An Energy Vision to Link Our Nations

IMGXYZ425IMGZYXOn October 21, 2005, the Carnegie Endowment for International Peace hosted a meeting entitled “An Energy Vision to Link Our Nations,” with Alxander Medvedev, Director General of Gazpromexport and Deputy Chairman of the Management Committee of Gazprom. Anders Aslund, Director of the Carnegie Russian and Eurasian Program, chaired the session. Mr. Medvedev’s remarks are summarized below.

Gazprom’s performance in 2005 has been excellent. According to all significant metrics growth over the first quarter of 2004 was at least 30 percent. Not only is Gazprom the world’s biggest natural gas producer and exporter, but it also controls the world’s largest gas transportation system. Moreover Gazprom recently acquired Sibneft [from Roman Abramovich’s Millhouse Capital] for over $13 billion.

The company increasingly enjoys the confidence of international financial markets. Standard & Poor’s recently upgraded its bond rating from BB- to BB. Over the past two years Gazprom’s market capitalization has quadrupled to $115 billion and over the next few years we expect it to reach $300 billion.

In structural terms Gazprom aims for vertical integration. The company will control not only production, but transportation. The latter will include upgrading existing infrastructure, developing new transportation and storage assets in Europe, and building facilities for LNG [liquefied natural gas]. More than fifty percent of our investments go to transportation. Gazprom will also develop its capabilities in sales and distribution, notably in new markets like the United States.

Internationally Gazprom’s strategy is three-pronged, including: liberalization of the rules on foreign investment; diversification into LNG, power generation and distribution, petroleum, and emissions trading; and expansion into new markets.

In Europe the largest ongoing project is the North European gas pipeline. [The pipeline will run under the Baltic from Vyborg, Russia to Greifswald, Germany.] Beginning in 2010 it will carry gas to Germany and other European countries. Once fully operational it will carry 1.9 tcf [trillion cubic feet] per year. Gazprom is also building the Blue Stream pipeline through the Black Sea to Turkey.

The Asia Pacific region will be vital to Gazprom’s long-term growth. Demand in China, South Korea, and Japan may grow to 14 tcf by 2020 and we can supply a significant part of this total. Together with the Russian government, Gazprom has worked out an Eastern Siberia and Far East Development Program, which we expect to be approved late this year or early next year.

Commerce between Gazprom and US firms will allow both sides to diversify their energy trade and minimize risk. The Sakhalin-2 project is aimed at Asian and North American markets. Gazprom is currently negotiating the purchase of a majority stake in this project from Shell. In return, Shell will get access to the Zapolyarnoye gas field. In Western Russia, the liquefaction plant near Petersburg could begin exporting LNG to the US as soon as 2009.

But the most important LNG project is Shtokman, with its 113 tcf of gas beneath the Bering Sea. Phase one of this project will produce up to 15 million tons of LNG per year beginning in 2010. A few months ago Gazprom announced a short list of companies being considered for the Shtokman development consortium: Chevron, ConocoPhillips, Hydro, Statoil, and Total. In spring 2006 Gazprom will select the best two to three companies. The selection will depend on which participants can help Gazprom become a player in the midstream and downstream business. To become an equal player on the US market Gazprom needs access to local distribution and marketing infrastructure.

In summary, Gazprom’s first set of priorities is to expand its presence in Europe while adapting to market liberalization and diversifying its business. Its second is to enter new markets in East Asia and the US.

Q&A

Q: Thomas Graham of the National Security Council said last week that U.S.-Russia energy cooperation was largely untapped because of US support for democracy. Can you comment on that, please?
Medvedev: Democracy is not in danger in Russia. The U.S.-Russia Energy Dialogue will allow us to move beyond talk to real projects that will deliver energy to the United States.

Q: The Shtokman project is 15 years old already. How can US investors be safe if relations between the US and Russia deteriorate?
Medvedev: The Shtokman project really began in the 80s. But now we have a good political climate for the project and the economics are obviously favorable. Shtokman is closer to the US than any other LNG supply. As for dependence and independence, I’m often puzzled by the statements the come from places like the International Energy Agency, which questioned the reliability of Russian supply because of Gazprom’s monopoly. Gazprom operates internationally in competitive, liberalized markets. Indeed it leads in liberalization in Europe. So we’re prepared to play a role in accordance with prevailing market conditions.

Q: Can we infer that the US companies on the short list have better chances than the companies from Norway and France? When will you decide on your partners? How many will there be?
Medvedev: We expect two, maximum three, companies to take part and we’ll decide early next spring. As for who has the better chance, well in every beauty contest you’d like the participants to be not only pretty but clever. We will look not only at the companies but at their proposals.

Q: Gazprom currently charges Ukraine $50 per 1,000 cubic meters, which is paid in barter for transit fees. There has been word that Gazprom might raise prices to $150-160 per 1,000 cubic meters, the market price in Western Europe. What is the state of Gazprom’s relations with Ukraine? Are you going to continue to subsidize Ukraine, and if so, why?
Medvedev: The relationship between Gazprom and Ukraine should be based on international practice. Not only would Gazprom like to charge the market price, but the new leadership of Ukraine has expressed the desire to play by international rules. So we proposed to switch from the barter, which is really a subsidy, to European prices and practice. We would like to switch as soon as possible. But it’s not only a matter between Gazprom and Naftogaz Ukrainy, but also a matter between governments. Mr. Khristenko [the Russian energy minister] and the Ukrainian energy minister are involved. We hope to move to the market price next year.

Q: Demand in China and elsewhere is growing fast and most of that demand is in the far eastern part of China. That suggests pipeline gas through the west-to-east pipeline might not be competitive price-wise, which takes us to Sakhalin supply, but that’s associated gas and there might not be enough to meet both Russian and Chinese demand. What are your thoughts on Kovykta as an additional supply for northeast China?
Medvedev: Without involvement in exports, the economics of Kovykta are questionable. It could be part of the supply for eastern China, supplementing or replacing declining Sakhalin production. Initial discussions with China dealt with supplying gas from a particular field and this was a mistake. We will never accept this concept because it will degrade discussions about competitive price. We will sell gas to China and then decide which resources should be involved. Kovykta is one of the options.

Q: The big subsidization Gazprom does is in Belarus, where the price is only $30 per 1,000 cubic meters. This represents a subsidy of over $1 billion, a substantial part of Belarussian GDP. Is this Gazprom policy or Kremlin policy? Will you maintain it?
Medvedev: Actually the price is $46.68. We will maintain it for this year and next and we will implement all the obligations related to the Yamal-Europe pipeline. Once this project is completed, which should be next year, we will increase prices in accordance with our general principles.

Q: WTO accession has hinged in many ways on gas price and world market prices coming to Russia. What is Gazprom’s view about how that’s going to develop in the domestic market?
Medvedev: Our WTO accession protocol with the EU calls for escalating the local price. This fits our energy strategy because it will force Russia to adopt energy-saving technologies and put Gazprom in the black in the local market. We should reach a $60 price by 2010 under the protocol. But Russian gas will never sell at European prices because we are a produce and our industry enjoys this comparative advantage of the Russian economy.

Summary prepared by Matthew Gibson, Junior Fellow with the Russian and Eurasian Program at the Carnegie Endowment for International Peace.