General Outline of the Gas Market

Salient Features of the Russian Gas Market

Gas is a special type of fuel in Russia

Natural gas dominates in the structure of fuel and energy consumption in Russia. In 2005, consumption of gas on the internal market amounted to 44.3 billion cubic meters. 389.4 billion cubic meters were supplied to consumers in Russia.

This is no exception in the world practice, however.

However, this is not an exclusive phenomenon in the world practice. Most resource-producing countries successfully use their natural advantages.

Gas is produced in Russia not only by OJSC Gazprom

Apart from the producing enterprises of OJSC Gazprom, gas in Russia is also produced by independent producers, most of which are vertically integrated oil companied.

Gas production in 2005

Producing company	Natural and associated gas, billion cubic meters	Share, %	Gazprom	547.9	85.48	Novatek	25.4	3.96
Surgutneftegaz	14.4	2.25
Rosneft	13.0	2.03
TNK-BP	8.7	1.36
Lukoil	5.8	0.90
Sibneft	2.0	0.31
YUKOS	2.0	0.31
Slavneft	1.0	0.16
Russneft	1.0	0.16
Tatneft	0.7	0.10
Bashneft	0.4	0.06
Other	18.7	2.92
Total	641	100

Source: Ministry of Industry and Energy of the Russian Federation

Gas demand in Russia grows in current conditions

In current conditions, the demand for gas in Russia is growing steadily. The largest consumers of gas are the Moscow Region, Sverdlovsk Region, Chelyabinsk Region, Republic of Bashkortostan, Republic of Tatarstan, and Perm Krai.

Dynamics of natural gas consumption, billion cubic meters

Source: Ministry of Industry and Energy of the Russian Federation

The largest consumer of gas is the electric power industry

The largest consumer of gas in Russia is the electric power industry, which accounts for more than 38% of the consumer demand for natural gas. In 2005, 152.8 billion cubic meters of gas was supplied to enterprises of RAO Unified Energy System of Russia.

Shares of prime energy resources in the electric power generation structure in different countries, %

Source: International Energy Agency

The gas industry itself is a large consumer of gas. In 2005, 52.9 billion cubic meters of gas was used for its own gas pipeline process needs.

Combined functions of OJSC Gazprom is the key problem of the gas market

The main problem on the way of development of a competitive market of natural gas in Russia is that the functions of gas production, transportation and sales are all combined in OJSC Gazprom, which owns the national gas transportation system. This structure of OJSC Gazprom allows the company to control the gas flows of independent producers and force independent producers to conduct their business transactions only after coordination with the interests of OJSC Gazprom.

There is a formal solution, …

Formally, this problem is resolved with the state regulation instruments. The Federal Tariff Service sets tariffs for transportation of natural gas from independent producers through the gas transportation system of OJSC Gazprom. The Federal Antimonopoly Service prevents abuse of the dominant position of infrastructure monopolies.

… but it does not work for gas transportation …

In actual practice, however, the development of state regulation instruments lags behind the dynamic development of economic and administrative relations among players in the sphere of natural gas production, transportation and sales. In particular, the currently effective regulatory framework is incapable of fully ensuring the right of independent producers to have fair access to facilities of the national gas transportation system in everyday practice. The practice of setting tariffs for transportation of natural gas from independent producers based on the cost-plus principle fails to pay due attention to the wholesale prices of natural gas produced by OJSC Gazprom, which actually shape the regional markets.

…and gas sales

OJSC Gazprom sells gas in regions at lower state-regulated prices owing to the fact that the state subsidizes the company from the profits derived from export of natural gas. This scheme of price dumping allows the regional sales companies of OJSC Gazprom to control the internal gas markets by selling subsidized gas at lower prices than those independent producers can afford and thus winning the competition. The absence of special regulation, the sole control of the transportation infrastructure, and the dominating access to gas reserves allows the regional companies of OJSC Gazprom to offer the specific service of additional supplies, which breeds gas larceny and corruption.

