“European” Gas Prices: Implications Of Gazprom’s Strategic Engagement With Central Asia

June 2009 Vol. 236 No. 6

Danila Bochkarev, East West Institute

Gazprom’s decision to pay higher prices for Central Asian gas will reduce the company’s short-term profits. However, the move will compensate for a slowdown in domestic gas production.

Gazprom’s decision to pay higher prices for Central Asian gas will reduce the company’s short-term profits. However, the move will compensate for a slowdown in domestic gas production, allow Gazprom to delay exploitation of remote Siberian and Arctic reserves, and preserve its long-term strategic position in European markets. An understanding of Gazprom’s strategic imperatives in Central Asia could have helped to predict the conglomerate’s new pricing strategy towards Ukraine. Further, it could have avoided – or at least attenuated – the January 2009 gas crisis between Moscow and Kiev.

Situation analysis: a look a the importance of Central Asian natural gas for Gazprom’s energy balance. Natural gas imports from Kazakhstan, Turkmenistan and Uzbekistan are crucial for Gazprom’s ability to honor contractual obligations in Europe and the Caucasus. In 2008, Gazprom underlined the importance of these imports by starting to pay for Central Asian gas at a similar price that it charges customers in the European Union. Gazprom’s willingness to pay these higher, ‘European’ prices for Central Asian gas underlines its decision to sacrifice short-term profits for long-term strategic gains.

The 2003 Russian Energy Strategy mandated the use of Central Asian gas to fulfill Gazprom’s contractual obligations while it waits for the development of cheaper technologies to exploit untapped Arctic and East Siberian gas deposits. Until such technologies become available, these Arctic and Siberian deposits remain prohibitively expensive to explore.

The purchase by Gazprom of Central Asian gas prevented a price war in which European companies could have played Russian and Central Asian suppliers against each other to secure the lowest possible price. Such competition could have depressed gas prices – and profits – when Gazprom is already reeling from the effects of the financial crisis.

Gazprom’s business strategy in Central Asia is one of moving toward European prices and long-term agreements. First, consider the transfer to European prices. In switching to European pricing in March 2008, Gazprom more than doubled the price it paid to Turkmenistan, Uzbekistan and Kazakhstan – from between $140-160 per thousand cubic meters (Mcm) of gas to the January 2009 average price of $340/Mcm. This price is expected to decrease during 2009.

Gazprom also offered Turkmenistan zero interest loans for joint energy projects, which are projected to cost between $4-6 billion. (The global financial crisis is likely to delay, if not cancel, this part of the deal). Gazprom even went beyond Central Asia, proposing a similar deal to Azerbaijan in June 2008, finalized as a formal offer in a Memorandum of Understanding signed by Gazprom and SOCAR of Azerbaijan on March 29, 2009. As a result of these deals, Gazprom was able to replace intermediary companies (such as RusUkrEnergo, co-owned by Gazprom and Ukrainian private entrepreneurs) when reselling Central Asian gas to Ukraine.

The new price scheme in Central Asia forced Ukraine, a traditional consumer of Central Asian gas and RusUkrEnergo’s main client, to turn to Gazprom to meet energy needs.

Now let us consider increased imports of natural gas from Kazakhstan, Turkmenistan and Uzbekistan. Central Asia is clearly playing an important role in Gazprom’s fuel balance. In 2007, Gazprom’s internal gas production, without affiliated companies, was 548.7 billion cubic meters (Bcm). Meanwhile, it sold 161.5 Bcm to Europe and another 54.3 Bcm to Ukraine. In order to meet European, Ukranian, and domestic demand, Gazprom had to import 63 Bcm from Central Asia. It is expected to import 70-82 Bcm by 2015.

Furthermore, Gazprom’s engagement in Central Asian pipeline projects, even if they are delayed by the financial crisis, shows its determination to maintain and expand its role as a dominant importer of Kazakh, Turkmen and Uzbek gas.

