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By the sounds of this speech by deputy chairman Alexander Medvedev, Gazprom (OTCPK:OGZPY) is indeed feeling that its beloved oil-linked pricing mechanism is under siege. Medvedev’s tone is very defensive, and his arguments risible. How risible? Let’s deconstruct.

Fail #1:

“Oil-indexed , long-term contracts that ensure the basic supply volumes from Russia, Qatar, Norway and Algeria… are exactly the mechanism that protects all the parties, since the gas market is not like, for example, the fish market, where you can catch, sell, and make a profit in one day,” Medvedev said.

Well. Oil isn’t like fish: Don’t catch, sell, and profit in a day on oil. But there are vibrant spot and term markets for oil. Oil prices aren’t linked to anything else, but fluctuate minute-to-minute with market forces. And gas isn’t like fish either, but there is a vibrant spot and term gas market in North America. So it’s obviously nothing inherent in gas as a commodity that precludes the development of a vigorous spot market, or necessitates oil-linked pricing.

Jeez, apparently Medvedev has been consulting with Gensler about inane market analogies. Gensler: Apples. Medvedev: Fish. Both: Lame.

Fail #2:

Two-and-half years of abominably low spot prices in Europe have created the illusion that gas has lost its link to oil once and for all. This is not true.

So gas has decoupled from gas in the short run. Even if they recouple in the future, gas is always coupled with gas. A gas-based pricing mechanism can never become decoupled from gas, but gas and oil can become decoupled. So the movement away from oil-linkages towards reliance on robust gas pricing mechanisms reduces the risk of decoupling and more efficient pricing.

Fail #3:

Spot-price trading is incapable of giving correct price signals to the market due to the small volumes and low liquidity.

Trading volume is endogenous. Liquidity feeds liquidity. As the U.S. experience shows, liquid and deep cash and derivatives markets can develop very quickly given the right structural conditions: Movement away from oil-linked mechanisms would accelerate this process dramatically. What’s more, the Dutch gas hub is already pretty liquid, as is the U.K.’s National Balancing Point. They certainly give better pricing signals than oil. They will only give more accurate signals as market liquidity develops–which it will quite rapidly if oil-linked pricing and contracts fade away. Moreover, prices that don’t reflect fundamentals spur transactions that tend to eliminate inaccuracies.

Fail #4:

U.S. prices are so low they do not cover operating costs and in our opinion this situation will not last long. The situation there will return to normal and will make the U.S. market attractive again.

A lot of smart people are betting otherwise.

And here’s some whine to go with all that fail:

Medvedev also hit out at Europe’s efforts to reduce Gazprom’s dominance. “Natural gas has become a hostage of geopolitics in which there is an artificial demonisation of Gazprom,” he said. “Sometimes it seems that if even the export of bananas or coal were the largest source of budget revenues for Russia, it is in this area that political games would be played. We do not believe that there is an energy security problem in the EU.”

All at once now: awwwwwwwwww. Boo-frickin’-hoo. Poor, poor, persecuted Russia. Poor, poor, misunderstood Gazprom.

Amazing. Gazprom is a grotesquely inefficient state protected monopoly with a reputation for thuggishness, corruption, and opacity. Gazprom isn’t demonized: It is justifiably reviled. 100% natural ingredients, nothing artificial about it.

Again, it warms the cockles of my heart to hear Gazprom attempt to defend an archaic pricing mechanism. The defensiveness means the company is feeling the heat. The silliness of Gazprom's arguments makes it plain that the economics are inexorably consigning oil-linked contracts to oblivion. The fundamentals of the gas market are changing as dramatically as the contracting practice. Indeed, these fundamental changes will drive the move to new pricing mechanisms.

Medvedev knows that Gazprom is a Soviet relic that will face daunting difficulties in a more competitive environment in which gas fundamentals, not oil fundamentals, drive prices. Gazprom is attempting to fight market forces, but in the end, market forces will win–with bleak consequences for Gazprom, and the parasitical class that feeds off it.

Source: Gazprom Finally Feeling The Heat?