Gazprom forced into major concessions in Russian contracts

By bne IntelliNews June 4, 2013

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Facing rising competition at home and weak external markets, Russian gas giant Gazprom announced on June 3 that it is cutting its "take-or-pay" requirements for major domestic customers as it looks to renew contracts.

Gazprom's domestic supply agreements expired at the end of 2012 and it is in the middle renegotiating deals. However, it is under increasing pressure from independent gas producers such as Novatek and Lukoil, which have eaten into the inefficient Gazprom's market share in recent times due to more competitive pricing.

"Fines for failure to draw gas are completely absent from the new contracts," Maria Frolova, spokeswomen for domestic supply division Mezhregiongaz, said, referring to the take-or-pay rules which require consumers to pay for an agreed volume of gas whether they take physical delivery or not.

The clause is a contentious issue for the Russian state-controlled company in its main export market of Europe. It has been forced to compensate major EU customers to the tune of billions of euros since the start of 2012, as weak demand sees spot prices drop below Gazprom's long-term contracts and consumers seek alternative sources such as liquified natural gas (LNG) from the Middle East.

The stipulation in the contracts is also a major point of attack for Brussels, which is seeking to reduce the bloc's reliance on Russian gas imports. Gazprom is currently defending the practice in a European court.

Meanwhile, Gazprom's export monopoly is at risk from regulators, although until that barrier is lifted for the likes of Novatek, Russia's independent companies are left to fight for the less-profitable domestic market. Gazprom said its share of the domestic market fell to 73% last year from 80% in 2008, reflecting rising output from competitors.

Russian gas production data for May, released on June 3, showed Gazprom's output falling 2.5% year on year, while Novatek's production, excluding subsidiaries, rose 3%. All of Russia's integrated oil companies - which produce associated gas - also showed an increase.

"We note that all other producers showed an increase in YoY production," write analysts at VTB. "We therefore remain cautious about Gazprom's long-term prospects (even though Gazprom has started to make some changes in its domestic strategy)."

"We welcome the company taking some steps to hold on to its domestic market share (73% in 2012 down from some 82% in 2007, with 75% targeted by 2020, according to the company)," they add. "We note, however, that the company is limited by regulations and so is still not able to compete with independent gas producers on price, which complicates Gazprom's positioning."

With difficulties mounting at home and in Europe then, the gas giant is moving to expand its options by pushing projects to open greater exports to the energy hungry markets to the east. Although the likes of China and Japan have huge demand to fulfill, and sit next door, the failure to agree on pricing and a lack of infrastructure limits trade.

In the latest example of the company's bid to get things moving, Gazprom's Deputy CEO Andrey Kruglov said on June 3 that the company has started to negotiate the contracts for future production at the Vladivostok LNG plant, which would serve markets to the east. However, analysts note that although Gazprom signed a memorandum of agreement for LNG supplies with Petrovietnam last year, a lack of detail on volumes and price remains.

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