Gazprom: Cracks Are Appearing

Oct. 3.11 | About: PJSC Gazprom (OGZPY)

Your favorite company and mine is under some stress. Gazprom (OTCPK:OGZPY) faced raids from EU officials pursuant to an antitrust investigation of the company against the background of Euro hemming and hawing (so what else is new?) over the creation of a unified energy market.

But perhaps more interestingly, Gazprom’s customers are rebelling against the anachronistic oil-based pricing, take-or-pay contracts under which the company has sold gas since the 1980s. These contracts made economic sense then, when there was no liquid spot market. They are not economically sensible now, given the development of such a market. But given the divergence between oil prices and spot gas prices, they are quite lucrative for Gazprom, so the company is holding onto them with a death grip.

But cracks are appearing. One long-standing contract (dating from 1986), with Turkey’s Botas, is about to expire. Botas has terminated the contract citing a dispute over the pricing mechanism. Perhaps this will give impetus to the efforts of other companies, such as Germany’s E.ON who are also pressing the Russian corruporation to move towards spot pricing.

The Turkey episode is actually quite entertaining, and should make anyone think before believing any Gazprom statement. The initial threat to terminate the contract came from Turkey’s energy minister. Gazprom then huffily said that the Energy Minister was irrelevant, because it was negotiating with Botas not the Energy Ministry. 2 days later, Botas told Gazprom to hit the road.

I love it when that happens. A twofer. Gazprom loses a deal, and then looks foolish trying to deny it’s going to lose the deal.

The disputes over contracting are a short-to-medium term problem for the company. Longer term, there is the threat from shale. U.S. shale is developing apace. There was recently an announcement of a huge shale gas find in the UK (although there were soon naysaying reports–all of which is par for the course in this business). Poland has also claimed that it has bright shale prospects (although a private correspondent who has investigated the issue closely argues these claims are overstated).

The company has ambitions to raise its market share in Europe from about 25 percent to 30 percent. It will not be able to achieve those ambitions and maintain its anachronistic pricing mechanism (which greatly overprices gas). Moreover, it will face new competing suppliers. Gazprom will no doubt continue to maintain its swagger, but as the Botas episode shows, cracks are appearing in its facade. Look for those fissures to grow.

Disclosure: No positions