Five major challenges facing Russia’s gas giant Gazprom

Five major challenges facing Russia’s gas giant Gazprom

The leadership of Gazprom — the state-owned company which in the past has accounted for about one-fifth of Russia’s budget revenues—is upbeat about the energy giant’s prospects, formally pursuing a range of ambitious projects. Yet, these projects conceal a struggling gas giant.

From the proposed Turkish Stream pipeline to a planned expansion of Nord Stream and the construction of the Power of Siberia pipeline, Gazprom is looking to expand and implement projects with big price tags.

There are indications, however, that the state-owned company is struggling. The energy giant’s natural gas production fell by 12.9% in the first half of 2015 compared to the previous year, while the company’s exports dropped by 8%, according to a report by Russian investment bank Sberbank CIB.

In July, the company unexpectedly cancelled its contract with Italy’s Saipem for the construction of a pipeline under the Black Sea, raising concerns regarding Gazprom’s commitment to completing the planned Turkish Stream pipeline project on schedule.

There are clear reasons for the company’s difficulties. Gazprom currently faces five major risks and challenges.

1. Decline in world energy prices

Gazprom’s natural gas prices are indexed to the price of oil, with a lag of about six to nine months. The company’s net profits fell 86% in 2014, due in part to a plunge in the value of the ruble. Falling natural gas prices will continue reducing Gazprom’s revenues.

2. European political will to diversify away from Russia

The crisis in Ukraine has accelerated the process of diversification away from Russian natural gas. Norway has already overtaken Gazprom as the top supplier of natural gas to Western Europe. EU funding for energy infrastructure projects, as well as the planned Energy Union, will further integrate the European natural gas market, reduce the dependency of Central European countries on Russian energy imports, and undermine Gazprom’s leverage in negotiations with EU clients.

3. Negotiations with China National Petroleum Corporation

Construction of the eastern section of the Power of Siberia pipeline, which is set to bring 38 billion cubic meters of Russian natural gas to China, officially began in June. Still, the signing of an agreement regarding the Altai pipeline, which would bring 30 billion cubic meters of natural gas from western Siberia to Northwest China, has reportedly been postponed. As natural gas prices decline and Gazprom’s European market share decreases, the Russian company will be in a weaker negotiating position vis-à-vis its Chinese counterpart.

4. Domestic pressure and competition

Gazprom holds a monopoly on natural gas pipeline exports from Russia. The company’s rivals, however, have long pressed for the monopoly to be broken up. In a letter to Russia’s Energy Ministry, Rosneft urged Russian authorities to break Gazprom’s pipeline export monopoly and split the company into two parts. While Rosneft itself is in a weak position, Gazprom’s growing challenges could reduce the company’s ability to defend its interests in Moscow.

5. Western sanctions.

In September 2014, the US imposed sanctions on Gazprom Neft and Gazprombank, both subsidiaries of Gazprom. Gazprom Neft cannot access US exploration technology or receive assistance for Arctic offshore, deep water and shale projects, while both Gazprom Neft and Gazprombank cannot quality for long-term financing from US banks.

At the same time, the EU also sanctioned the two companies. Moreover, in June 2015, Canada imposed sanctions on Gazprom itself. Despite financial assistance from the Russian government, these sanctions will have a negative impact on Gazprom’s production and financing capabilities in the long-term.

About Author

Lili Bayer

Lili Bayer is an analyst focusing on Central and Eastern Europe. She has written extensively on the crisis in Ukraine, as well as Russian foreign policy and Central European politics. Lili holds a master's degree in Russian and East European Studies from the University of Oxford and a bachelor's degree from Georgetown University's Walsh School of Foreign Service.