OJSC Gazprom dominates the industry

OJSC Gazprom accounts for 85.5% of gas production in Russia and a fifth of the world gas production. In 2005, OJSC Gazprom supplied 286.9 billion cubic meters of gas to consumers in Russia. OJSC Gazprom produced 547.9 billion cubic meters of gas in 2005, which is 2.8 billion cubic meters more than in 2004.

Production of natural gas by OJSC Gazprom, billion cubic meters

Source: OJSC Gazprom

The situation will remain the same in the nearest future

OJSC Gazprom is planning to increase gas production up to 550-560 billion cubic meters by 2010, to 580-590 billion cubic meters by 2020, and to 610-630 billion cubic meters by 2030.

Structure of natural gas production, %

Source: Energy Strategy of the Russian Federation

The level of gas production planned for 2010 will be maintained by development of existing and new fields of the Nadym-Pur-Taz region, in particular, the South-Russian field, the Lower Cretaceous deposits of the Zapolyarnoe and Pestsovoe fields, and the Achim deposits of the Urengoi field. Development of fields in this region is economically expedient owing to its proximity to the existing gas transportation infrastructure.

Decline of gas production in the main fields of OJSC Gazprom, billion cubic meters

Source: estimates of ERTA-Consult

New production involves development of remote and difficult fields

After 2010, the forecasted level of gas product will be maintained by development of fields on the Yamal Peninsula, the shelf of arctic seas, in the offshore areas of the Gulf of Ob and the Taz Bay, in East Siberia, and Far East. The Yamal Peninsula is a strategically crucial region of gas production for the company. This is one of the most promising oil and gas bearing regions in East Siberia. Twenty six fields have been discovered on the Yamal Peninsula, whose explored reserves of gas amount to 10.4 trillion cubic meters, recoverable reserves of gas condensate to 250.5 million tons, and recoverable reserves of oil to 291.8 million tons.

OJSC Gazprom is preparing for development of Yamal fields

In 2002, OJSC Gazprom, in cooperation with the Administration of the Yamalo-Nenets Autonomous Area, worked out the «Program of Comprehensive Industrial Development of Fields of the Yamal Peninsula and Adjacent Offshore Areas,» which now is under consideration of the Russian Federation Government.

Currently, OJSC Gazprom is preparing for construction of facilities and infrastructure in Yamal fields. The company holds licenses for development of the Bovanenkov, Kharasavei, and Novoport fields, whose total reserves are estimated at 5.8 trillion cubic meters of gas.

The cost of new gas will be higher

The cost of gas production on the Yamal Peninsula will be considerably higher than in existing fields. For this reason, according to OJSC Gazprom, development of the mineral resources of the Yamal Peninsula requires target support of the state.

Forecasted production of gas by independent producers, billion cubic meters

Source: Energy Policy Institute

OJSC Gazprom is going to go to the East

The Energy Strategy of the Russian Federation until 2020 implies development of the oil and gas complex of East Siberia and the Republic of Sakha (Yakutia). Calculations show that oil and gas reserves have to be developed concurrently. Emphasis should be made on development of gas fields in order to satisfy the gas demand of Far East and supply gas to Asia-Pacific countries.

OJSC Gazprom is preparing consumers for higher prices

According to OJSC Gazprom, the conditions in the industrial sector of the Russian economy are ripe for expansion of gas sales at free prices. For this reason, in 2006 the company proposed using market-based prices of gas supplied to industrial consumers and regulated prices for gas supplied for household maintenance and utility needs and to the population and industrial consumers on the state budget.

Resources and consumption structure — which comes first?

Gas is the most inexpensive fuel in Russia. One of the consequences of this is changed structure of energy consumption in the country. The use of coal, residual oil, and other types of alternative fuel has decreased and reduced the necessity of growing their production and developing the corresponding industries. According to OJSC Gazprom, this situation is not good as it causes distortion in the adequate evaluation of the economic efficiency of different types of fuel.

At the same time, it seems natural that a country with huge reserves of inexpensive and high-quality fuel is developing its national economy by making a maximum use of this fuel in all sphere of production. In this aspect, comparison of fuel consumption structures in different countries cannot be used a reason for deliberately changing them.

