2020 – time for a Gazprom re-think?

James Henderson,
Director, Gas Programme,
Oxford Institute for Energy Studies,
The United Kingdom

Since 2016 Gazprom has enjoyed a period of significant growth as its production and exports have rebounded sharply. The political impact of Russia’s annexation of Crimea combined with stagnant gas demand in Europe in the mid-2010s had led to a slump in production to a post-Soviet low of 419bcm, but by 2019 this had recovered to over 500bcm and exports to Europe had reached record levels of around 200bcm in 2018 and 2019. The company’s strategy of adapting to EU market rules and providing cost competitive gas appeared to be working well, and despite political concerns about over-dependence on Russian gas in Europe, consumers were keen to purchase gas from the largest, and one of the lowest cost, suppliers to Europe.

Events in 2020 have turned against Gazprom, though, and have re-emphasized some major concerns for the long-term. Obviously, a global event outside the company’s control, the COVID 19 pandemic and its economic consequences, has had a major impact, with European gas demand falling and the gas price collapsing due to a surplus of LNG on the market. Gazprom’s export volumes have fallen back to levels last seen in 2015, while its revenues have fallen even more sharply due to the dramatic decline in prices to below $2/mmbtu. This has led to the unusual circumstance that sales of gas in the Russian domestic market have actually become more profitable than exports for the first time in many years, leading Gazprom to rethink the balance of its business and to refocus efforts on recovering domestic market share that has been lost in recent years to competitors such as Novatek and Rosneft. However, Gazprom’s ability to compete with them is undermined by the fact that it is forced to sell at a regulated price that is now relatively high, meaning that reclaiming its position is not a simple task. Indeed, it may have to contemplate the unthinkable and agree to market liberalisation if it wants to re-assert itself.

However, it is in export markets that Gazprom is running into the biggest problems. Although it is undoubtedly in a competitive position in Europe, its plans for expansion are running into political problems in the short term and commercial/environmental challenges in the long-term. The key short-term issue is export pipelines, and in particular Nord Stream 2. Already hit by US sanctions, which have delayed completion of the pipe to Germany, it now seems as if the consequences of the poisoning of key opposition figure Alexei Navalny could further undermine the project. The German authorities are considering whether to continue their support for the pipeline, and it is now not inconceivable that it may never be completed, leaving Gazprom in the awkward position of having to renegotiate its transit agreement with Ukraine.

While this short-term issue has left the company questioning its attitude towards Europe, in the longer-term the question of the EU’s environmental policy presents a more existential question. As the EU heads towards a net zero emissions target by 2050, the role of all gas, not just Russian gas, is in question. Gazprom has responded by announcing its plans for possible involvement in a hydrogen economy, touting the benefits of its plans for pyrolysis as a means to transform methane into hydrogen and solid carbon. However, it remains to be seen whether the company can really find a way to be a core part of Europe’s decarbonised future.

An alternative strategy, also being pursued by the company, is to diversify into new markets, and this process began in earnest at the end of 2019 with the start of supplies to China via the Power of Siberia pipeline in the East of the country. However, development of Asian markets will require more than expansion of Gazprom’s core pipeline business, where its expertise lies. Asian countries rely on LNG imports to supply the majority of their gas, and here Gazprom is not the leading Russian player. Novatek has established itself as the champion of Russian LNG, with the successful development of its Yamal LNG project in the Russian Arctic and its plans for dramatic expansion over the next decade. Gazprom has struggled to keep up, with a number of its projects being delayed or cancelled. It is currently planning to construct a 13 million tonne liquefaction plant on the Baltic Sea near St Petersburg, but its plans in the East, where the major growth in gas demand over the next two decades is expected, are minimal. As a result, the company’s role as the most important exporter of Russian gas is under threat, if not in volume terms then at least in terms of strategic growth.

As a result, Gazprom finds itself faced with a number of key strategic questions as 2020 comes to a close. Should it continue to rely on Europe as a major source of export sales over the long-term? Can it develop a diversification strategy in Asia while relying mainly on pipelines to China? Does it have the capability to become a major LNG player or does the Kremlin now see Novatek as the major Russian player in this field? Is it prepared to countenance changes in the domestic market that would allow it to compete on equal terms with its rivals but might undermine its position at the heart of the domestic gas sector? The events of 2020 have made these questions more urgent and important, and the answers will define Gazprom’s future.

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