Situation on the Gas Market: Key Problems of the Market

14.09.2007
Источник: Группа ЭРТА

Автор: Группа ЭРТА
Дата публикации: 26.12.06

Key Problems of the Market

Gas market — different meanings lead to different positions

The gas market of Russia is in most cases understood as a free market with a large number of sellers and buyers, a full set of open information on the demand and proposal, a set of nondiscriminatory trading rules, etc. This hypothesis, however, is not always correct. Managers of OJSC Gazprom think that the gas market exists and we only have to renounce state regulation of prices. Consumers hold that there is no market as there is no alternative to purchasing gas from OJSC Gazprom. Independent producers say that the market needs actually working rules of nondiscriminatory access to the gas transportation system.

Market formation requires many different conditions

Here are some of the conditions desirable for efficient market formation:

1. Availability of a qualified seller

· availability of goods to sell

· seller’s capability of facing nonpayment risks and providing delivery guarantees

· seller’s desire and possibility of earning profits from sales of goods

2. Availability of a qualified buyer

· demand for goods

· buyer’s capability of facing non-delivery risks and providing payment guarantees

· deal’s involvement in the buyer’s business: economic concernment in the deal

3. Free access to the operational infrastructures of transaction, delivery and payment

4. Efficient system of delivery and payment guarantees

5. Publicity of key information

6. Availability of transaction alternatives: freedom of choice of sellers and buyers

7. Formal and public trading rules

9. Fair market entrance rules

10. System of quantity and quality measurements

11. Balance of interests inside the market (market participants) and outside the market (market environment, state, society)

Absence or instability of these conditions makes it impossible to form a gas market in Russia.

Fuel and Energy Balance of Russia

OJSC Gazprom’s version: the share of gas is large out of proportion

The key seller of gas, having a relative freedom to choose the market, regularly tries to increase the volume of gas offered on the more profitable market (the export market) and therefore decrease the volume of gas sold on the regulated market (the internal market). These attempts adds imbalance inside the market (conflict between RAO Unified Energy System of Russia and OJSC Gazprom, problem of access of independent gas producers to export markets, etc.) and outside the market (the Government is compelled to solve energy supply problems in the country). OJSC Gazprom need some ideological concepts to provide a legitimate basis for such actions. The concept of proportional fuel and energy balance of the country allows the company to talk about the necessity reducing the internal consumption of natural gas in Russia.

Independent producers’ version: natural advantages should be employed

Independent producers have no right to export gas outside the country. The have to encourage growth of gas consumption inside the country. This is fraught with a gas production shortage, for which reason they have a chance to enter their gas resources into the production part of the gas balance. The already formed selling price of gas from independent producers ensures return of their investments into gas production. In this context, there is a good reason in the appeal of independent producers to grant internal consumers the natural preference over foreign consumers in the price of gas (at least equal to the transportation costs and customs duties). This will maintain the existing proportions in the use of different types of fuel, may probably increase the internal demand for gas, and will definitely enhance the competitive edge of Russian goods.

Coal as a real rival of gas in the long-term perspective

The largest consumer of natural gas in Russia is the electric power industry. The closest real alternative to gas in this sphere is coal. Development of coal combustion technologies, proximity of coal mines to consumers, and tremendous coal reserves make transition to this alternative fuel quite adequate and expedient.

The only problem is that construction of large electric power plants using coal requires 3-5 years on average. The last power plant of this kind was built in Russia some twenty years ago. This means that the country lacks relevant technologies, practice and experts for solving this problem, which extends the required period of time by a few years more.

Growth of the customs duty for fuel oil as an instrument for changing the structure of fuel and energy balance

There is a time-tested state-regulated method of administrative control of the fuel balance, which is increasing the export customs duty on fuel oil. The proponents of this idea strive to reduce the internal price of fuel oil to bring it to parity with the price of gas and promote its use as an alternative fuel. The technologies of the existing Russian oil refineries is on their side as these technologies were developed mainly for separation of heavy fractions. Thus, the possible way is to either bring down the prices of fuel oil by raising the prices of light oil products, or renounce internal oil refining using the existing technologies. Both of these versions are unacceptable for the Russian Federation Government now.

