Gazprom and the Uncertain Future of Russia’s Natural Gas Industry

Natural gas is a very important good in the Russian economy. In 2013 alone, natural gas exports totaled 14% of their total exports—a whopping number only surpassed by crude oil (33%) and petroleum products (21%). Interestingly, the majority of this natural gas is exported to the European market, but Russia has taken steps to increase exports elsewhere, notably through a 2014 deal that will see $400,000,000,000 in natural gas shipped to China over the next 30 years.Russian Exports

And though the natural gas export business plays such a pivotal role in the Russian economy, there is only one player in the game—Gazprom, a firm that has a government sanctioned monopoly on natural gas exports. The reasGazprom's Logoon, according to First Deputy Energy Minister Alexey Texsler: Russian gas should not “compete with itself” in foreign markets, as such competition would only lead to lower prices and decreased export revenue for the motherland.

But the Russian energy industry, and the Russian economy as a whole for that matter, have struggled in recent years. Very low crude oil prices have put a strain on the Russian budget, in turn creating problems in the natural gas sector, where export revenues have fallen 28.5% in the last year.

This graph from NASDAQ shows the fall of oil prices over the last year.

This graph from NASDAQ shows the fall of oil prices over the last year.

Rosneft, Russia’s largest exporter of crude oil, has turned towards natural gas production in the wake of oil restrictions imposed on Russia due to both their conflict with Ukraine and low global prices. To do so, they have pressured the Russian government to end Gazprom’s natural gas monopoly, a move that has reignited questions about Gazprom’s effectiveness and the solubility of the Russian natural gas industry as a whole. That begs the questions: is Gazprom’s monopoly still advantageous for Russia? And, should Russia even continue to export natural gas?

A recent paper by scholar Marina Tsygankova sheds light on some possible answers. For one, Tsygankova’s analysis of the Russian natural gas industry finds that abolishing the Gazprom monopoly would lead to more combined profits for Russian producers in both domestic and foreign markets. However, she also notes that liberation of the Russian natural gas export market would lead to firms divesting in domestic sales to instead flood the European market with their product. This would lead to an increase in domestic price and a corresponding loss in Russian consumer surplus, which she finds outweighs any producer gains realized by eliminating Gazprom’s export monopoly.

Based off of the empirical evidence Tsygankova presents, Russia certainly should not sell more natural gas by ending Gazprom’s export monopoly. Moreover, she notes that given the entrance of shale natural gas into the gas market, the export market for Russia’s natural gas could become even more uncertain should European nations that are so reliant on Russia for energy decide to diversify their gas consumption. Ultimately, the ramifications of continued political pressure by firms like Rosneft and market entrance by shale gas producers could end up dealing a huge blow to both Gazprom and Russia’s financial security, which could destabilize one of the most important players in global politics and international relations.

Sources: US Energy Information Administration (includes export graph), World Affairs, Bloomberg and Energy Economics article

Images: Wikipedia for logo and NASDAQ for prices

11 thoughts on “Gazprom and the Uncertain Future of Russia’s Natural Gas Industry

  1. If Gazprom has market power, then isn’t it natural / sensible for it to be government owned? You seem to conclude “yes”. The only other way to restrict quantities is to force all domestic producers to sell to the government, and pay them a low price so that they produce less. In that case, isn’t it better to run everything as one big firm and eliminate the distortions that would come from pushing domestic prices down and creating a large gap between domestic and international prices!? Of course Gazprom can still price domestic natural gas below their export price, to transfer some of their monopoly profits to consumers. That becomes a choice for Russia’s political leaders.

    So … ending the Gazprom monopoly could lead to higher exports. But that also means a faster depletion of the country’s reserves, the patrimony of future generations, another argument to keep Gazprom in place??

    [There are many examples of government export cartels, coffee in Brazil and cocoa in Ghana, where producers are small but the country is large (or at least was once large) in global markets. What does the government then need to do to restrict total exports? There are various options, but think through the problem.]

    • Attempting to answer your last question, I believe government could restrict total exports by imposing a quota on net exports. Politically this could be easily accomplished since the main exporter is Gazprom which is owned by the government. The quota law would mainly affect other producers and exporters, since the governments hopes are almost identical to Gazproms.

      In a scenario where Gazprom is broken up, the quota system would still prove to be effective where private companies operate independently from the government. I am not too familiar with the political atmosphere in Russia, but again I believe that imposing a quota system would be fairly easy and effective to limit total net exports.

    • I guess another option here would be for the Russian government to incentivize companies, which would possibly create a policy trade off where Gazprom can continue exporting as is while companies like Rosneft could benefit from keeping their natural gas in the domestic market/in other foreign markets.

