Gazprom Agrees to Pay European Prices for Central Asian Gas from 2009

A "Market" Strategy

The chief executive officer of Gazprom, Alexei Miller, yesterday hosted a working meeting with Uzakbai Karabalin, president of Kazmunaigaz, Nurmmukhamad Akhmedov, chairman of the management committee of Uzbekneftegaz, and Yagshigeldy Kakaev, chairman of Turkmengaz. In a press release, Gazprom said that the heads of the state-run gas companies from Russia, Kazakhstan, Uzbekistan, and Turkmenistan discussed the outlook for co-operation in the gas sector and that “based upon the interests of the national economies and considering the international commitments with regard to the energy supply reliability and continuity, starting from 2009 natural gas will be sold at European prices.”

Although the meeting was apparently brief and the press release shorter still, that announcement will have immediate and wide-ranging impacts. For the three Central Asian states, the fact that Gazprom has now consented to pay an equivalent "European" price for gas supplies is a major victory, ratification of their growing importance in helping Gazprom balance out its domestic supply requirements and export commitments, as well as their key role in underpinning European energy security. Lest anyone forget, as recently as 2005 the Central Asian states were not even being paid fully in cash for their gas exports to Russia, with Turkmenistan—the region's major gas exporter—locked in a barter deal with Gazprom at implied prices of less than US$45 per 1,000 cm. Since then, however, Turkmenistan has secured a series of price hikes for the gas it supplies to Russia: Gazprom agreed last year to buy Turkmen gas in the first half of this year for US$130 per 1,000 cm, rising to US$150 per 1,000 cm in the second half.

Gazprom currently charges Europe around US$378 per 1,000 cm for gas, so even taking into account transportation costs, the Russian gas giant is getting a deal with its Central Asian gas imports. Critics have argued that Gazprom is not paying enough for Central Asian gas, asserting that cheap imports from Turkmenistan, Uzbekistan, and Kazakhstan are allowing the Russian firm to supplement its own flat gas production and delay costly new investments in greenfields in the Yamal Peninsula. The comparatively low export price for Central Asian gas has prompted the United States and European governments to attempt to lure the "Stans" to diversify their export markets and instead supply gas directly to Europe, arguing that they could get a better price. Europe's drive to reduce its own growing dependence on Gazprom and diversify its source of gas supplies has translated to political support for the trans-Caspian gas pipeline, which could allow the Central Asian countries to bypass Russia and supply gas to south-eastern Europe via the Caucasus and Turkey.

Now, however, Gazprom has turned that strategy on its head, using the very same logic—appealing to the desire of the Central Asian countries to receive higher prices for their gas exports—to effectively undermine the rationale for the trans-Caspian pipeline. Moreover, by agreeing to pay an undefined "European" price (presumably prices will more closely approximate the fuel oil-indexed average European price from 2009), Gazprom has given Turkmenistan, Uzbekistan, and Kazakhstan the incentive to continue supplying the bulk of their gas to Russia. Thus, the desire to diversify their own export partners is somewhat dissipated. Besides, the Central Asians are already moving forward with a separate diversification project with a new pipeline to China, so the pull of Europe as a market is surely less strong today than it was before yesterday's deal with Gazprom.

Ukraine to Feel the Pinch

While, for Europe, yesterday's deal could mean potentially higher gas prices and a lack of alternative, non-Russian gas supplies from Central Asia, it is likely to be Ukraine that feels the more immediate effects. Coming just before the resumption of talks between Russia and Ukraine on gas prices and the latter's gas debts thus far this year, Gazprom's consent to pay a European price for Central Asian gas supplies from 2009 puts Ukraine in the uncomfortable position of trying to negotiate a deal for a phased-in transition of market prices as the country remains dependent on Gazprom as a source and/or transit partner for its gas supplies. Negotiators from Naftogaz Ukrainy and Gazprom are still seeking to agree on the size of the former's gas debt for supplies received thus far this year, with key questions on the volume supplied and the source of the gas: Ukraine is seeking to assign a value of US$179.5 per 1,000 cm for all gas received, while Gazprom has argued that around 25% of the gas supplied was of Russian origin and should be paid at the Russian export rate of US$314.6 per 1,000 cm.

However, with yesterday's deal Gazprom has executed a brilliant tactical manoeuvre that amounts to a virtual checkmate in the chess match with Naftogaz. Whatever the size of Ukraine's debt for gas supplies in 2008 thus far, and regardless of how and whether the intermediaries in the Russia-Ukraine gas trade are eliminated, Gazprom has now put Ukraine in the position of paying substantially more for gas imports next year. Gazprom can rightfully state that it has moved to paying market prices for its own gas imports and thus put the onus on Ukraine to do likewise. If Russia and Ukraine return to a direct gas supply deal, Gazprom can use yesterday's agreement to justify hiking prices to European levels for Ukraine. On the other hand, even if the Ukrainians insist on direct supply agreements with the Central Asian countries—an unlikely outcome given Gazprom's long-term deal with Turkmenistan—the move to "European" prices for Central Asian gas exports means that Ukraine will still be unable to avoid a major hike in the price of its gas imports.

Outlook and Implications

Gazprom's deal with the Central Asian state gas companies marks another salvo in the battle between the Russian gas giant and Ukraine over the price and delivery of its gas imports, as well as another victory in Gazprom's ongoing efforts to maintain its dominant position in supplying gas to Europe. Gazprom is ensuring that the bulk of gas exports from Turkmenistan, Kazakhstan, and Uzbekistan will flow into the Russian pipeline system, undermining the prospects of the trans-Caspian gas pipeline (never very hopeful in the first place) and, further downstream, the Nabucco pipeline. Convincing the Central Asians to supply their gas to Russia rather than seeking out a direct export route to Europe allows Gazprom to balance out its own gas needs—for both the domestic and export markets—while dealing another blow to Europe's attempts to diversify suppliers away from Russia.

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