A.Ryazanov, Deputy Chairman of the Management Committee of OJSC Gazprom, 2002

— I hope that some day Russia will sell gas at free-market prices. I definitely do not think that the price of gas in the country should be equal to the prices of gas in Europe. Do we in a country producing almost 600 billion cubic meters of gas a year have to sell it to our consumers at $100 per 1000 cubic meters when its actual cost is $30-35?

A market is possible even if it is a market of one seller

Gas prices in free competition conditions will be pressed hard by alternative types of fuel (and raw materials for the chemical industry, such as, for example, broad fraction of light hydrocarbons). There is even more to that. Many technologies developed in conditions of concealed subsidies for gas exploration and production and oriented to natural gas transported through trunk pipelines and supplied in the framework of long-term agreements will have to change in conditions of energy market liberalization. This means that the demand characteristics will change not only because of the availability of alternative fuel types, but also because of the emerging alternative technologies of production based on the use of gas and/or changes in the structure of final and intermediate demand. The dramatic change of the strategic importance of rubber-bearing plantations after the transition from natural rubber to synthetic rubber is an excellent example. Thus, in the strategic perspective, a market may be organized even if there is only one supplier of gas — OJSC Gazprom.

Unbalanced Parity of Prices and Tariffs

The geographic imbalance of distribution of prices and tariffs will apparently be eliminated in the nearest years

Historically, the procedures of setting regulated prices for gas from OJSC Gazprom and setting tariffs for trunk pipeline transportation of gas from independent producers were not related. This resulted in a considerable distortion of the gas market. In particular, in conditions of the same gas production costs, gas from independent producers could not compete with gas from OJSC Gazprom at distance of more than 1,500 km from the production site.

Prices of gas from independent producers and OJSC Gazprom for the same production cost,

rubles per 1000 cubic meters

Source: Federal Tariff Service of the Russian Federation

Enforcement of the procedure for calculation of trunk-pipeline transportation tariffs started to cure the situation. However, the goal of the Government was to gradually reach a price parity by setting nonlinear correction coefficients for tariffs every year. Thus, the possible resolution of the problem will come about only in a few years.

The time imbalance of setting prices and tariffs still persists

The disparities of the market were caused both by the sizes of prices and tariffs and different times of their adoption. In conditions of traditional annual planning (with annual gas balances, annual gas supply and transportation contracts, etc.), adoption of new prices and tariffs with a half-year gap used to unpredictably change the market conditions for participants.

A possible solution of this problem is adoption of a procedure of setting wholesale prices, which is currently being developed by the Federal Tariff Service of the Russian Federation.

Growth dynamics of prices and tariffs compared,

rubles per 1000 cubic meters and rubles per 1000 cubic meters per 100 km

Source: Federal Tariff Service of the Russian Federation

Issues of Access to the Infrastructure

Granting access clashes with OJSC Gazprom’s interests

It is widely known that, in spite of access regulation, there are serious problems with transportation of gas from independent producers for a number of reasons:

· OJSC Gazprom rules the free capacities. All rights of access to the gas transportation system depend, first of all, on the availability of free capacities, which is determined and ruled by OJSC Gazprom. Information on the actual load of the gas transportation system is kept by OJSC Gazprom as a top secret. Nevertheless, all participants of the market do know, to a certain extent, the actual situation and really compete for access with other participants (including OJSC Gazprom) in the bottlenecks of the gas transportation system. However, there is still no transparent mechanism for fairly determining the winner of this competition and no clear and transparent mechanism of investments for de-bottlenecking the gas transportation system.

· There is no real arbitration mechanism. Despite the right of independent producers to require arbitration of issues related to access to the gas transportation system (for example, by the Federal Antimonopoly Service of the Russian Federation), so far solution of these problems never went beyond publications in the press and unfulfilled formal recommendations. The business of independent producers hinges on the decisions of OJSC Gazprom, and independent producers are not going to endanger there existence for the abstract triumph of justice.

· OJSC Gazprom decides on all issues related to connection of producers and consumers to the gas transportation system. There are some formal procedures for connection to the gas transportation system, but the actual practice of their application (such as, for example, in the case of the Beregovoe field) reveals that they are inadequate and insufficient for ensuring the rights of market participants.

· Non-transparence of determining gas transportation routes. Independent producers are forced to pay for gas transportation along routes whose length is far from being optimal. The choice of such routes is often explained by excessive loads of certain segments of the gas transportation network. The actual amount of gas transportation services is almost impossible to estimate correctly, and, as a result, OJSC Gazprom is regularly blamed for doubling and even tripling the prices for transportation of gas from independent producers.