According to the Energy Strategy of Russia, gas prices will increase, first of all for industrial consumers, 2.5 times by 2010 compared to the prices of 2003.

There is a formal procedure for distribution of subsidized gas, …

In planning gas supplies to consumers, OJSC Gazprom follows the document «Procedure for Distribution of Gas Resources by OJSC Gazprom with Due Regard to Gas Export and Production of Gas by Independent Companies.»

According to this document, once in every quarter Mezhregiongaz LLC provides dedicated departments of OJSC Gazprom with information on the actual supplies of gas to consumers in the previous quarter. Apart from that, Mezhregiongaz collects consumers’ gas supply requests for the following year. Gas is distributed according to the obtained data.

… and this procedure is carried out without participation of the state.

Distribution of gas is also based on the fulfillment of obligations by consumers in the previous years. When necessary, OJSC Gazprom supplies additional volumes of gas to solvent consumers according to the technical possibilities of the Unified Gas Supply System and the obligations under signed gas export contracts and internal gas supply contracts.

Apart from that, gas is also supplied to new consumers. A consumer company has to file a request and present detailed reports on its heat and fuel requirements and a conclusion of transport organizations on the technical possibilities of gas supply. Permissions for use of gas are issued with due regard to the availability of gas resources in Russian regions, optimal load on the gas distribution systems, and economic expediency of using gas as fuel.

The housing maintenance and utilities sector is a large consumer of gas in Russia.

In Russia, gas is supplied to

· 77.1 % of houses and residential buildings in towns and urban-type settlements and

· 42.3 % of houses and residential buildings in the countryside

The dynamics of gas consumption by the population is controlled by OJSC Gazprom.

Beginning from 2002, OJSC Gazprom approves region gasification programs.

Selection of the regions where OJSC Gazprom is planning to start gasification works is based on the following factors:

· level of gasification of the region;

· capacity of the region to defray a part of gasification expenses;

· arrears in the payment of current gas supplies; and

· absence of cases uncoordinated with OJSC Gazprom when gas consumption exceeded the established limits.

OJSC Gazprom controls the actions of constituent entities of the Russian Federation

In August 23, 2003, the Management of OJSC Gazprom approved a new version of concept of participation of OJSC Gazprom in gasification of regions of the Russian Federation. The new document prescribes a mechanism of interaction of OJSC Gazprom with the administrations of regions at the preparatory stage of gasification comprising the following:

— Conclusion of an agreement of cooperation between OJSC Gazprom and the administration of the constituent entity of the Russian Federation;

— Conclusion of a gasification agreement;

— Conclusion of an agreement for development of an investment project;

— Collection of proposals from the administrations of the regions subject to gasification for development of an investment project;

— Development of an investment project with its master scheme of gasification, technical and economic substantiation (feasibility study), and business plan;

— Development and approval of a stage-wise program of gasification of the constituent entity of the Russian Federation based on the investment project;

— Approval of the objects and facilities subject to gasification based on the technical and economic substantiation (feasibility study);

— Determination of the forms of participation of OJSC Gazprom in gasification of objects and facilities and sources and forms of financing.

The scale of gasification is large

In 2005 OJSC Gazprom constructed, at its own expense, 2,500 km of medium-pressure and low-pressure gas pipelines in 40 regions of the Russian Federation. Gazprom started implementation of the large-scale program for gasification of regions in the Russian Federation in 2005-2007. According to this program of gasification, within three years Gazprom will lay more than 12,000 km of gas distribution pipelines and invest 35 billion rubles, of which 5.2 billion rubles will be invested in 2005, 17.6 billion rubles in 2006, and 12.2 billion rubles in 2007.

Implementation of this program with raise the level of gasification with natural gas up to 60% on average in Russia, 66% in urban areas, and 42% in rural areas. The program implies construction of more than 12,000 km of gas pipelines, which will increase the load of existing gas distribution pipeline branches 1.5 times on average.

