Alexander Medvedev: Profit is our priority

April 26, 2011, the interview was taken by Sergey Pravosudov
Published in corporate Gazprom Magazine Issue 4

Alexander Medvedev

Alexander Medvedev, Deputy Chairman of the Gazprom Management Committee, Director General of Gazprom export answers questions posed by the Gazprom Magazine.

Mr. Medvedev, what are the operating results achieved by Gazprom export in 2010?: Last year was difficult and all the time we felt the global crisis effects that haven’t been overcome yet. Nevertheless, despite these unfavorable conditions and remaining adverse impacts on the gas industry we may consider the results as optimal. The absolute export volumes dropped down to 138.6 billion cubic meters (versus 140.65 billion cubic meters in 2009) although the earnings increased from USD 42.5 billion to USD 43.87 billion.

Efficiency

In other words, we were facing two options: either to maintain the volumes and the market share or to give priority to the earnings. Being a public and commercially oriented company, Gazprom is interested in raising the profit to provide shareholders with profit. Therefore, we have made the right choice in favor of earnings and the year-end results confirmed that. Moreover, we preserved the system of long-term contracts with the take-or-pay clause, the principle of gas price pegging to the petroleum product basket, etc. This lays a reliable foundation for a long term.

Let me quote an outside opinion to prove our case. PFC Energy, an American consulting company, has prepared a research demonstrating on the basis of its own techniques the efficiency of the export strategy pursued by Gazprom Group. According to the company’s estimates, the overall price discount amounted to 3 per cent only through inclusion of the spot component into the pricing formula applicable to 10–15 per cent of its overall contracted volumes in 2010. If the spot component covered 30 per cent of contracted volumes (that’s what Norwegians did), Gazprom export would have to sell 160 billion cubic meters of gas at USD 266 per 1,000 cubic meters or 157 billion cubic meters at USD 270 per 1,000 cubic meters to yield equivalent profit. In the environment of 2010 such scenarios would have been unreal, given the specified combination of the volume and the price, confirming by the efficiency of our sales strategy.

What are your plans for 2011?: We assume that revival of the European gas market will continue in 2011, although not all the parameters will get back to normal. Nevertheless, Gazprom export is expecting to supply foreign consumers with 151 billion cubic meters of natural gas.

What is your assessment of 2010/2011 winter results?: Cold winter periods are always favorable for the gas industry as natural gas is a seasonal commodity and gas consumption in winter is especially sensitive to temperature changes. The final results will become clear by the year end, but it is possible to say right now that gas supplies over the first three months of 2011 have far exceeded our expectations.

What will be the average gas price in 2011?: It is too early to speak of the average price now – though the gas price follows the oil price changes with a certain time lag and this lag never exceeds nine months. Everything will depend on the oil market behavior. The oil price keeps growing while the common financial speculative component of the market price is aggravated by the unrest in the Middle East and North Africa. As for the first quarter, the average price in Europe is expected to stand at USD 327 per 1,000 cubic meters of gas. Anyway, every market has a different price and the accuracy of this indicator may be compared to the average body temperature among patients in a hospital.

Prospects

Let’s speak of the trends and the price evolution rather than of the absolute values. Naturally, the ongoing growth in oil and petroleum product prices will lead to an increase in the price for gas supplied under long-term contracts. This is not our influence or the result of coordinated efforts of both parties to the contract, but an objective effect of the pricing formula in action. Moreover, the spot market prices or, rather, their fluctuation mode, will be unable to reach the pre-crisis level this year exerting a certain pressure on the European gas market. Although, the parameters of long-term contracts and spot prices will continue moving closer to each other. Last winter the spot prices surpassed our prices as it used to happen every year before the crisis and this proves we are getting back to normal. We haven’t changed our mind: the spot market in the continental Europe is rather small, it lacks depth and liquidity. It only balances gas supplies and therefore, is unable to serve as a pricing benchmark. Naturally, a tail can’t wag a dog!

What are the prospects for Russian gas in the European market? How do you evaluate the competition with LNG projects?

I have already mentioned about the prospects for 2011, if we take a larger period of time, the main trends are as follows. Firstly, the indigenous blue fuel production will continue to decline in the EU countries, which is explained by gradual reserve depletion. Secondly, a number of well-established natural gas suppliers to Europe won’t be able to maintain the present level of production for the same reason. Thirdly, gas consumption will grow, though not too much. As a result, gas import will build up.

Our experts have analyzed the researches of the world’s most reputed analytical centers and institutions and compiled a consensus forecast. It shows that Europe’s demand for imported gas will amount to 380 billion by 2020 and as much as to 440 billion by 2030. No doubt, this shortage will be partially covered by LNG supplies and even (if a miracle happens) by shale gas, but the share of Russian gas will grow as well.

