Derek Brower in London -

Brussels should stop worrying about natural gas cartels and politics interfering with the supply of energy to the simply continent. There is a bigger threat: what happens if Russia's Gazprom can't meet all of its supply commitments to domestic and foreign consumers?

With demand for gas rising by at least 2.5% a year in Russia, domestic prices for gas still just a fifth of international levels, and, argue analysts, chronic underinvestment by Gazprom in the upstream part of its business, the company could be facing a supply gap of 100bn cubic metres a year (cm/y) by 2010. The most pessimistic forecasts say the crunch could be as high as 200bn cm/y.

But is there enough of it?

Would the company decide to cut supplies to Russian consumers – the constituency of its famous "social obligation" – or European buyers, who pay international market rates for the gas? Gazprom generates some 20% of Russia's tax revenues.

Vladimir Milov, a former deputy energy minister of Russia and now head of the Institute of Energy Policy in Moscow, predicts a gas deficit of 100bn cm/y by 2010. He blames state interference in the energy sector and, above all, Gazprom's reluctance to invest in the new fields of the Yamal peninsula. To make matters worse, Gazprom's meddling threatens to hurt the independent gas companies – the only part of Russia's gas sector that is showing any real growth in production.

While Gazprom's output has stagnated in the past few years, the success of the independents has made them targets for the gas monopoly: it bought Sibneftgaz (and the Beregovoe gasfield), Yamal LNG (and the South Tambey gasfield) and part of Novatek in 2006, and is likely to take control of the Kovykta gasfield from TNK-BP later this year. Despite those acquisitions, Milov says Gazprom's production remains lower than it was in 1999.

Russia has already begun rationing gas in the country. Milov says that supplies to some consumers last winter got as low as 80-85% of contracted volumes.

What's the problem?

The biggest problem might not be Gazprom. Jonathan Stern, of Oxford's Institute for Energy Studies, points out that since Gazprom took a 19.99% stake in Novatek, one of the most successful independents, its output has not fallen. And a "sea-change" in opinion within the state-controlled company now understands the independent sector to be "part of the solution."

The real problem, believes Stern, is the Kremlin's "timid" approach to raising natural gas prices. "They're waiting until way after the elections to increase prices," he says, referring to the Duma elections in December and the presidential polls in March 2008.

But at least the government has accepted the need to do so. By 2011, prices to industrial consumers will more than double in real terms from around $45 per 1,000 cm now to $125 per 1,000 cm.

The announcement of those price increases, in November last year, was a boon for Gazprom. Sources in Moscow say it has held out on developing three large gasfields in Yamal as a way to pressure the Kremlin to increase domestic rates. With rises on the agenda, development of the region, requiring an estimated $70bn, can take place. However the likelihood of production coming on stream by 2011, is small, say analysts. The OECD predicts that the greenfield production won't be on stream until 2015 at the earliest.

Other projects, like the Shtokman field in the Barents Sea that Gazprom previously wanted to develop for liquefied natural gas but now intends to use for pipeline exports, look just as challenging. Milov says Gazprom will have to cede some share in the project to a foreign partner – or it won't happen. Last year, Gazprom ended negotiations with four international oil companies and said it would develop the field on its own.

But going solo in Shtokman would add to the heavy debt that Gazprom carries, largely as a result of its takeover of Sibneft, putting more pressure on the company's finances. And neither Shtokman nor the Yamal fields in the north are likely to come on stream in time to ease the supply crunch Milov predicts.

In denial?

Gazprom denies that the problem even exists. Aleksandr Medvedev, head of its export arm, told bne in November that there would be "no gas shortage either in 2010 or 2020".

To make sure, the company plans to rely on imports from Central Asia to fill any gaps. Bizarre as it seems that the country with 27% of the world's gas reserves should import gas from its neighbours, Stern says it is makes sense: Turkmenistan's gas is cheaper to buy than Yamal's is to develop.

But Alan Riley, at the Centre for European Policy Studies, says that relying on Central Asian gas could be unwise. Moscow's hopes that Turkmenistan will double its production to 80bn cm/y by 2009, for example, could be undermined by that country's own relatively weak investment. And, points out Riley, relying on the Central Asian Centre pipeline, "which has not been maintained in good order" and is already operating beneath its capacity, could be risky.

Another worry, says Riley, is Gazprom's "perverse" decision to promote urban and regional gasification in Russia. The company wants 60% regional gasification by 2008 and is spending $1.3bn adding another 12,000 km of pipelines to its network. It might be good news for efficiency and the environment, but it will add at least another 9bn cm/y to demand. Riley says the figure could be closer to 20bn cm/y. Meanwhile, losses from inefficient gas processors on the network amount to some 46bn cm/y. Milov says energy waste across Russia amounts to almost 100bn cm/y.

That leaves Riley estimating a shortage of around 126bn cm/y. He says it could be as high as 200bn cm/y. Exports to Europe last year were around 156bn cm.

Stern is more optimistic. For a start, he says that Russia's exports to Europe could reach a natural – and political – limit of 200bn cm/y by the middle of the next decade. Something the EU hasn't realised, he points out. And with gas from the independents and Central Asia, Gazprom should just about muddle through the next few years, until production from Yamal's new fields starts.

The longer-term problem, says Stern, is the colossal inefficiency of Russia's "capital stock" – or industrial plants and infrastructure. Gas price rises won't send the signal to improve efficiencies at existing plants because those plants are too old to bother upgrading, he says. While most of the country's capital stock is decades old, only 20% of it was replaced in the last 10 years. To make genuine improvements in the energy efficiency of Russian industry will require fundamental economic change to promote the replacement of this stock. That, he says, has been made more difficult by the politics of the last few years.

While the state's destruction of Yukos might not have had the predicted negative impact on foreign investment in Russia, argues Stern, it has increased the perceived risk for Russia's own businessmen in the country. That makes them less willing to take important long-term decisions affecting the economy.

To keep exporting gas to wealthy foreign consumers, Gazprom needs to develop new reserves in the upstream and Russia must use them more efficiently at home. The complexity of both challenges suggests that the supply question will be around for some time.

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