· There are no procedures for independent access to gas storage capacities. The operation of the 24 underground gas storages of OJSC Gazprom is not subject to state regulation and is a part of the natural gas transportation activities of the gas monopoly. Currently, there are no mechanisms for getting guaranteed access to gas storage capacities.

· The is no possibility of concluding long-term contracts or take-or-pay contracts. Although the application procedure allows granting access for periods of longer than five years, in actual practice OJSC Gazprom never grants such permissions. Thus, even if a supplier gets a short-term access to the gas transportation system, this is no guarantee of any actual supply, because there always exists a real chance that the customer may be switched over to another supplier (usually affiliated to OJSC Gazprom).

· Rigidity of the gas supply system. Contemporary gas supply systems abroad actively use various technological and financial instruments for maintaining the daily balance of demand and proposal. These instruments include high-pressure and low-pressure gas storages and peak fields that may be used by system operators for physical balancing of the gas stream, take-or-pay contracts with consumers, special systemic tariffs for overtake or undertake of gas from the system, etc. In Russia, such instruments are usually not used or, when used, are used in a very specific way. The Russian gas supply system is not sufficiently flexible for efficient development and does not provide economic incentives for development of a fair gas market.

· Absence of fair competition. As long as OJSC Gazprom combines the functions of natural gas production and its transportation for independent producers, there always is a temptation to use its exclusive position for correcting business results. In cases of failure to fulfill the production plans, the gas monopoly always has an opportunity to sell other producers’ gas transgressing the terms of its transportation without any significant sanctions from the owners of gas.

· Motivation to sell gas at the well. OJSC Gazprom is interested in purchasing natural gas from independent producers at the well at minimal prices. Thus, the gas monopoly has the possibility to cover the gas balance deficit without any additional investments. OJSC Gazprom has a wide spectrum of methods and implements for forcing independent producers to this form of interaction.

Solution of the problem is organizational detachment of the gas transportation system of Russia

The general concept of detachment of potentially competitive activities and natural monopolistic activities in the gas industry was put forward by governmental departments many times. Many different versions were proposed for dividing OJSC Gazprom ranging from organizational detachment of Gas Transportation System LLC within the OJSC Gazprom holding to separation and sale of producing companies of OJSC Gazprom.

The official counterarguments of Gazprom managers always boil down to the same threat that the company will divest itself from the responsibility of gas supply reliability in case of any extraneous transformations of the holding. In fact, the Government still has no sound plan for minimizing the risk of losing control of the gas industry in case of reforms in the industry.

Political decision made: there will be no detachment

President V. Putin first made it clear that he did not like the plans of OJSC Gazprom division in February 2003 during the celebration of the 10^th anniversary of OJSC Gazprom. He said that the Government will not support any plans for dividing OJSC Gazprom.

In October 2003, President V. Putin put an end to discussions on OJSC Gazprom restructuring. «We will not divide Gazprom,» said he during the visit of the German Chancellor.

The last comment on this subject was made by the President on October 27, 2006. Mr. Putin is sure that Russia will preserve and protect integrity of companies like OJSC Gazprom as long as there is a disparity between the prices of gas in Russia and the rest of the world. «Division of our companies into production and transportation companies is completely under the jurisdiction of the Russian Federation,» said V. Putin.

Problems of Organization of Organized Trade

Trading site of Mezhregiongaz LLC — a pocket market of OJSC Gazprom

The trading site of Mezhregiongaz LLC is performing gas selling and buying operations since 2002. Trading sessions followed the scheme of simple auctions originally and then, since 2005, the scheme of continuous reciprocal auction. Approximately 11 billion cubic meters of gas was sold and bought in 2002-2005. The main participants of trading sessions are regional gas companies and major industrial consumers with a shortage of gas. In most cases, prices at the trading site used to vary fluctuate around the regulated whole sale price set by the Federal Tariff Service of the Russian Federation. In different periods, the deviation from the regulated wholesale price varied between 9 and 33%.

Since fall 2006, the trading site of Mezhregiongaz is a prototype of a National Gas Trading System

In September 2006, the status of the trading site of Mezhregiongaz LLC was changed. According to Resolution No534 of September 2, 2006 of the Russian Federation Government «On a Gas Trading Experiment on the Trading Site,» it was decided to stage an experiment for selling up to 5 billion cubic meters of gas from OJSC Gazprom and its affiliated companies at prices unregulated by the state (with due regard to fulfillment of obligations under previously signed contracts).

