Editor's Note: This is the third installment in a three-part series on Russia's energy sector. Part 1 covered the Russian energy industry from the 1990s through the Putin era; Part 2 discussed upcoming national policy changes; and Part 3 will examine Russia's oil and natural gas giants and their relations with Europe.
In addition to discussing the state's dependence on energy revenue, Russia's presidential energy commission is also tasked with examining the role of Gazprom and Rosneft in the Russian energy sector. Gazprom is already a monopoly, responsible for the vast majority of natural gas production and holding compete control over the natural gas export network to Europe. This position has virtually ended competition within the Russian natural gas sector and reduced the motivation to improve efficiency, which the Kremlin may be ready to change. Unlike Gazprom, Rosneft is not yet a monopoly even though it is the largest and most powerful oil firm in the country. Rosneft has taken a number of steps to increase its overall share of the energy sector, something the Kremlin is wary of allowing since this could create a monopoly in the oil sector.
Both of these developments are closely linked to the firms' relations with Europe. European governments are wary of their reliance on Russian energy, given Moscow's willingness to use that dependence as a foreign policy lever. As a result, many countries have pushed back against Gazprom's dominance and pursued alternative energy sources, and the commission will be evaluating how to retain its European customers. At the same time, some European firms may have an opportunity to invest in Rosneft, which the Kremlin could welcome as a way to accelerate its modernization efforts through an influx of foreign technological expertise.
Gazprom's Monopoly and Ties With Europe
The structure of the natural gas sector was designed to give Gazprom a near monopoly on production and a full monopoly on natural gas exports. This arrangement was decided upon for internal political reasons, but also to allow the Kremlin to wield Gazprom as a tool to influence the behavior of its natural gas consumers. This arrangement has been beneficial for the Kremlin for years, bringing in a great deal of revenue and allowing it to shape developments in Europe. However, three major issues have arisen because of the system.
First, there has been little internal competition in the natural gas sector. Because Gazprom makes up 80 percent of domestic production, there is no counterbalance to Gazprom's authority in the field. This has allowed the state-run company to dictate the policies in the natural gas sector. In part stemming from that lack of competition, mismanagement within Gazprom has reduced the incentive to modernize and caused many natural gas projects to go over budget or fall far behind schedule.
The second major issue is the firm's monopoly over natural gas exports and the export system. Other firms are allowed to sell natural gas abroad, but they must use Gazprom as an intermediary, and Gazprom has repeatedly shown it is willing to interfere with or halt shipments without notice.
Third, Gazprom's monopoly has led to a backlash in Europe, which is Russia's largest and most important customer base. Europe regards Russian energy supplies as a tool for the Kremlin to shape its relationships on the Continent — usually not in Europe's favor. Consequently, some Europeans are seeking to unbundle Russian control over energy production, distribution, sales and generation in Europe, as well as look for alternative sources that could supply energy. The Kremlin cannot afford to lose Europe as an export destination not only for financial reasons but also politically, since it would deprive Russia of its primary means of influence.
Russia is countering diversification plans by striking long-term contracts offering lower natural gas prices to strategic partners like Germany. However, the concession on natural gas prices is not enough for many European countries, which want to see Gazprom's control reduced. Lithuania and several other European states have opened lawsuits against Gazprom, and the European Council itself has a probe launched into Gazprom's activities. More ominously, a real competitor to Russian natural gas may be emerging due to the increased prevalence of liquefied natural gas. Unlike other competitors like Azerbaijan that only can export small amounts, globally accessible liquefied natural gas has the long-term potential to seriously disrupt Russia's natural gas hold over Europe.
The Kremlin may be forced to make additional concessions or changes to avoid losing its most important customers and thus its influence in Europe. Beyond the lower natural gas prices, signs of a potential new strategy have emerged out of the Kremlin. Putin has said that he and his commission will discuss whether to revoke Gazprom's monopoly on exports to Europe. This would be a monumental concession if realized, since it would allow other firms such as Novatek, Rosneftgaz, Itera, LUKoil and others to be able to export their natural gas to Europe and create competition with Gazprom for contracts. When he made the statement, however, Putin was quick to add that he would not give in to European pressure on unbundling Gazprom's assets in Europe.
