Higher Gas Prices Create a Dilemma

Gazprom's plans to raise natural gas prices for Europe by at least 20 percent next year could generate more cash for a faster development of its giant Arctic fields, but could easily cast a shadow over future demand on the market.

Meanwhile, extra revenues could lead to pressure on the Kremlin to put off raising gas prices for domestic industry, as the country faces rising inflation during a sensitive election period.

Gazprom deputy chief executive Alexander Medvedev told analysts this week that the company's European customers would have to pay from $300 to $400 per 1,000 cubic meters of gas next year.

Gazprom, which supplies more than one-quarter of Europe's gas needs, links its prices to those for oil products with a lag of six to nine months. Oil prices have climbed above $90 per barrel in recent weeks, at times stopping just a hair's breadth short of $100.

Under long-term contracts that Western consumers have with Gazprom, they agree to pay for a certain preset amount of gas even if they actually take less. Demand will stay the same at least until 2015 because "so far nobody is building many coal and nuclear power stations," which take at least seven years to complete, said Jonathan Stern, director of gas research at Oxford Institute for Energy Studies. "The question is, 'Will it rise?'"

"It is possible that some countries will build nuclear stations and some countries will build coal stations, but we will not see the effect of it until 2015 at the very earliest," Stern said.

Production of energy from environmentally friendly renewable sources such as solar and wind power could get a boost from the gas price hike, as they will need less or no subsidy from governments, Stern said.

Eurogas, a Brussels-based nonprofit group representing European gas companies, also warned that higher and more volatile gas prices would spell uncertainty for the fuel's longer-term demand.

"Only if natural gas can be supplied at competitive prices would it be in a position to expand its market share and its sales volumes at the expense of oil and coal," Eurogas president Domenico Dispenza, who is also chief operating officer at the gas and power division of Italian energy firm Eni, said at a gas industry conference in Moscow on Tuesday.

Gas-fired power stations -- seen as easy to construct and environmentally clean -- account for one-fifth of the electricity produced across the European Union. Environmental risks have been a major obstacle in getting permission to build coal and nuclear energy plants.

Moscow-based brokerage Antanta Pioglobal estimated that Gazprom would charge an average price of $320 per 1,000 cubic meters and earn $38 billion next year. Exports to EU will total 163.8 billion cubic meters, said Timur Khairulin, an analyst at the brokerage.

But amid concerns about rising inflation, driven mainly by higher oil and food prices globally, the government could spoil the big picture for Gazprom by refusing to allow a planned 25 percent hike in regulated prices to Russian industry next year, analysts said. Gazprom currently loses money on such domestic supplies.

The government last year decided to gradually raise domestic prices for industry, bringing them to netback parity with European prices by 2011.

"Fears of inflation have left this issue up in the air," said Konstantin Reznikov, an analyst at Dresdner Kleinwort in Moscow.

The inflation rate has consistently beat official targets since September, prompting the country's main food retailers and producers to heed government calls for price curbs on basic foodstuffs.

Oleg Popov, a spokesman for the Federal Tariffs Service, said he was unaware of any plans to rethink the domestic pricing strategy for gas. He didn't say when the service would make a decision, but last year the new prices were announced Dec. 5.

Gazprom's better financial footing next year could mean greater investment into its massive projects on the Yamal Peninsula in the Arctic, such as the development of the Bovanenkovo field, Reznikov said. Gazprom plans to start production at the field in 2011 as part of an effort to replace dwindling production.

Royal Dutch Shell and its partners told President Vladimir Putin in a meeting earlier this month that developing other Arctic gas fields in Yamal and the Kara Sea may cost several hundred billion dollars, Bloomberg reported. Yamal fields alone are estimated to hold 50 trillion cubic meters of gas, more than Gazprom's existing proved reserves, Gazprom said.

Gazprom could also use the extra revenues to buy minority stakes in electricity assets in Italy if its talks with Italy's energy companies Eni and Enel are successful, Reznikov said.

A Gazprom spokesman said the company would comment on the higher price for Europe and its spending plans after it approves its budget for next year.