HardAssetsInvestor

Written by Julian Murdoch  |

January 15, 2009

No Gas For You

Details

The U.S. may feel the effects of the natural gas dispute between Russia and Ukraine for some time to come.

• Russia's Gazprom turns off the spigot
• Deprivation is a two-edged sword
• Ripple effects

 

As you may have heard, Russia's Gazprom (OTC:OGZPY) cut off the flow of natural gas into Ukraine at the beginning of January. Since natural gas is such a localized market, it could be tempting to write off the news as a local concern-but we live in a global economy, and a shortage in one country can have far-reaching ripple effects.

Here's the background:

Russia has the natural gas, but for it to get that gas to its customers, it has to pipe the gas through Ukraine, and a lot of it. In an average year, 300 million cubic meters flows through Ukraine and on to the rest of Europe. For this partnership to work, Russia has been charging Ukraine lower-than-average rates for the gas it uses domestically compared with what the rest of Europe pays. In 2008, that amount was $179.50 per 1,000 cubic meters, as compared with the average $500 for European countries. In return, Ukraine charges Russia lower tariffs than it might for the transport of natural gas across its country.

It's an uneasy partnership, and they've been grumpy neighbors over time (2006 in particular was contentious). At the end of December, the two countries were in negotiations, and according to an article in the New York Times, the negotiating gap between the two countries was only about $50. At least, that's where things were at the end of 2008.

2009 dawned and Gazprom upped its selling price to Ukraine to $418 per 1,000 cubic meters, a huge increase of $238.50 per 1,000 cubic meters. Happy New Year Ukraine!

Needless to say, Ukraine wasn't at all thrilled. Things escalated and Gazprom decided to turn off the spigot.

From a pure kid-in-the-sandbox perspective, if someone won't play with you, you take your marbles and go home. But in this instance, stopping the gas flow is a double-edged sword, and Gazprom is getting bit badly, even as countries beyond Ukraine feel the cold.

 

Gazprom And Russia

In some ways, Gazprom is Russia and Russia is Gazprom. The line between the state-owned company and the government of Russia is blurry, complicated by the fact that the current president of Russia, Dmitry Medvedev, was formerly Gazprom's chairman, and the Russian government holds a 50% stake in the company.

The company is primarily involved in exporting natural gas to Europe and fulfilling domestic demand at subsidized rates. Gazprom is the world's largest natural gas producer, responsible for 85% of Russia's gas production. (They also have their fingers in lots of pies at home, including Telecommunications and Russia's banks.) Gazprom opened to foreign investment in 2006. In the past year, the stock price has followed a pattern similar to the rest of the Energy sector.

 

 

It's one thing for an independent company to be feeling the pain of low energy prices, but when the government itself needs more than $70 a barrel to meet its budget obligations (as Russia and many analysts have said), the recent commodity slide has hurt - a lot. Taxes on Gazprom, all by themselves, make up 20% of the Russian budget.

On Wednesday, President Dmitry Medvedev revealed that Gazprom has lost $1.1 billion so far because of the dispute. According to Forbes, 58% of Gazprom's gas revenues come from its European customers, although that makes up only 25% of its actual volume. This means that it is critical for the gas to flow to those European customers.