Prices and Tariffs

History and Prospects

Planning and budgetary regulation of prices are still there in the legislation

The soviet economy of the gas industry was regulated by schedules of prices and rates, which set tariffs for every operation and cost of products at every stage. Centralized planning implied regular recalculations of these characteristics according to the results of plan implementation in the previous periods and volumes of products in the planned period.

Currently, the Russian Federation Government regulates the wholesale price of natural gas supplied by OJSC Gazprom on the internal market without regulating the volume of supplied gas and the structure of its distribution.

Average gas selling price of OJSC Gazprom on the internal market, rubles per 1000 cu. m not including VAT

Source: OJSC Gazprom

When independent producers came to the market, the Russian Federation Government has to introduce regulation of transportation tariffs, which, however, did not change the structure of the planning and budgetary regulation system of relations in the industry.

Strategic goals: transition from regulation of wholesale prices to regulation of the unified transportation tariff

State regulation of prices and tariffs in the gas industry is based on the cost plus principle. Thus, every revision of economic parameters implies deep disclosure of industrial information and substantiation of changes. Until recently, the complex procedure of such substantiation was substituted by a political decision on raising the previous prices and tariffs up to a socially coordinated level.

Adoption of the «Procedure for Determining the Tariff of Transportation of Natural Gas from Independent Producers Through Trunk Gas Pipelines» by the Russian Federation Government made it necessary to start analyzing the economic factors and the structure of loading the transportation system with products.

The next step in the transformation of the industry had to be transition from state regulation of wholesale prices to regulation of the unified transportation tariff. Maybe, this will happen after completion of organization detachment of a transportation company in the structure of OJSC Gazprom.

Tariffs for transportation services, rubles per 1000 cubic meters not including VAT

Source: Federal Tariff Service of the Russian Federation

Tactical milestones: adoption of a wholesale price determination procedure

The difference in implementation of gas price formation principles by OJSC Gazprom and independent producers leads to a regular misbalance of demand, which has a negative impact on all subjects of the industry. Tariffs and prices are changed at different times and on the basis of uncoordinated information.

Prior to transition to a unified transportation tariff, this problem could have been solved by a procedure of setting wholesale prices developed on the theoretical basis of the adopted tariff determination procedure. Such a procedure is now being discussed by experts of the Federal Tariff Service of the Russian Federation.

Typical Gas Price Structure

OJSC Gazprom’s structure of price formation: internal and external components

Formally, the structure of regulated prices of gas supplied by OJSC Gazprom at the outlet of the gas transportation system consists of the following components:

1. Wholesale price of gas

2. Rate of supply and distribution services

3. Tariffs for gas distribution companies

OJSC Gazprom’s structure of natural gas price formation

Source: Federal Tariff Service of the Russian Federation, OJSC Gazprom, estimates of ERTA-Consult (2005)

In addition, OJSC Gazprom’s structure of gas price also include the internal prices and tariffs established by OJSC Gazprom for its subsidiaries:

4. Gas price at the inlet of the gas transportation system

5. Internal transportation tariff (per 1000 cu. m and 100 km)

In the final analysis, these expenditures determine OJSC Gazprom’s structure of gas price. The Attachment to this review presents the internal process of OJSC Gazprom subsidiaries and the transportation tariffs.

The transportation tariff depends on the cost of gas

Apart from other factors, the transportation tariff depends on the cost of gas and electric power, because a part of gas is used as fuel in the process of transportation. For example, gas supplied from the Krasnodar Krai has the highest price at the inlet to the gas transportation system and, at the same time, the highest transportation tariff.

Wholesale prices as the key instrument of state regulation in the industry

Wholesale prices are approved by the Federal Tariff Service of the Russian Federation once a year with their breakdown for 11 price zone (6 price zones until January 1, 2005). Wholesale prices are approved for two categories of consumers: industrial consumers and the population. The Attachment to this review presents the distribution of strategically important regions in price zones.

In determination of wholesale prices, due attention is paid to the cost of gas production and transportation in every direction and the internal gas selling price of Mezhregiongaz LLC at the outlet of the trunk gas pipeline. Based on these data, OJSC Gazprom forms its proposals for the Federal Tariff service of the Russian Federation for wholesale gas prices in every concrete region.

Rates of supply and distribution services

The rates of supply and distribution services are approved by the Federal Tariff Service of the Russian Federation usually once a year for the subsidiaries of OJSC Gazprom selling gas in each concrete region.

The rates of supply and distribution services are approved for the following three groups of industrial consumers and the population according to the volume of gas consumption:

· more than 1000 billion cubic meters a year,

· between 10 and 100 billion cubic meters a year, and

· less than 10 billion cubic meters a year.

