Vedomosti, March 6, 2006

For a western reader, the letter of President Vladimir Putin to The Wall Street Journal may look like a piece of propaganda of advantages of centrally planned economy. Widening gap between supply and demand, prices affordable to exporting countries, counterproductive competition – these terms belong to the old Soviet textbooks on the political economy of socialism. However, everything does make a lot of sense if “energy egotism” is replaced by “gas egotism”.

A gap between supply and demand is typical for centrally planned economy. In pipeline gas trade, it can be easily created by turning off the gas tap (until January 2006, this option was considered as a theoretical one). In pipeline gas trade, prices affordable to both exporters and importers can be used as there is no world market price of pipeline gas.

The events of the past winter indicate that Vladimir Putin applies the term of “energy egotism” to the states of the former Soviet Union (FSU). One must keep in mind that just few months ago these countries were able to buy inexpensive gas directly from Central Asia and Kazakhstan. Two years ago, there were several independent gas producers in Russia selling gas to the FSU states at prices lower than Gazprom. From the standpoint of western reader, the addressee of Putin’s letter, “egotist” is the company that has liquidated competition in gas markets of all FSU states.

This counterproductive competition has never interrupted stable supplies of Russian gas to Europe. Until January 2006, Gazprom’s reputation of reliable exporter was impeccable, same as the reputation of Ukraine as reliable transit ground for the export flow of Russian gas.

It took nearly forty years of hard work to build a good reputation of Gazprom. Gas exports were stable when there was a civil war in the vicinity of export pipelines in Moldova. In the late 1990s, when Ukraine was paying just a third of its gas bills, transit flows of Gazprom gas through Ukraine were even higher than in 2005.

The security of exports was achieved by increasing the number of gas suppliers to Ukraine and other FSU states. The introduction of independent producers and traders made a lot of economic sense. Sales of gas transportation services to independents and traders were a way more profitable for Gazprom than sales of gas at very low price with payments postponed for many years.

European energy security existed at the prices that do not look affordable to the Russian exporter now. In 1999, the average price of Russian gas exports to Europe was just $61 per thousand cubic meters (compared with $250 now), but Gazprom was making profit at that price.

In this context, the price of $50 for Ukraine was quite normal. It would be wrong to call this price gas altruism in the period after 2000. In March 2005, Vladimir Putin agreed to keep the price of $50 and other transit terms with Ukraine. In June 2005, top managers of Gazprom called the transit terms with Ukraine very beneficial for the Russian monopoly.

Gazprom benefited from the very low transit fee and virtually free use underground gas storage facilities of Ukraine. Three-quarters of storage capacity is located near western border of Ukraine. Technically, these facilities can supply gas only for exports. Had the facilities been cut off, Ukraine would have survived by increasing legal and illegal withdrawal from export flows of Russian gas. To replace Ukrainian storage facilities, Gazprom would have had to add 55-60 bcm of annual production capacity and to build two new 56-in export pipelines, 3500 km each. It would require at least $26 billion of investment and additional operating expenses. It proves that the transit relations with Ukraine were based on mutual economic benefits rather than altruism of Russia.

Gas altruism did exist in Russia until 2004, when Gazprom was selling gas to Russian buyers below cost. This altruism has helped Russia to recover from the economic crisis.

Gazprom and Ukraine has worked as a good gas export team through the periods of crises, low prices and non-payments. The teamwork failed in the time of record high price of gas and record high profits of Gazprom.

While Europe was liberalizing its gas markets, Russia was moving the opposite way creating a gas equivalent of Standard Oil of the 1880s. The number of gas exporters out of the FSU was reduced to one, which has increased the risks of importers and reduced the security of supplies.

In our view, the return of gas producers of Russia and Central Asia to the gas markets of Ukraine and other FSU states can improve the European energy security and reduce the risks.

Mikhail Korchemkin, Executive Director, East European Gas Analysis, USA 

Full text of Vladimir Putin's letter