Heiner Klemm and Ben Aris in Berlin -
If Russia's state-controlled gas monopolist Gazprom continues to increase its natural gas production at the present rate, then the growing domestic demand for gas means by 2020 the firm's entire production will be insufficient to even meet Russia's domestic needs, let alone its commitments to Western Europe.
This simple fact has sent shivers down the spines of European leaders, who are nervous about both their reliance on Russia's energy supplies and mistrustful of Gazprom's reassurances it will be able to meet its delivery contracts.
The situation is not as bleak as it first seems. The calculation of rising production and Russian demand doesn't take into account the possibility of several new gigantic fields coming on stream, or the significant savings that Russian consumers could make by using their gas more efficiently. But the promises of these gains are vague. The famously opaque company has never listed the fields that it already operates nor given details of the size, maturity and stage of development of its existing fields.
There are even problems with the as-yet-untouched, big, new fields. The most high profile of these are the Kovykta field in western Siberia, Shtokman in the Barents Sea and the Sakhalin blocs in Russia's Far East, which are all the subject of politically charged wrangling that has yet to be resolved.
So what is the likelihood that Gazprom can come up with the gas?
Gazprom has more gas than any other company on the planet. At Gazproms annual general meeting on June 29, Deputy Chairman of the Management Committee Alexander Ananenkov announced that the company's gas reserves, which previously accounted for some 17% and 60%, respectively, of global and Russian reserves, had increased by 723.4bn cubic meters (cm) to reach 29.85 trillion cubic meters (cm) as of year-end 2006.
Vadimir Kleiner, an analyst at Bill Browders Moscow-based investment firm Hermitage Capital, which is a big Gazprom shareholder, believes that the firm's actual reserves could be much higher than the official figure since many of the larger fields, where work has not yet started, are not even included in the companys reserve figures.
Russia is the undoubted world leader in gas production. However, thanks to a booming economy that is on course to top 7% this year and its horrific energy inefficiency, the country is also a world leader in gas consumption.
According to figures presented by BP chief economist Christopher Ruehl at the annual energy conference in Moscow in mid-June, global gas consumption reached 2.85 trillion cm in 2006, up 2.5% on the previous year. Russia's domestic consumption is rising nearly three times faster than the global average and grew 6.7% in 2006 from the year before. Russia already consumes over a seventh of the worlds gas and this increase equates to burning a massive 27bn cm per year (cm/y) extra.
In mitigation, the winter of 2006 was, even by Russian standards, exceptionally cold, so domestic consumption was atypically high. However, if the consumption of 2005 is included, the annual compound growth rate of gas consumption for domestic demand still stands at about 5.65% in other words, still over twice the global average.
The company produced 556bn cm of gas in 2006, of which 316.3bn cm was sold in Russia to satisfy domestic demand and the remaining 161.5bn cm was exported to Europe.
The difference between the rise in the global consumption and Russian consumption doesn't seem like much, but if domestic demand continues to rise at about 5% a year, then for Gazprom to continue to satisfy its current share of domestic consumption, it will have to produce some 626bn cm/y by 2020.
The company says production will only reach 580bn-590bn cm/y by 2020, which means it will not be able to meet domestic demand let alone its export commitments.
If European consumption continues to rise at the average global rate of about 2.5%, then Russia will have to export some 228bn cm/y to the EU by 2020.
To meet both demands, Gazprom will need to increase production to around 850bn cm/y by 2020. And this is exactly what scares the EU, because based on Gazprom's own planned production, there will be an enormous annual 260bn cm gas deficit by 2020. If Gazprom is forced to choose between its master and its best customers, Europeans fear they will be left out in the cold.
Kremlin's game plan
The Kremlin's solution to filling the shortfall is multifaceted. More gas will be sourced from supplies in Central Asia. New fields are in the works that could significantly boost output and alternative sources of energy are being developed to stand in for gas. And massive savings can be made by encouraging Russians to use their energy more efficiently simply by hiking the prices for domestic gas.
Russian Foreign Minister Sergei Lavrovs told EU leaders at a conference on July 9 that by their own forecasts 81% of the EUs gas needs will be supplied by external sources by 2030. Russia already accounts for 44% of Europe's imports and will clearly play an increasingly important role in the future.
"Gazprom has reportedly honoured all its European supply contracts for some 40 years and is confident of its ability to continue to do so well into the future. So confident in fact, that it takes orders first, and then starts thinking about where itll go to get the gas," says Alex Brooks, an analyst with UBS in London.
Firstly, President Vladimir Putin has been busily building a Eurasian Energy Union almost since he took office in 2000, which unites Russia's gas production with those in Central Asia. His first foreign trip as president was to Central Asia, only choosing to make a welcome tour in Europe afterwards.
Progress has been good, especially in Kazakhstan where Russia enjoys warm relations with President Nursultan Nazarbayev. And relations with Turkmenistan, the biggest gas producer in the CIS after Russia, are expected to improve following the regime change at the start of this year.
The second plank of the plan is to build an entire energy complex rather than simply focus on oil and gas. Hydropower, nuclear and even renewable sources of energy are all being vigorously developed, in part, to take the pressure off gas demand.