Construction of gas distribution networks, km

Source: Draft Strategy of Development of the Gas Industry until 2030

Gasification is accompanied with structural changes in OJSC Gazprom

For ensuring efficiency of its capital investments into development of the gas distribution infrastructure, Gazprom consolidates its gas distribution assets. Assets are transferred to OJSC Gazpromregiongaz incorporated in the Gazprom Group. Consolidation of these assets creates requisite conditions for implementation of a unified tariff policy and creation of financing sources for maintaining the region gas distribution networks in working conditions.

Investments required for construction of gas distribution networks, million rubles

Source: Draft Strategy of Development of the Gas Industry until 2030

Prospects of Development of the Gas Industry in Russia

The Energy Strategy of the Russian Federation is the only official document outlining the prospects of gas industry development

Long-term milestones for development of the gas industry in Russia are outlined in the Energy Strategy of the Russian Federation until 2020, hereinafter referred to as the Energy Strategy of the Russian Federation, approved by Resolution No.1234-r of August 28, 2003 of the Russian Federation Government. With all its known shortcomings, this document provides the only official long-term forecast for development of the gas industry in Russia.

For several years now, OJSC Gazprom has been developing the Strategy of Development of the Gas Industry in Russia, whose constituent part is the Program of Development of Production, Transportation and Sales of Natural Gas in East Siberia and Far East. However, the Russian Federation Government still has not received the final version of this document for approval. The principal reasons for this are as follows:

· absence of consensus in OJSC Gazprom on development of the gas industry;

· reluctance of the gas monopoly to officially register additional requirements of the state;

· and unsettled problems in the relations between OJSC Gazprom and other gas companies.

The Energy Strategy of the Russian Federation implies a tendency to rising gas prices

The Energy Strategy of the Russian Federation has documented the wishes of OJSC Gazprom related to the dynamics of internal gas price growth and approved by the Russian Federation Government. For 2003, it was a rather revolutionary document that officially justified the necessity of regular increase of the regulated price of gas on the internal market.

Range of wholesale gas prices on the internal market, $/1000 cubic meters

Source: Energy Strategy of the Russian Federation until 2020

The Energy Strategy of the Russian Federation sets priorities of new field development

Even in 2003 it was clear that the decline of gas production in traditional fields can positively be compensated only by development of new very large fields. The Energy Strategy of the Russian Federation provides a strategic vector of gas production expansion from the fields of the Nadym-Pur-Taz region to European Russia, East Siberia, and Far East.

The Energy Strategy of the Russian Federation implies considerable growth of gas production in East Siberia, including development of the Kovykta gas condensate field in the Irkutsk Region, the Chayanda oil and gas condensate field in the Republic of Sakha (Yakutia), hydrocarbon fields in the Krasnoyarsk Krai, and fields on the Sakhalin Island shelf.

Dynamics of gas production in new regions, billion cubic meters

Source: Energy Strategy of the Russian Federation until 2020

Forecast of gas production in Russia, billion cubic meters

Source: Energy Strategy of the Russian Federation

OJSC Gazprom predicts gas demand growth

According to the forecast of OJSC Gazprom, the level of gas consumption in Russia will grow from 383.9 billion cubic meters in 2004 up to 436.3 billion cubic meters by 2030 in the intensive version and up to 410.8 billion cubic meters in the moderate version.

According to the forecast, gas consumption growth is expected in all sectors of the market. The most dynamic growth of gas consumption, according to the adopted priorities, is predicted in the domestic household sector, where gasification of rural populated areas will continue. The level of household gasification in the countryside will be increased from 34.7% in 2003 up to 40% by 2030. This corresponds to the growth of domestic household gas consumption in rural areas by 11.6 billion cubic meters by 2030 compared to the level of 2003. In urban areas, towns and urban-type settlements, the gas demand of domestic household consumers is also expected to grow.

The intensive version predicts growth of gas consumption in the industrial sector mainly due to gas supplies to high-technology industries with highly efficient and rational use of gas, socially-oriented industries, and industrial facilities in the regions with new gas distribution infrastructures. In the moderate version, gas consumption in the industrial sector will slightly increase by 2015 and then decrease to the level of 2006.

