Reports of Gazprom’s death are greatly exaggerated

“Despite the problems, one cannot talk of Gazprom's bankruptcy,” believes Konstantin Simonov, a Russian energy expert. Jakub Biernat talks to him on the future of the largest Russian company.
Reports of Gazprom’s death are greatly exaggerated

(Aamanatullah, CC BY)


CE Financial Observer: Could the deteriorating economic situation of China harm Gazprom’s plans for the construction of the “Power of Siberia 1” gas pipeline?

Konstantin Simonov: For that to happen, the Chinese economy would have to collapse. “Power of Siberia 1” is a special project, but not because Russia would be the only supplier of gas to China, as it is already supplied by Australia, Turkmenistan or Myanmar. The new gas pipeline, however, would reach areas where gas isn’t supplied at all. The 300 billion cubic meters of gas (over 30 years – editor’s note) provided for in the contract is not such a tremendous volume that China would be forced to give it up.

The forecasts about the catastrophic state of the Chinese economy are exaggerated as well. Although there was a crash on the stock market there, the Chinese stock exchange is not as strongly tied to the real sector as in the US or Europe. In addition, there is economic growth anyway – 7 percent in 2014 and about 5 percent in 2015. This guarantees that “Power of Siberia 1” will be built after all.

The price of gas is linked to the price of oil – will this project be profitable at all if the price of oil falls even further?

Such speculation appears in the Western press, but the real issue here is not how much oil is going to cost in the near future, but during the commencement of the supplies, that is – according to my predictions – in 2020. In my opinion, there are many signs that it will not be very cheap. Moreover, the decrease in oil prices has traditionally resulted in the depreciation of the ruble in relation to other currencies. The depreciating ruble is convenient for exporters and also causes the costs of the entire project to fall. Despite Chinese pressure, Gazprom negotiated that only Russian materials and devices would be used for the construction. So the opposite has happened than in the case of the Central Asian Gas Pipeline (from Turkmenistan to China – editor’s note), which was built entirely with Chinese materials.

Why are the Chinese delaying the signing of the agreement on the construction of a gas pipeline from Western Siberia? We are referring to the “Power of Siberia 2”, previously known as the Altai Pipeline.

In this case, the outlook is worse, because gas from Central Asia is already supplied to this part of China (the Xinjiang Uyghur Autonomous Region in western China – editor’s note) and there are no shortages of this raw material there. For this gas pipeline to make sense, the  Chinese would have to find a way to deliver Russian gas further to the East of the country. While in the case of “Power of Siberia 1” we are delivering gas directly to the customers, in the case of “Power of Siberia 2” Russia will supply gas to the 40-kilometre stretch of the Russian-Chinese border between Mongolia and Kazakhstan. The Chinese side will have to do something with it, and is therefore trying to negotiate the best possible conditions.

What about the South Stream gas pipeline? It was supposed to bypass Ukraine and provide gas to South Eastern Europe, but ultimately its route ended in Turkey. What next?

Gazprom was criticized in the West for the idea of bypassing Ukraine and, in fact, it was also the more expensive variant for the company. It’s cheaper to use an existing gas pipeline than to build a new one. Although Europe has a different opinion, Russia believes that Ukraine is a country creating problems in the transit and this is not based on some sort of revenge for the past year and a half, or a desire to harm its economy. These problems occurred during the rule of all the political parties, including the supposedly pro-Russian Viktor Yanukovych.

The idea of building alternative supply routes emerged long before the second and even the first Maidan. In Brussels, this topic is incorrectly seen as a political matter, even though the construction of each additional pipeline increases the EU’s energy security and therefore the EU should say “thank you” if Russia is willing to invest its money in building infrastructure on the territory of Europe.

If it’s not about politics, then why is Gazprom willing to build its pipeline on the territory of Turkey instead of reaching an agreement with Ukraine? Is Turkey more trustworthy than Ukraine?

