Gazprom: A ‘dinosaur’ slow to react to global change

Russia's state-controlled monopoly seems stuck in the 1950s

February 01, 2011

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A liquefaction plant, part of the Sakhalin-2 liquefied natural gas project at the island of Sakhalin, Russia
CP Images

The more things change the more they stay the same. It’s tempting to apply the hackneyed adage to Russian politics. From the retrial of former oligarch and oil tycoon Mikhail Khodorkovsky to the WikiLeaks revelation that Gazprom, the country’s state-controlled gas monopoly, is corrupt and poorly managed, the Kremlin seems stuck squarely in the 1950s.

But Russia’s resistance to change does not make it immune to global forces beyond its control. The global credit and energy-price contraction hit the resource-driven economy championed by former strongman president and current Prime Minister Vladimir Putin hard. “The crisis broke that model very strongly,” observes Pavel Baev with Peace Research Institute Oslo. Putin’s reliance on resources and his penchant for corruption are beginning to show signs of weakness. “It cannot sustain the system,” Baev says.

But old habits die hard. New realities like shifting global supplies of natural gas are not being accepted by the political elite, and the country’s businesses, including Gazprom, remain entrenched in the old world. “There is a lot of desire to deny” the changes, Baev says.

Widespread corruption that permeates the oil and gas sector combined with the shabby treatment of foreign investors are together draining revenues and stifling the modernization the petroleum sector so desperately needs, the scholar believes. As in other parts of the world, conventional deposits of fossil fuels are fast becoming more expensive to exploit. Without foreign capital, declining production is all but guaranteed.

To be sure, Russia still controls massive reserves of oil and gas, but the country’s ability to leverage resource wealth to gain political clout is increasingly constrained by systemic weaknesses. Baev is quick to distinguish between the country’s oil and gas industries. Both are equally corrupt, he says. But the oil industry is comprised of smaller firms and is generally considered more dynamic and quicker to adapt to global changes.

The gas business is another matter, characterized by poor planning and political interference. “Political expedience always dominates,” Baev says, “so Gazprom does not use the big advantage that it could have: strategic planning. It is very bad at that.”

The state-controlled firm is also “a huge dinosaur that has mutated very slowly in the past 20 years.” International changes including, but not limited to, the proliferation of shale gas, LNG and the indexation of the gas price to the oil price are all areas that have been recently causing problems for Gazprom.

Of those, self-sufficiency of the U.S. gas market has colossal implications for Gazprom, the world’s largest producer. “Gazprom cannot grasp it, it cannot adapt and doesn’t really know what is happening and how to behave so it is sticking to its old plans.”

But old plans don’t align with global realities. The market for gas is saturated, the price in the U.S. has collapsed and terminals that were built for LNG imports into North America are standing empty or, worse still for Russia, being converted into export terminals.

The Gazprom push to enter the LNG market through a much publicized deal with Qatar seems increasingly pointless. Rather than being a term setter to its rich EU gas consumers and allowing the Kremlin to muscle around its neighbors, Gazprom is finding itself forced to renegotiate price contracts and conditions at worse terms. It is even facing legal challenges from some of its big consumers who are becoming increasingly irritated at having to pay a gas price still archaically indexed to the oil price while the spot price is less than half.

Even the North Stream pipeline being built at great cost across the Baltic Sea in order to bypass transit countries such as Poland and Belarus when piping Russian gas to Germany, the EU’s biggest consumer, might not be the crown jewel Gazprom expected it to be.

Other options should have been considered but weren’t, Baev says. “It definitely would be cheaper to put another pipeline next to Jamal Europe [currently going through Poland and Belarus] but that wasn’t done.” Gazprom, and by extension the Kremlin, expected to gain leverage with North Stream. But persistently low gas prices and project costs have compromised the profitability of the venture.

Baev believes Gazprom will eventually adapt itself to these new realities. Pricing will move away from the oil-indexed contracts Gazprom knows and loves towards those based on spot prices. Riskier propositions will increasingly take a backseat to core strengths. “My assumption is that the whole LNG discourse in Gazprom will come to nothing. They will understand that this in not their strength and that this is not their interest,” Baev says.

He points to the company’s sharp U-turn last year away from developing the resources of central Asia as an indication that it wants to go back to what it knows. Further change is afoot. Presidential elections are looming. Regardless the results, money will be thrown around and political expediency will be the order of the day, Baev predicts. He anticipates politics in the world’s largest country to cling to well worn paths, and that the world will move on, leaving Russia and its energy-superpower aspirations well behind.

Patrycja Romanowska is a former Alberta Oil associate editor and Alberta-trained economist currently working in Poland.

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