It thus appears that the Kremlin is trying to reach a compromise with Europe: Russia will give in on price and the export monopoly issue if Europe backs down on the unbundling lawsuits. Such a compromise would be difficult to strike, not only because of the Europeans, but also due to internal opposition from Gazprom's beneficiaries to a move that would severely curtail the company's power in Russia.
Rosneft's Aspirations and Ties With Europe
Rosneft's role in the energy sector is also in question. Rosneft does not have near the power of its sister firm, controlling only 24 percent of the oil sector and less than 5 percent of the natural gas sector. The company has been looking to expand its overall energy footprint by opening negotiations to purchase several companies that control Russia's electricity grids, which would essentially give Rosneft an electrical utility monopoly in Russia. Rosneft has also increased its stake in independent natural gas firm Itera and held negotiations with other independent firms like Novatek. In the oil sector, Rosneft had drawn up a plan to take over 50 percent of the embattled joint Russian-British company TNK-BP from the British partners BP. Rosneft's acquisition of TNK-BP would give the state firm nearly 44 percent of oil production in Russia.
Critics of the TNK-BP, Itera and electricity grid deals believe that Russia does not need another monopoly and argue that the Russian oil sector runs more efficiently than the natural gas sector because it has competition from other powerful and modern firms. Naturally, the proposed expansion also faces opposition from powerful political and industry leaders who want to prevent Rosneft from gaining more control over the oil sector, since that would necessarily give the firm's political patrons in the siloviki clan more power as well.
Rosneft's pursuit of TNK-BP is not just about gaining more access to the oil sector in Russia, but also about Europe's role in the Russian energy sector. Rosneft is looking to pay for its shares in TNK-BP in part by offering half their worth to BP in Rosneft shares. This would give BP a 12.5 percent stake in the state firm, once again raising the prospect that foreign firms may be able to invest and operate in Russian energy.
Over the past decade, Russia sought to purge most foreign influence from the energy industry, but now realizes it needs foreign, and particularly European, firms to help modernize the sector. Most of Russia's future energy projects — from the Yamal natural gas project in northwestern Siberia to Arctic oil drilling — need technological expertise that Russia currently lacks. BP's relationship with Rosneft is one avenue for this type of cooperation. Additionally, Russian Energy Minister Alexander Novak said Oct. 4 that Russia is considering allowing foreign companies to own oil licenses in the Arctic once again, which is a reversal of policy.
The discussion of foreign control over assets in the energy sector is another issue the commission will reassess in the next few months. Here, too, the Kremlin has hinted at its inclination, with Putin saying Oct. 10 that he backed a deal in which BP would gain shares in Rosneft in exchange for buying out the British stake in TNK-BP. While nothing has been finalized, it appears foreign firms may find an opening to acquire stakes in Russian state-controlled assets.
Ramifications for Russian Power and Stability
A comprehensive review of the Russian energy sector is under way. The overall structure of the oil and natural gas industry served the Kremlin's purposes well over the past decade, enabling it to consolidate power over the strategically important sector, eject foreign influence, provide a revenue stream for the Russian government, create leverage over Europe and strike balance between Russia's rival clans. But Moscow understands that the current arrangement cannot last indefinitely.
The Kremlin has already started to re-examine the various components under pressure, including the state budget, internal competition (or lack thereof) and energy firms' relations with Europe. Each of these issues is interconnected and one cannot be changed without affecting the others. The Kremlin needs to lessen its dependence on energy revenues in order to ensure that the energy firms have the money they need to modernize and reform. It also must ease Gazprom's monopoly without jeopardizing Russia's influence over Europe or upsetting the Kremlin's internal political power balance.
The Russian energy sector is too important to make changes lightly, and Putin's commission has a difficult task ahead of it in trying to establish the proper course of action. On its efforts hinges not just the future of Russian energy, but Russian power and stability — now and in the decades to come.
