As EU gives up on Russian gas, what will happen to Gazprom?

On August 31, shortly after Russia cut back on gas supplies in the Nord Stream 1 pipeline, share prices of the state-run energy giant Gazprom went up by 35 percent, according to the Moscow stock exchange. 

What sparked the market enthusiasm was the recommendations of the company’s board of directors to pay dividends for the first half of the year: 51.3 rubles per share for a total amount of 1.208 trillion rubles. The company also announced a record 2.5 trillion roubles ($41.75 billion) in net profit in the first half of 2022.  

It was sweet music for shareholders who were earlier left disappointed in June when the Russian government decided not to pay dividends on last year’s results, a first since 1998.

But Gazprom could be walking on thin ice as Russia and the West, particularly the European Union, engage in a bitter ‘gas war’ over the Ukraine conflict. 

Moscow has retaliated against Europe’s decision to cap gas and oil prices by cutting off supplies through the Nord Stream 1 pipeline, with President Vladimir Putin even warning that the West would be “frozen” like a wolf’s tail in a famous Russian fairy tale.

Russia is the world’s second-largest oil exporter after Saudi Arabia and the world’s top natural gas exporter and even a slight disruption of exports by Gazprom roils the global energy markets.

But can Gazprom survive if Europe does away with Russian gas altogether, as hinted by the EU member-states? 

By rough estimates, stopping gas exports to Europe in full would lead to a loss of $13 billion (800 billion roubles) for Russia. Moscow is well aware of the challenges it faces if Europe manages to find alternate energy sources.

Reuters reported that a Russian strategy document warns that “a reduction in supplies to foreign consumers will lead to an imbalance in the system….” The document was discussed at a closed meeting chaired by Prime Minister Mikhail Mishustin in Moscow on August 30.

If Europe refused Russian gas, it would lead to a potential reduction in gas exports of more than 100 billion cubic metres a year by 2027, almost half of total exports in 2021, according to the document titled ‘On the Strategic Directions of Activity in the New Conditions for the Period up to 2030’.

Production and exports 

Russia annually produces 720 billion cubic metres of natural gas. Last year, it exported 204 billion cubic metres, including 130 billion, to Europe. It exported 10.5bcm to China, about 28bcm to Türkiye, 30bcm to CIS countries and 20bcm to Belarus. It is not difficult to calculate that most of the production goes to the domestic market, that is, about 500 bcm. As for this year, over the seven months, Gazprom has produced 12 percent or 35.8 billion cubic metres less gas. Exports have fallen by almost 35 percent, or 40 billion cubic metres, and totaled only 75.3 billion cubic metres, according to Gazprom's data reported by Vzglyad. 

Moreover, the steep decline in both gas production and exports is only gaining momentum.

At the same time, Gazprom says that it fulfills all requests of the Europeans. Gas exports slumped because of reduced demands while rising prices also played a part. 

As journalist Olga Samofalova says, “If the price increases for a short period of time, the demand automatically begins to decrease because not everyone can afford to buy gas for 1000 dollars for a thousand cubic metres, let alone 2000 dollars ....”

What do experts think?

However, Russian experts say that the situation looks bad for Gazprom and Russia in general only at first glance. In fact, the current situation is kind of advantageous for them. 

“We don’t expect the current situation to negatively affect Gazprom's and the government’s revenues in the short term,” Philip Muradyan, senior director for corporate ratings at Expert RA, told Vzglyad. 

Natalia Milchakova, the lead analyst at Freedom Finance Global, also feels that Gazprom can “more than compensate for the dropped-out volumes due to the high price” while Alexei Gromov, director of the energy division at the Institute of Energy and Finance, says that the company’s revenues could double from last year to reach $80-90 billion.

Last year Gazprom’s revenues from pipeline gas exports reached a record $55 billion. 

West is waste, welcome East 

In 2021, the average price of Gazprom’s gas for Europeans was $275 per 1,000 cubic metres, while in the first half of this year, it was three or four times as much. According to Gazprom’s “conservative estimates”, this winter, the price of gas in Europe may reach $4,000 per 1,000 cubic metres.

“However, such a high price cannot remain for a long time,” Promsvyazbank analysts say. On the one hand, it will significantly reduce the demand for gas. On the other hand, it will lead to additional volumes of gas destined for the Asian market, even by breaking contracts and paying fines on them.

“Strange as it may seem, the world does not necessarily have to collapse,” Yevgeny Kogan, the president of Moscow Partners, says on his Telegram channel. “What is clear is that gas consumption will fall dramatically. However, it has already fallen quite a lot. 

Energy-intensive industries, such as aluminum production, have been shrinking for a long time, and chemists  and steelmakers are suffering.”

Today’s gas prices are almost unaffordable for the industry in Europe, Irina Kezik, an expert at the analytical centre of the Union of Oil and Gas Producers of Russia, adds. 

She says that in Germany, about 16 percent of energy-intensive industries in the metallurgical, glass, paper and chemical sectors have already reduced production or are ready to do so. 

In Slovakia, the Slovalco aluminum plant will be closed from September, and in the Netherlands, the Budel zinc plant. The list goes on, says Kezik.

Experts believe that the main decline in exports to Europe has already happened. During the winter period, Europeans will actively buy Russian pipeline gas. However, it is unlikely that they will be able to return to last year's volumes.

“In light of reduced pumping or complete suspension of several major gas routes, exports may drop to 125 billion cubic metres by the end of the year, that is, more than 50 billion cubic metres compared to 2021,” says Pavel Makarov, personal broker BCS World Investment.

While gas deliveries to Europe are decreasing, deliveries to the East are increasing. In particular, in July, deliveries to China were regularly in excess of the daily contracted volumes, Gazprom notes. The construction of a new gas pipeline to China is also being discussed.

However, the current capacity of the pipeline to China is significantly inferior to the capacity of Gazprom’s pipeline supplies to Europe. It is impossible to quickly and promptly redirect gas to other markets, as it happens with oil. 

Even under an optimistic scenario, i.e., if China signs a long-term contract with Russia, it would take 3-4 years. But Beijing is clearly stalling, squeezing out the most favourable terms for itself and, most importantly, at a low price.

What are the forecasts?

The long-term forecast of the BCS investment company for 2025 states that the export of Russian gas to Europe will decrease to 100 billion cubic metres. If exports to Europe are nullified at all, Gazprom will still have Türkiye, China, Central Asian countries and other states which are not recognised as 'unfriendly' to Russia.

But the bare truth is Europe consumes three times as much. So, as Tinkoff analysts say, Gazprom will have a “new life.” 

It will start turning into a company focusing on the domestic market without big export revenues. There is already an example of “Rosset,” a large infrastructure company that provides transportation of electricity inside Russia. 

However, the problem is that gas prices on the domestic market and in Europe are very different. They are almost 20 times higher when exported, now they are even higher than usual.