Seasonal surcharge as the fine for excess consumption of gas

According to Paragraph 17 of the Rules of Gas Supply in the Russian Federation approved by the Resolution No.162 of February 5, 1998 of the Russian Federation Government, for excess consumption of gas without preliminary coordination with the supplier, the customer pays for the additional volume of gas consumed in excess to the volume of gas stipulated in the contract with the following seasonal correction factor applied:

1.1 from April 15 through September 15;

1.5 from September 16 through April 14.

Apart from that, according to the Rules of Gas Supply, the gas price may be corrected for calorific value if the average actual specific calorific value of gas is different from 7,900 kCal per cubic meter.

Forecasted Dynamics of Prices and Tariffs

Theoretically, internal gas prices must grow

The economic theory of market states the necessity of price growth in conditions of stable shortage of products. Estimates and actual requirements of consumers show that the shortage of natural gas is stable in the Russian market and will grow of the existing conditions remain the same.

Gas balance forecast, billion cubic meters

Source: OJSC Gazprom, Russian Federation Government, estimates of ERTA-Consult

The Russian Federation Government says that gas prices will increase sharply only after 2008

Still, the Russian Federation Government considers gas prices as one of the key factors regulating the level of industrial growth and the level of welfare safety and social security in the country. On November 30, 2006, Russian Federation Government decided that state control over the gas price growth is necessary.

The decision of the Russian Federation Government sets the following upper boundaries of gas price growth:

15% from January 2007,

25% from January 2008,

13% from January 2008,

13% from July 2009,

13% from January 2010,

13% from July 2010, and

level «ensuring equal profits» from January 2007.

Upper boundary of gas price growth on the internal market, rubles per 1000 cubic meters

Source: Russian Federation Government

Price growth will not be uniform for different territories

The price growth approved by the decision of the Russian Federation Government implies general growth of gas prices in the country. However, the structure of regional differentiation of wholesale prices with change with the growing level of prices. The final goal of these changes in ensuring equal profits on the internal and external markets. In case of uniform growth of prices, the regions remote from the traditional production locations would have achieved this goal much earlier than 2011 and further growth of prices there would have been impossible.

Price growth will non be uniform for different consumers

The Russian Federation Government is going to continue checking the growth of prices for energy resources for the population. This means that gas prices for industrial consumers will grow much faster than declared because gas prices for the population and electric and heat power generation will be subsidized at the expense of industrial consumers.

OJSC Gazprom actively pushes forward the idea of sharing the burden. According to GGO, higher price burden should be taken by industries with higher rates of returns and profit margins, such as export-oriented producers of mineral fertilizers, the metallurgy industry, etc.

The tariffs of OJSC Gazprom mat become a price raising instrument

Introduction of a unified transportation tariff with the same existing procedure of rate calculation may become a convenient mechanism concealed price escalation through redistribution of interregional cross-subsidies.

The necessity of introducing tariffs for system balancing and tariffs for storage services and other services for ensuring system reliability will lead to inclusion of additional expenses earlier ignored in wholesale prices into the expenses of OJSC Gazprom.

Tariff growth will change the geographic curve

The procedure for calculation of gas transportation tariffs implies regular updates of correction factors that compensate the nonlinear growth of tariffs with distance. Growth of tariffs will aggravate this non-linearity, which may result in considerable changes in the market forces of certain players in different regions.

It is worthwhile to construct a detailed model of situation development for working out strategies for reduction of risks associated with the regulatory activities of the Government.

Logics of Estimates

The owner of the gas transportation system will determine the industrial production strategy

Forecasts of natural gas production should be based in the draft Strategy of the Gas Industry, the latest document of OJSC Gazprom related to gas production strategy. Gas production will be limited, first of all, by the throughput capacity of the gas transportation system and access to it. Thus, in spite of considerable changes in the structure of gas production, the owner of the gas transportation system will determine the industrial production strategy.

Forecasted gas production in the Russian Federation, billion cubic meters

Source: Energy Strategy of the Russian Federation, Ministry of Industry and Energy of the Russian Federation, estimates of ERTA-Consult

Moderate consumption forecast

Forecasts of gas consumption dynamics should be based on the moderate version relying on conservative estimates of gas demand growth in the electric power industry, the estimates of the Russian Federation Government for industrial gas consumption growth, and the optimistic forecast of gas consumption by the population and the domestic household sector, which is associated with implementation of large-scale gasification plans.

Forecasted internal gas demand, billion cubic meters

Source: Energy Strategy of the Russian Federation, Ministry of Industry and Energy of the Russian Federation, estimates of ERTA-Consult

Role of Gas Export and Import in Internal Price and Tariff Formation

State regulation of prices and tariffs guarantees profitability of OJSC Gazprom

The cost plus principle put in the basis of the antitrust legislation provides OJSC Gazprom with state guarantees of profitability as long as prices and tariffs are regulated by the state, In search for a balance of interests between the gas monopoly and consumers, the Russian Federation Government has no right to endorse prices and tariffs that are lower that the economically justified level.

