The Potential Impact on Europe of Russia’s Evolving Domestic Gas Market

Dr James Henderson, Oxford Institute for Energy Studies

Historically Russia, and particularly Gazprom, has relied on gas exports to Europe to subsidise low domestic prices. However, Russia’s attitude towards European sales is set to change over the next decade as its domestic market is gradually liberalised, with potentially profound consequences for gas supply to Europe. As domestic prices rise towards export netback parity gas producers in Russia will be able to generate profitable returns from domestic sales as well as exports. Indeed, a number of independent producers such as Novatek are already doing this, and the rise of these new producers could fundamentally change the Russian gas portfolio supplying western markets. As prices and pipelines are liberalised, so” Independents”, whose production has previously been restricted by Gazprom’s monopoly, will be allowed to increase sales of their relatively low-cost gas domestically and may even be given access to export markets. Meanwhile Gazprom, whose new west-facing fields are both remote and high cost, may find itself increasingly focused on eastern markets to secure its growth. Gazprom’s monopoly on fields in eastern Russia and exports to Asia is relatively secure, while its desire to continue selling gas at oil-linked prices is more likely to be satisfied in Asia than in Europe. As a result, Russia may be developing two separate gas production and export strategies. In the west, where competition in domestic production is greatest and where Russia’s export sales to Europe are facing significant competition, a liberalised domestic market may evolve where low-cost producers compete to sell into markets in Russia and Europe at related prices, meaning that domestic supply and demand will for the first time start to affect the volume and price of Russian sales to Europe. Meanwhile in the East the traditional model of Gazprom’s export monopoly is likely to be maintained (at least for any pipeline sales and possibly also for LNG) for sales into a market where rapidly growing demand and an oil-related pricing structure may place less pressure on Gazprom’s traditional business practices. The paper will discuss the potential impact of these domestic changes on the sale of Russian gas to Europe and will analyse whether the liberalisation of the Russian gas market could actually provide lower cost and more flexible gas that could be increasingly competitive in a European market where the current debate over the continued relevance of oil-linked long-term contracts is putting Gazprom’s traditional export model under significant strain.


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