Russia's Gazprom settles Ukraine gas row, but profits could dip

It's been an important week for Russian energy giant Gazprom's bid to strengthen its hold on oil and gas markets.

After withholding 50 percent of Ukraine's gas supplies in a brief dispute last week, Gazprom on Thursday struck a deal that cuts out middlemen and gives it more access to the ex-Soviet country's industrial gas customers. But while putting the squeeze on Ukraine, Gazprom also felt new pressure from increasingly bold Central Asian states, whose energy resources are being sought by the US, Europe, and China, as well as Russia.

Facing the heightened competition, Gazprom agreed to pay European prices for gas from key energy partners Turkmenistan, Uzbekistan, and Kazakhstan. Although it could result in lower revenues for Gazprom, experts say Russia has effectively bought control of Central Asian exports.

"Russia will maintain its control on gas supplies even though its profit will go down," says Sergey Smirnov, energy expert from the Expert Kazakhstan journal. "All other alternative routes that are on paper today become unreal."

The deal is likely to affect Europe most, which analysts say will face higher prices. In addition, the European Union is likely to find less receptivity now from Central Asian states for a proposed Trans-Caspian pipeline that would diversify energy supplies from Russia.

"High import prices can force Russia to raise export of its own gas," says Mikhail Krutikhin of Russian Energy, a consultancy firm in Moscow.

Ukraine, particularly, may be in the worst situation as most of its imported gas comes through Russia from Turkmenistan, which is likely to raise its gas prices from the current $130 to $150 per 1,000 cubic meters (tcm) to $250 to $350 tcm.

Russia's role as sole exporter

Because all operational pipelines in Central Asia date to the Soviet era, all gas exports go through Russia. Russia has effectively used this position to dictate prices to ex-Soviet states. Just two years ago Russia was buying Turkmen gas at $65 per tcm and sold it to European countries at $250 to 300 per tcm.

Such price inequalities drove Central Asian nations to seek alternative gas export routes – a task not difficult when China and the West were looking to diversify energy supplies away from Russia and the Middle East.

In the past few years, the United States and EU intensified their attempts to convince Central Asian states to deliver its gas straight to Europe via a Trans-Caspian pipeline, bypassing Russia. High-profile US delegations and EU energy officials became frequent visitors to Ashgabat, the capital of Turkmenistan, which claims it has up to 24 trillion cubic meters of gas reserves, though no independent assessment is available.

Europe, which worries that its dependence on Russia's energy supplies can be used by Moscow for political purposes, hopes to receive up to 30 billion cubic meters (bcm) of Turkmen gas annually if the project is implemented. It would be transported from the Caspian region, where Turkmenistan claims the largest gas reserves, to Turkey and then Europe via the proposed Nabucco pipeline. Only one link in the planned route is complete – the Baku-Tbilisi-Erzrum line, which runs from Azerbaijan to Turkey. All other routes exist only on paper.

In addition, some analysts argue that a Trans-Caspian pipeline will lose its economic incentive in the eyes of Central Asian states – especially since they locked in higher prices from Russia on Tuesday.

"It will cross eight countries and each country will charge for transit," says Mr. Smirnov. "Why would Central Asians need this route when they can ship [their] gas directly to Russia and make the same profit without much hassle?"

The Nabucco pipeline project that is aimed to diversify European energy supplies and make less dependent on Russia, will suffer from this deal as well. Mr. Krutikhin claims that without the Trans-Caspian pipeline, Europe will struggle to get enough gas to fill the pipe.

"Azerbaijan ships to Turkey a maximum of up to 6 bcm of gas. Iran can give maximum 10 bcm a year, but a recent gas crisis there shows that they also need gas for domestic use. Egypt has neither enough reserves nor serious plans to ship gas to Turkey." Thus, Nabucco is ultimately dependent on Turkmen gas, summarizes Krutikhin.

New deal for Chinese pipeline

Unlike the Trans-Caspian and Nabucco projects, the Chinese pipeline is already being implemented. Last year Turkmenistan agreed to ship 30 billion cubic meters of gas to China starting in 2009. Construction started in August 2007. Kazakhstan and Uzbekistan also joined this project and plan to ship their gas to China via this pipeline.

This project is a major blow to Russian influence in the Central Asian energy sector. For the first time, Central Asian nations will gain access to energy markets without being dependent on Russia.

Russia thus had little choice but to compromise and agree to new prices.