But perhaps the most effective way of spinning out existing supplies of gas is to reduce domestic demand simply by hiking prices, which would force Russian energy consumers to think a little more about their usage of gas.
In November, the Duma passed a bill to increase the maximum level of regulated gas prices in stages up to 2010: prices will go up 15% in 2007, 25% in 2008, 20% in 2009 and 28% in 2010. The domestic prices for gas will more than double in less than five years.
Yet such a rapid rise in prices will come as a big shock to domestic consumers, who will probably slam on the energy brakes.
"After  domestic gas demand will only grow at 1-2%," says one energy analyst with Credit Suisse. "Even up to 2015, Gazproms share of total domestic demand will never get above 400bn cm."
By 2011, there are plans to bring the profitability of the internal market in line with European levels (taking account of transportation costs and customs duties). This will represent a crucial step to normalizing the fuel and energy sector structure.
"In contrast to the trends in the oil segment, we are delighted to report see-saw changes for Russias gas industry," say analysts at Moscow investment bank Renaissance Capital. "The policy and regulatory commitments made by the Russian government over recent months are simply mouthwatering - only the replacement of management at Gazprom in 2001 strikes us as having been as important."
Renaissance says that while the electoral cycle and possibly management changes at Gazprom beyond it - still cloud the near-term horizon, a liberalised gas market by 2011 should transform the economics for gas producers, enabling much-feared higher gas taxes to be absorbed.
"Most importantly of all, with domestic prices depoliticised, Gazprom suddenly has an incentive to rein in costs. Higher revenues and lower costs seem an attractive combination," says Renaissance.
The three old men of Russia's gas tank
Gazprom has caught the headlines recently as it muscled in on the Sahkalin-2 oil and gas project in the Far East and snapped up the Kovykta gas field in Eastern Siberia. But the bulk of the companys production has been steadily and unspectacularly flowing from the three old men of the Russian gas sector - the Yamburgskoye, Urengoiskoye and Medvezhye fields in the Nadym-Pur-Taz region of western Siberia.
The Nadym-Pur-Taz basin is Russia's gas tank, but as the fields there have been in production since the late 1970s they are starting to get a bit tired. Gazprom has been pouring investment into the region, but all it can do is maintain the current levels by bringing on new smaller satellite fields to compensate to the slowly falling production at the three old men.
Urengoiskoye is the oldest field and started production in 1978. Three years later it had pumped out its first 100bn cm of gas and it still remains Gazprom's single biggest source.
Western Siberia accounted for some 93% of the companys total gas output in the nine months ending September 2006 and the regions gas reserves of 21.7 trillion cm accounts for about three-quarters of Gazproms stated reserve base.
Gazprom openly admits that production at these fields has been declining in recent years and will continue to fall as the reserves are gradually depleted.
There are 17 active natural gas, gas condensate and crude oil fields in the Nadym-Pur-Taz region. So far, the decline in gas from the three old men has been offset by gradually ramping up output at the surrounding fields, which can be efficiently developed due to their proximity to existing infrastructure.
The Zapolyarnoye field, which is reportedly the most recently discovered large gas field to be located on land, came on stream in 2001 and reaching its planned annual capacity of 100bn cm in 2005. It has been an invaluable stopgap for Gazprom.
The other main satellite fields that have helped maintain production in the region are the Pestsovoye area of Urengoiskoye, which came on stream in October 2004 and reached its planned annual capacity of 27.5bn cm by the end of 2006. There is also the Kharvutinskaya area of Yamburgskoye, which started up in 1996 and is expected to be producing 25bn cm annually by 2009.
Overall, between 2002 and 2006, new production capacity of over 170bn cm/y was commissioned and Gazprom managed to increase production from western Siberia to 378.9bn cm in the first nine months of 2006, up 6.9bn cm from the same period in 2005.
"This gas tank will not run dry for another 50 years, but it's steadily being emptied at a rate of 500bn cm/y," says Hermitage's Kleiner.
The much talked about Yuzhno-Russkoye field in the same region should come on stream later this year or next, and will be producing 25bn cm annually by 2010. Wintershall, a subsidiary of Germanys BASF, holds a 25%-1 stake in this field, which has proven gas reserves of over 700bn cm, and fellow German giant E.ON may still receive a 25%-1 stake if it manages to work out its planned asset swap with Gazprom before this autumn.
After 2010, Gazprom intends to go further afield into the Yamal Peninsula and offshore to the Barents Sea, Ob and Taz bays, and the Far East to open up as yet untouched gas resources.
Again three main fields in Yamal will take the brunt of the strain. Bovanenkovskoye, Kharasaveyskoye and Novoportovskoye have 5.8 trillion cm of gas, accounting for over half the peninsulas explored gas reserves of 10.4 trillion cm.
The Bovanenkovskoye field is scheduled to be producing 15bn cm/y by 2011, with annual production to be increased to 115bn cm, or possibly even 140bn cm, in the years to come.
On the downside, Gazprom says that the Yamal peninsula has an even harsher climate than the Nadym-Pur-Taz region, which itself isnt exactly renowned for its hospitability.