OJSC Gazprom did not plan to increase gas supplies to electric power plants

The forecast implies limited growth of gas consumption by electric power plants mainly associated with gas supplies to electric power plants in the regions with new gas distribution infrastructures. The share of gas in the fuel balance of electric power stations will decrease to 58% by 2020 and 55% by 2030. Presumably, gas will be supplied to electric power plants, used in advanced technologies, and replaced by coal where it is technically feasible and economically expedient. In view of the predicted dynamics of gas prices, construction of new electric power plants using gas is not implied. In the period until 2030, Russia and its Unified Gas Supply System will be characterized by a significant decrease in the relative share of the energy industry and steady growth of other market sectors.

November 30, 2006 meeting of the Russian Federation Government

At its meeting held on November 30, 2006, the Russian Federation Government decided to supply 162.9 billion cubic meters of gas to power generation facilities in 2007, 166.9 billion cubic meters in 2008, 174.8 billion cubic meters in 2009, and 186 billion cubic meters in 2010 divided into the corresponding monthly supply volumes and recommended conclusion of long-term five-year contracts for transportation of gas from independent producers in the volumes prescribed by the long-terms gas supply contracts.

Forecasted consumption of natural gas, billion cubic meters

Source: Draft Strategy of Development of the Gas Industry until 2030

Information on the forecasted demand and supply of gas in the two versions is presented in the Attachments.

Import is considered as a source of additional gas demand satisfaction

The sources of satisfaction of the internal and external demand are production of gas and import of gas. In the period until 2030, three possible versions of gas import are considered: 57 billion cubic meters, 70 billion cubic meters, and 105 billion cubic meters of imported gas. Gas will be imported from Turkmenistan, Uzbekistan, and Kazakhstan.

New field development is considered as a source of additional gas demand satisfaction

The resource base of the eastern regions of Russia (the zone that is currently not covered by the Unified Gas Supply System) and its prospective development ensures satisfaction of the internal gas demand of these regions, export of gas to countries of the Asia-Pacific region, and possible supply of 35 billion cubic meters of gas a year to the Unified Gas Supply System.

For analysis of the considered scenarios, OJSC Gazprom identified new gas resources in the regions covered by the Unified Gas Supply System. These gas resources include the following fields:

· fields of the Yamal Peninsula (250 billion cubic meters of gas a year from onshore fields and up to 90 billion cubic meters of gas a year from offshore fields by 2030);

· fields in the Gulf of Ob and the Tax Bay (82 billion cubic meters of gas a year);

· Shtokman field (69 billion cubic meters of gas a year);

· fields on the Caspian Sea shelf (12 billion cubic meters of gas a year); and

· virgin fields of the Nadym-Pur-Taz region (up to 80 billion cubic meters of gas a year by 2010 with a maximum of 135 billion cubic meters a year).

OJSC Gazprom admits an increase of the share of independent producers

The strategy of development of the gas industry implies an increase of the share of independent producers on the gas market. This forecast of OJSC Gazprom is based in the Energy Strategy of the Russian Federation until 2020.

The share of independent producers of gas on the internal market will increase as it will in gas production and gas sales. Presumably, all gas produced by independent producers will be sold on the internal market.

The share of independent producers in gas production will grow from 14% to 20% by 2020, and their share in supplies of natural gas from 20% to 35% by 2020.

Structure of natural gas production, %

Source: Draft Strategy of Development of the Gas Industry until 2030

Structure of natural gas supplies, %

Source: Draft Strategy of Development of the Gas Industry until 2030

State Regulation in the Gas Industry

The structure of gas industry regulation is imperfect

The current structure of gas industry regulation is far from being harmonious. The basic mechanisms of regulation were created for the former Ministry of Gas Industry, which in fact was OJSC Gazprom. The subsequent considerable changes in the gas industry were not always followed by corresponding changes in the goals, instruments, and legal framework of regulation.

The legal framework of the industry is the result of the balance of forces

Changes in the legal framework of the industry were rather spontaneous and reflected the stages of interaction of the state and OJSC Gazprom. Some legal changes were initiated by OJSC Gazprom. These changes were hailed by the Russian Federation Government and approved with minimum corrections. Other legal changes were initiated by different liberal groups in the Russian Federation Government and obstructed by OJSC Gazprom in every possible way. Eventually, most of these initiatives were not adopted. Nevertheless, the most important regulatory documents of the gas industry reflected the acceptable compromise of the conflicting parties at the moment of their adoption.

