IEEJ: 2011 August All Rights Reserved

Special Bulletin
A Japanese Perspective on the International Energy Landscape (56)

August 26, 2011

New Russian Move Regarding Gas Pricing Problem
Ken Koyama, PhD
Chief Economist
Managing Director
The Institute of Energy Economics, Japan

A senior official at Russia’s Gazprom has made an interesting remark on gas pricing issues
between Gazprom and major European gas buyers. Media reports quoted Vlada Rusakova, aGazprom director heading the strategic development department, as making a statement which
implies that it would be reasonable for natural gas prices to be based on gas supply and demand
factors in principle.
Heated arguments on how to price gas have continued between the Russian gas seller andEuropean gas buyers since an economic crisis emerged in 2008. In the face of slack gas demand andan influx of cheaper spot LNG, major European gas buyers including Germany’s E.On have strongly
urged Russia’s Gazprom, their largest gas supplier outside Europe, to revise the traditional gas
pricing approach under long-term contracts to move away from gas prices linked to petroleum
product prices and adopt a new approach allowing gas prices to better reflect natural gas market
conditions. European gas buyers have had a growing sense of crisis as Russian gas prices linked topetroleum product prices have deviated far from spot gas and LNG prices that have plunged on theeasing gas supply/demand relationship.
Any easy compromise may be unacceptable for Gazprom because sales to Europe are its
cash cow accounting for most of its gas export revenues. Moved by the easing supply/demand
relationship and major European customers’ strong demand, however, Gazprom has made aconcession allowing some part (reported at around 15%) of gas sales under long-term contracts toreflect spot prices. But the European customers have sought to link all gas purchases underlong-term contracts to spot prices.
In response to the European request, however, Gazprom Chief Executive Officer Alexey
Miller in June made clear his policy of continuing to link natural gas prices to petroleum productprices for sales to Europe under long-term contracts. The recent remark by Rusakova, though
representing no official decision at Gazprom, is far different from the Gazprom CEO statement from1

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two months ago.
Why has the responsible Gazprom official made such remark? There are two conceivablereasons. The first reason is that Gazprom could have faced up to the “reality” of market
supply/demand situation and changed its recognition of the situation. In 2010, gas demand in theEuropean Union recovered to 492.5 billion cubic meters (BCM), up 7.4% from the previous year.
But gas supply from Russia via pipelines declined 2.0% to 110.4 BCM while LNG imports expanded
16% to 79.8 BCM. Under the wide price gap, Gazprom’s sales to Europe remained sluggish in 2010,
reducing its share of the European market. Since early 2011, the future situation has grown moredifficult to foresee due to the impact of Great East Japan Earthquake, the Middle East and North
Africa crisis and other developments that are expected to affect future Russian and European naturalgas situations. But Gazprom might have acknowledged that the decline in its European market shareis intolerable for the gas company and Russia’s national interests and may grow more serious ifGazprom sticks to the traditional policy.
In this respect, Rusakova made an interesting point in a manner to justify her view that it
would be basically reasonable to base gas prices on the gas supply/demand relationship. If
supply/demand conditions for gas and oil are the same, gas prices’ linkage with oil prices may see noproblem. Actually, however, oil supply is limited with gas supply expanding remarkably while
demand is increasing for both oil and gas. Rusakova noted that the difference between oil and gas
markets indicates that oil and gas prices should be based on their respective market conditions.
The second reason may be that European gas buyers including E.On and RWE haveresorted to the tough measure of bringing the gas pricing problem to the European Court of
Arbitration as no breakthrough has been made in negotiations between Gazprom and European gas
buyers over the problem even this year.
As noted above, the Rusakova’s remark may represent no official decision at Gazprom. Thismeans that it is still uncertain whether gas prices under Gazprom’s long-term contracts for gas
exports to Europe would be based on gas market conditions. In addition, even if these gas prices
shift away from their linkage with petroleum product prices, a more important problem may be thespecific formula to link these prices to gas market conditions. No specific formula has come intosight.
Nevertheless, it is significant that a sign of new remarkable move has emerged in regard to
the gas pricing problem between Russia and Europe that has attracted global attention. As gas isexpected to play a greater role not only in Europe but also in the world including Japan, the gas
pricing problem and the relevant issue of how best to enhance the price competiveness of gas are2

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very significant. Those who are involved in gas market in Japan may have to keep close watch on
future relevant European and Russian moves.

Contact: report@tky.ieej.or.jp

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