Nevertheless, the Yamal Peninsula, including the surrounding offshore region is thought to contain a massive 50 trillion cm of gas, or enough to single-handedly satisfy current global demand for more than 15 years. This gas will be fed into a new controversial pipeline called Nord Stream that is being built between Russia and Germany under the Baltic Sea, thereby bypassing traditional transit countries such as the Baltic states and Poland.
Adding all this up and Gazprom looks like it will comfortably hit its annual 580bn cm target by 2020. The western Siberian fields are already producing about 500bn cm/y. Then once Bovanenkovskoye in the Yamal peninsular comes on line, it will add another 115bn cm/y, exceeding that 580bn/y figure.
The new fields in Nadym-Pur-Taz such as Yuzhno-Russkoye and Bovanenkovskoye in the Yamal Penisular are big, but Gazprom doesn't seem to be counting in the three really big fields it has recently acquired in its production estimates for the future.
The first of these is the Kovykta gas field, which Gazprom just took over after the UK-Russian joint venture TNK-BP succumbed to indirect Kremlin pressure and handed over its 62.9% stake in the fields license holder Rusia Petroleum for $700m-900m.
The field, located some 450 kilometres north of the city of Irkutsk in eastern Siberia, has estimated resources of 2 trillion cm of reserves. The production start-up was planned for 2017, but Gazprom said last month it would accelerate the programme and could be ready to start selling Kovykta gas in three to four years time.
At issue here is where the gas will go. Just north of the Chinese and Mongol borders, Beijing is keen to see the Kovykta gas used to fuel the development of China's northwest regions. TNK-BP had the same idea that China is the obvious market. However, the Kremlin has said the gas should go to feed the local regions and so free up precious domestic gas for more lucrative markets in the West.
Then there is the Shtokman field, some 600 kilometres out into the icy waters of the Barents Sea, deep into the Arctic circle off Russia's northwest coast. The problem here is that the massive field with estimated reserves of over 3.7 trillion cm is technically very difficult to develop.
The Kremlin has been tempting foreign majors with minority stakes in the project, but is holding out for swaps into foreigners downstream assets and access to their home markets in return something that has not gone down well with the politicians at home, say sources close to the negotiations.
Development work at Shtokman is slated to start in 2010, with production to begin in 2013. But analysts say that the timetable is unrealistic, even with the help of foreign partners, and the actual start date is anyone's guess because the Kremlin is playing hardball and wants to leverage the maximum advantage from the stakes on offer. Gazprom shocked market observers last October when it turned its back on potential international partners and said it would develop the field on its own. Deputy Gazprom CEO Alexander Medvedev said in an interview in the Financial Times on July 9 that talks were back on and Gazprom was on the verge of signing a deal with one or more international majors. Initial production is planned at 22.5bn cm per year, to be increased to 71bn cm or even 94bn cm in the future.
In addition to the politics, the other problem with this project is it has a huge price tag. The plan is to build a giant liquid natural gas (LNG) plant on Russia's northwest coast, which would in effect open up a global market for Russian gas.
"Russia is maybe a world-class gas producer, but because you have to send gas through a pipe and can't easily put it on a ship, Russia is very much a European energy supplier, as that is where the pipes go," says BP's Ruehl. "Building an LNG plant would break the bond and turn Russia into a global player overnight, but it comes with a very big price tag."
Finally, there is the Sakhalin-2 project in the Far East of Russia. In December 2006, Gazprom agreed to pay $7.45bn for a 50% stake in the field reducing Shell, Mutsui and Mitsubishi stakes to 27.5%, 12.5% and 10%, respectively.
Sakhalin-2's Lunskoye field is estimated to have gas reserves of 700bn cm. Some $12bn has already been spent to develop Sakhalin-2 oil and gas projects, and a total investment of $21bn will be spent to develop the field and also build another LNG plant, this time on Russia's eastern coast. Work here is much further advanced and the LNG is due to be shipped as soon as 2008.
And Gazprom has entered the Eastern Siberian lottery, where the Kremlin said in July it could hand out licenses for little or no cost to develop 37 gas fields with over 11 trillion cm of gas reserves.
Analysts at UBS somewhat put a grey lining on the lottery silver cloud, commenting that: "Some of these fields are hard to reach, explore and develop, and will present as much of a challenge to Gazprom as an opportunity were it to decide to develop them."
Gazprom has taken a lot of flak for focusing too much attention and money on empire building rather than investing in its own upstream production. However, the gas giant may finally have woken up to these concerns. First Deputy Prime Minister Dmitri Medvedev, who is also chairman of Gazprom's board, said in an interview with the business daily Vedomosti on July 5 that the company would invest $420bn into the gas sector up to 2003. "It is an average of $18bn per year. We have the money and it will be invested," Medvedev said.
Some analysts agree. UBS' Brooks says the $18bn a year investment commitment is extremely important since it is continuous and so could even increase.
"Gazprom take their supply commitments extremely seriously and have consistently met them for the past 40 years, which is more than can be said for pretty much any other gas supplier," Brooks says.
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