Regulation structure and draft laws

Disputes are still underway on possible approaches the structure of the gas industry legislation. For example, development and adoption of an industry-wide law «On Oil and Gas» is being discussed for several consecutive years now. This law could cover all the main aspects in regulation of production, transportation, storage, and export of hydrocarbons and operation of the market of hydrocarbons. Apart from that, back in 1999, the State Duma (Parliament) of the Russian Federation adopted the draft law «On Pipeline Transport» in its first reading, which was intended for legislative resolution of issued related to construction and operation of trunk pipelines. Despite the high importance of the issued addressed by this draft law, its outcome is still unclear. In recent years, the issue of revising certain provisions of the law «On Gas Supply in Russian Federation» is being raised more and more often as its existing version is outdated and cannot adequately regulated contemporary processes in the industry.

The conservative position of OJSC Gazprom prevails in the current balance of forces

In conditions of rapid changes in the Russian economy, the entire legal framework of the industry is very outmoded and inadequate. Only a small number of regulatory documents related to operation of the industry were adopted recently. Certain regulatory documents critical for proper development of the gas market in the Russian Federation, such as the «Rules of Access to Trunk Pipelines of OJSC Gazprom» approved by Resolution No.858 of July 14, 1998 of the Russian Federation Government and the «Rules of Gas Supply» approved by Resolution No.162 of February 8, 1998 of the Russian Federation Government, are outdated beyond hope.

One of the latest positive news is adoption of the «Procedure for Calculating Tariffs for Gas Transportation in Trunk Gas Pipelines» approved by Resolution No.338-e/1 of August 23, 2005 of the Federal Tariff Service of the Russian Federation. However, all this is very far from being sufficient, especially in view of the fact that discussions on reforming the legal framework of the gas industry are underway for a long time now.

The industry regulation system is highly eclectic

We inherited the planning and distribution mechanism of state regulation in the gas industry from the soviet period. In particular, OJSC Gazprom performs the functions of the state and decides who will receive gas at the prices regulated by the Russian Federation Government and how much.

The attempts of the Russian Federation Government to follow the changes in industrial relations only added new instruments of microeconomic restrictions and limitations. The adopted procedures for limiting the tariff-based revenues of OJSC Gazprom are based on the principles of covering the «economically justified expenditures.» For this reason, the Russian Federation Government regularly estimated the economic necessity and soundness of the investment programs of OJSC Gazprom.

The danger of losing control over assets and the efficiency of their use compelled the Russian Federation Government to introduce numerous apparent and concealed restrictions and limitations. The overt prohibition of selling the right of field development conceals the disguised prohibition of construction of transportation infrastructure and storage systems. Stringent restrictions are imposed on the right to use gas as fuel.

The liberal attempts of the Russian Federation Government to clear up the industry economy and make it more transparent were transformed into instruments for raising gas prices and complicating the rules for entering the market. In particular, extra dues in addition to gas prices were introduced in the form of payments for supply and distribution services. The procedure of determining the rate of supply and distribution services by the Russian Federation Government has in fact become a procedure of licensing sales companies on the market of natural gas.

So far, all discussions of OJSC Gazprom and the Russian Federation Government on the adequacy of the state revenues (taxes, customs receipts, etc.) ended up in favor of the industry, which is associated, first of all, with the large size and relatively easy management of this flow of money (in contrast to the flow of money in the oil industry which is equally large but smeared over numerous oil companies).

Typical Gas Supply Terms

The level of gas prices is annually set by the Federal Tariff Service for each individual region

The wholesale gas selling price of OJSC Gazprom on the territory of the Russian Federation is regulated by the state and set according to the territorial zones. In 2006, the wholesale gas price for consumers (except the population) ranged from 677 rubles for zone I (Yamalo-Nenets Autonomous Area) to 1,455 rubles for zone X (Kaliningrad Region) for a thousand cubic meters of gas not including VAT. For the population, the wholesale gas prices varied from 677 rubles for zone I (Yamalo-Nenets Autonomous Area) to 1,040 rubles for zone X (Kaliningrad Region) for a thousand cubic meters of gas not including VAT.

