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John Daly

John Daly

Dr. John C.K. Daly is the chief analyst for Oilprice.com, Dr. Daly received his Ph.D. in 1986 from the School of Slavonic and East European…

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Russia’s Oil and Natural Gas Industry Facing Market Turmoil

Several years ago, the Russian Federation’s Open Joint Stock Company Gazprom had every reason to feel that it was “top of the world,” to quote James Cagney’s crazed character Cody Jarrett in the movie “White Heat.”

But like Jarrett, the gas storage unit may be about to explode under its feet.

Majority state-owned Gazprom company executives, sitting atop the company’s 35-story headquarters in Cheryomushki, Moscow, had every reason to feel like masters of the universe. In 2012, Gazprom exported around 238 billion cubic meters of natural gas worldwide, 17 percent of worldwide gas production. The majority of it to Europe. According to Eurostat, the EU’s official data service, Gazprom currently supplies roughly a quarter of the 27-nation European Union’s gas needs, roughly 124 billion cubic meters annually.

Even better for Moscow, Gazprom's activities accounted for 8 percent of the Russian Federation's gross domestic product.

But storm clouds are gathering over this roseate cash-cow picture. Russian state-owned companies, including Gazprom, have a long history of long-term contracts and fixed prices, a growing complaint among their European clients, who feel “overcharged” by being bound to long-term, fixed rate contracts rather than the forces of the free market. Weakening European natural gas demand has caused strains between Gazprom, and its European customers, as Gazprom charged customers for fuel they did not use under “spot market pricing,” with the practice forcing utility companies to sell gas at lower prices than those they had agreed to pay under long-term deals.  If there is a silver lining to this dark cloud, it is that only 20 percent of Gazprom’s gas exports last year to the EU were spot deals, with the remainder being “fixed” formulas.

And this discrepancy has been noted in Brussels, where Gazprom is under investigation by the European Commission over alleged unfair competition and price fixing in the natural gas markets of Central and Eastern Europe.

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In a sign of the shifting economic landscape, German energy company RWE has won the rights to amend its contracts with Gazprom, which has steadfastly refused to negotiate on pricing for four decades. In a dramatic corporate turnaround following the arbitration ruling, Gazprom CEO Aleksandr Medvedev told reporters that his company will amend its contract with Germany’s second largest utility provider as well as adjust the gas pricing formula, commenting, "We'll do this within a month. We are interested in doing this quicker because amendments will be made before final documents are signed."

But this is hardly the end of Gazprom’s woes with its disgruntled European customers, as Austria’s OMV subsidiary EconGas has initiated a similar lawsuit against Gazprom as well.

Nor are things going much better for Gazprom subsidiary Gazprom Neft, previously Sibneft, primarily responsible for the company’s crude oil production. During the first six months of 2013, Gazprom Neft’s net profit declined 27 percent.

The reasons for Gazprom’s change of fortune are myriad and complex, but the simplest immediate answer is that new sources of natural gas are shortly coming online, broadening EU options. Azerbaijan’s massive Caspian offshore Shah Deniz field is coming online and new discoveries in Africa and eastern Mediterranean, ranging from Uganda to Israel are also promising for the EU, which currently buys most of its natural gas imports from the Russian Federation and Norway. Europe is also importing increasing amounts of liquefied natural gas from Qatar, and the final “wild card” in the mix is that the burgeoning U.S. shale boom could see the U.S. begin LNG exports in the next several years.

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Accordingly, if Russia is to retain its dominant EU market share, then it is going to have to start behaving more like a reasonable producer subject to the vagaries of the market place rather than continue to regard its European clientele as option-less consumers to be fleeced as thoroughly as possible at every opportunity.

Will that reality penetrate the 35th floor of Gazprom’s corporate headquarters? Hard to say, though Medvedev’s comments are a start.

By. John C.K. Daly of Oilprice.com

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  • Jasper on July 28 2013 said:
    Global fracking also presents a problem for the erstwhile monopoly.

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