Gazprom in the Post-Soviet Region: Shrinking Markets, Politicised Relations

This article was originally published by the Center for Security Studies on 26 October 2015.

Abstract

Gazprom’s position in post-Soviet gas markets has changed from secure to ambiguous over the last five years. Ukraine has reduced its takings of Russian gas considerably, while Moldova and Lithuania have established links with alternative suppliers that could potentially weaken Gazprom’s export position. Meanwhile, two post-Soviet states with a foreign policy line much closer to Russia’s, Belarus and Armenia, pay a lower price, but will likely remain stable markets for Gazprom in the years ahead.

Following the financial crisis of 2008–9, Gazprom’s position has changed considerably in its three main markets: Russia, Europe, and the post-Soviet region. Demand has stagnated or decreased in all markets. Gazprom’s supply capacity now exceeds demand. Gas sales to the post-Soviet region were reduced from 70.2 billion cubic metres (bcm) in 2010, to 48.1 bcm in 2014. ¹ The increasing role of exports to China of Central Asian gas, beginning in 2009, has deprived Gazprom of influence on the development of gas production there. Is Gazprom’s dominance in post-Soviet gas markets now less secure?

The Reduced Demand for Russian Gas in the Post-Soviet Region is Mainly a Ukrainian Affair

The post-Soviet region is Gazprom’s smallest pipeline gas market by volume, as well as by income. Within the last 15 years, Gazprom’s position in post-Soviet markets appears to have come full circle. In 2001–03, the post- Soviet region represented eight to nine percent of the gas volume sold by Gazprom, around 40 bcm. When Gazprom’s overall sales volume peaked in 2006, at 578.8 bcm, the post-Soviet share of sales had increased to 17.4 percent of the total. This was also the year when Gazprom’s deliveries to the post-Soviet region peaked in absolute terms, at 101 bcm. Following the 2008–9 financial crisis, post-Soviet gas consumers reduced their gas demand. In 2014, the region took 10.9 percent, or 48.1 bcm, of Gazprom’s sales. ²

Gazprom’s weakening post-Soviet position in the last few years is mainly a result of Ukraine’s reduced demand. Ukraine has traditionally been the largest post- Soviet market, taking between 50 and 60 percent of all gas supplied by Gazprom to the region. In the peak year of 2006, Ukraine acquired 59 bcm. By 2010, this was reduced to 36.5 bcm, in 2013 to 25.8, and in 2014 it only took 14.5 bcm.

Ukraine has steadily reduced the share of gas in its total primary energy supply, from 43 percent in 2007 to 33 percent in 2013, and which now may have dropped further below 30 percent. ³ Overall gas consumption in 2014 stood at 42.6 bcm, compared to 75 bcm a decade earlier. ⁴

When Gazprom continued to increase the gas price to Ukraine from 2009, Ukraine’s price concerns grew, and it accelerated a downwards trend in import reliance for gas. Import reliance has declined over the last two decades, to 60 percent in 2012 and 46 percent in 2014. ⁵ Domestic gas production has increased slightly over the last decade, to 20–21 bcm annually.

In 2014, Russia’s annexation of Crimea and support for the separatists in Donetsk and Lugansk promptedUkraine to access supply from Slovakia, Poland and Hungary. These gas flows, essentially reverse flows of Russian gas, delivered around 5 bcm in 2014. Significantly, Russian gas from Europe in reverse flow could compete on price with gas purchased directly from Gazprom, exposing how Gazprom had inflated the price (in early 2015, 330 US$ per thousand cubic metres (mcm)). ⁶ Gazprom has now reduced its price to Ukraine. ⁷ While Gazprom initially reacted to the reverse flow by restricting gas flows to European customers, this was costly in the context of a stagnant European market, and therefore this strategy was abandoned.

Ukraine’s reduced demand for gas from Gazprom in the space of only a few years represents a considerable reversal of its position in the post-Soviet region, a position that a decade ago seemed solid. Gazprom has lost positions not only due to its sometimes politicised role in regard to Russian foreign policy, but also because it priced itself out of the Ukrainian market. It is less likely, however, that Gazprom’s supply to the Ukrainian market will be further reduced in the immediate future, not least due to the technical limitations of supply by reverse flow.