Price zones of the Russian Federation

Source: Federal Tariff Service of the Russian Federation

Consumption of natural gas in Russia is highly non-uniform in seasons

According to the information of the Ministry of Industry and Energy of the Russian Federation, the seasonal non-uniformity of gas supplies to consumers in Russia may be represented by the following diagram (billion cubic meters):

Typical structure of natural gas supplies to consumers in Russia

Source: Ministry of Industry and Energy of the Russian Federation

The state has no formal gas distribution powers

Coordination of gas supplies is regulated by the internal document of OJSC Gazprom «Procedure for Distribution of OJSC Gazprom Gas Resources with Due Regard to Gas Export and Gas Production by Independent Producers» developed in pursuance of Resolution No.100 of October 14, 2002 of OJSC Gazprom.

Outline of the procedure

Every year, the Central Production Control Department of OJSC Gazprom works out a gas balance in the Unified Gas Supply System by no later than October 1, for which purpose it collects data from Mezhregiongaz LLC and independent producers of gas. The gas balance defines the total volume of gas supplies.

Mezhregiongaz LLC collects requests from consumers authorized to use gas[1] and by November 1 sends to the Department of Marketing and Gas and Liquid Hydrocarbon Processing of OJSC Gazprom, hereinafter referred to as the Department of Marketing, an estimate of requirements for sales of gas to consumer divided into the zones of activities of the subsidiary companies.

By November 15, the Department of Marketing distributes the required volumes of gas (in fact, corrects and approves the proposals of Mezhregiongaz LLC). Based on this distribution of gas volumes, the Department of Economy of OJSC Gazprom works out an annual plan of gas transportation.

Based on the approved plan of gas volume distribution, Mezhregiongaz LLC concludes contracts of gas supply with consumers through its regional companies by the end of the year.

Based on the concluded contracts, Mezhregiongaz LLC presents quarterly data on the contracted volumes of gas supply to consumers to the Department of Marketing in the form of return input sheets. Based on these input sheets, the Central Production Control Department forms consolidated volumes of gas supply to consumers.

Within 45 days prior to the planned quarter, Mezhregiongaz LLC and independent suppliers, having an approved access to the gas transportation system and contracts for transportation and supply of gas to consumers, distribute the quarterly gas supply volumes on a monthly basis.

Additional volumes of gas may be allocated by the Department of Marketing.

Permission for access to the gas transportation system is the key stage in a gas supply contract

There are be long-term gas supply contracts. Currently, there are no long-term gas transportation contracts with independent companies. Gas sales contracts are concluded under a condition of getting access to the gas transportation system. Signing a gas transport contract requires obtaining a decision of the Gazprom commission on access to transport. Mezhregiongaz LLC does not have to lodge requests for access as it gets access automatically.

For approval of access to the gas transportation system, independent gas sellers have to present a set of documents to OJSC Gazprom in accordance with the established form and procedure.

Gas transportation request (set of documents)

Name and bank details of the independent company

Sources of gas (name and location of the field and gas pipeline) and their characteristics (reserves by categories, production volume, total capacity, etc.)

Gas supply start and end dates

Gas supply volumes (by months during the entire gas supply period)

Composition and quality characteristics and parameters of gas

Coordination of technical possibilities of connecting gas feed pipelines with OJSC Gazprom

Location and scheme of connection of the gas feed pipeline to the gas transportation system

Location and scheme of gas delivery to the customer

Confirmation of the gas transportation organization not incorporated in the system of OJSC Gazprom, gas distribution organization, and customer that they are ready to receive the declared gas volume during the supply period

Documents certifying the ownership of gas or contractual obligations to buy (or sell) gas (license, contract)

Information on the availability of pipelines for gas feed from the suppliers and pipelines for gas delivery to the customers with gas metering stations with their types and characteristics by the time of implied supply of gas to the customers

The access granting procedure is not transparent

Documents are coordinated, endorsed and approved in more than 10 departments of the gas monopoly. Until recently, the chairman of the access commission was Alexander Ryazanov, Deputy Chairman of the Management of OJSC Gazprom. However, the access-related authorities of Kirill Seleznev, Head of the Department of Marketing, and Alexander Ryazanov were identical as formally the Department of Marketing prepares the final version of protocols of the access commission.

