prices of another important energy export: natural gas.

    Gas represented 14% of Russia’s export revenues in 2013, compared with 54% for crude oil and oil products. But its gas is more important to Europe and Ukraine.

    Gas is more than a commodity for Moscow: It has been a political tool that has helped it assert its influence in Central and Eastern Europe and beyond. Because of pipeline architecture, some European Union countries have had few alternatives to buying gas from Russia.

    But its grip over Europe’s gas markets is weakening. As natural-gas prices have fallen in the European market—less dramatically than oil but still by at least a quarter—Moscow’s revenues have tumbled. In the longer term, further losses in Russia’s pricing power and market share in Europe appear inevitable.

    Russia has itself largely to blame. The Soviet Union treated gas as a commercial commodity and deliveries were unaffected by tensions between East and West. Under President Vladimir Putin , gas exports became a political instrument, and Russian disputes with Ukraine caused stoppages in supplies in 2006 and 2009 to Ukraine and to EU countries to its west.

    That set the European Union to work to “depoliticize” gas, including splitting gas transport from production, said Kristine Berzina of the German Marshall Fund think tank in Brussels. That meant companies like OAO Gazprom , the state-owned Russian gas monopoly, could no longer engage in both, at least in the EU.

    Other trends undermined Russia’s gas dominance, curbing European demand. U.S. exploitation of shale and other unconventional gas reduced U.S. coal imports and caused European coal prices to collapse. Coal, rather than gas, became the fuel of choice in Germany for base-electricity generation—needed when the country’s solar and wind farms weren’t producing.

    Many Gazprom export contracts are linked to the price of oil, with a lag of several months. That means that the oil-price fall is now feeding through into gas prices. On Thursday, as Gazprom reported a 62% drop in net profit for the third quarter of 2014, analyst Alexander Kornilov from Alfa Bank said Gazprom’s average gas prices this year will likely slip to between $200 and $250 per thousand cubic meters, from $352.70 in the first three quarters of 2014.

    EU buyers of gas are demanding still-better deals. Just Wednesday, Gazprom announced a change in its agreement with Austria’s OMV to provide more favorable terms to the buyer.

    Even Ukraine has shifted. Andriy Kobolyev, chief executive of Naftogaz, Ukraine’s state-owned oil and gas company, said in an interview last week in Davos that Russia last year provided 70% of Ukraine’s gas imports, compared with 95% in 2013.

    “In 2015, we plan that at least 60% of natural gas will come from the EU’s direction,” he said, helped by EU projects that allow more gas to flow from west to east, particularly via Slovakia.

    European prices are currently 10% lower than the price Ukraine pays for Russian gas—even after a $100 discount to the official price that was negotiated through to the end of March. Russia is thus the source of last resort for Ukraine. If Moscow stops offering the discount after March, as it said it plans to, it will raise the price to a level that Mr. Kobolyev said is “totally uncompetitive.”

    Mr. Kobolyev said Gazprom is fighting the tide. “They should accept the fact that markets have changed and their attempts to keep a monopoly position in certain markets will only lead to negative consequences, further shrinkage of consumption volumes and a switch to other suppliers,” he said.

    Gazprom’s longer-term strategy has hit resistance too. Russia has canceled its planned South Stream project through the Black Sea to Bulgaria, as it struggled, Ms. Berzina said, to deal with rules policed from Brussels rather than by national governments.

    Now, Gazprom has announced plans to bypass Ukraine with a new pipeline through Turkey that would deliver up to 63 billion cubic meters a year of gas to the Turkish border with Greece.

    After a meeting in Ankara on Tuesday between Gazprom Chairman Alexei Miller and Taner Yildiz, the Turkish minister of energy, Gazprom said that they approved a new route, and that Gazprom would pay for all of the offshore section of the pipeline.

    There’s skepticism about the plan because the pipeline’s capacity appears to be bigger than demand from potential customers. “A first assessment is that this would not work,” EU energy commissioner Maros Sefcovic said in Davos. If the pipeline is to be built, Gazprom will have to assume a greater financial burden than under South Stream, which was to be financed with partners.

    Gazprom is also shifting its focus—some analysts believe belatedly—from Europe toward Asia, where it is planning to build new pipelines to China. It also needs to invest large sums upstream in developing new wells to keep the natural gas flowing, said Ms. Berzina.

    All that will require large sums of money, a commodity that Russia is running out of at a rapid rate.

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