Energy Reform in Russia and the Implications for European Energy Security

The Russian natural gas and power industries are currently undergoing a reform that has potentially far-reaching consequences for Europe's gas supply and energy security. After fifteen years of subsidizing domestic industry through the regulation of natural gas and electricity prices, the Russian government has embarked on an ambitious program of price deregulation that will result in free market pricing for domestic industrial consumers by 2011. This program has involved many politically difficult decisions about the best use of Russia's comparative advantage in indigenous energy resources and the state's responsibility for the support of the national economy through the subsidy of domestic industry. It has also highlighted a complex identity within Gazprom and revealed that its relationship with the Kremlin is not as harmonious as one might expect.Conceived as a national champion company by the Russian government, which holds a majority of its stock, Gazprom has been expected not only to provide cheap supplies of natural gas to support the development of Russian industry but to secure Russian government interests in international business. However, despite their close relationship to President Putin, Gazprom's CEO, Aleksei Miller, and Chairman, Dmitry Medvedev, have been showing greater concern for Gazprom's profitability and survival and have been giving greater consideration to how macroeconomic factors influence the profitability of industry and the sustainability of economic development. Arguing that cheap electricity, and the need for an abudance of cheap natural gas to supply cheap electricity, was actually a hindrance to healthy domestic development, Gapzrom has successfully persuaded the government to abandon price regulation in favor of a free energy market. Although domestic price reform was a key recommendation of the World Trade Organization for Russia's admittance, the final program won by Gazprom is far more ambitious. Furthermore, Russia's entry still faces many hurdles and is far from imminent. It may even be delayed until after 2008 and may be deprioritized by Putin's successor. Therefore, Russia has demonstrated a great sense of responsibility in addressing its energy-wasteful practices immediately, and has demonstrated responsible recognition of its best long-term interests.Gazprom's long-term production capacity has been a source of concern both domestically and internationally. Output at Gazprom's main producing fields in the Nadym Par Taz (NPT) region-including the supergiant fields of Urengoy, Yamburg, and Medvezhe-has been in steep decline since the early 2000s. By 2015, production at these fields will be half their peak output. To replace this diminishing output, Gazprom has been developing shallow fields in the Ob and Taz Bays on the Yamal Peninsula. While these shallow fields can complement output from NPT, adequate future supplies can only be guaranteed through the development of major new fields, a move that Gazprom has been reluctant to undertake. The Shtokman project has been continuously delayed and development of the giant Yamal Peninsula fields is still in the discussion stages. Despite pressure from the Russian government and expression of deep concern from European customers, Gazprom has resisted these major development projects because of their high marginal costs and uncertainty over future domestic and international prices.The domestic market has traditionally been a financial liability for Gazprom. Despite absorbing approximately 60 percent of Gazprom's output, the company have never realized a profit from sales within Russia. Instead, Gazprom relies on exports to European markets for its entire profit margin. Recently, Gazprom has lost more than $1 billion per year. While this has been somewhat sustainable over the past twenty years, as no new significant development has been necessary, the growing shortfall and the high marginal costs necessary to guarantee future supply to both domestic and foreign markets have caused Gazprom to rebel against its continued subsidization of the domestic market. …