We look optimistically at our prospects, particularly taking into account high environmental and financial standards met by natural gas in today’s energy sector. In this context, no rivals to natural gas are expected.

Unfortunately, Europe hasn’t realized it yet on the political and partly on the expert level, but it is a matter of time.

What is the impact of the European market liberalization on Gazprom Group’s export policy? When will the unified gas market come into being in the EU? Are you planning to increase the share of spot sales?: The ongoing liberalization-related changes in the European market are no surprise to us. We are carefully tracking the changes that happen in individual countries and in the whole EU, we are an active participant of various groups including those established as part of the EU-Russia energy dialogue. This enables us to make specific changes in our tactics when it’s needed.

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Liberalization

You are asking about the date of the unified gas market establishment in the EU. This is the same as speaking about absolute accuracy of a long-term oil price forecast. There remains uncertainty related to the architecture of this future market and the gas industry processes running in the EU as well as to the economic future of individual countries. You see, gas market is not isolated and gas marketing is not a goal in itself. On the one hand, the blue fuel is supplied via absolutely material infrastructure networks, stored in UGS facilities and offloaded at LNG regasification terminals. On the other hand, any infrastructure projects and, correspondingly, any gas flows should be economically and socially reasonable – in other words, a pipeline being built should be supported by a guarantee of long-term demand from, for instance, industrial or household consumers. Of course, these are not the only segments of the real economy that widely use natural gas. Particularly the future gas consumption architecture in a country determines the fuel demand for decades to come. At the same time, every country has a unique consumption pattern. Should we therefore expect that the gas markets of, let us say, Germany, Spain and Bulgaria will develop and integrate into the unified European market in the same way? That’s why it is inappropriate to announce the date of the unified market establishment.

As for our spot sales share, it depends on the spot market behavior. Is it expedient for Gazprom or not? This issue should be addressed considering the overall effect of raising or lowering the spot sales. We are ready to operate on the platforms that will yield profit though we will continue giving priority to long-term contracts with a price link to petroleum products.

Is Gazprom Group going to sell natural gas as a motor fuel in Europe?

Gazprom Group has long been a player in this market – our subsidiary and affiliated companies, Gazprom Germania and Vemex (Czech Republic), have inaugurated their CNG filling stations. Although compressed natural gas is a simple and apparent solution we are not limited to developing only this type of fuel. In our opinion, against the background of growing prices for gasoline and diesel fuel and simultaneous toughening of European environmental standards for motor vehicles, all types of gas fuel will be in demand. Thus, LNG fueled heavy-duty trucks seem to be quite promising, while the GTL (gas-to-liquids) technology brings natural gas closer to conventional fuels in terms of their properties, thus raising its competitive power.

The advantages of natural gas as a motor fuel are indisputable. It reduces costs, minimizes emissions (natural gas is surpassed here by the expensive hydrogen fuel only) and lowers the noise margin which is a significant advantage for a city vehicle.

We are confident that this market segment will grow, and we strive to get fully involved in its development: we possess natural gas, know-hows and technologies, we have something to offer.

Tell us about the European power market. What are your plans in this industry?

Power assets abroad provide additional support for our core business – gas marketing. It enables to raise the efficiency of the blue fuel sales and guarantee its supply for power generation, diversify market risks associated with the gas price link to the petroleum product basket as well as with the fuel market volatility.

Over the recent two years the European power markets have undergone changes. They are primarily related to the financial crisis and the European Commission’s pledge of the EU economy decarbonization. Under these circumstances Gazprom Group is revising the markets of potential importance for our business in Europe. Jointly with Gazprom energoholding, we are planning to outline a list of European countries prioritized for the power business development as well as to select pilot projects before the end of 2011.

Life is full of surprises as well. The March earthquake and tsunami in Japan and the subsequent tragedy at Fukushima 1 nuclear power plant may have their effect on the global power industry development. It is early to say what these events will affect, but they will certainly play a role. In this context, the overall interest in gas-fired generation is quite predictable especially in the European market, the one that is most important for us.

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Africa

What tasks does Gazprom formulate for North Africa? Is the Company going to join the project on creating the Trans-Sahara gas pipeline?

In North Africa Gazprom is participating in a number of prospecting and production projects, namely in Algeria, considering a number of North African petroleum projects of potential interest that pursue the objective of ensuring the regional energy security. Nowadays, however, we have to take into account the sociopolitical instability in the entire North African and Middle Eastern region that affects the petroleum business. This, by the way, is another reminder of Gazprom Group’s reliability as a blue fuel supplier.

We are closely watching the situation with construction and operation of the Trans-Sahara gas trunkline intended for natural gas transmission from Africa to Europe.

Algeria, Niger and Nigeria have reached an agreement to design such a gas pipeline stretching for some 3 thousand kilometers. With its extensive experience in creating large-scale and comprehensive gas transmission systems, Gazprom Group could take part in this project as a rightful partner in the company acting as the customer and the operator of the gas pipeline.

