Why Is Gazprom’s Output on the Decline?

Why Is Gazprom’s Output on the Decline?

photo: Ricardo Cabral

The monopoly is forced to adjust supplies against falling demand on the Russian and European markets.

In the past year, Gazprom has set a new anti-record for gas production. Based on the results for the past 12 months, its production volume is set to 409.4 billion cubic metres in the wake of the company’s updated projections. Earlier this year, the company had anticipated that production would reach 417.2 billion cubic metres in 2016. Then, however, the forecast was adjusted to reflect reality: over the period from January to September, the monopoly’s output contracted by 1.4%, to 277 billion cubic metres (CDU TEK data).

In the ‘post-vyakhirev’ era, Gazprom’s production peaked in 2006, attaining 556 billion cubic metres of gas. In recent years, the monopoly’s output has assumed a negative trend, despite several intervals of respite, finally reaching 418.5 billion cubic metres in 2015. Increased gas sales in Russia by independent companies, with stagnant consumption figures, provides one explanation for this: from 2011-2015 demand for gas in Russia plummeted by 6.1% (from 473 billion to 444 billion cubic metres), while Gazprom’s share in supplies to the Russian market fell sharply from 61.4% to 47.5% (2015 Gazprom annual report data). Unlike Gazprom, independent producers (Novatek, Rosneft and Lukoil, in particular) supply gas at unregulated prices, allowing them to attract solvent industrial customers.

The demand for gas is also falling in Europe: over the period from 2011-2014, consumption in 41 countries across the continent (not including Belarus, Ukraine, Moldavia, and Turkey) plunged by almost a quarter, reaching 460 billion cubic metres (hereinafter – HSE Institute of Energy and ERI RAS data). The production sector contributed heavily to the constriction of the European gas market: in 2014, because of the power-consuming industries ceasing to operate and the general economic stagnation, industrial consumption sank below 100 billion cubic metres for the first time since 1976.

Demand for gas from the electricity sector also contracted: in 2014, its volume dropped below the 2004 figure. In Italy from 2008-2014, gas consumption from the electricity sector shrank twofold (from 33.4 billion to 16.8 billion cubic metres); in the UK, it fell by over 40% (from 24.8 billion to 14.2 billion cubic metres), and in Spain, by almost three quarters (from 16 billion to 4.4 billion cubic metres).

In the structure of European electricity output, from 2005-2014, the share of gas slumped further (from 21% to 16%) than the share of coal (from 29% to 26%), while the share of renewable energy sources (RES) surged from 2% to 10%. This increase was promoted by high gas prices, relatively cheap coal for consumers, and a strong initiative to develop alternative energy sources in the EU. The European Commission has set a target to increase the share of RES in final power consumption, from 8.7% in 2005, to 20% in 2020. From 2008-2014, in line with the commissioning of new power generation capacities in Europe, gas stations (58 GW) have been replaced by solar (74 GW) and wind (64 GW) power.

The increasing popularity of gas exchange trading dealt yet another blow to Gazprom’s position in Europe. From 2005-2015, the share of competitive wholesale sales in the gas consumption structure on the European market swelled from 15% to 64% (International Gas Union data), while the share of contracts based on the oil price plunged from 78% to 30%. This shift was a result of exchange contracts more beneficial to the consumer than the long-term gas supply agreements with the ‘take or pay’ terms and conditions. In September 2011, for example, the difference between the value of gas futures for Europe’s leading gas hub NBP (UK), and the price of Russian gas on the German border, amounted to $100 – $400, against $300 per thousand cubic metres (Skolkovo Energy Centre estimates).

Gazprom started to moderate its pricing policy partially, given the impact of these changes. From January 2009 – July 2015, the monopoly renegotiated contracts with 30 Europe-based companies 65 times, even going through arbitration (HSE Institute of Energy and ERI RAS data). Gazprom’s contract partners were demanding the ‘take or pay’ conditions be relaxed, and either temporary discounts on the gas contract price be provided, or the proportion of the supply volumes over the ‘take or pay’ be adjusted against the spot price. The actual price of supplies proved to be lower than the contractual price; in 2014, the discrepancy between them amounted to $90 ($355 against $445 per thousand cubic metres).

In terms of customer relations, the Russian monopoly has remained more conservative than European gas providers. In 2015, the Norwegian company Statoil adjusted 75% of its European gas exports аgainst the spot price; Gazprom used this facility only for its customers in France and Germany. Using this spot adjustment facility on a more frequent basis would allow Gazprom to increase supplies; provided there is free access to the Ukrainian gas transportation system, Russia could export over 220 billion cubic metres of gas every year to Europe.

Not only the increasing competition on the European market, but also the problems affecting Gazprom’s two subsidiary companies – Gazprom Dobycha Yamburg and Gazprom Dobycha Urengoy – could constrict development potential: from 2011-2014, due to the depletion of the Yamburg and Urengoy fields, they cut output by almost one quarter – from 160.2 billion and 85.9 billion cubic metres, respectively.

However, even if the production problems are resolved and Gazprom’s physical exports volume increases, it will be difficult to regain previous profitability figures. In the first six-month period of 2016, Gazprom supplied a quarter more gas (109 billion cubic metres) to non-CIS states than for the same period in 2014 (86 billion cubic metres). The twofold reduction in supply prices to Europe ($182 against $366 per thousand cubic metres), which will inevitably lead to a decline in sales revenue (413 billion against 640 billion roubles – data from IFRS Gazprom reporting), made this feasible.

This result is the price for many years of a rigid pricing policy on the foreign markets, damaging Gazprom’s competitiveness in Europe and its output in Russia. To avoid these costs, Russia should resume the debate about the de-monopolization of the gas sector; reform, which was on the agenda at the start of the ‘noughties’, disappeared altogether from the agenda after Vladimir Putin firmly stated in 2003 that “Gazprom will not be divided up.”

Kirill Rodionov is an analyst at IndexBox