Based on this resolution, the Ministry of Industry and Energy of the Russian Federation issued Resolution No.294 of October 31, 2006 «On a Gas Trading Experiment on the Trading Site,» according to which Mezhregiongaz LLC was chosen as the organization conducting the «experiment for selling up to 5 billion cubic meters of gas from OJSC Gazprom and its affiliated companies at unregulated prices on the trading site since November 2006.»

The first public trading sessions held in the new status did not change the procedural content

The procedure for conducting trading sessions («Procedure for Organization of Gas Sales to Consumers in Russian Federation at Prices Unregulated by the State on the Trading Site of Mezhregiongaz LLC») was approved by Resolution No.122 of November 11, 2006 of Mezhregiongaz LLC. The first trading session for selling gas to be supplied in December 2006 was held on November 22. The second trading session for selling gas to be supplied in January 2007 was held on December 15, 2006. Trading sessions are conducted with transportation from three balance points: Yagelnaya compressor station, Nadym compressor station, and Vyngapurovsk compressor station.

The first trading session sold 119 million cubic meters of gas, of which 90 million cubic meters was gas from OJSC Gazprom and 29 million cubic meters was gas from independent producers (OJSC NOVATEK, OJSC NGK ITERA, OJSC NK Rosneft, and CJSC Transnafta). The average weighted price of gas amounted to 1009 rubles. With due regard to the cost of gas transportation to the gas distribution stations of gas buyers, this price was equal to 131.6% of the gas price set by the Federal Tariff Service of the Russian Federation. According to the results of the trading session, the maximum excess of the gas selling price at the gas distribution stations of buyers amounted to 144% from the price set by the Federal Tariff Service of the Russian Federation.

Administrative passivity of the Russian Federation Government is compensated by initiatives of Mezhregiongaz LLC

All the main requirements, regulations and procedures for conducting trading sessions are formulated and approved by a resolution of Mezhregiongaz LLC, the organizer of the trading site, rather than a regulatory legal act. In fact, the resolutions of the Russian Federation Government and the Ministry of Industry and Energy of the Russian Federation mentioned above do not contain any substantive regulations and provisions related to the general principles of organization and conduct of trading sessions on the trading site of Mezhregiongaz LLC.

The resolutions only allow OJSC Gazprom and its affiliated companies to sell a part of gas at unregulated prices and sets a general requirement to the volume of gas sold on the trading site by OJSC Gazprom and its affiliated companies: this volume should not exceed the volume of gas sold by independent organizations on the trading site.

Apart from that, the resolutions contain recommendations for ministries and agencies (The Ministry of Industry and Energy, Ministry of Economic Development and Trade, Federal Tariff Service, and Federal Antimonopoly Service of the Russian Federation) for ensuring legal and procedural support of the trading experiment and presenting to the Russian Federation Government in September 2007 proposals for further development of the gas market in the Russian Federation based on the results of the trading experiment.

Apart from the approval of Mezhregiongaz LLC as the organization entitled to conduct trading sessions at the stage of trading experiment, the only substantive provision of these resolutions is that trading sessions should be conducted once in every ten days beginning from February 2007. Other provisions of these resolutions are dedicated to organization and control of the trading experiment: establishment of a special working group (consisting of representative of the Federal Tariff Service, Federal Antimonopoly Service, and Ministry of Industry and Energy of the Russian Federation and the nonprofit organization «Association of Independent Gas Producers) and coordination of activities in the Ministry of Industry and Energy of the Russian Federation.

Independent organizations (producers and traders) and gas consumers did not take any part in development of the procedure of trading sessions on the trading site. The document was entirely worked out by OJSC Gazprom. Mezhregiongaz LLC developed and proposed the following scheme for organization of gas trade on the trading site at free-market prices.