Russia wanted to lay a pipeline directly to Bulgaria (on the bottom of the Black Sea – editor’s note) and it caused a rather nervous reaction from the European Union. The project was abandoned. As for Turkey, that is a good question. However, Europe itself sees it as a trustworthy country and is investing, for example in the partially abandoned Nabucco or the TANAP (Trans Anatolian Natural Gas Pipeline Project), which is still under construction and is intended for the transport of gas from Azerbaijan, or the Trans-Caspian gas pipeline, which is supposed to run from Turkmenistan through Turkey. Since Europeans are not afraid of Turkey, Russia concluded that it had no reason to be afraid either. I’m more sceptical about Turkey, especially since the situation has changed very much in recent months. Initially Turkey was offered the relocation of the South Stream project in its full transmission capacity. The pipeline was supposed to have four parallel lines and a capacity of 64 billion cubic meters per year, including 50 billion cubic meters in transit. However, this plan collapsed in 2014 due to Turkey’s attitude.

And what were the problems created by Turkey?

Firstly, they cost half a year delaying the approval of the text of the intergovernmental agreement, which had just been sent to Russia. In the meantime, the Turkish political crisis erupted – the parties were unable to form a government after the elections. Now, the future of the agreement is not clear. Secondly, Turkey began demanding a reduction in the price of gas. And the biggest problem is the official statement of Turkey’s Minister of Energy, who suggested that Turkey should not only transit Russian gas, but also sell it further. And Russia would not agree to that – especially since Ukraine made the same demands in the past.

Turkey, however, only harmed itself, because Russia found another variant, i.e. the construction of additional lines of the Nord Stream. A memorandum was signed in June and the first partners were acquired: E.ON, ONW, BASF, and Stell. There is talk of expanding this group. The project is materializing and there are rumours that the first contracts will be signed in September. As a result, the South Stream will be thinner and it will only have two lines. One will be used for supplying Turkey and the second one will be used to deliver gas to the Balkans. Instead of 50 billion cubic meters, Turkey will only be sending 15 billion cubic meters in transit. Thus, two lines will be moved to the north. At the same time, the Opal gas pipeline, which will deliver gas to the Czech Republic, is being expanded. There are plans for the creation of a corridor leading through Austria to a key importer – Northern Italy.

Despite various predictions Ukraine coped without supplies from Gazprom.

However, it wouldn’t cope without Russian gas in the winter. It is still forced to directly purchase from Gazprom. Alternative sources of gas through reverse flows (from Slovakia, Hungary and Poland – editor’s note) send the same Russian gas. Lately, the Hungarians and Slovaks have been buying great volumes of gas from the Nord Stream and sending it to Ukraine.

And Russia cannot stop that…

Unlike the managers of Gazprom, I’m not approaching this situation with anxiety, because for Russia the most important thing is to maintain the overall volumes of deliveries to Europe. If Ukraine doesn’t want to buy gas directly from Russia, it is free to do it through intermediaries. Another winter is coming and that is a period of increased demand for gas. Ukraine will not cope without direct deliveries from Russia.

Can you confirm, however, that direct deliveries to Ukraine decreased tenfold and Gazprom has been effectively pushed out of the market and fallen to third place among the suppliers? In addition it is offering higher prices than the European intermediaries.

This was caused by the catastrophic collapse in industrial production and the reverse flows, which are, however, sending Russian gas. As for the gas prices, one cannot say that Gazprom is selling it at higher prices than others. The Ukrainian energy minister recently stated that the reverse flow deliveries are slightly more expensive than supplies from Gazprom. Indeed, it is sometimes the case that when Western suppliers have too much gas, it is more affordable for Ukraine to buy it from them than from the Russians. However, based on my assessment, in general in 2015 reverse flows cost Ukraine more than the gas from Gazprom.

And when will Ukraine cease to be a transit country?

This process is progressing – 90% of the transit went through Ukraine in 1990 and in 2015 the share is around 40%. In reality, Ukraine is punishing itself, by depriving itself of the status of a transit country. As for the particulars, we know the date, and even the exact hour when all transit through Ukraine will come to an end. That will be on 1 January 2019 at 10 in the morning. From that point on, the Ukrainian pipelines will become a reserve supply route, e.g. in the case of problems with Turkey. Maybe then Russia will resume talks about transit through Ukraine, but for the time being there is no indication that transit will continue.

