European Deal A Major Challenge For Gazprom

February 2013, Vol. 240 No. 2

A landmark gas-supply agreement with Germany signed last month by Statoil put the challenges facing Gazprom’s business model in the spotlight, one of many recent setbacks for Russia’s largest company that experts see as signs of its diminishing power.

The $17.4 billion deal between Statoil and Wintershall was the largest of its kind. It is based on flexible spot-market pricing arrangements which Gazprom shuns in favor of more rigid long-term contracts. It is likely to mean that in 2013 Statoil will replace Gazprom as the biggest supplier to the stagnating German gas market. Gazprom’s answer was immediate.

“We will defend the system of long-term contracts with all our energy,” said Gazprom deputy chairman Alexander Medvedev. Supply and production partners should never forget what it’s like to be in each other’s shoes, he said, adding that “they are dancing together forever.”

Experts believe there is nothing permanent about the dominance long enjoyed by the behemoth that emerged out of the Soviet Gas Ministry in the 1990s. Gazprom’s stubborn resistance to the dynamics of the European gas market is placed alongside its high operating costs, failure to conclude an export deal with China, loss of domestic contracts and sputtering Arctic projects.

Taken together, it all suggests that the writing is on the wall for one of the world’s biggest energy companies. Some experts even predict that if current trends are not reversed, the Kremlin will break up Gazprom into smaller companies by 2020.

The company will begin losing money in 2013 or 2014, said Mikhail Korchemkin, director of eastern European gas analysis. He said Gazprom will probably be carved up into several smaller companies around the time of the 2018 presidential election.

The European gas market will determine Gazprom’s fate. Gazprom is Europe’s biggest supplier of gas, and European revenues account for about 80% of the company’s income. European demand for gas has been falling because of macroeconomic troubles, efforts to reduce carbon emissions and an influx of cheaper alternatives, including coal.

Demand peaked in 2006 and, with the exception of 2010, has fallen steadily since. It dropped 11% in 2011, according to the International Energy Agency.

If there is a recovery in demand, it is expected to be slow. Europe’s gas needs won’t reach 2008 levels again until 2020, analysts say. The downward momentum is partly driven by higher prices associated with Gazprom’s long-term contracts with European suppliers. The contracts are tied to the price of crude oil and refined oil products which have a time lag as long as nine months.