Gas Transit through Ukraine

Gas transit remains important in Gazprom’s relations with Ukraine. In 2014, Ukraine transited around 62bcm. Over the last two decades, Gazprom has pursued a transit avoidance strategy with regards to Ukraine. As of today, the bypass pipelines to Europe and Turkey provide around 100 bcm transit capacity in excess of Gazprom’s needs. South Stream, a transit avoidance project under the Black Sea from Russia to Bulgaria, was shelved in late 2014, following European Commission pressure on EU transit states. In Gazprom’s strategy, South Stream has now been replaced by Turkish Stream, the prospects for which currently have an uncertain outlook. However, the planned construction of Nord Stream II will reduce transit through Ukraine. A binding agreement with shareholders BASF, E.ON, Engie, OMV and Shell came into place in early September.

Nord Stream II will add a third and fourth leg to the Nord Stream pipeline, with a combined annual capacity of 55 bcm, bringing total capacity on this route up to 110 bcm. When the third leg comes into operation, annual transit to Ukraine will most likely be reduced to around 30 bcm. The fourth leg will make Ukraine’s transit pipelines superfluous in theory. However, specific contractual arrangements with Gazprom’s European customers may prolong the demand for Ukraine as a transit state. In light of Europe’s stagnating demand, Gazprom will most likely continue to under-utilise almost all its available transit routes to Europe.

Other Post-Soviet States Still Rely on Gazprom

Gazprom’s deliveries to post-Soviet states other than Ukraine have been relatively stable over the last five years, at around 33 bcm. Belarus takes around 20 bcm annually, and is now Gazprom’s largest post-Soviet customer. Kazakhstan has increased its purchases of gas from Gazprom recently and took around 5 bcm in 2014. Among the smaller markets (up to 3 bcm annually), the Baltic states, Armenia, Georgia and Moldova are 100 percent dependent on gas imports for their consumption, with gas covering from 10 percent (Estonia) to around two thirds (Armenia and Moldova) of their total primary energy supply.

This reflects an inherited dependence on Russian, and therefore Gazprom’s, gas, which Gazprom has used to its business advantage. It has increased its overall presence in the post-Soviet energy sector, mostly through equity deals, which have placed it in control of pipeline systems in several post-Soviet states. This secures both stable deliveries and demand for Russian gas in the post- Soviet region. In the still unlikely event that other Russian gas producers would be allowed direct access to Russia’s Single Export Channel for gas, post-Soviet markets would most likely remain dependent on Gazprom.As Gazprom’s supply capacity currently far exceeds demand, it can also, if need be, undercut the price offered by any potential alternative supplier.

Politicised Gas Relations

In regards to its smaller post-Soviet customers, like the Baltic states, Moldova, Armenia and eventually Belarus, Gazprom early on recovered old gas debts by taking stakes in gas networks. In business terms, this was a sound strategy. Where gas had not been paid for, and it was difficult to recover debts in cash or barter goods, equity in gas infrastructure was the second-best option. With regards to transit states, this also minimised the risk of transit interruptions. But in bilateral relations, Gazprom’s stakes in post-Soviet energy sectors could be, and have been, used for political ends. Above all, gas stakes have been used to coerce states into a foreign policy line closer to Russia’s. In turn, several post-Soviet states have undertaken, or intensified, efforts to reduce or mitigate their dependence on Gazprom for gas. In this way, what was for a long time a favourable business position for Gazprom, where it reached a captive and stable post-Soviet gas market, has turned into a more ambiguous outlook and a shrinking market. Several customers now have access to alternative supply that puts pressure on its price and therefore profits. The others have remained closer to Russia in their foreign policies, and also pay a lower price for gas.

Belarus is a stable Gazprom customer and a transit state with the Yamal pipeline (owned by Gazprom). When Gazprom, from 2002, tried to recover Belarus’s gas debts by acquiring equity in the gas network Beltransgaz, Belarus responded with patient negotiation. Only with the relaunching of the Nord Stream pipeline in 2005 did Belarus’s position weaken. In 2006, Belarus and Gazprom finalised the Beltransgaz deal, on terms quite favourable to Belarus. The deal itself was completed in stages between 2007 and 2011. Gazprom all in all paid 5 billion US$ for Beltransgaz, while Belarus secured Russian loans for a new nuclear power station, and a temporary gas price discount. Belarus is supplied on a long-term contract, currently paying 139 US$/mcm. ⁸

