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Russian-EU Discussions on Reforming the Gas Sector—Headed for a Dead End?

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by Charles Movit

German Gref, Russia’s minister of economic development and trade and an architect of the Putin administration’s strategy for economic reform and restructuring, described the most recent round of negotiations with the European Union as “entering into a cul-de-sac.” Gref was referring to consultations aimed at garnering EU support for Russian accession to the World Trade Organization. In the view of the EU, the major obstacle to Russia joining the WTO is the policy of pricing domestic deliveries of natural gas well below the export price net of the additional cost of transporting natural gas to Western Europe. The EU regards this practice as subsidization of Russian manufactured exports, which is inconsistent with WTO rules and provides Russian exporters with an unfair competitive advantage. Prime Minister Mikhail Kasyanov, however, was more optimistic than Minister Gref in regard to meeting the objections of the EU, stating that “a compromise can always be found.”

While Russia is currently debating the strategy for overhauling the natural gas sector, sharp increases in domestic natural gas prices are a political non-starter, particularly with parliamentary elections scheduled for December 7 and a presidential election slated for next March. Moreover, high-level discussion of gas sector reform is being actively thwarted by Gazprom, the giant gas monopoly. Russian economic policymakers do understand, however, that in order to attract much-needed investment in the gas industry it will be necessary to liberalize the sector, but whatever institutional changes are eventually arrived at to begin the process, the plan will call for only gradual increases in gas prices toward cost-recovery levels, including a competitive return on capital. The reform plan put forward by Gref in 2000 identified the separation of the pipeline transport system from the Gazprom monopoly as the necessary first step in reforming the natural gas sector. Such a step was to guarantee access to natural gas transport to independent gas producers. Gazprom—the country’s single-largest taxpayer and thus wielding enormous influence in the halls of power—has effectively resisted this interim step, even after the company’s long-ensconced top management was replaced by a group hand-picked by new CEO Aleksei Miller, a close associate of President Vladimir Putin.

The reform of the gas sector was finally slated for discussion by the cabinet at the end of last month. Gref was set to submit a plan whereby the transport and dispatching arms of Gazprom would be split off into separate entities, with the gas-producing companies eventually spun off as well. In a letter to President Putin, Miller asked that the topic be removed from the cabinet’s agenda. Miller maintained that the plan would cripple Gazprom and the natural gas industry, eventually resulting in sharp declines in output. Miller maintained that restructuring would cause the company’s creditors to demand early repayment of loans and slash the company’s capitalization. Furthermore, he claimed that spun-off production companies would be swallowed by the oil majors, who would then choose not to invest further in them. Gazprom’s position was that the only requirement for encouraging independent gas production was a pledge by Gazprom to allow access to the pipeline system by third parties. While Prime Minister Kasyanov initially refused to consider altering the cabinet agenda, the following day, apparently yielding to pressure from the presidential administration, he announced that due to differing positions among the ministries, the discussion would be moved to a dedicated meeting outside the cabinet.

Russian political leaders are also giving Western Europe mixed signals about likely further developments in Russia’s gas industry. Two weeks after the cabinet discussion was canceled, President Putin stated in connection with talks with German chancellor Schroeder that Gazprom would not be broken up, and that state control of both Gazprom and the gas pipeline system would be preserved. The very next day, Prime Minister Kasyanov stated publicly that, to the contrary, the government planned to decide on the restructuring of Gazprom within several months’ time. For its part, Gazprom may also be taking a minimal step that would at least accommodate third-party access to the pipeline network. It was reported that Gazprom management is prepared to suggest to its board of directors that separate financial accounting be instituted for the various segments of the company’s business. This would help identify the true costs of transporting the gas that Gazprom currently produces as a basis for an eventual pricing scheme for gas transport on behalf of independent producers.

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