Revenues from the external and internal markets are the only source of financing

Until recently, revenues from gas sales on external markets were included into consolidated reports of OJSC Gazprom and taken into consideration in most governmental decisions, including governmental approvals of investment programs of the gas monopoly.

Growth of export revenues helps the Russian Federation Government check internal prices

The considerable growth of gas export prices helped the Russian Federation Government postpone reforms in the gas industry, including liberalization of internal gas prices, by more than five years. During this period, the growth of internal gas prices was limited by political decisions of the Government based on the negotiated compromise of the key concerned parties (different groups in the Russian Federation Government, industrial lobbies, representatives of the gas industry) rather than the balance of demand and supply.

The administrative weight of marketing subsidiaries of OJSC Gazprom helps them lobby the growth of prices on the internal market

Being subject to state regulation, formally OJSC Gazprom cannot exceed the established rate of returns from its activities. In this aspect, the growth of prices on the internal does not have any significant impact on the economy of the gas monopoly. However, the profits of certain subsidiaries of the holding and, consequently, their budgetary processes (investments, wages, emoluments, bonuses, and other financial flows) strongly depend on the relations between internal and external prices. Thus, growing internal prices raise the status Mezhregiongaz LLC, the main marketing subsidiary of the gas monopoly.

Export is a protected item in the gas balance of the Russian Federation

Historically, most gas export contracts were concluded on behalf of or with considerable participation of the Russian Federation Government. Currently, direct obligations of the state under these contracts are minimal as the relations are formalized in the form, of commercial contracts with OJSC Gazprom. On the one hand, this does not hamper the Russian Federation Government to actively use gas supplies as an instrument of its foreign policy and, on the other hand, all this gives OJSC Gazprom a serious argument for defending its commercial interests, even in its dialogs with the state.

The terms of foreign-trade contracts of OJSC Gazprom are still one of the most protected secrets in Russia. This situation helps the company manipulate the volumes and prices of gas sales 9in other words, the gas export revenues) in discussions of trade balance projects or financial statements.

The latest political processes lend credence to the version of active use of the «gas weapon of Russia» and immunity of gas export from state regulation authorities. The gas export legislation only legalized the status quo and added force and guarantees to the tacit treaty between the state and OJSC Gazprom.

Import buildup is one of the ways to eliminate deficit on the gas market

The state pursues its «gas policy,» continues to take part in shaping the terms of gas sales, and actively helps OJSC Gazprom in solution of the strategic problems of the industry. In particular, the Russian Federation Government plays an important role in organization of gas import from Central Asia. This mechanism is considered as one of the key sources of covering the forecasted shortage of gas. Gas import volumes depend on the possibilities of gas suppliers (reserves, production volumes, and technical state of gas pipelines), whereas prices are determined exclusively at the political level between the governments of countries.

The parameters of gas import deals have a serious impact on the mirror export operations and the economy of the entire holding. The actual and forecasted gas import and export operations should be taken into consideration for ensuring adequate understanding of the situation in the internal market.

Summary

1. The price history of the internal market in Russia is based on the budget distribution principles. Russia has neither experience of using market indicators nor free market agents. However, changes are inevitable and the time is probably ripe for applying the best international practices and experience to the developing gas market in Russia.

2. Institutional models of decision making taking into account economic factors, social motives, political relations, legal restriction, and regulatory obligations should be used for predicting the situation on the internal market of the Russian Federation.

3. Internal market prices are still an instrument of macroeconomic regulation rather than indicator of balance between demand and supply. It is unlikely that the situation will change in the nearest future. The key driving force of possible changes is reforms in the electric power industry.

4. The gas demand will grow in the nearest future irrespective of the growth of internal prices. The population and domestic household sector will be the leaders of gas demand growth. Gas-saving mechanisms will not be activated on their own, and their implementation will require active administrative participation of the state and subjects of the industry.

5. The Russian Federation Government has no intention to radically change the structure of the industry in the nearest future. This means that «economically justified prices and tariffs» will be based on the partial information disclosed by OJSC Gazprom. Thus, the key driving force for development of the internal gas market should be public disclosure and open expert examination of the information in the industry.

Other Links:

Report Outline
General Outline of the Gas Market
Prices and Tariffs
Infrastructure of the Gas Industry
State Regulation of Natural Gas Transportation and Sales
Market Participants and Their Strategies
Consumers. Economic and Regional Segmentation
Key Problems of the Market
Risks and Limitations
Market Development Prospects
Conclusions

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Оглавление и сокращения
Краткое содержание отчета
Цены и тарифы
Центральная отраслевая инфраструктура
Государственное регулирование
Участники рынка
Сегментация потребителей
Проблемы рынка
Риски и ограничения
Перспективы рынка
Выводы

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