Dynamics of decisions on access to the gas transportation system

	1999	2000	2001	2002	2003	2004
Number of companies granted access to the gas transportation system	10	20	24	33	31	35
Volume of transported gas not belonging to OJSC Gazprom, billion cubic meters	83.7	106.2	92.4	103.6	95.4	110.4

Source: Federal Tariff Service of the Russian Federation

It should be mentioned that in statistical reports the volumes of transported gas not belonging to OJSC Gazprom include gas from Central Asia and Kazakhstan (50.2 billion cubic meters in 2004).

Consumers prefer gas from independent suppliers

Supplies of gas from independent suppliers are more reliable and transparent. Regional gas marketing subsidiaries of OJSC Gazprom often fail to fulfill their contractual obligations to consumers. OJSC Gazprom fails to fulfill its gas transportation obligations in 20% of cases. Contracts of independent suppliers and resellers are usually written in the spirit of partnership and even in customer’s favor.

Summary

1. The share of natural gas in the fuel balance of Russia is significant and continues to grow. Most of natural gas in Russia is produced by OJSC Gazprom. Main consumers of natural gas in Russia are electric power plants, the population, and the domestic household sector. OJSC Gazprom itself is a large consumer of natural gas. The Provolzhsky Federal District is the leader in natural gas consumption.

2. The gas supply business includes production of gas , transportation of gas through trunk gas pipelines (including storage of gas), transportation of gas through low-pressure gas pipelines, and supplies of gas (commercial purchase and sale relations). For execution of a gas supply contract, the seller has to get access to the gas transportation system and sign gas transportation contracts.

3. Gas supplies vary in seasons. The volumes of gas supplies, including supplies of gas from independent producers through the gas transportation system of OJSC Gazprom, are determined every year by OJSC Gazprom. The shortage of gas and difficulty of meeting the requirements of OJSC Gazprom result in organization of semi-legal schemes of gas supply.

4. The main problem for development of a competitive market of natural gas in Russia is combination of the functions of production, transportation and sales of natural gas in OJSC Gazprom, which owns the national gas transportation system. This structure of the company allows it to control the gas flows of independent producers and force them to conduct their business only after coordination with the interests of OJSC Gazprom.

5. In actual practice, the existing legal framework does not allow independent producers to exercise their legitimate right to get fair access to the national gas transportation system.

6. The dominating position of OJSC Gazprom on the market makes it possible for the sales companies of this holding to impose their stringent contract terms on consumers. Consumers prefer to deal with independent suppliers of gas, but the regional sales companies of OJSC Gazprom reluctantly give up their markets and resort to a wide range of competitive weapons.

7. OJSC Gazprom sells gas in regions at lower state-regulated prices owing to the fact that the state subsidizes the company from the profits derived from export of natural gas. This scheme of price dumping allows the regional sales companies of OJSC Gazprom to control the internal gas markets by selling subsidized gas at lower prices than those independent producers can afford and thus winning the competition.

8. Gas transportation accounts for a considerable part in the wholesale price of gas. The rules of gas supply allow consumers to buy gas at the well and transport it to the site of its utilization.

9. Official prospects of development of the gas industry are associated, first of all, with gas production in new regions and increase of gas prices. No reforms in the legal framework of the industry is implied yet.

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[1] According to Resolution No.832 of October 29, 1992 of the Russian Federation Government «On the Procedure of Determining the Type of Fuel for Enterprises and Installations Using Fuel,» decisions on the use of gas are made by the Ministry of Trade and Economic Development of the Russian Federation and executive authorities of constituent entities of the Russian Federation in coordination with OJSC Gazprom.