In the following piece we outline some of the major challenges facing the gas sector in Russia and focus on where some of the potential upsides are to be found. While we remain concerned about the overall level of investment in Russian upstream and transportation, the potential of the independent gas producers to rise to the challenge seems strong given the right supporting policy measures.

The Russian government seems to be moving in the right direction with regard to domestic pricing policy and third party access to the pipeline system, yet reliance on imported gas from Central Asia is likely to increase the risks to security over the medium term. Our concerns on investment need to be seen within the context of our overall concern about global levels of investment, in upstream gas, pipelines and other infrastructure and even in the burgeoning liquefied natural gas (LNG) industry.

Importance of Russia for Global Gas

Russia holds the largest share of proven gas reserves worldwide, it produces and exports more gas than any other country and is the second largest gas market in the world after North America. Russia also has a very strong export market in Europe where it accounts for almost a quarter of OECD Europe gas needs. It is in Western Europe that pipeline gas from Russia meets competition from Atlantic LNG. Through this interaction, Russian gas production and demand has the potential to affect other markets, such as the US or Japan, indirectly through the global LNG market. Therefore, an appreciation of supply and demand fundamentals in Russia is critical to gaining an understanding of the future of gas markets worldwide.

One state-controlled company, OAO Gazprom, dominates the Russian gas and hydrocarbon sector, accounting for over 60% of Russian reserves and almost 85% of Russian production. Gazprom owns the Russian gas pipeline system, a key part of any country’s gas industry, and also has a legal monopoly on gas exports. There are a series of “independent” gas producing companies operating in Russia, which by dint of the above arrangements can only sell in Russian domestic markets where prices are some 15– 20% of those in Europe. These companies, along with Russia’s oil companies (which produce gas from their own fields as well as associated gas) account for another 20% of Russian gas reserves and produce between 15 and 20% of total production.

Demand for Russian Gas

The calls on Russian gas are many: Russian domestic gas demand, currently accounting for 65% of Russian production (430bcm in 2005) is growing at an annual rate of 4–6%. This growth is driven by demand for electricity generation (gas provides almost half of Russian power) to support the strong economy, as well as a successful regional gasification program by Gazprom. Meanwhile, existing export customers in Europe are increasingly looking to Russia to replace falling domestic gas supplies while they too see rising gas demand, again from the power sector. Russia is also looking to new markets, such as China, India and North America.