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

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.