Are the new oil fields discovered off the coast of Egypt by the Italian company Eni a nail in the coffin of Gazprom?

I’m not worried about this scenario, because such deposits were discovered before and some claimed with satisfaction that it would be the end of Russian gas producers. A few years ago the Italians found similar giant gas deposits in Mozambique. Ten years have passed and the gas still isn’t extracted. The same was true for gas from the Israeli shelf – licenses were issued, the American company Noble became involved, but problems emerged. I’m not saying that the deposits discovered in Egypt are not a serious source of gas, but let us wait a few years for the results.

Over six years, Gazprom’s capitalization fell by USD300bn, and in 2014 the net income plunged by 86 per cent. Is the company really bankrupt, as the Western press is claiming?

Indeed, the company’s market capitalization has dramatically declined and the previously announced plans for its value to reach USD1 trillion ceased to be realistic. In regard to bankruptcy, I would simply refer to the popular and transparent ratio of debt to EBITDA (company’s profit before interest on contracted loans, taxes, depreciation and amortization – editor’s note). This ratio is currently 0.8, which is very low. Meanwhile, in 2008, which was a year of crisis for many Russian companies, it even exceeded 8. Of course, there are big problems, but if we simply look at the books, the company is not bankrupt.

And what are the problems it is facing?

Gazprom has problems with internal competition, and this is not a problem limited to this company, but a general problem of our national policy. In Russia there is no understanding of how the gas market works and in turn, for example, Rosnieft is increasing extraction, although there is no deficit in the country, and as a result companies begin to compete with each other.

You are a supporter of preserving Gazprom’s monopoly.

The thing is that in our country, when they begin reforming a monopoly, the prices for its products on the domestic market grow instead of falling. The plans to liquidate Gazprom’s export monopoly is another story. The Western recipients would probably like this idea. However, from the point of view of the Russian State as a seller, I don’t see the point in a situation where, following the opening of the Bovanenkovo gas field in Jamal (in 2012 – editor’s note), we don’t have a problem with gas extraction – this is the largest field opened for extraction in the past 20 years. And this is precisely  the main problem of Gazprom, which has been criticized for many years for failing to increase extraction. Today it has a reserve capacity for the extraction of 180 billion cubic meters per year and such volumes of gas cannot be utilized. Not to mention the so-called Eastern Gas Programme – the Chayandinskoye gas field (planned commencement of extraction in 2017 – editor’s note).

Perhaps Gazprom has trouble selling its gas because many countries consider it to be the Kremlin’s political tool? Gazprom was used in political games not only against Poland and Ukraine, but also against Belarus – Russia’s most dedicated ally in the region.

It’s a fact that we are the least liked in the Baltic states and in Poland. It is true that there were many trade wars, e.g. even before the counter-sanctions we introduced an embargo on the import of milk products, sprats, etc. against the Baltic countries. Despite this, we never cut off their gas supply, we never even threatened to do that. The same was true in regard to Georgia, where we continued the supply of gas even during the war in 2008.

But you behaved differently towards “brotherly” Belarus. You did close the tap.

Yes, but as a result of these gas wars, Belarus received a very good price (USD5bn) for the sold section of its pipeline and a very preferential price on gas. In addition, 30% of the transit is going through Belarus. Has it lost its sovereignty as a result? No, on the contrary, Lukashenko has become even more independent.

There is also the issue of prices. Gazprom sells gas to Poland and the Baltic states at much higher prices than to Germany.

This is because we have a special relationship with Germany – for Gazprom it is the no. 1 market in Europe, and in addition, German companies are stakeholders in Russian oil fields and in the Nord Stream.

Konstantin Simonov – founder and director general of the National Energy Security Foundation. Vice-Rector of the Financial University at the Russian Council of Ministers. Doctor of Political Sciences, specialist in the field of energetics, non-public policy and the structure of executive power in Russia. Author of books about the oil and gas industry.

(Aamanatullah, CC BY)

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