      This could take the form of some kind of subsidy, but then again, where would Russia get the money considering their economic/budget situation? Instead then this incentive could take the form of giving these companies access to the Asian market – in this situation maybe Gazprom controls European exports, maybe Rosneft controls China due to the 400 mil deal, and then other companies can focus on maximizing the total benefit in the domestic market…

      In this manner, Gazprom would operate on a similar scale (depending on what shakes out in the domestic market); whereas, maybe Rosneft sees some scalar benefit from increasing their production to enter new foreign markets free from the burden of competing against the established giant. But in the event that oil prices rebound, how would firms’ strategies change – would companies like Rosneft just move back to the oil export game where they have more experience/established large scale manufacturing and distribution access?

  2. This is an interesting insight into Russia’s energy industry. Natural gas and oil prices have come under siege (to say the least) over the past two years. Russia is one of the world’s greatest producers of oil and natural gas and, therefore, are strongly connected to depressed prices. I wonder if their support for or against Gasprom is tied to low prices. I know that there are rumors that Saudi Arabia and Russia are looking to strike an output deal…

  3. A recent U.S. News and World Report article by Dr. Khatuna Mshvidobadze of the Georgian Foundation for Strategic and International Studies states that Gazprom is not only a government-sanctioned monopoly, but also an arm of their new liberal imperialism. Russian Gazprom leader Alexey Miller (who U.S. News says is a part of Putin’s inner circle) has been meeting with Georgia’s Energy Minister to discuss a possible natural gas deal masquerading as yearly meetings. It seems Russia is looking to cut off other supplies of natural gas in Georgia and implement Gazprom as the primary supplier for the country. If Russia uses Gazprom as a means to control the supply of natural gas in Georgia, the effects will not stay in those two countries. Armenia, Iran and Caucasus countries could all be affected by the decision to use Russian Gazprom to monopolize neighboring Georgia’s natural gas supply. The article concludes the following: “So now, the Kremlin seeks to re-establish energy leverage over Georgia. It is part of a strategy dubbed “liberal imperialism” by Anatoly Chubais (former Russian privatization czar and later chief of the government energy holding company UES), aimed at keeping the post-Soviet space economically dependent on Russia.” So the future of natural gas might be uncertain, but the Russian tendency to control the industry might not be limited to economic pursuits.

    Source:
    http://www.usnews.com/opinion/blogs/world-report/articles/2016-02-10/gazprom-deal-puts-georgia-at-risk-of-becoming-energy-dependent-on-russia

  4. I believe more examination should be focused on first shock in success Gazprom faced in August of 2015. At this time Gazprom went back on a $2.6 billion contract to build a pipeline under the Black Sea. This deal would not only be lucrative in the short term for the company but could also provide great yields for future investment, leading the uncertainty you mentioned in the article to be almost non-existent. It is important to understand the thought process for this renege for it can further explain the following actions and decreased value of the company.

    As already mentioned, the introduction of shale into the market as effected gas prices and consequently gas producers all over the globe. However, I believe that Russia is a case where traditional theory of business strategy cannot be applied. As we have learned in class, in this scenario an oil company faced with falling stock prices, emerging competition, and a slew of other obstacles should work to increase output. But why is the government owned company not doing this? Is it practical to develop different theories accounting for the business strategy of Putin and the company’s CEO (who is believed to be in inner circle)? Would this help our understanding by painting a clearer picture of the companies futures uncertainty or the muddy the water even more?

    • How do we know they aren’t “increasing output”? Prices are lower – but that doesn’t let us distinguish a shift in demand from one of supply. Instead we’d need to look at market share: if that’s higher, then they have in fact increased output! But the analysis is not so simply if the supply curve of other countries has shifted.

      More generally, isn’t this a nice example of a price war in a Bertrand oligopoly? With a negative demand shock and/or new entrants, any attempt to maintain price collapses, and the bottom line is p=MC with firms potentially losing money because of substantial fixed costs.

      Trying to use politics to eliminate competition in a few markets is a natural if invidious response.

  5. I think it would be wise for Russia to focus on diversifying their exports instead of considering demonopolizing the natural gas industry. As you discussed Russia’s economy is very reliant on European countries’ demand for natural gas. By diversifying into other exports Russia will hopefully be less susceptible to fluctuations in demand and the availability of such resources.

    • Diversification is easier said than done. There aren’t any cross-Pacific [or cross-Arctic Ocean] pipelines, and in any case prices in North America are low. Building a new pipeline is a multiyear process, and hard to commercially justify when prices are so low. What, you want to increase supply????

      Gas liquification isn’t a short-run answer either. Constructing plants again takes years. There have to be enough LNG [liquified natural gas] tankers. And unless potential buyers are set up with appropriate ports and storage facilities, there’s no market to which you can ship. (Any of these 3 quickly adds up to US$ billions.)

  6. As a state owned entity, the potential for Gazprom to be used as much as a political tool as an economic is an all to real block to any entry into the natural gas market in Russia. Some restrictions of sale of natural gas to certain European countries over the last few decades have widely been interpreted as a political moves more than economic ones. To allow any other firms to enter into the market would pose a threat to the longevity of Gazprom as a political tool and thus provides a motive to maintain Gazprom’s monopoly in the industry.

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