Gazprom Still Disconnected From Commercial Reality

| About: PJSC Gazprom (OGZPY)

Gazprom is having difficulty making inroads into Asia generally, and into the LNG market particularly. Its problem? Apparently so used to dealing with Europeans who have few outside options (yet), the company is incapable of operating in a competitive environment. It is fixated on maintaining its traditional oil-linked pricing formula, despite the facts that (a) in the U.S. natural gas prices on an energy equivalent basis have fallen to an all time record low vis-a-vis oil, and (b) U.S. firms, notably the Cheniere Energy* (NYSEMKT:LNG) mentioned in the Bloomberg piece, are gearing up to export LNG, particularly to Asia, making the U.S. the likely supplier of the marginal mmbtu of gas, and hence making it the world price setter:

OAO Gazprom (OTCPK:OGZPY) the world’s largest natural-gas exporter, is struggling to get a foothold in the Asian markets leading global economic growth.

The Russian company’s plan to supply liquefied natural gas to India from 2016, the year the U.S. is set to start gas exports, is faltering after buyers said they’re looking for cheaper fuel from North America. Last year, decade-long talks to supply pipeline gas to China foundered over price disagreements.

“Gazprom has a major problem of having a fixed view on what the price of gas should be, irrespective of market conditions,”Jonathan Stern, chairman and senior research fellow at the Oxford Institute for Energy Studies, said by e- mail. “If this continues, it will create increasing problems for Russian gas exports.”

“Irrespective of market conditions.” Yup. That’s the Gazprom way, and that way doesn’t work when it’s not the market. In contrast, Cheniere is linking LNG prices to U.S. natty gas prices:

GAIL India Ltd. (OTC:GAILF), the country’s largest gas supplier, became the first Asian buyer of U.S. natural gas in December when it signed a 20-year deal with Cheniere Energy Partners LP (NYSEMKT:CQP), which is planning the first U.S. export terminal. The contract, targeting 3.5 million tons a year starting in 2017, is linked to the day- to-day U.S. benchmark gas prices, which fell to a 10-year low of $2.21 a million British thermal units in January. It will also include a fixed component.

Note that this also permits companies like GAIL to lock in a fixed price fairly easily, given its ability to use derivatives to swap floating prices into fixed ones. (The fixed component in the formula mentioned above covers liquification and transportation costs.)

Gazprom is a hidebound organization, grotesquely inefficient, notoriously corrupt, and unused to and arguably incapable of operating in truly competitive conditions. It has a guaranteed monopsony at the upstream end (being the only company permitted to export Russian gas) and has traditionally sold in markets downstream where there is little, and often no, competition from other sellers.

Its disconnect from commercial reality grows with every widening of the difference between gas and oil prices. It can insist on its self-serving formula, but as the U.S. becomes a major exporter of gas- as fundamentals imply that it should be- its insistence will make it an also ran in the LNG market.

Right now, Gazprom’s biggest hope is that political resistance to gas exports in the U.S. lead to bans or limitations on those exports, or the approvals and permitting for export terminals getting bogged down in the American bureaucracy. Usual Suspect Ed Markey (D-MA) has introduced a bill to ban gas exports. This will not go anywhere, but it does give edgy Asian buyers pause. In the aftermath of Keystone XL, moreover, it is clear that failure to secure regulatory approvals can delay or derail altogether extremely beneficial energy initiatives.

Ironic, isn’t it, that Gazprom’s biggest hopes may be in DC: The White House, Capitol Hill, and FERC (which is responsible for permitting LNG export facilities)?

* Full disclosure: #1 daughter works for Cheniere. Any reader of this blog knows, however, that my criticism (ridicule, really) of Gazprom and my commitment to free trade long pre-date her employment there.