In Moldova, Gazprom holds a 50 percent stake in the gas network company Moldovagaz, and manages a 13.44 percent stake for the separatist authorities in Transnistria. Transnistria has generally not paid for its gas supplies. Beginning in 2004, Gazprom held Moldovagaz responsible for Transnistria’s gas debts. The ever-accumulating gas debts by September 2012 stood at around 4 billion US$ (5.2 billion US$ by 2015). At that point, Russia and Gazprom offered Moldova a price discount in return for not implementing the EU’s Third Energy Package, to which Moldova had signed up in October 2011. The Russian side also demanded that the Moldovan government assume full responsibility for Transnistria’s debts. Moldova then obtained a four-year delay (to 2020) from the EU in implementing the Third Energy Package, in return for a one-year gas price discount. Following this, the Moldovan government proceeded with a new 1.5 bcm export-import pipeline leg (Ungheni–Iasi) to connect to the Romanian pipeline network, in an effort to access alternative gas supply and improve its negotiating position with Gazprom. Romania has supplied small volumes of gas from March 2015. Possible greater volumes depend on the further development of the Romanian gas sector, especially in the Black Sea. Reduced Russian transit through Ukraine will affect Moldova’s gas supply from Gazprom.

In the Baltic states, Lithuania has reduced its purchases of Gazprom’s gas after the opening of the floating regasification terminal for liquefied natural gas (LNG) in late 2014. Initially, the main effect of the terminal, given Gazprom’s dominance of the gas sector in the Baltic states, has been as pressure on Gazprom’s position in price negotiations. The Baltic states, in early 2015, paid a relatively high price level, at 326 US$/mcm. ⁹ Within a few years, as long-term contracts expire, the LNG terminal may cover as much as 90 percent of gas demand in the Baltic states.

In Armenia, Gazprom also owns the gas network, Armrosgazprom. Its original stake, 45 percent, was acquired against Armenia’s gas debts in 1997. Armenia in 2004 expanded energy cooperation with Iran, centred around an exchange of Iranian gas for Armenian electricity. Following pressure from Gazprom to minimise this cooperation, Armenia in 2005 denied Iran gas transit from Georgia and Ukraine to Iran, and also reduced the diameter in a new domestic pipeline leg essential to gas trade with Iran. Over the period 2006 to 2013, Gazprom came to control the rest of Armrosgazprom, with shares sold gradually by the Armenian government in return for temporary price freezes and delayed implementation of Gazprom’s general price hikes. Gazprom and Armrosgazprom also assumed control of the pipeline to Iran. Overall, Russian dominance of Armenia’s gas, electricity and nuclear power sectors, combined with Armenia’s isolated position in the region, were important in Armenia’s abrupt reversal of the process that would have seen it enter into an Association Agreement with the EU in 2013, in favour of joining the Eurasian Economic Union. The outlook for Gazprom in the Armenian market is now stable. Armenia, like Belarus, currently pays a price that reflects its political closeness to Russia, at 165 US$/mcm.

Georgia has relied on gas from Azerbaijan since the opening of the Baku–Tbilisi–Ceyhan pipeline in 2006. Azerbaijan itself recently agreed to purchase some gas from Gazprom, to cover the domestic market while keeping its export commitments.

Is Gazprom’s Previous Dominance in the Post-Soviet Region Up for Change?

The potential for competition to Gazprom from other Russian suppliers remains very limited in the post-Soviet region. Gazprom’s main problem is therefore not competition from alternative Russian suppliers, but post- Soviet gas customers’ search for and expansion of alternative supplies through Europe, which may even come at a lower price than Gazprom’s. To the extent that such supplies—already established in the Baltic states, Ukraine and Moldova—weakenboth Gazprom’s overall market position and expose it to price competition, profits from post-Soviet markets will continue to fall.

References

1 Gazprom. 2015. Gazprom in Figures 2010–2014. p. 83. Available from external pagehttp://www.gazprom.com/f/posts/29/761233/gazprom-in-figures-2010-2014-en.pdfcall_made

2 Gazprom. 2015. p. 83

3 International Energy Agency. 2015. «Online Data Services».Available from external pagehttp://www.iea.org/statistics/call_made

4 Naftogaz Ukrainy. 2015. «Types of Activities». Available fromexternal pagehttp://www.naftogaz.com/www/3/nakweben.nsf/0/74B2346ABA0CBC69C22570D80031A365?OpenDocumentcall_made

5 Naftogaz Ukrainy. 2015.

6 Neftegazovaya vertikal’. 2015. Solo “Gazproma” na eksportnoi trube [Gazprom’s solo performance in the export pipe]. No. 13–14, p. 85.

7 J. Henderson and T. Mitrova. 2015. The Political and Commer cial Dynamics of Russia’s Gas Export Strategy. Oxford Energy Paper. Oxford: Oxford Institute for Energy Studies. p. 50. Available from external pagehttp://www.oxfordenergy.org/wpcms/wp-content/uploads/2015/09/NG-102.pdfcall_made

8 Neftegazovaya vertikal’. 2015. p. 85