Main Image Credit Shifting flows: Russia's Gazprom has been forced to seek alternative markets for its gas in the wake of European sanctions. Image: Kletr / Adobe Stock
The loss of European gas pipeline markets has had a profound effect on Gazprom’s – and therefore the Russian state’s – revenue stream. Replacing this lost market will likely drive Gazprom to pivot towards increased pipeline sales to China and increased liquified natural gas sales. This realignment will require substantial infrastructure investment and technical expertise, and will not be a quick fix. This has implications for Russian state finances and the funding of the war in Ukraine.
Russia has historically been a significant exporter of all forms of energy, including crude oil, refined products, coal and natural gas, and at the end of 2020 was in possession of a substantial proportion of the world’s fossil fuels. Proven reserves as a percentage of the worldwide total were in the region of 6.2% for oil and 19.9% for gas, giving Russia the largest proportion of worldwide gas reserves.
In 2021 – the year prior to the invasion of Ukraine – of Russia’s worldwide oil exports, approximately 53% of crude and 54% of oil products were exported to Europe. Following the Russian invasion of Ukraine in February 2022, and with the announcement of EU sanctions and commitments to reduce Russian imports, Russia has had to look for other markets in which to place its products. Moving oil and oil products can be managed relatively easily, with Russian oil and oil product sales to Europe and the US being displaced over the period from January 2022 to January 2023 largely by sales to India, and to a lesser extent to China and Turkey. By February 2023, Europe’s share of Russian oil exports had dropped to approximately 8% from above 50% in 2021.
Gas, on the other hand, is a more challenging commodity to find new markets for owing to specialist infrastructure requirements. Russia, via the largest and predominantly state-owned gas company Gazprom, was one of the major players in international pipeline gas and liquified natural gas (LNG) markets in 2021, contributing around 24% to worldwide gas trades, and sending 83% of its pipeline gas exports and 44% of its LNG exports to Europe in 2021. (As of the end of 2021, Gazprom had two major shareholders – the Russian Federation (>50%) and ADRs issued by BNY Mellon (16.2%) – and according to Forbes was one of the largest companies in the world and in the top 20 for profits in 2022. The company is currently delisted from international markets and no formal data has been published recently.)
Gazprom was in the enviable position of having ready markets and infrastructure on its doorstep that were keen to sign up to long-term agreements for the supply of gas. In the decade leading up to Russia’s invasion of Ukraine, the chart below shows that the ‘Far Abroad’ made up the majority of Russian gas exports, which could be broadly divided into three tranches: pipeline gas sales to Europe; pipeline gas sales to China (developing following the commissioning of the first stage of the Power of Siberia pipeline extension into Northern China in December 2019); and LNG sales, increasing almost threefold between 2017 and 2021, with over 50% destined for East Asia (Japan, China, Taiwan and South Korea) – Japan being the biggest buyer of Russian LNG.
It is interesting to note in the chart above that, despite the decrease in gas exports in 2022, Gazprom’s profits for the first half of the year were estimated to be higher than those for the whole of 2021, primarily due to the increase in gas prices during that period. The payment of dividends in relation to these profits resulted in Gazprom being the largest contributor (approximately $75 billion) to the Russian state budget for 2022. With lower gas prices and a drop in demand, analysts believe that Gazprom’s profits for the second half of 2022 are likely to be close to zero. Furthermore, the Kremlin imposed an additional ‘extraction tax’ on Gazprom in 2022, resulting in all of Gazprom’s 2021 profits being paid directly to the state (thereby depriving shareholders of any profits), with extraction taxes being imposed for the next three years.
What Does the Future Hold for Gazprom’s Gas?
European sanctions, together with the explosions on the Nord Stream 1 and 2 pipelines, have obliged Gazprom to look for other markets in which to place its pipeline gas, notably those countries which have not chosen to impose sanctions, such as China and Turkey.
In 2021, Russia exported 167 billion cubic metres (bcm) of gas into Europe (including Turkey), and it was announced by the Kremlin that in 2022, Russian gas exports decreased by 25%. On a global scale, analysts believe that the reduction is even greater, with global exports (not including those to former Soviet Union countries) falling by 45% in the year from 2021 (185.1 bcm) to 2022 (100.9 bcm). Furthermore, analysts believe that the figure is likely to decrease to approximately 50–65 bcm in 2023 (excluding supplies to China), leaving in excess of 100 bcm of gas to be placed elsewhere.
In the past six months, as European demand for Russian gas has dropped and gas prices have decreased, Gazprom’s profits have all but disappeared
Gazprom therefore has some challenging choices to replace the loss of its traditional European pipeline markets:
- Wait and hope that European gas buyers will return at some point in the future.
- Grow its pipeline gas supply to China and other non-sanctioning countries.
- Grow its LNG business.
Our view is that the first scenario is unlikely to happen in the near- to mid-term, with European buyers being more reluctant to place reliance on Russia as a trusted gas supplier.
It is expected that the largest share of the shut-in gas will end up in China, with the expansion of existing and construction of new pipeline infrastructure. The Power of Siberia I is expected to supply around 22 bcm of gas to China in 2023, rising to a full capacity of 38 bcm in 2025. The Power of Siberia II (with a capacity of around 50 bcm) is reported to begin construction in 2024, with transportation commencing in 2030. It is understood that key matters such as who will pay for the 2600 km-long pipeline (estimated to cost in excess of $10 billion for the pipeline alone) and the gas purchase price are yet to be agreed, with China remaining silent on any commitment to the project. Other willing European markets for pipeline gas include Turkey, Serbia and Hungary, although these are relatively small compared with the market lost.
This still leaves a surplus of more than 50 bcm, and it is unlikely that LNG sales will be able to make up for this. LNG capacity requires significant investment – for both liquefaction and shipping capacity – and takes time and technical expertise to build. Russia has increased its LNG capacity in recent years, and this growth trend is expected to continue. According to the Gas Exporting Countries Forum, in 2022 Russia had approximately 29 million tonnes per annum (Mmtpa) – equivalent to around 40 bcm – of LNG plant capacity, with a further 6.6 Mmtpa from the Arctic LNG Train I still on track to commence production in 2023, as confirmed by Japanese company Mitsui, one of the investors in the project. LNG exports to China have also increased threefold over the past year, and it is likely that this trend will only continue as Russia looks to the Far East to replace its lost exports.
None of the above choices will fill the gap left by the loss of European markets, and therefore a significant reduction in gas sales revenue and profits for Gazprom and its shareholders, and in turn for the Russian state, is to be expected.
The Russian economy has historically relied heavily on Gazprom’s profitability, with Gazprom being the highest contributor to the state in 2022. In the past six months, as European demand for Russian gas has dropped and gas prices have decreased, Gazprom’s profits have all but disappeared.
Gazprom has two feasible choices for attempting to fill the gap left by the European market: pipeline gas exports to China and increased LNG exports. The implementation of these choices will require significant investment to expand both existing and future infrastructure, and will take at least 5-7 years – but this may still not be enough. Given the reduced Gazprom revenues and potentially increased tax take from the state, the ability of Gazprom to fund the infrastructure required to facilitate this pivot is unclear.
With the reliance that the Russian state has placed on Gazprom’s profitability, this will have both economic and political ramifications, severely compromising Russian state finances, and raises the question of how Russia will continue to finance its war against Ukraine given the expected depleted gas revenue stream.
The views expressed in this Commentary are the authors’, and do not represent those of RUSI or any other institution.
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