Now look at Gazprom’s pricing strategy in former Soviet states which could be summarized as a move toward free markets and higher prices for former Soviet states. Russia heavily subsidized gas exports to former Soviet republics after the collapse of the Soviet Union. Estimates suggest that Gazprom and the Russian government provided $75 billion in hidden gas subsidies to former Soviet states between 1992-2008. About $47 billion of subsidies were to Ukraine alone.

This trend continued until the 2005 summit of the Commonwealth of Independent States, where Russian Foreign Minister Sergei Lavrov suggested that Russia should switch to free market trade relations with its CIS partners and eliminate these significant subsidies to former Soviet republics. As a result, Gazprom started increasing gas prices, including prices for Ukraine, in January 2006.

Hedging the bet: pay market prices or sell your pipeline system is the offer. Where Gazprom has been unable to secure market prices from a former Soviet republic, it has offered lower prices in return for a partial takeover of the country’s pipeline system to ensure easier access to higher-paying Western European markets. Gazprom used this strategy in Belarus after a 2006 dispute with Minsk. It negotiated the acquisition of a 50% stake in Beltransgas, a Belarusian pipeline operator, in return for significant price concessions.

But in 2007, Gazprom rescinded the deal and started charging Minsk market prices, minus gas export duties and the costs incurred for using Belarusian infrastructure to deliver gas to Poland. As a result, the price for Belarus is expected to rise to $200/Mcm in 2009, a 68% increase in two years.

There has been no such luck for Ukraine. Gazprom’s attempts to rent or buy Ukraine’s pipeline system were never as successful, putting Kiev in a more difficult position over gas prices.

In 2008, Kiev paid $179.5/Mcm for gas. All 55 Bcm were imported through RusUkrEnergo.

When the January 2009 gas crisis hit, Ukraine – unlike Belarus – was unwilling to cede control of its 1,100-km pipeline system, a critical means of gas delivery to Europe. Instead, Russia and Ukraine agreed to exclude RusUkrEnergo from the bilateral gas trade in favor of a long-term sale and transit contract between Gazprom and Ukraine’s Naftogaz. According to the new contract, Ukraine got an 80% discount on average European prices until January 2010. In exchange, Gazprom got preferential transit tariffs for Russian gas going to Europe through Ukraine’s pipeline system. In January 2010, the transit tariffs will be calculated on a commercial basis and are expected to increase by 65%.

Gazprom’s deal in Ukraine, with Ukraine’s retention of control over its pipelines and Russia’s preferential tariffs, caused a much steeper rise in gas prices in Ukraine than Gazprom’s deal in Belarus. Ukraine’s Naftogaz is set to pay around $360/Mcm in the first quarter of 2009, a 100% increase in just one year.

However, Ukraine is expected to import around 33 Bcm of Russian gas in 2009, compared to the 55 Bcm it imported in 2008. Ukraine’s total bill for imported gas in 2009, anticipated to reach $14.4 billion, apparently would be significantly less than originally expected if Gazprom and Ukraine’s Naftogaz reach a bilateral agreement on modification of imported volumes. Most of the money will be used by Gazprom as payment for gas from Central Asia.


Central Asian gas will remain an important part of Gazprom’s gas balance, as the company tries to ensure it can meet demand from its customers both at home and abroad. Gazprom most probably will downscale its price offers to Central Asian producers later in 2009, but still will continue to re-sell Central Asian gas to Europe and Ukraine with only a marginal profit. Over time, Gazprom hopes that reliance on Central Asian gas will allow the Russian gas conglomerate to postpone costly development and exploitation of the Arctic gas fields other than Yamal and Stokman. However, in the future, the conglomerate’s strategy could be challenged in the short term by relatively low gas price and in the mid-term by further Chinese and European expansion into the Central Asian gas market.

Author’s note: The views expressed in this commentary do not necessary represent the views of the EastWest Institute, of its Board or of its other staff members. Reprinted with permission of the EastWest Institute.

Danila Bochkarev is project manager, energy security, for the East West Institute. E-mail: dbochkarev@ewi.info.

Find articles with similar topics