Is Gazprom going to develop cooperation with Israel?: The Israeli petroleum industry is also quite interesting to Gazprom both in terms of hydrocarbons prospecting and recovery, as well as in their follow-up marketing in Israel and in third countries. The great potential of the Israeli resource base is underpinned by large gas discoveries made in the Mediterranean Sea in 2009. These are the Tamar and Dalit gas fields containing 238 and 19 billion cubic meters of proven recoverable gas reserves accordingly.

America

What are Gazprom’s plans in Latin America?

In 2008 Gazprom elaborated a comprehensive strategy for the Latin American petroleum market penetration. It defines the key Latin American countries where Gazprom’s subdivisions are operating intensely. The priority is given to gas exploration and production projects with reasonable risks and acceptable return rates and possibly integrated into the value chains.

In 2010 upon an in-depth economic analysis Gazprom resolved to join exploration projects in Bolivia. The parties have agreed on nearly all of the contract terms and conditions and soon we will commence exploration in our blocks. Gazprom Group companies also participate in exploration projects on the Venezuelan shelf and render services on engineering, construction, repair and servicing of gas transmission infrastructure and gas processing capacities.

In the long run the Company may look at potential participation in an integrated LNG project in Venezuela and Brazil to sell gas in the local markets as well as to export it to the Atlantic region. LNG supplies as part of the existing and perspective projects may become one of our businesses. In this context, the markets of Argentina and, later on, Uruguay are also rather appealing.

We will continue studying potential participation of our experts in the projects on gas processing in Bolivia and Venezuela. Gazprom will soon open a representative office in Brazil that we hope will help to reinforce our stance on the Latin American continent and contribute to developing the gas-fired power sector in the region.

It should be noted that Gazprom neft has joined the consortium of Russian oil companies participating in the Orinoco Oil Belt projects and in deep-water exploration operations offshore Cuba.

What are you going to do in the USA?

The US market is a strategic objective for Gazprom. Therefore, we are thoroughly examining the market behavior and expanding our presence in it. What are we facing now? It is common to speak of the shale gas revolution in the USA. This is not quite right. The prime cost of such gas exceeds the prices at the Henry Hub, the main American gas hub: approximately USD 6 per 1 million BTU versus USD 4. Until recently, shale gas companies hedged their costs. They sold their gas at a futures market a year or two before the production start-up. Since the middle of the last year, however, the futures curve has flattened out and it was impossible to cover the real production costs by hedging. This can’t last forever and matching of supply and demand in the US gas market is inevitable. Then the gas price will get back to normal that will make the US market appealing to LNG imports again. That’s why we consider the present situation temporal. With its present prices the US market is not interesting, but things will change soon.

We are ready for this work. Gazprom Marketing & Trading was set up as a subsidiary company to develop regional projects. In spring 2009 the company began trading in the energy resource market. In a year the company became one of the twenty largest regional players engaged in real gas volumes trading. In addition to direct purchases at trading platforms, its portfolio was replenished through swap operations between European and American markets. The company also operates capacities acquired by Gazprom Group after accession to the Sakhalin II project and division of the contract for off-take of LNG owned by Shell.

Later on, we are going to continue building up trade operations in the USA. Thus, our subsidiary company has taken additional transmission capacities in the region on a lease and develops contacts with numerous partners. The projects on greenhouse gases abatement is another focus area in this market.

Is necessary to build up the capacities in the USA, the world’s most liquid market for natural gas, to make worldwide LNG transactions flexible and subsequently – to make use of gas amounts from our new projects, namely, the Shtokman project.

Are you planning to expand the LNG plant capacity in Sakhalin?

The LNG plant in Sakhalin is a most precious asset in Gazprom’s portfolio. This is the first Russian project of the kind. It was inaugurated two years ago and produced 10 million tons of LNG by 2010. Gazprom had every opportunity to fulfill itself in the Sakhalin II project acting as the customer, the supplier and the purchaser at the same time.

Expansion of the Sakhalin II project is a priority for us. Growing LNG demand in the region calls for new efforts. In cooperation with partners we are investigating the opportunities for expanding the LNG plant in Sakhalin. We are evaluating the overall appeal of new projects in the region concerned with both Sakhalin II expansion and possible alternative projects. For instance, Sakhalin Energy, the operator of Sakhalin II, is evaluating the geological prospects for building up gas extraction from the Piltun-Astokhskoye and Lunskoye fields for its further liquefaction at potential train 3 of the plant in Prigorodnoye.

Our partnership with Mitsui, Mitsubishi and Shell within the Sakhalin II project has laid a solid foundation for discussing further initiatives. If Gazprom resolves to engage a foreign partner into its project, proposals will be made to these companies first.