Mezhregiongaz LLC organizes sales and transportation of gas as it likes

Participants of trading sessions (buyers and sellers) have to send their applications for participation in trading sessions on the trading site of Mezhregiongaz LLC to the organizer of trading sessions (Mezhregiongaz LLC) within a certain set period prior to the beginning of supplies. Mezhregiongaz LLC and the Central Gas Flow Dispatching Department of OJSC Gazprom consider these applications and grant access to trading sessions. Trade with transportation from the balance points is conducted by satisfying counter bids until the available capacities in each direction are exhausted. The price of transaction on the trading site for the seller includes the cost of transportation from the balance point to the respective transportation corridor. The price of transaction of the trading site for the buyer does not include the cost of transportation from the balance point to the gas distribution station. According to the results of trading sessions, Mezhregiongaz LLC organizes transportation of gas volumes sold and bought on the trading site, provides information, and executes gas sale documents.

The deadline for submitting applications for participation in trading sessions is 30 days before the trading session date. At the stage of experiment, this early deadline may seem quite reasonable, but as the trade period is reduced, the application period should also be reduced, because one of the main purposes of trading sessions on the trading site is the possibility to correct (sell or buy) additional volumes of gas required for covering the gaps of non-uniform consumption.

Participants of trading sessions are approved not only by the sales company of OJSC Gazprom but also by the transportation division

Conclusions on granting access to trading sessions are issued when the applications are considered by the organizer of trading sessions and the Central Gas Flow Dispatching Department of OJSC Gazprom. The reasons for which access to trading sessions may be denied include not only the aspects inspection of which falls under the jurisdiction of the Central Gas Flow Dispatching Department of OJSC Gazprom, but also the aspects related to Mezhregiongaz LLC. In other words, in cases of failure to meet the application deadline, failure to meet the requirements of nondisclosure of confidential information, and failure to provide the complete required information, applications may be rejected at the stage of their consideration by the organizer of trading sessions (that is, without their consideration by the Central Gas Flow Dispatching Department of OJSC Gazprom). In certain cases, the organizer of trading sessions has the right to deny access of participants or large consumers to trading sessions.

The information disclosure procedure is provided but not adequately elaborated

One of the positive aspects of the procedure of trading sessions is the availability of provisions on disclosure of information on the free capacities of the gas transportation system of OJSC Gazprom, because without quick access to the gas transportation system trading on the site will be rather limited. This aspect, in its turn, allows correction of proposals immediately during trading sessions. However, information on free capacities (and statistically average routes of transportation) is provided to participants of trading sessions when they have already submitted their applications, which may have a checking effect on further development of trade. Information disclosure mechanisms for potential participants (that is, entities that did not apply yet) are not formulated so far.

Experimental trading sessions do not allow for daily fluctuations of gas supply / withdrawal

The procedure of trading sessions requires daily uniform supplies of gas sold at trading sessions. At the same time, in future, when the trading experiment is over and trading sessions are conducted on a regular basis, participants of trading sessions should be given gas selling and buying conditions with more flexible (and non-uniform) supplies during certain delivery periods.

Independent and representative trade

The current concept of open trade implies organization of a trading site based on OJSC Gazprom. Control of the dominant supplier over the rules and regulations of granting access to the trading site means in actual practice considerable discrimination of both suppliers and consumers of gas. In these conditions, formation of market indicators of demand and proposal and free-market prices is impossible.

Delivery guarantees

One of the key factors in organization of gas trade is providing guarantees for delivery of purchased gas. His function may only be performed by OJSC Gazprom. It is necessary to establish conditions favorable for the owner of the gas transportation system in the trading scheme that would encourage it to commercially profitable fulfillment of its gas delivery obligations.

Summary

1. There is no coordinated strategic concept of the gas market future in Russia. There is neither official position nor public understanding of gas industry development in this direction.

2. OJSC Gazprom is trying to reduce internal consumption of gas in Russia and is actively building up vertically integrated businesses ranging from gas production to generation of heat and electric power, production of fertilizers, rubber, etc.

3. The coal reserves of Russia are sufficient for considering coal as an alternative fuel. However, the state capitalism model implies division of business into businesses that are good for the authorities and allowed to use cheaper and easier gas, and all other businesses made to search for alternative energy solutions. Gas will be actively used as an instrument of both foreign and domestic policy.

4. Despite the low absolute efficiency of OJSC Gazprom’s business, the company will remain in the industry and retain its position in the industry structure for a long time. Construction of gas business in Russia will be closely associated with having good relations with OJSC Gazprom.

5. The gas trading floor is not a serious project capable of having real impact on the economy of the gas industry and country. As a negotiation floor, this project may allow its active participants to change the structure of informal relations.

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